Salesforce: The Elusive Goal of Profitability

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As some of you may know, my former employer, Oakton, was a partner with both Salesforce and Microsoft. While I did my best to judge fairly, any fear of bias is now removed as I have moved to KPMG. KPMG is “all in” with Microsoft especially with their cloud, ERP and CRM solutions. Do not get me wrong, their technology enablement arm also work with Oracle and products like Workday but, in terms of CRM, their path is pure. On to the analysis…

Last quarter, on the back of a lease termination, Salesforce made a small profit. Has lightning struck twice? Has Salesforce finally turned the profitability corner or are losses still the normal with non-GAAP reporting to cover it up?

There was also rumours of a mystery buyer looking to scoop Salesforce up. Who was this mystery buyer and why did they pull out? All will be revealed.

Salesforce Quarterly Results

The GAAP numbers, as reported to the SEC and taken from Salesforce’s web site. Any disparity to press releases, especially in regards to profitability, are an illusion created by ignoring certain expenses to generate what are called non-GAAP reporting. The promoters of non-GAAP reporting say it is designed to give a more accurate reflection of the day to day operations, ignoring those inconvenient outlying expenses. However, when the expenses you ignore are regularly occurring, this justification is harder to swallow. Also, I am yet to see a non-GAAP report which shows the business to be in a worse state than the GAAP numbers report. This is why I consider non-GAAP reporting to be little more than a public relations exercise to quell the nerves of nervous share holders and, in my opinion, it is not worthy of actual financial analysis. So here are the ‘real’, GAAP numbers.

 

2015 Q2

2015 Q3

2015 Q4

2016 Q1

2016 Q2

Revenue

1,318,551

1,383,655

1,444,608

1,511,167

1,634,684

Subscription Revenue

1,232,587

1,288,513

1,345,358

1,405,287

1,521,319

Revenue Cost

307,831

333,211

355,923

381,802

405,384

Operating Cost

1,044,154

1,072,486

1,123,501

1,098,260

1,209,476

Salesforce Income

-61,088

-38,924

-65,765

4,092

-852

Highest Transaction

2,037,819,946

2,502,030,346

2,872,068,400

3,186,923,759

3,349,320,621

Transaction Growth QoQ

 

23%

15%

11%

5%

Revenue Growth # YoY

361,457

307,621

299,366

284,395

316,133

Revenue Growth % YoY

38%

29%

26%

23%

24%

Revenue Growth % QoQ

7%

5%

4%

5%

8%

Total Cost % YoY

36%

20%

18%

15%

19%

Total Cost % QoQ

5%

4%

5%

0%

9%

Staff

15,145

15,458

16,227

16,852

17,622

Staff Growth YoY

20%

21%

22%

18%

16%

Margin

-4.63%

-2.81%

-4.55%

0.27%

-0.05%

Growth Difference

2%

9%

8%

8%

5%

Cash

774,725

846,325

908,117

941,956

1,089,351

Accounts Receivable

834,323

794,590

1,905,506

926,381

1,067,799

Cash/AR

93%

107%

48%

102%

102%

Expenses Relating to Stock Based Awards

142,411

139,460

151,802

142,560

147,779

Stock Based YoY

29%

-1%

11%

9%

4%

 

Numbers of Note

Transaction Growth

The transaction growth numbers are calculated from the largest transaction count of any day on http://trust.salesforce.com, on the day of writing the blog. In other words, it is the highest level of activity in the last 30 days, every quarter.

image

Here is the growth in the last four quarters; it has gone from just shy of 25% growth quarter on quarter, to 5%. It is clear the number of transactions being conducted by Salesforce users is slowing down. My prediction is that, by next quarter, it will be near flat and the quarter after that will begin to drop.

So what does this mean? Well it means either:

  • The user base is doing less with Salesforce
  • The user base is slowing in growth
  • Salesforce software allows you to do the same stuff with less server transactions
  • The transaction fluctuations are settling down and my use of the highest transaction in the period is in error

My guess is it is a combination of the first two but it is a guess. I was hoping the revenue growth would give an indication of what is happening but not the case.

Revenue Growth

Looking at the quarter on quarter revenue growth, we see an interesting upturn in this quarter.

image

So, if the user growth is slowing down, it is not reflected in the revenue. It is a bit of a mystery. The only way I can resolve this is to speculate that Salesforce are focussing more on upselling to existing customers than trying to find new customers. Therefore, the revenue is increasing by having existing customers pay more per user without resulting in a significant increase in system use.

In terms of the growth difference between revenue and costs, for the quarter this has slipped into negatives (costs are growing faster than revenues). For year on year, while they have narrowed, revenue is still outpacing costs meaning long term profitability is still an option for the future.

Staff Growth

Staff growth (year on year) has slowed down again this quarter.

image

Here we see the last six year’s of staff growth and a three year moving average trend line. The growth continues to slow and, as it was last quarter, reflects a staff growth rate of five years ago. As with the last quarter, the slowing of factors such as staff growth and transaction growth suggests the business is finally slowing down.

