Salesforce, Inc. — Form 10-Q Summary
Period clarification: The request identifies “2015 Q2,” but the supplied filing is for the quarter ended July 31, 2016 (Salesforce fiscal 2017 second quarter), with comparative results for 2015.
Business context and reporting period
Salesforce provides cloud-based enterprise applications, primarily CRM, through subscription services and professional services. Subscription and support accounted for 93% of revenue. The company reports as one operating segment. The quarter’s results include Demandware only from its July 11, 2016 acquisition date.
Key financial metrics
| Metric | Three months ended July 31, 2016 | Three months ended July 31, 2015 | Six months ended July 31, 2016 | Six months ended July 31, 2015 |
|---|---|---|---|---|
| Revenue | $2.037 billion | $1.635 billion | $3.953 billion | $3.146 billion |
| Gross profit | $1.511 billion | $1.229 billion | $2.931 billion | $2.359 billion |
| Operating income | $32.6 million | $19.8 million | $84.5 million | $50.9 million |
| Net income (loss) | $229.6 million | $(0.9) million | $268.4 million | $3.2 million |
| Operating cash flow | $250.7 million | $304.3 million | $1.302 billion | $1.039 billion |
| Free cash flow, company-defined non-GAAP | $154.6 million | $239.4 million | $1.122 billion | $903.4 million |
Quarterly revenue rose 25% year over year; subscription and support revenue grew 24%, while professional services and other revenue grew 33%. Six-month revenue increased 26%. Quarterly gross margin was approximately 74%, versus 75% a year earlier; operating margin was approximately 1.6%, versus 1.2%.
Quarterly diluted GAAP EPS was $0.33, compared with approximately $0.00 a year earlier; six-month diluted EPS was $0.39, versus approximately $0.00. The increase in GAAP net income was substantially affected by a $265.7 million discrete tax benefit from a partial release of the valuation allowance following the Demandware acquisition. Excluding specified items, non-GAAP diluted EPS was $0.24 for the quarter and $0.49 for the six months.
Liquidity, debt and balance sheet
- At July 31, 2016, cash and cash equivalents were $1.115 billion and marketable securities were $604.7 million, approximately $1.72 billion combined. Accounts receivable was $1.323 billion. Current assets were $3.278 billion against current liabilities of $5.376 billion; deferred revenue is a major component of current liabilities.
- Cash and marketable securities were approximately $2.50 billion at January 31, 2016. The decrease largely reflects the Demandware acquisition and related investment activity.
- Debt included $1.102 billion carrying value of 0.25% convertible senior notes, $496.6 million net carrying value of the new term loan, and $198.1 million for the loan associated with 50 Fremont. The term loan’s $500 million principal was drawn to partially fund Demandware and matures in July 2019.
- The $1.0 billion revolving credit facility, maturing in July 2021, had no borrowings outstanding. Salesforce reported compliance with its debt covenants at quarter-end.
- Current and noncurrent deferred revenue totaled approximately $3.824 billion. Unbilled deferred revenue, an operational measure and not a balance-sheet liability, was $8.0 billion.
Material changes and management commentary
- Demandware was acquired for preliminary consideration of approximately $2.93 billion. Salesforce recorded approximately $1.885 billion of related goodwill and $800.3 million of acquired intangible assets; purchase accounting remained preliminary.
- Other acquisitions included SteelBrick, MetaMind and three additional companies. Goodwill increased from $3.850 billion at January 31 to $6.030 billion at July 31.
- Subscription revenue growth was attributed mainly to new customers, upgrades and additional subscriptions, rather than price increases. Management reported an attrition rate of 8%–9% and expected it to remain consistent.
- Management expects continued investment in sales and marketing, research and development, data-center capacity, personnel and integration of acquired businesses. It expects professional-services costs to exceed related revenue in future quarters. No specific revenue or earnings guidance is provided in the supplied filing text.
- Stock-based compensation was $371.2 million for the six months; $1.7 billion of outstanding compensation expense remained to be recognized. The company cautioned that these expenses and acquired-intangible amortization may remain significant.
- Operating cash flow is seasonal: the first fiscal quarter is typically strongest because collections follow fourth-quarter billings. Second-quarter operating cash flow declined year over year, while six-month operating cash flow increased.
Risks, contingencies and unusual items
- The tax benefit drove unusually high reported GAAP earnings and a negative effective tax rate; Salesforce said its effective tax rate may remain volatile due to its valuation allowance and tax circumstances.
- Foreign exchange reduced reported international revenue; the filing cites a $23.7 million quarterly and $42.4 million six-month reduction versus constant-currency results. Derivative losses recognized in other income (expense) were $33.8 million for the quarter and $47.2 million for the six months.
- Commitments include $2.893 billion of future operating lease payments, $477.6 million of undiscounted capital lease payments, and a four-year infrastructure services agreement with payments totaling $365 million over the stated fiscal periods.
- Salesforce disclosed a patent-infringement allegation from a large technology company; no litigation had been filed. Management did not expect current matters to materially affect consolidated results or financial position, but noted an adverse outcome could affect a particular quarter.
- Key risks include service outages or security breaches, evolving privacy and cross-border data rules, competition, acquisition integration and execution, foreign exchange, reliance on third-party infrastructure, and the possibility of impairment or losses on strategic investments.
- In August 2016, Salesforce completed the approximately $410 million stock-based acquisition of Quip and agreed to acquire BeyondCore for estimated consideration of approximately $110 million, subject to closing.
Investor verification priorities
- Confirm the period mismatch in the request: the filing is fiscal 2017 Q2, not 2015 Q2.
- Assess earnings excluding the $265.7 million tax benefit, and review the company’s non-GAAP adjustments alongside GAAP results.
- Track Demandware integration, acquisition-related amortization, goodwill and future operating contribution.
- Monitor recurring subscription growth, attrition, deferred revenue and unbilled deferred revenue, noting management’s caution that unbilled deferred revenue is not a reliable stand-alone revenue forecast.
- Review cash conversion, seasonal billing and collections, acquisition spending, debt service, and lease and infrastructure commitments.
- Evaluate exposure to currency movements, strategic-investment valuation, and the disclosed patent claim and other litigation risks.