Salesforce, Inc. quarterly report, Q1 FY2016

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Salesforce, Inc. — Form 10-Q Summary

Reporting period: The filing covers the three months ended April 30, 2016, Salesforce’s first quarter of fiscal 2017, and compares results with the three months ended April 30, 2015. The supplied request metadata says “2015 Q1,” but that does not match the filing period. Financial statements are unaudited.

Financial performance and position

  • Revenue: $1.917 billion, up 27% year over year. Subscription and support revenue was $1.775 billion, up 26% and 93% of total revenue; professional services and other revenue was $141.1 million, up 33%. Growth was primarily volume-driven. Revenue growth was 28% in constant currency.
  • Profit and margins: Gross profit was $1.420 billion; gross margin was 74%, versus 75% a year earlier. Operating income was $52.0 million, or 2.7% of revenue, versus $31.1 million, or 2.1%. GAAP net income was $38.8 million ($0.06 diluted EPS), versus $4.1 million ($0.01). The comparison period included a $36.6 million non-cash gain from the 50 Fremont lease termination; the current period included $12.9 million of gains on strategic investments.
  • Non-GAAP results: Non-GAAP net income was $167.5 million, up 55% from $108.3 million; non-GAAP diluted EPS was $0.24 versus $0.16. These company-defined measures exclude, among other items, stock-based expense and acquired-intangible amortization.
  • Cash flow: Operating cash flow was $1.051 billion versus $735.1 million. Free cash flow, as defined by Salesforce (operating cash flow less capital expenditures), was $967.8 million versus $664.0 million. Capital expenditures were $83.3 million. First-quarter cash generation is typically seasonally strong; early adoption of new stock-compensation cash-flow rules contributed approximately $25 million to operating cash flow in the quarter.
  • Liquidity: Cash and cash equivalents were $1.799 billion; marketable securities totaled $1.916 billion, or approximately $3.7 billion combined. Accounts receivable was $1.193 billion. Current assets were $3.775 billion and current liabilities $5.085 billion, including $3.992 billion of current deferred revenue. Total deferred revenue was $4.007 billion, up 31% year over year (32% in constant currency); unbilled deferred revenue, a non-GAAP operational measure, was $7.6 billion.
  • Debt and commitments: The 0.25% convertible notes had $1.15 billion principal and a $1.095 billion net carrying amount, due April 2018. The assumed 50 Fremont loan had a $198.1 million net carrying amount. No borrowings were outstanding on the $650 million revolving facility, and the company reported compliance with its covenants. Present value of capital lease obligations was $448.7 million. Operating lease minimum payments totaled $2.635 billion; these commitments are not all recorded as balance-sheet debt.

Material changes versus the prior year

  • Revenue increased 27%; subscription and support revenue grew 26%. By offering, subscription growth was 15% for Sales Cloud, 32% for Service Cloud, 45% for App Cloud and Other, and 29% for Marketing Cloud.
  • Operating income increased despite the prior-year period’s 50 Fremont lease-termination gain. Marketing and sales expense fell to 46% of revenue from 49%; gross margin declined one percentage point, while R&D fell to 14% of revenue from 15%.
  • Stock-based expense increased to $188.9 million from $142.6 million. Remaining unamortized stock compensation was $1.6 billion as of April 30, 2016.
  • Interest expense rose to $22.0 million from $16.7 million; other expense was $13.8 million versus $0.9 million. The current period also recorded the $12.9 million strategic-investment gain.
  • Cash and marketable securities rose from approximately $2.7 billion at January 31, 2016 to approximately $3.7 billion at April 30, 2016. The company acquired SteelBrick, MetaMind, and two other businesses; acquisition-related goodwill rose to $4.130 billion.

Outlook, commentary, risks, and unusual items

  • Management gave no specific revenue or earnings guidance in the supplied filing text. It said it expects to continue investing in sales and marketing, R&D, data-center capacity, personnel, facilities, and acquisitions. It expects marketing and sales to remain a substantial expense and professional-services costs to exceed related revenue in future quarters.
  • Management reported an attrition rate of 8%–9% at April 30, 2016, excluding Marketing Cloud, and expected it to remain consistent. It cautioned that first-quarter cash flow is seasonally elevated and that results for the quarter are not necessarily indicative of the fiscal year.
  • Salesforce early adopted ASU 2016-09, recording an $8.7 million cumulative adjustment reducing accumulated deficit and changing cash-flow presentation. The quarter’s tax benefit was $1.6 million, producing a negative 4% effective tax rate; tax valuation allowances and acquisition-related tax effects make the rate potentially variable.
  • Acquisitions included SteelBrick for preliminary consideration of approximately $314.8 million, MetaMind for approximately $32.8 million cash net of acquired cash, and two other companies for $41.6 million cash net of acquired cash. SteelBrick generated a $9.8 million remeasurement gain on Salesforce’s prior investment. The chairman had an ownership interest in MetaMind and received approximately $6.0 million in proceeds, subject to customary escrow.
  • New commitments include a four-year infrastructure-services agreement with payments of $70 million in fiscal 2017, $96 million in fiscal 2018, $108 million in fiscal 2019, and $126 million in fiscal 2020. The filing also describes a New York office sublease of approximately $288 million over about 12 years and a May 2016 Indianapolis lease of approximately $77 million over about 13 years.
  • Key risks include cybersecurity incidents or service outages, third-party data-center and technology-provider dependence, privacy and cross-border data-transfer regulation, competition, foreign-exchange exposure, acquisition integration and strategic-investment impairment, and substantial lease and debt obligations. A large technology company had alleged patent infringement; no lawsuit had been filed, and management did not expect a material adverse effect on financial condition, though a particular quarter’s results or cash flows could be affected.
  • Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Confirm the intended period: the filing is fiscal 2017 Q1 (ended April 30, 2016), not 2015 Q1.
  • Assess the quality and seasonality of operating cash flow, including the approximately $25 million benefit from the new stock-compensation cash-flow presentation.
  • Review GAAP results alongside non-GAAP measures, especially the effects of $188.9 million in stock-based expense and acquisition-related amortization.
  • Track deferred revenue and $7.6 billion of unbilled deferred revenue with the company’s cautions that unbilled balances fluctuate and are not a reliable standalone indicator of future revenue.
  • Monitor acquisition integration, goodwill valuation, the related-party aspect of the MetaMind acquisition, and the performance and impairment risk of private strategic investments.
  • Evaluate liquidity against debt, lease, infrastructure-service, and future office commitments, as well as the 2018 convertible-note maturity and potential conversion or dilution.
  • Follow developments in the patent allegation, tax audits and valuation allowances, foreign-exchange movements, and security, service-continuity, and data-privacy risks.