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Rally Reports a Reasonable First Quarter

Rally Reports a Reasonable First Quarter

Rally reported a reasonable first quarter, with subscription revenue coming in $100,000 above the Street, non-GAAP loss per share $0.23 better than consensus, and seat additions of 12,000 (above our expectation of 7,000). However, the company lowered its full-year revenue guidance primarily due to lower perpetual and services revenue (both of which were weak in the period as well) and to salesforce execution issues, which affected net new customer additions in the period.

Management s new guidance calls for fiscal 2015 revenue growth of 17%-21% (versus prior expectations of 23%-26%). While the key forward-looking metric (seat count) was ahead of our expectation and we continue to believe that Rally (as the leading provider of agile development management and collaboration applications) will benefit from secular tailwinds in the long run, as developers shift from traditional waterfall methodology to agile, we are downgrading the stock for the following reasons.

The company continues to face salesforce execution challenges, which have persisted since the third quarter of last year (longer than both we and management had anticipated), and we are concerned that they could continue to persist for a few additional quarters. The company has hired quite a few new sales reps over the past few quarters and has implemented changes in the salesforce structure over the same time period; this resulted in poor execution with signing new customers, as the new sales reps ramp up and existing reps get used to the new structure.

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Although we believe management has identified the salesforce issues and is working through them, and that pipeline coverage rations for the next 6 to 12 months out are materially higher than they have been in the past, we are staying on the sidelines until we see a return to execution.

The second issue we are concerned about is the change in the engineering organization. Recently, the head of engineering was removed, and the company is looking for a replacement; we believe that management is making the right long-term move, but we are concerned that this could create a disruption in the business over the next few quarters.

Rally Reports a Reasonable First Quarter

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