Salesforce: Hell Freezes Over

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bizarrohell

(original image courtesy of bizarrocomics.com)

It has not been a good month for Salesforce; thousands of customers had no access to Salesforce for a couple of days and when it did come back 4-5 hours of data had been lost.

It is hard to defend a cloud platform where this can happen and it strikes a significant blow to the “cloud is better than on-premise because we know best” paradigm but the Salesforce share price barely registered the event. Also, perhaps Marc called on the universe for some karmic balance because, in the wake of this disaster, Salesforce managed to turn a profit.

Yes, while there have been ‘rogue’ quarters of profitability due to tax checks or big asset selling, this appears to be the first ‘genuine’ profit in about five years (if we take our measure as three profitable quarters in a row, this was literally five years ago). This is great news and I congratulate them for getting on top of their spiralling marketing and sales costs. It is not all powder snow and roaring log fires though as there is plenty for Salesforce to keep a watchful eye on.

Schnapps Back at the Lodge

In light of the theme, I will use peach schnapps, rather than whiskey.

4peach-schnapps

No slurring or visit to the hospital this quarter with a respectable four Non-GAAP mentions and no GAAP mentions.

So, in two quarters, we have gone from 12 drinks to 6 and now to 4. If Salesforce remain profitable into the following few quarters, we may reach the day where we have a negative score and I will have to shout drinks for both of my blog readers.

Earnings Call Buzzword Bingo

I am reading the transcript so you do not have to. Words make the cut if they are mentioned 10 times or more in one of the last five quarters. Here is this list.

 

2016 Q1

2016 Q2

2016 Q3

2016 Q4

2017 Q1

Number of words

3495

4175

5147

2163

1997

Customers/Customer

34

42

41

5

27

Revenue

24

18

16

14

10

Cloud

28

20

18

8

6

Platform(s)

14

16

13

4

5

Service

9

13

4

1

2

Growth

16

17

21

12

7

Cash

11

11

8

6

7

Operating

11

13

8

11

8

Dreamforce

1

21

7

0

2

Software

4

9

10

4

1

We say farewell to ‘Analytics’ which has failed to get mentioned in this quarter and the last and no new words were added to the list. It is not clear to me why Salesforce Analytics is on the nose as there is nothing I can find in the news to suggest it is failing. As usual though, the transcript is all about the customers and revenue.

For the next quarter, no words are in danger of dropping off, but the word count (the lowest it has ever been) means getting those ‘10-bagger’ words will be increasingly difficult. Marc and the executive team are literally saying half of what they used to. Maybe they are tired of hearing themselves pump out the same key messages quarter after quarter.

Numbers of Note

Profitability

Obviously the big news this quarter is a genuine GAAP profit of $38m on revenues of just shy of $2b (about a 2% margin). I have poured over the financial entries and there is nothing obviously out of place. There are no ‘special’ line items and none of the line items there are uncharacteristically jumping in a way to explain it. In other words, this could the start of a sustainable company.

Here are the historical margins to give context.

image

The thick blue line is the actual margin values and the thin black line is a four-period moving average. We can see that profits began eroding about six years ago and Salesforce went into the red about five years ago. There they stayed, with margins being poorly managed as evidenced by the erratic line behaviour. This seems to have changed two years ago when the losses began reducing until this quarter when we finally appear to be returning to the black in a calm way.

Backing this up we have the story from the revenue and cost growth graphs.

image

Here we see the same erosion at 2011 Q1 with cost growth accelerating past revenue growth. Similarly, at the 2012 Q1 we see the out-of-control marketing and sales costs growing at 50% year on year compared to the famously advertised revenues at around 30% year on year.

It was only back in 2015 Q1 that Salesforce took control of this disaster and revenue growth began to again win out over cost growth with revenue numbers catching up this quarter to make the profit.

The danger can be seen at the end of the graph where cost growth is, again, doing its best to get on top of sales growth. If this happens, Salesforce will descend into the red. The two growth rates are practically equal this quarter with only 1% between them.

Transaction Growth

image

Something does not add up here. Transaction growth was the lowest it has been since I began monitoring it, yet revenue growth continues in the mid-twenties, year on year (around 6-7% quarter on quarter). I cannot explain this; Salesforce are getting more money and their servers are doing little additional work.

If I have a customer base growing in line with the revenues, I would expect the transaction growth to follow suit but this is not the case. The only other explanation I can come up with is the same customer base are choosing to spend more money for the same service or old customers are being replaced with new ones who are paying a premium for the a similar level of service.

Even if it is a case of people abandoning the platform but not turning off the subscription, revenues should flatten while transactions go down but this does not appear to be the case either.

My prediction is we will see a negative growth in transactions i.e. transactions reducing next quarter but I doubt revenues will follow suit. It is very confusing.

Insider and Institutional Sales

 

2016 Q1

2016 Q2

2016 Q3

2016 Q4

2017 Q1

Insider Sales

4.50%

4.40%

4.90%

4.90%

4.80%

Institutional Sales

3.04%

3%

5.87%

5.87%

5.75%

Both insider and institutional sales are consistent with the last couple of quarters. Nothing unusual here other than the habitual selling of a stock by people who publicly claim to love the company and its future prospects.

Looking into the Future

Last quarter I predicted $1.9b in revenue (nailed it) and break even. Salesforce did make a 2% profit so even in this I am taking some pride.

Next quarter, given the cost growth is nudging revenue growth, I predict either a diminished profit or a return to a loss. In terms of revenue I predict $2.05b in revenue. This is higher than Salesforce’s prediction ($2.005b-$2.015b) so we will see who is right.

Conclusions

It is good news that Salesforce has turned a profit. Microsoft does its best work when it is following fast and the scale of innovation we have seen in Dynamics CRM over the last few years is a testament to this.

In terms of the sustainability of Salesforce’s profit, I have my doubts. Costs are looking to overtake revenues, which will begin to thaw Old Nick and his fiery denizens if it happens. As usual, all will be revealed next quarter.

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One thought on “Salesforce: Hell Freezes Over

  1. Hosk

    Great post, I enjoy your reports on Salesforce.

    I think you are right that Microsoft need Salesforce to help it raise it’s own game and keep it honest.

    I often get the feeling Salesforce is too good to be true in it’s business model and profitability but it has won quite a few big clients this year and it’s market share is enormous. So maybe it’s implementing a long term Amazon like strategy (except without the Fire phone)

    Like

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