Salesforce, Inc. — Form 10-Q Summary
Period clarification: The filing is for the quarter ended October 31, 2013 (Salesforce fiscal Q3 2014), with year-to-date results for the nine months ended that date. It is not a 2012 Q3 filing. Amounts below are in U.S. dollars; financial statement amounts are stated in millions unless noted.
Business context and reporting period
Salesforce provides subscription-based enterprise cloud computing services, including Sales Cloud, Service Cloud, ExactTarget Marketing Cloud and the Salesforce Platform. Subscription and support represented 93% of quarterly revenue and 94% of year-to-date revenue. The unaudited interim statements are prepared under U.S. GAAP.
Key financial metrics
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Revenue | $1,076.0 | $788.4 | $2,925.8 | $2,215.5 |
| Gross profit | $807.8 | $602.2 | $2,230.9 | $1,715.3 |
| Gross margin | 75% | 76% | 76% | 77% |
| Operating loss | $(97.9) | $(54.2) | $(182.3) | $(89.9) |
| Net loss | $(124.4) | $(220.3) | $(115.6) | $(249.6) |
| GAAP diluted loss per share | $(0.21) | $(0.39) | $(0.19) | $(0.45) |
| Operating cash flow | $137.9 | $105.9 | $604.2 | $455.3 |
- Revenue: Quarterly revenue increased 36% year over year; nine-month revenue increased 32%. Subscription and support revenue rose 36% for the quarter and 32% year to date. Management attributed growth mainly to new customers, upgrades and additional subscriptions, with lower attrition; pricing was not a significant growth driver.
- Margins and costs: Gross margin declined about one percentage point in both comparisons. Quarterly operating margin was approximately negative 9%, versus negative 7% a year earlier. Marketing and sales was 54% of quarterly revenue and 52% year to date. GAAP operating losses widened as expenses rose, including stock compensation, acquisition-related amortization, headcount and service delivery costs.
- Cash flow and investment: Nine-month operating cash flow was $604.2 million. Investing activities used $2.24 billion, principally reflecting acquisitions and capital expenditures; financing activities provided $1.54 billion, including convertible-note and term-loan proceeds. Cash and cash equivalents were $651.8 million at October 31, 2013.
- Liquidity: Cash, cash equivalents and marketable securities totaled approximately $1.085 billion; accounts receivable was $604.0 million. Current assets were $1.801 billion and current liabilities were $3.097 billion, including $1.686 billion of deferred revenue and $541.1 million of convertible notes classified as current.
- Debt and commitments: Debt included $575 million principal of 0.75% convertible notes due 2015, $1.15 billion principal of 0.25% convertible notes due 2018, and $292.5 million outstanding on a term loan due 2016. The notes’ net carrying values were $541.1 million and $1.041 billion, respectively. Present value of capital lease obligations was $518.6 million; minimum operating lease payments were $1.690 billion. The company reported compliance with term-loan covenants.
- Other indicators: Unbilled deferred revenue was approximately $4.2 billion, up from $3.5 billion at January 31, 2013; management cautioned that its fluctuations are not a reliable indicator of future revenue. Approximately 603 million common shares were outstanding at quarter-end.
Material changes versus the prior comparable period
- ExactTarget was acquired for approximately $2.6 billion in July 2013. It contributed $97.4 million of revenue and an $81.9 million loss from acquisition through October 31. The acquisition drove substantial increases in goodwill, purchased intangibles, headcount and related amortization.
- Goodwill increased to $3.495 billion from $1.529 billion at January 31, 2013. Total assets rose to $8.098 billion from $5.529 billion.
- Quarterly operating loss increased to $97.9 million from $54.2 million, and nine-month operating loss increased to $182.3 million from $89.9 million. Stock-based expense was $141.5 million for the quarter and $366.7 million year to date.
- Net loss was narrower than the prior-year quarter and nine-month period, but comparisons were materially affected by taxes: the prior-year periods included a one-time, noncash valuation allowance charge. The current nine-month period included a $135.5 million tax benefit from a partial release of the valuation allowance following the ExactTarget acquisition.
- In March 2013, Salesforce issued $1.15 billion of 0.25% convertible notes and entered into related note hedges and warrants. It also obtained a $300 million term loan in connection with the ExactTarget acquisition. The 0.75% notes due 2015 were convertible at holders’ option and classified as current at quarter-end.
- Cash and marketable securities decreased from approximately $1.759 billion at January 31 to $1.085 billion at October 31, largely alongside acquisition spending and other investing activity.
Outlook, commentary, risks and unusual items
- Management expected GAAP net losses for the next several quarters, citing growth investments, stock-based compensation and acquisition-related intangible amortization. It expected R&D, marketing and sales, and capital expenditures to rise in absolute dollars; marketing and sales was expected to remain a substantial cost.
- Management stated that existing cash, cash equivalents, short-term marketable securities and operating cash flow should be sufficient for working capital and capital expenditure needs over the next 12 months. It also noted that additional financing might be needed for future acquisitions or investments and might not be available on favorable terms or at all.
- Attrition remained in the low double-digit percentage range and had declined slightly from January 2013. Management expected gradual further decline. The fiscal fourth quarter is historically strongest for new business and renewals, so billing and cash-flow patterns are seasonal.
- Key risks include service outages or security breaches; competition and uncertain adoption of newer offerings; customer renewal and attrition trends; acquisition integration and realization of expected benefits; rising fixed costs and infrastructure needs; international, currency, privacy and regulatory exposure; and debt service and covenant constraints.
- Interest-rate sensitivity analysis estimated that a 100-basis-point move could change the market value of the fixed-income portfolio by approximately $7.5 million. The term loan has variable-rate exposure.
- A multi-year intellectual-property license agreement resulted in approximately $8.0 million of expense for prior periods, recorded in Q1 FY2014. Management did not expect current legal matters to have a material adverse effect overall, but noted an unfavorable outcome could materially affect a particular quarter.
- The filing reports no material change in internal control over financial reporting during the quarter and that disclosure controls were effective at a reasonable-assurance level.
Most important facts for investors to verify
- Whether subscription growth, renewals and attrition trends continue to support revenue growth, and how much growth reflects the ExactTarget acquisition.
- Whether expense growth, stock compensation and acquired-intangible amortization continue to widen GAAP operating losses and pressure gross margin.
- The timing and cash requirements of the convertible notes, term loan and capital leases, including the current classification and potential conversion of the 2015 notes.
- How acquisition integration proceeds, including ExactTarget’s contribution to revenue, losses, customer retention and expected benefits.
- Whether operating cash flow and available liquidity remain adequate amid acquisition, data-center, office and other capital spending.
- The assumptions and effects behind the substantial tax valuation-allowance release, and the status of open tax examinations and legal contingencies.
- How seasonal billings and unbilled deferred revenue evolve; management cautions that unbilled deferred revenue is not a reliable stand-alone forecast of future revenue.