- CRM was flat after-hours as investors digested a mildly-positive earnings report.
- While revenue was up 38%, deferred revenue is growing more slowly, and expense increases are keeping profits from growing substantially.
- At 100x earnings with high expenses and slowing revenue growth, I would be a seller of CRM.
After the bell on Tuesday, Salesforce.com (NYSE:CRM) released its quarterly earnings, and the results were mildly positive. Typically, CRM shares are very volatile often moving 10% after earnings, but shares were basically flat after-hours as investors digested these results. On the whole, CRM continues to be a great growth story with a very rich valuation. These earnings are probably not enough to convert many bulls or bears, and the same valuation versus growth battle that has hurt shares over the past three months will likely continue for the foreseeable future. While the company clearly has a great product, I cannot recommend CRM as its shares are trading roughly 100x earnings, which is simply excessive.
In its fiscal first quarter, CRM earned $0.11 on revenue of $1.23 billion, which was up 38% year over year (all financial and operating data available here). Analysts were looking for $0.10 on $1.21 billion in sales, so this was a mild beat. Thanks to these solid results, CRM incrementally increased its guidance for the full year and expects to earn $0.49-$0.51 on a non-GAAP basis with sales between $5.3 and $5.34 billion. Factoring in the mild first-quarter beat, CRM is basically guiding to current consensus over the next nine months. CRM is not offering the type of guidance that could turn the bears neutral, instead sticking to what Wall Street already expected. When revenue growth is 38%, that is not necessarily a bad thing, but it will likely leave shares capped below $55.
For CRM, it is important to look at deferred revenue, which is a good leading indicator for future revenue as CRM fulfills its contractual obligations. In the quarter, the deferred revenue balance jumped 34% year over year to $2.32 billion. This growth rate is slower than actual revenue growth of 38%, which suggests growth will decelerate over the course of the year. During the quarter, the deferred revenue balance actually shrank by about $185 million as CRM worked through its backlog. Unbilled deferred revenue, which can be a leading indicator for revenue further down the road (9-15 months away), hit $4.8 billion, which was up 33% year over year. Again, this is a great growth rate, but it is slower than current quarter revenue growth. As CRM grows bigger and comps get tougher, it simply is difficult to grow as fast. Over the next 24 months, I expect to see decelerating revenue growth from CRM.
Even with this growth, we are not seeing CRM get the needed scale to significantly increase profitability. On a GAAP basis, operating expenses were 81% of revenue compared to 82% last year. CRM's net loss on a GAAP basis actually increased year over to year to -$97 million from -$68 million a year ago. CRM continues to spend aggressively on R&D, sales, and marketing, which is negating the increase in revenue. At this point, CRM will need to continue to significantly grow revenue before it is generating significant profits. Right now, CRM is mainly a revenue growth, not profit growth, story, which is why valuation is so excessive.
Now on the positive side, cash flow continues to be very strong with operating cash flow of $473 million, up 67% year over year. However, there are several factors that make cash flow appear stronger than it is. First, CRM uses a lot of equity to pay employees with equity compensation totaling $131 million in the quarter. While this costs no cash, it does dilute shareholders with the share count up 4% year over year. CRM also saw a massive drawdown in its accounts receivable, resulting in a cash inflow of $677 million compared to an inflow of $370 million last year. Over the balance of the year, receivables will trend back up, which will negate some of this gain. CRM does generate a fair bit of cash, but timing issues made this quarter's cash flow look abnormally strong.
All in all, CRM reported decent results. Revenue was up a solid 38%, and it gave pretty good guidance. Deferred revenue was strong but does confirm the trend of decelerating revenue growth. CRM also is spending a lot, which is why revenue growth is not flowing through to the bottom line. With $0.50 of non-GAAP earnings this year, shares are trading a rich 104x earnings. Shares are also trading 6.06x revenue. With decelerating revenue growth that should fall to about 23% in calendar 2015, this is a really excessive multiple. Momentum names have been falling out of favor, and CRM is still not a value stock by any means. With expenses growing as fast as profits and revenue growth slowing, I would not pay 104x earnings for CRM and wouldn't be interested until shares fell back towards $40. At current levels, the best trade is to sell CRM. This quarter shows that CRM is still excessively valued.