Salesforce.com (NYSE:CRM) continued to exhibit double digit revenue growth in its Q1 fiscal 2014 results. Revenues grew by 28% on a yearly basis to $893 million for the quarter ending April 30, 2013. 
Growth was mainly driven by its core businesses Sales Cloud and Service Cloud as the company continues to gain market share in the customer relationship management (CRM) software market. New products such as Marketing Cloud is also gaining traction with customers. However, increasing marketing and R&D expenditures weighed on its operating margins and profits. Non-GAAP net income increased by 10% to $61 million.
Free cash flow increased by 33% to $229 million in the first quarter as capital expenditure as a percentage of revenues declined. Based on strong growth of existing products and growing adoption of its new offerings, the company slightly raised its fiscal 2014 revenue guidance to $3.83 billion and $3.87 billion, up 25% to 27%, on a yearly basis. For the next quarter, the company guided revenues of $931 -$936 million and non-GAAP EPS of $0.47-$0.49. 
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The stock corrected sharply despite the higher full year guidance, as Q2 guidance was below the market expectations. Despite ballooning costs, Salesforce’s share price has risen over 25% in the past one year in anticipation of continued growth. Below we take a detailed look at the key highlights of the earnings.
Continuing Adoption of Cloud CRM Services Drives Growth
The growth in Sales cloud and Services cloud was mainly driven by the growing adoption of cloud-based CRM services across enterprises as they look at various ways to cut costs. The Software as a Service (SaaS) model makes it cheaper to adopt and easier to integrate the deployment on the cloud. This trend is evident from the fact that while on-premise CRM software majors Oracle and SAP reported mid-single digit growth, Salesforce revenues continued to grow by near 30%. Further, Salesforce, which was the market leader in cloud CRM, became the largest CRM platform in the world replacing SAP, according to Gartner. 
Deferred or unearned revenue on the balance sheet increased 30% in Q1 over the same period last year to approximately $1.7 billion.  Deferred revenue implies that the contract has already been signed and advance payment has been received against it. However, it is recognized on the income statement only when the product or service has been delivered. Further, unbilled deferred revenue, which is the revenue that is contracted but not yet invoiced and is off the balance sheet for now, was close to $3.6 billion and grew 33%.  These figures point towards high revenue growth in the near term as Saleforce begins to realize them in their income statement.
While the management said that its Marketing Cloud suite continued to make inroads into the market, it remains unclear if it is creating any shareholder value considering the huge amount spent by the company on the acquisitions of Buddy Media and Radian6 coupled with a significant increase in marketing expenditures.
Rising Costs Weigh On Profit, But Stock-Based Compensation Could Be A Concern
As expected, overall gross margins declined as the cost of revenues has been trending higher. Stronger dollar also weighed on gross margins as a significant chunk of the company’s costs are in the U.S. dollar. Most of the revenue growth was offset by rising R&D and marketing costs as the company invests and pushes its new businesses, particularly Marketing Cloud. R&D costs have gone up by more than 40% to $132 million while marketing expenses are up nearly 26% at $466 million.
However, one of the key aspects to note is the significantly higher stock-based compensation costs, which rose over 40%. While this is a non-cash cost and doesn’t affect cash flows directly like cash compensation to employees, it does result in stock dilution. Total stock-based compensation was $114.8 million during the quarter, more than 10% of the quarter’s revenues. On an annualized basis, this would imply close to 2% dilution on the current market cap of $25 billion.Notes:
- Salesforce.com Announces Fiscal 2014 First Quarter Results, Salesforce, May 23 2013 [↩]
- Salesforce.com’s CEO Discusses F1Q14 Results – Earnings Call Transcript , Seeking Alpha.com, May 23, 2013 [↩] [↩] [↩] [↩]