Salesforce just released their first quarter results for 2012 (what they call 2013 Q1) so I thought it would be interesting to see how salesforce kicked off the new year. Obviously the growth in revenue is the main push of their messaging but the numbers show a few more things.
For previous analysis (of which there is a fair amount, use the search engine on the left with the keyword ‘salesforce’. The last analysis was on the full year results).
Where Do I Get My Numbers From?
There was a recent LinkedIn survey asking which CRM will be the leader in five years. In that I put in my five cents regarding my fears for the long term prospects of a company failing to make a profit and was challenged on where I was getting my numbers from. As usual, all financial numbers come from the detailed financials on salesforce’s own web site. I use the GAAP numbers (Generally Accepted Accounting Principles) rather than the non-GAAP numbers used in salesforce press releases.
What is the difference between GAAP and non-GAAP? GAAP financials follow conventions adopted by bodies such as the Securities and Exchange Commission (SEC) so that different companies can be compared on an equal footing. Non-GAAP means the company in question deviates from these conventions, limiting the ability to compare them to other companies.
Often the reason cited for such a deviation is because the company believes their model is unique and that usual accounting does not accurately reflect their prosperity. Another reason companies deviate from the GAAP path is because of ‘one-off’ events skewing results (what is called pro-forma accounting). While certainly a pioneer in cloud software, I am not convinced they need to deviate as they do such that substantial losses and negative free cash flows turn into non-GAAP profits and non-GAAP positive cash flows.
In other words, if you want to hear about ‘unbooked work’ and ‘deferred income’ or about non-GAAP EPS go to the salesforce press center. Here I use the numbers salesforce report to the SEC.
Here I will bring in some addition data, taken from money.msn.com ten year summary for salesforce. The annual revenue growth was:
To January 2004: 88%
To January 2005: 84%
To January 2006: 76%
To January 2007: 60%
To January 2008: 51%
To January 2009: 44%
To January 2010: 21%
To January 2011: 27%
To January 2012: 37%
We see that, like many small start ups, initial growth was massive but tapered as the company grew larger. More recently, with Benioff’s strong focus on revenue, growth has picked up again. Looking at the numbers from salesforce’s detailed financials we see the nature of this new-found growth.
The black line is a two-period moving average. Moving averages tend to smooth out the bumps to give a clearer picture of the underlying trend. In this case we see that whatever Marc was doing to generate the growth in sales is starting to wear off with the curve flattening.
Again, using the ten year summary, we see margins (income as a percentage of revenue were):
To January 2003: –19%
To January 2004: 4%
To January 2005: 4%
To January 2006: 9%
To January 2007: 0%
To January 2008: 2%
To January 2009: 4%
To January 2010: 6%
To January 2011: 4%
To January 2012: –1%
So while revenues increased over the past couple of years, margins have suffered and are back in the negative which has not been seen since the company’s early days.
Again, the quarter-by-quarter graph from the salesforce detailed financials is even more damning.
To compare to the revenue growth, about the same time revenue started improving (2010 Q1) was the same time margins started suffering. The situation now being such that for every $100 of revenue, the cost to the business is $103.
Back in February I suggested that while the business was losing money, the bleeding seemed to be constant and not getting worse. This has proven to not be the case.
While the drop in margin is small (about 2%) because the revenue has increased so much, the loss this quarter is greater than the combined loss of the previous three quarters combined. Let me write this in bold, large letters to drive home the point.
THIS QUARTER’S LOSS FOR SALESFORCE IS GREATER THAN THE LOSS OF THE LAST THREE QUARTERS COMBINED
Salesforce managed to make a loss of $19m compared to the $12m lost of the previous three quarters. Part of me wonders whether there was some creative accounting done to keep the previous quarter in line with the others to round off the year, pushing the bad news to this first quarter, giving another three quarters to make up for lost ground before the next annual report. If this is the case I would expect to see the next quarter recover slightly from this dreadful result.
What surprised me is, in the announcement call for the quarter, Benioff describing the quarter as a “great start…absolutely spectacular” and the CFO, Graham Smith, describing is as “excellent start…better than we expected”. If this is a good start I would hate to see a bad one. I understand Benioff is focussed on revenue growth but when he said in the previous quarter’s call he was ‘committed to increasing our margins’ I was thinking he would put the company towards profitability not sink in further into the red.
What surprised me more was not one analyst on the call for this quarter picking him up on it. Everything was about the ‘deferred income’ and ‘unbooked work’. Here is the thing:
SALESFORCE CAN HAVE AS MUCH AS THEY LIKE IN NON-GAAP INCOME BUT IF THEIR MARGINS ARE NEGATIVE THEY ARE STILL STUFFED
Selling $10 bills for $9 does not make for a healthy business and lately, to get the revenue growth up, they have been selling them for $8. The analysts are asking how many $10 bills are likely to be sold next week when they should be asking “why are you selling yourself short?”
Back in February I asked what the directors of Microsoft and salesforce were thinking. I looked at the messages they are sending to the market compared to their personal share sales. Graham Smith, CFO, despite lauding the praises of the company in every quarterly announcement (this one included) continues to offload his ownership of the company. Here are the numbers if you are interested. Every week Graham exercises some options and also has an automatic share sale in place. The automatic shares netted him around $2.7m in April and the share options generated around $320,000.
While there is an argument to say share ownership and options aligns an employees interest to that of the shareholders, there is also an argument that says if I am exercising options and selling shares every week I will, within my ability, do whatever it takes to convince the market the share price should remain as high as possible. The difference in these goals is the difference between the long term prosperity of the company and telling the market what they want to hear to maintain the share price in the short term.
While I have no doubt Graham is acting with all appropriate care in his capacity as CFO, I can also understand if he feels conflicted in his role and I do not envy his position in this regard.
Unfortunately salesforce kept tight lipped about the enterprise deals they did this quarter and about their subscription numbers, so I, again, have to speculate based on their revenues. My best guess, assuming they are maintaining a revenue per subscriber per quarter level of around $150 is that they have 4.6m subscribers. Assuming the average company size is still around 35, this means the number of customers is about 132,000. The bad news is, if these numbers are correct, each month each subscriber costs salesforce $1 ($1 * 4.6m users * 4 months = the approximate loss for the quarter).
I understand Marc is keen to capture market share but it seems the price for doing so is proving very high to the point where the health of the business is being jeopardised. While the trend of tapering growth as the size of a company increases has been rebuffed, the cost has been margin to the point that the company is making significant losses.
The question I have is “where to from here?” Being in the red is simply not a sustainable position, otherwise every company would do it and pay no tax. Salesforce are quick to point out there is plenty of revenue in the pipeline but this is only of benefit if they can make a profit from it. Will salesforce raise prices? Will they find new efficiencies in the business to reduce operational costs while maintaining service? Will they slash sales and marketing spend, killing revenue growth, cruise along on subscription income but inevitably sacrifice share price? Time will tell.