Salesforce.com (NYSE:CRM) is expected to announce its fourth quarter and full fiscal 2014 earnings Thursday, February 27, after the close of markets. The company has a market capitalization of approximately $38 billion and is the global leader in both cloud-based and overall CRM deployments. In its prior three quarters, Salesforce recorded revenues of $2.93 billion at a 32% year-on-year growth rate. However, this impressive top line growth comes with a margin expense for the company. Gross margins for its subscriptions and support business declined to 81.3% in the three quarters in fiscal 2014, compared to 82.7% during a similar period last fiscal. The company’s professional services division, which accounted for roughly 6% of overall revenues in these three quarters, continues to operate with negative gross margins of -3.1%.
On the whole, Salesforce’s aggressive top line growth strategy continues to pressure margins on all fronts, with non-GAAP operating margins dropping from 17% to 12% between CY09 – CY11. A favorable one-time tax item amounting to $149 million favorably expanded margins to 17.4% in CY12. In the nine months reported so far in CY13, Salesforce’s non-GAAP operating profit margin stands at 9.71%, compared to 11.24% from a similar period a year ago.
In the three quarters concluded in fiscal 2014, GAAP operating margins stood at a much steeper -6.2% against -4.1% figure seen in a similar period in fiscal 2013. We are of the view that Salesforce’s growth strategy at the expense of negative margins is detrimental to the company’s business in the long term.
Our price estimate stands at $50 for Salesforce, which is at a 21% discount to its current market price of $64 and reiterates our view despite the company’s impressive revenue growth.
Focus On Newly Launched Salesforce1 Platform
Salesforce launched the ‘Salesforce1′ platform before the start of its annual Dreamforce conference in November 2013. This new offering is engineered to connect various apps and a multitude of devices across on a single platform and greatly increases mobility for sales representatives. Built on an API first philosophy, Sales cloud on Salesforce1 features additional API tools for developers to create and deploy enterprise-level applications across mobile devices. The platform has ten times more APIs than before on its Force.com development platform, with more than 1.4 million developers and more than 250 major independent software vendors (ISVs) working on the platform. The new 1 Touch service in the Salesforce1 Service cloud enables developers and ISVs, to build and embed service features into products and applications.
Employees are increasingly using their own device for work, owing to this shift, Salesforce’s bet on a mobile CRM platform looks promising. Technology research firm, Gartner, expects the number of mobile CRM applications to increase from approximately 200 in 2012 to more than 1,200 by 2014. Moreover, the share of SaaS CRM deployments for certain types of applications is expected to cross 50% by 2016 from 40% in 2013, indicating the top line opportunity Salesforce has in the CRM industry. We expect to see a high single-digit sequential growth in subscription revenues, supported by strong traction in the the Salesforce1 platform.
No Containment On Margin Pressure Yet
Salesforce’s operating margins have taken a plunge in the past four years, entering the negative territory at -1.5% in fiscal 2012 (ending January 2012). Since them, operating margins have deteriorated steadily to reach -6.2% in the three quarters this fiscal. Increasing competition in the niche cloud software market has forced Salesforce to ramp up on its R&D and SG&A expenses from 10% and 61% in fiscal 2010, to 15% and 67% in the three quarters in fiscal 2014 so far. Going forward, we expect to see further erosion in the company’s margins as legacy players such as SAP AG (NYSE:SAP) and Oracle (NYSE:ORCL) start offering their products on an SaaS model.
We currently forecast Salesforce’s operating expenses as a percentage of Gross Profits to tread lower going into 2014 and beyond, and expect the company to post an operating profit by 2017. See the impact of operating expenses on Salesforce’s stock price using our widget presented below, an indication of the premium at which the stock is trading currently.
Disclosure: No positions