Salesforce.com (NYSE:CRM) touts itself as having the leading edge customer relationships management software on the planet, a truly "amazing" suite of products. With the Salesforce.com platform, your marketing department can track every detail of your customers' behavior from orders to sales to intentions. Or can you?
SA Author James Ryan published a recent article pointing out that Salesforce.com is telling the SEC that it can't even tell where its own revenue comes from. The SEC correspondence between Salesforce.com and SEC staff is a great read. In response to an SEC query on June 18, 2013, Salesforce.com wrote a letter to the SEC, an excerpt from which follows:
You state that the 35% increase in total revenues was due primarily to new customers, upgrades and additional subscriptions from existing customers and improved renewal rates as compared to a year ago. Please explain to us what consideration you have given to including more detailed disclosure regarding the extent that each of these individually impacted your increase in revenues. In addition, you discuss the significance of renewal rates throughout your filing. Please tell us what consideration you have given to quantifying renewal rates and including a discussion and analysis of period over period changes. See Item 303(a) of Regulation S-K and for guidance, refer to Section III.B of SEC Release No. 33-8350.
We respectfully advise the Staff that while total revenues are positively impacted by new customers and additional subscriptions or upgrades from existing customers, we do not separately quantify the revenue impact of these factors affecting total revenues in assessing the performance of our business. While part of our business strategy is to pursue new customers aggressively and to deepen our relationship with existing customers, we have found that this incremental revenue by its individual source is not meaningful information. During our relationships with our customers, we hope to upgrade customers to one of our premium service editions, sell additional subscriptions to service offerings currently being used, or sell additional subscriptions to different service offerings. When those events occur however, the terms are typically coterminous with the original contract end date. When a contract renewal occurs, it then becomes difficult to evaluate period-over-period dollar comparisons by individual revenue source. Accordingly, we respectfully note that we provide the narrative discussion of these revenue trends consistent with Item 303(a) (3) (NASDAQ:III) of Regulation S-K where a quantitative breakdown is not meaningful for the reasons discussed above.
OK, I get it. Revenues increased 35% and some of it came from new customers, some from upgrades, some from additional subscriptions from existing customers, and some from improved renewal rates. But Salesforce.com has no record of how much of the revenue change came from each source.
Why does Salesforce.com just export those data from its state-of-the-art CRM system? Surely it records who its customers are, when they upgraded or ordered a new subscription, and if and when they renewed. Maybe it doesn't even use Salesforce.com CRM for its own operations. I don't know.
On August 29, 2013, the SEC wrote again to Salesforce.com with the following question:
2. Your response to prior comment 2 states that you do not track or monitor the separate impact of new customers, or upgrades and additional subscriptions from existing customers, on total revenues for a period. Please explain to us how you determined that your:
- 38.1% increase in subscription and support revenues from fiscal 2012 to fiscal 2013 was due to new customers, upgrades and additional subscriptions from existing customers, and improved renewal rates; and
- 28.5% increase in subscription and support revenues from the first quarter of fiscal 2013 to the first quarter of fiscal 2014 was due to new customers, upgrades and additional subscriptions from existing customers, and improved renewal rates.
In addition, given that your revenue recognition policy appears to have remained constant from fiscal 2012 to fiscal 2013, it is unclear why your revenue recognition policy impacts your ability to provide a more detailed explanation of the material increases in recognized total revenues from fiscal 2012 to fiscal 2013, and from the first quarter of fiscal 2013 to the first quarter of fiscal 2014. Please advise. Finally, tell us whether you have considered including a metric, such as bookings, to give additional insight into sales trends.
Hmmm? Good questions. Salesforce.com does not track these items, but knows to one decimal place how much they contribute to the rise in revenues, at least in aggregate. Are there some other sources of revenues or does the Salesforce.com gobbledygook simply mean revenues rose 38.1% and it must have come from these sources?
On September 27, 2013, Salesforce.com wrote to the SEC with inter alia this reply:
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations, page 40
We note your response to prior comment 1. In future filings, please quantify the "majority" of your total revenue derived from subscriptions to your Sales Cloud.
