Any keen observer of the psychology of markets would be intrigued by Salesforce.com's (CRM) earnings call, which was an exemplary performance in creating a parallel reality.
Right from the outset the company claimed (link to transcript here), "Please note that our commentary today will be primarily in non-GAAP terms. Reconciliations between GAAP and non-GAAP metrics for both reported results and our forward guidance can be found in our earnings press release."
It reminds me of a writer's objective of drawing a reader into his fictional story by providing a credible scenario which allows the reader to suspend his/her disbelief. In a similar vein, this earnings call was not about GAAP or Generally Accepted Accounting Principles, but CRM's version of the world.
I have written previously about how the conference calls seem staged to portray how "great and amazing" the company is (here). And on this call also, virtually every analyst started his/her question with "great quarter guys…" (even as the share price - in real time in the aftermarket - began to register weakness) before giving the CEO, Mark Benioff, the stage to eulogize the company's exploits.
I will not elaborate here my main problem with CRM's altered reality, or more specifically, its version of earnings (see the previous article linked above for detail). But suffice it to say that for this quarter, a GAAP loss of $67.7m (12c loss per share) is "transformed" into a Non-GAAP profit of $60.9m (10c per share) by ignoring $114m of wages it pays to employees, as these wages are paid via the issue of options in lieu of cash.
This article focuses on a new concern. Salesforce.com has always portrayed itself as a growth company. Admittedly the revenue growth has been stellar as it secures its status as the CRM (Customer Relationship Management) vendor of choice for corporates that wish to monitor, understand and harness social media.
For this quarter, the company registered a 28% increase in YOY revenues. The company also states that Deferred Revenue climbed to $1.7bn, up 30% from the previous year, very impressive numbers given the macro-economic context.
It is only through reading the fine print that a more ominous concern raises its head.
Some background. About 2 years ago, the SEC questioned CRM on its earnings disclosures. Particular concern was raised about the nature of deferred revenue and whether CRM was extending the horizon of deferred revenues to inflate growth. Since the enquiry, CRM has been obliged to detail the term of deferred revenue, and this statement from its April quarter is typical: "Current deferred revenues increased by 33% year over year to $1.67bn, benefited in part by longer invoice durations."
The market has become aware of the potential to manipulate growth by extending the invoice duration, and it has also become more vigilant on the combination of revenue and deferred revenue growth, namely the billings growth. This metric provides the best gauge of overall success at winning business, whether it falls into this quarter (current revenue) or a new client is secured and billed for subsequent quarters (deferred revenue). The table below illustrates the revenue growth and the billings growth for CRM.
As can be seen, although the revenue momentum has been maintained, the billings momentum tells an entirely different story: the momentum has almost halved from 28.5% in the January 2013 quarter to 17% in the just-published April 2013 quarter. This is the lowest billings growth rate since July 2009.
How did this happen, despite the impressive array of other metrics? The change in invoice duration in the January 2013 quarter (in part) allowed a quantum jump in deferred revenue (from $1,380m in Jan 2012 to $1,863m in Jan 2013). This amount was then "in the base" from Jan 2013 onwards. In the April 2013 quarter, the QOQ change in deferred revenue was actually negative 133m, leading to overall billings moving from $650m in April 2012 to $760m in April 2013, a yearly increase of merely 17%.
The graph below (the table above in graphic) illustrates the dramatic downturn of momentum in billings.
(Click to enlarge)
As Mark Benioff, the CEO stated on the earnings call:
"And honestly I think we are doing a great job of that, I think you are going to see, you saw some great new technologies from us this quarter if you have it seen what we have delivered on the app stores, it is incredible and this summer you are going to see some more amazing things we are going to completely transform the CRM market and by the time we get dream for us the end of this year, I promise you we will have completely transformed our vision and our core for CRM market and how we are operating and - we do in whether it's user interface or application programming interfaces and I will tell you it is not a focus of our competitors, because if you go and look at there, if you go and look at their conferences, that are seminars, the webinars, which I do it's my job to do that, they are not focused in this area, they are focused in other areas, what they probably should be focused in other areas, because that's their core, but our core is the customer here at Salesforce and…"
He's right; when he looks at his competitors' webinars and seminars, they probably focus on other things like GAAP earnings.
But even if one adopts the altered reality of CRM, even if one judges it purely on sales and billings momentum, (in total isolation of any realistic profit or valuation metric), the company's results unarguably depict a dramatic slowdown.
Is the lovefest over?