Salesforce.com (NYSE:CRM) is set to announce its Q2 fiscal 2014 earnings on August 29. We expect the company, which recently pipped SAP to become the market leader in the customer relationship management (CRM) market, to continue to post double digit growth rates. Its Sales Cloud and Service Cloud offerings continue to see strong traction. Other products such as Marketing Cloud have also been gaining traction with customers.
However, despite the impressive revenue growth, we expect more pressure on its operating margins due to soaring marketing and R&D costs. In the last quarter, Salesforce reported quarterly revenues of $893 million, 28% growth on a yearly basis. For this quarter, the company guided revenues of $931 -$936 million and non-GAAP EPS of $0.47-$0.49. Below we take a look at the key trends that affected the company’s performance during the quarter.
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Continuing Adoption of Cloud Services To Drive Growth
While the on-premise software market continues to remain weak due to dwindling IT spending as reflected in the earnings of SAP (SAP Earnings: Software Licenses Decline But Cloud And HANA Lend Support) and Oracle (Oracle Doubles Dividend, Steps Up Buyback As Software Sales Disappoint), the adoption of cloud-based software is growing rapidly. The global on-demand portion of the CRM software market is growing at a double digit rate compared with low single digit growth for the on-premise segment of the CRM software market. The Software as a Service (SaaS) model makes it cheaper to adopt and easier to integrate deployment on the cloud. In particular, small and medium businesses are driving the demand for cloud software. Salesforce has been the pioneer in providing CRM software on-demand through the cloud and therefore is benefiting immensely from this trend. A couple of months back, Salesforce ended the dominance of long time leader SAP to become the largest player in the CRM software market. . Further, Salesforce has also been expanding its offerings through new launches and integration of other services.
In the last quarter, deferred or unearned revenue on the balance sheet grew 30% over the same period last year to approximately $1.7 billion. Deferred revenues are created when the contract has already been signed and advance payment has been received against it. Further, unbilled deferred revenue, which is the revenue that is contracted but not yet invoiced and was off the balance sheet at that time, was close to $3.6 billion. This would ensure a continued high growth in the near term.
The spurt in consumer and business use of social networks, mobile devices, and new digital technologies is leading a revolution in marketing spend. Social media campaigns are becoming an increasingly important aspect in brand building and awareness. Marketing spend on social media is becoming a significant part of companies’ marketing budgets. Salesforce is tapping this demand with its Marketing Cloud suite, which includes Buddy Media, Radian6 and Social.com. These tools enable clients to listen, engage, gain insight, publish, advertise and measure social marketing programs. Intensifying its efforts, Salesforce recently acquired a cloud marketing company, ExactTarget, for a whopping $2.5 billion. ExactTarget generates most of its revenues from e-mail marketing and will fill in the gap in Salesforce’s offerings, which lacked a significant presence in email marketing (Read our note Salesforce Targets Social Media Marketing Spend With ExactTarget)
Rising Costs Will Continue
In the previous few quarters, the cost of revenues as a percentage of sales has trended higher and came in just under 20% in the last quarter. We expect gross margins to continue to remain under pressure in the near term. Further, as the company enters new businesses and beefs up its efforts to promote them, we expect R&D costs and marketing expenses to outpace revenue growth before trending lower. Last quarter, these expenditures were up by ~25% to 40%. The other concern is hyper growth in huge stock-based compensation expenditure, which has been increasing as a percentage of sales.Notes:
- Salesforce.com Takes Lead Over SAP in CRM Market Where SaaS, Apps Dominate, CMS Wire, April 2013 [↩]