Salesforce.com Q2: The One Metric That Matters

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Salesforce CEO Mark Benioff

 

Salesforce.com (CRM) reports quarterly earnings after hours. Analysts expect revenue of $2.51 billion and EPS of $0.32. The revenue estimate implies 23% growth Y/Y. Investors should focus on the following key items:

Growth In Deferred Revenue

Saleforce delivers enterprise software through the cloud that focuses on customer relationship management (“CRM”). Salesforce allows its clients to interact with their own customers via mobile devices, through the cloud, Internet of Things (“IoT”), etc. It derives revenue from subscription fees from customers accessing its enterprise cloud computing services and from professional and training services. The lion’s share of its revenue is derived from subscription services. Therefore, its deferred revenue and/or backlog is a key metric to determine what is future revenue will look like.

The following chart outlines the company’s historical deferred revenue and Y/Y growth:

Growth in deferred revenue over the past six quarters has consistently exceeded 20% and was as high as 31% for the quarter ended April 30, 2016. On a dollar basis deferred revenue was over $5.0 billion for the quarter ended April 2017, and its growth has been highly-correlated with revenue growth. If the company meets revenue and earnings estimates, but deferred revenue disappoints or its growth falls far below previous growth rates then it could hurt sentiment.

Another metric that connotes the strength of the company’s backlog is unbilled deferred revenue. It represents unbilled future bookings that have not been invoiced. At April 30, 2017, it was $9.6 billion, up 26% Y/Y.

Gross Margin

Some of the company’s growth has been through acquisition. In calendar year 2016 the company made at least nine acquisitions, mostly in the artificial intelligence space. The acquisition of Demandware which provides e-commerce services was rather sizable at around $2.8 billion. It could take at least a year to integrate so many acquisitions, so the company’s operating income margins could be skewed.

I previously thought its gross margin would be less impacted by merger integration costs. The company’s gross margin declined to 72.8% for the quarter end April 30, 2017 versus 74.1% in the year earlier period. The diminution in gross margin has not become a point of contention as of yet. The cost for growth through acquisition could be a hit to the company’s long-term gross margins.

Takeaway

CRM is priced to perfection. I suspect the company will meet or exceed expectations this quarter. However, its gross margins could be an area of focus in the second half of the year or early next year.

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