Salesforce Q1’15 Earnings: Revenue Growth Strategy Continues To Trim Margins

Cloud Customer Relationship Management software leader Salesforce.com (NYSE:CRM) reported Q1’15 results on May 20. Quarterly revenues reached approximately $1.28 billion for the company, with $1.15 billion recognized from its subscription and support business for its Sales Cloud, Service Cloud and Marketing Cloud offerings. The Subscription and Support business is Salesforce’s largest division, and the company has been reinvesting aggressively to accelerate its revenue growth rate. In Q1’15, subscription and support revenues grew 36% compared to 29% during a similar period a year ago. Additionally, revenues from its professional services business, which include various consulting and other training services to its customers, expanded 58% on a year-on-year basis to reach $80 million.

Non-GAAP gross profit for the company stood at $975 million in Q1’15. This represents a gross margin of 79.5% for the quarter. In comparison, non-GAAP gross profits were approximately 70 basis points higher in Q1’14. This decrease in gross margins between Q1’14 and Q1’15 is a result of an increase in cost of revenues. Similarly, non-GAAP margins for Salesforce’s income from operations declined from 10.5% in Q1’14 to 9.7% this quarter, mainly due to an increase in operational expenses. Income from operations on a non-GAAP basis (which excludes non-cash charges such as stock-based compensation and amortization of purchased intangibles) stood at $119 million in Q1’15 compared to $94 million from Q1’14. Net income on a non-GAAP basis reached $69 million in Q1’15, representing a net income margin of 5.7%. Comparatively, net income was $61 million in Q1’14, representing a net income margin of 6.8%.

In this earnings note, we take a look at the major trends that are expected to continue shaping Salesforce’s robust revenue growth. We have a $47 price estimate for Salesforce which is under revision to incorporate the latest Q1’15 earnings.

See our full analysis for Salesforce.com

Headcount Expansion Continues As Revenue Growth Remains Priority

Salesforce’s total headcount at the end of Q1FY15 was just over 14,200, up 38% on a year-on-year basis. The 38% increase over Q1FY14 was mainly because of the consolidation of ExactTarget into Salesforce. Excluding inorganic growth in headcount, the company hired more than 900 employees in the quarter, which is the most significant organic hiring completed in a quarter ever. The rapid increase in personnel is one of the driving factors for Salesforce’s robust revenue growth. The company relies on its sales team for generating qualified sales leads and contributing to a steady expansion in deferred revenue reserves. It has a direct sales force in its regional hubs and field sales personnel in territories close to its customers. Both the direct sales force and field sales personnel are supported by sales representatives, who interact with potential customers and provide verifiable leads.

Salesforce’s deferred revenue reserve (current portion plus non-current portion) expanded 34% on a year-on-year basis to reach $2.32 billion. Unbilled deferred revenues, which have not been invoiced yet, expanded to $4.8 billion. For Salesforce, unbilled deferred revenues have a high probability of contributing to future revenue, particularly because these billings are contracted under a non-cancelable subscription agreement. As the company invoices these unbilled portion of deferred revenues for its customers, the invoiced portion gets transferred to its deferred revenues account on the balance sheet. Upon realizing these services, revenues are recognized appropriately. With a total deferred revenue reserve of over $7 billion, Salesforce revenue pipeline remains robust for the foreseeable future.

However, the expanding headcount continues to strain gross and operating profit margins for the company. Salesforce’s SG&A expenses stood at $800 million in Q1FY15, compared to $600 million from a similar period in FY14. Excluding stock-based compensation expenses associated with SG&A expenses, net cash-based SG&A expenses for Salesforce are approximately $703 million. Comparatively, the same net cash-based SG&A expenses were approximately $507 million in Q1FY14. As a percentage of revenues, these net cash-based SG&A expenses were approximately 56.8% and 57.3% in Q1FY14 and Q1FY15. The higher percentage on a broader revenue base indicates the higher investments that the company is making into its business. This has impacted the company’s operating and net income levels over the past few years. We expect this expansion in SG&A expense to continue going forward.

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