Source: Salesforce.com September 17, 2013 reply to SEC
We don't have transcripts of the oral discussions referenced, but this letter adds to our knowledge that Salesforce.com not only cannot break out new customers, upgrades and additional subscriptions from existing customers or revenues from improved renewal rates but also can't determine how much of its revenue comes from any of its particular services.
I think I get it again. It gets revenues and say those revenues come from customers and that is about it. I guess the standard of full, plain and true disclosure in the United States securities regime doesn't require any more.
Surprisingly, in light of the SEC exchange, it might seem that Salesforce.com does have a better handle on its revenue sources than it told the SEC. However, in its Investment Community Session November 19, 2013, Salesforce.com was able to break out the details of customer attrition in this slide:
Source: Salesforce.com Investment Community Session November 19, 2013
In addition, Salesforce.com was able to provide investors with details of how much additional revenues it had from existing customers to offset that attrition, in this slide:
Source: Same as above slide
The second slide has a footnote that says: "Note: Excludes Renewal Business". Somehow, without financial controls that permit separation of such data for the SEC, Salesforce.com was able to break it out for investors.
I will send a link to this article to the staff at the SEC who asked Salesforce.com to break out the data. Maybe the SEC will ask Salesforce.com if it wants to reconsider its response. Maybe I should send the link to Carson Block as well - he seems able to get to the bottom of mysteries like this one.
An important issue for investors is the implications of the breakout Salesforce.com did provide in the slides above. I took those data in rough terms (I had to estimate the plot points on the charts) and produced the following spreadsheet, which I included in my SA article a few days ago:
Source: Michael Blair analysis
The implication of the charts is that Salesforce.com is not adding new customers that make any material contribution to revenue. If that is so, how can revenues continue their relentless growth at about 30% a year?
If Salesforce.com is losing customers at 12% each year and new customers are providing little added revenue, the growth can only be higher revenues from the existing but apparently shrinking customer base. I suppose it is possible that the new customers who added $42 million to fiscal 2014 revenues might be customers with "amazing" growth in their demand for Salesforce.com services. But I doubt that growth will explain much of the $1.2 to $1.3 billion revenue increase Salesforce.com is guiding to in fiscal 2015.
Part of the explanation may be related to the way Salesforce.com books deferred revenue. As I understand it, if a customer buys a three year subscription and pays up front, Salesforce.com banks the upfront payment, but recognizes revenue for the part of the contract that coincides with the fiscal year being reported and sets up the balance as "deferred revenues." While Salesforce.com already has the payment in this example, the revenue will be recorded in future periods and the "deferred revenue" liability reduced as the revenue is recognized.
If that is a material part of future revenue, it is a future cash flow problem. The cash is already on the balance sheet and in the bank and the portion of revenue being recognized in the future periods will not add any cash, that having already been received. With a few billion of debt now and any slowing in cash coming in - deferred or otherwise - this puppy is going to the pound.
Since Salesforce.com is apparently unable to break out its revenues by any segments requested by the SEC, it seems unlikely that investors will get much insight into future revenue sources except the company's "amazing" guidance and some arm-waving all-encompassing gobbledygook about revenues coming from new customers, upgrades and additional subscriptions from existing customers, and renewal rates, improved or otherwise.
If I am right that revenues from new customers are falling off a cliff as set out in the spreadsheet above, the rubber will hit the road pretty soon.
Salesforce.com has a deferred revenue liability of $2.5 billion as at January 31, 2014. If I am correct in my understanding of its accounting, the benefit of that deferred revenue is already either in the bank or in accounts receivable and will not result in future inflows of cash. That is about half of the $5.25 to $5.3 billion Salesforce.com is guiding to as fiscal 2015 revenues.
Amazingly, that $5.25 to $5.3 billion continues the roughly 30% growth in revenue Salesforce.com seems to achieve year after year despite an apparent and almost miniscule contribution from new customers (based on my analysis anyway) and a 12% attrition rate of existing customers.
To misquote from Hamlet, something seems to be rotten in the state of Denmark.
I may be way off base in my analysis, but the absence of details and transparency from Salesforce.com is a contributing factor if I am. Investors deserve better, and the SEC deserves a better response.
I am going to do a cash flow analysis of Salesforce.com from its date of incorporation through its fiscal 2014 balance sheet. It will take some time, but it should make for fun reading.
I am short the stock.
Disclosure: I am short CRM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.