Salesforce, Inc. — Form 10-Q summary
Period clarification: The supplied filing covers the quarter ended October 31, 2016 (Salesforce fiscal 2017 Q3), not 2015 Q3 as stated in the request metadata. Amounts below are in U.S. dollars.
Business context and reporting period
Salesforce provides enterprise cloud software, primarily CRM, through subscription services and professional services. Subscription and support generated 93% of revenue in the first nine months. The company reports one operating segment.
Financial performance
| Metric | Three months ended Oct. 31, 2016 | Year-over-year comparison | Nine months ended Oct. 31, 2016 | Year-over-year comparison |
|---|---|---|---|---|
| Revenue | $2.145 billion | +25% | $6.098 billion | +26% |
| Subscription and support revenue | $1.984 billion | +24% | $5.646 billion | +25% |
| Gross profit / margin | $1.559 billion / 73% | 75% margin in prior year | $4.490 billion / 74% | 75% margin in prior year |
| Operating income / margin | $3 million / approximately 0% | $43 million / 2% margin | $88 million / 2% | $94 million / 2% margin |
| Net income (loss) | $(37) million | $(25) million | $231 million | $(22) million |
| Operating cash flow | $154 million | $163 million | $1.456 billion | $1.202 billion |
| Free cash flow (non-GAAP) | $14 million | $82 million | $1.136 billion | $986 million |
Quarterly diluted loss per share was $0.05, versus a $0.04 loss a year earlier. Nine-month diluted earnings per share were $0.33, versus a $0.03 loss. The nine-month result included a $205.6 million tax benefit from a partial release of the valuation allowance related to Demandware; reported earnings therefore do not represent operating performance alone.
Liquidity, debt and balance sheet
- Cash, cash equivalents and marketable securities totaled approximately $1.75 billion at October 31, 2016, down from about $2.72 billion at January 31, 2016. Accounts receivable was $1.28 billion.
- Current deferred revenue was $3.48 billion and noncurrent deferred revenue $16 million. Unbilled deferred revenue, an operational measure not recorded on the balance sheet, was $8.6 billion.
- Debt included $1.15 billion principal of 0.25% convertible notes due in 2018 (about $1.11 billion carrying value), a $500 million term loan due 2019, and the 50 Fremont loan with about $198 million carrying value. No revolving-facility borrowing was outstanding at quarter-end; the facility was $1.0 billion.
- Operating lease commitments were $2.94 billion; capital lease obligations had a present value of $425 million. Management said existing liquidity and operating cash flow should meet working-capital, capital expenditure and debt repayment needs over the next 12 months.
Material changes and unusual items
- Demandware was acquired in July for approximately $2.93 billion, partly funded by the $500 million term loan. It contributed $57.9 million of revenue and an $82.1 million net loss from acquisition through quarter-end. Purchase accounting reduced revenue recognized on acquired contracts, and the acquisition drove a substantial increase in goodwill.
- Other acquisitions included Quip ($412 million) and BeyondCore ($107 million), among others. Goodwill rose to $6.62 billion from $3.85 billion at January 31.
- Salesforce reported $576 million of stock-based compensation for the nine months and approximately $1.9 billion of remaining unamortized stock compensation. Purchased-intangible amortization and acquisition-related costs also weighed on GAAP operating income.
- Gross margin declined year over year as service delivery, employee and acquired-intangible costs increased. Management cited higher data-center investment and headcount growth; headcount was up 36% year over year, partly reflecting Demandware.
- Foreign exchange losses on derivatives were $86.5 million for the nine months, included in other income (expense). The company also recorded $13.7 million of gains on strategic investment sales.
- In November, after quarter-end, Salesforce acquired Krux for estimated consideration of approximately $700 million and borrowed $750 million under its revolving facility, in part to fund the acquisition.
Outlook, commentary and risks
The filing provides no specific numeric revenue or earnings guidance. Management expected continued investment in sales and marketing, research and development, data-center capacity, professional services and integration of acquired businesses. It said marketing and sales would remain a substantial expense and that R&D and G&A expenses were expected to increase in absolute dollars. Management also said it remained focused on improving non-GAAP operating profit for the remainder of fiscal 2017. Attrition was reported at 8%–9%, with management expecting it to remain consistent.
Key risks include competition and the ability to sustain growth; customer retention and renewal trends; service reliability, security and data privacy; integration and valuation of acquisitions; foreign exchange and interest-rate exposure; tax-asset realizability and tax-rate volatility; strategic-investment losses; and substantial lease and debt obligations. A large technology company had previously alleged patent infringement; no suit had been filed, and management did not expect current matters to materially affect consolidated financial position, though a dispute could affect a particular quarter.
Investor verification priorities
- Reconcile GAAP results with underlying performance, especially the $205.6 million tax benefit, stock compensation and acquisition-related amortization.
- Track organic revenue growth and Demandware’s contribution, acquired-contract revenue effects, renewals and attrition.
- Monitor gross-margin trends, data-center spending, headcount, and whether operating profit improves as management intends.
- Assess cash conversion and seasonality alongside deferred revenue, $8.6 billion unbilled deferred revenue, capital spending and large lease commitments.
- Review post-quarter Krux financing and integration, debt-covenant compliance, and the valuation and impairment risk of goodwill and strategic investments.