Profitability

Unfortunately, Salesforce was not able to maintain a GAAP profit this quarter, again slipping into a loss, albeit a small one ($850,000). Perhaps the rumoured buyer saw this coming and backed off.

The Mystery Shopper

Towards the end of April, there was speculation that someone was looking to buy Salesforce. My assumption at the time was either Google, Oracle or IBM. It turns out the shopper was much closer to home; Microsoft. This surprised me when I first heard it but follows a bit of a trend in their market acquisition strategy. To cite a similar example, let us consider Skype. Microsoft had IM and Lync so when they acquired Skype, it was a bit of a surprise, given they already had products which did similar things. However, by taking on the millions of paying Skype subscribers, they had a path for turning a profit as well and carving out a significant part of the instant messaging market.

I think this was a similar play. While Microsoft has Dynamics CRM, the only other horse in the race these days, according to Gartner, is Salesforce. If Microsoft managed to seal the deal, they would be the only vendor in the Gartner’s leaders quadrant. Unfortunately, Marc’s price was a bit rich and Microsoft pulled out.

Earnings Call Buzzword Bingo

Still no talk of profit, of course (seriously, the word was not mentioned once in the earnings call) but our usual suspects are there. In fact there were no new key words and no words dropped off the list.

For those new to the game, I take the transcript of the quarterly earnings report, up to but not including the question and answer session and run it through a word analyser. The result are the words at the front of mind of the the Salesforce executives. As long as the word is mentioned 10 or more times in the last five quarters, it remains on the list.

 

2015 Q2

2015 Q3

2015 Q4

2016 Q1

2016 Q2

Number of words

4731

3922

4017

3495

4175

Customers/Customer

38

34

23

34

42

Revenue

27

26

25

24

18

Cloud

22

47

32

28

20

Platform(s)

13

27

18

14

16

Service

15

12

5

9

13

Growth

18

16

13

16

17

Marketing

10

8

4

8

6

Cash

11

9

10

11

11

Operating

11

8

20

11

13

Enterprise(s)

10

8

7

8

5

Dreamforce

11

14

2

1

21

Analytics

 

14

11

9

4

Software

   

12

4

9

In fact the only things of note are the steady decline in talk about analytics and the massive spike in Dreamforce mentions. Dreamforce is in a few weeks time so it is not too surprising.

Words on notice are “Marketing” and “Enterprise(s)”. One more quarter with less than ten mentions and they are off the list. Salesforce has ExactTarget aka the Salesforce Marketing Cloud. If it was doing great things, Marc would be talking about it as much as Dreamforce (which, to my knowledge, is Salesforce’s only profitable venture). The fact that marketing barely features on Marc’s radar makes me think the acquisition is not yielding fruit.

As for the diminishing importance of the enterprise, this surprises me a little. Marc used to be about the number of 7- and 8-figure deals he had done. These days Marc does not talk in these terms so perhaps he is finding more traction in the smaller end of town.

Google Trends

Let us see how “Dynamics CRM” and “Salesforce.com” are trending on Google.

image

Blue is “Dynamics CRM” which holds steady. “Salesforce.com” continue its linear drop. In terms of the region split, it is a story we have seen before. Salesforce is concentrated on the US domestic market.

image

While Dynamics CRM is more international.

image

We also see this in the city split. While Salesforce’s cities are in the USA and India.

image

Dynamics CRM is more metropolitan.

image

While the positions juggle a little from quarter to quarter, the names remain the same. Salesforce may be well known at home but, abroad, it is a different story.

Insider and Institutional Sales

A trend is emerging in the insider trades.

 

2015 Q2

2015 Q3

2015 Q4

2016 Q1

2016 Q2

Insider Sales

0.40%

4.70%

4.60%

4.50%

4.40%

Institutional Sales

2.67%

3.20%

3.11%

3.04%

3%

Since the spike in insider sales in 2015 Q3, sales have slowly tapered, dropping 0.1% each quarter. Similarly institutional sales are slowing. In both case they are still selling their holdings, just not as rapidly as before. What does this mean? Perhaps the prospect of someone buying Salesforce at a premium was giving them pause for thought. Now that the deal has fallen through, maybe we will see an upturn next quarter.

Looking to the Future

My last prediction was revenues of $1.66b and breakeven on the profits. In terms of revenue I was within 2% and they did pretty much break even so I call that as a successful prediction.

Next quarter I predict revenues of around $1.78b and another breakeven result.

Conclusions

Salesforce looks to be fighting for profitability but it keeps eluding them. Last quarter, based on a real estate deal, they did make a small profit but this was truly a once-off adjustment and the proof is their inability to make a profit this quarter. Hopefully, as the business slows down, costs will be reined in and Salesforce will return to the profits it used to have four years ago. While every quarter Marc claims it has been “the best quarter ever” or some similar hyperbolic statement, the day they make a sustainable profit and continue to grow that profit, as they once did, I may start believing him. Until then I will continue to believe the Kool Aid being passed around is little more than shareholder Snake Oil.

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