Salesforce Q2’15 Earnings Preview: Revenue Growth And Margin Contraction To Continue

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The world’s largest Customer Relationship Management (CRM) Software vendor, Salesforce.com (NYSE:CRM), is scheduled to release its second quarter fiscal 2015 results on August 21, after markets close. Salesforce mainly derives revenues through the sale of subscriptions related to its Sales Cloud, Service Cloud and ExactTarget’s Marketing Cloud. Additionally, the company provides consulting and other professional services that account for about 6% of overall revenues.

Last quarter, Salesforce reported revenues of $1.23 billion, higher than its guidance of $1.205-$1.21 billion. Revenues from subscriptions and support increased 36% on a year-on-year basis to reach $1.15 billion, while revenues from professional services increased 58% to reach $79 million. For the current quarter, the company guides revenues to range between $1.285-$1.29 billion, marking a increase of 34-35% on a year-on-year basis. Revenue mix between subscriptions and professional services is expected to remain approximately the same.

Margins, however, continue to be trimmed by hefty investments upfront to support revenue growth. In the first quarter of FY15, non-GAAP gross profit margins were down approximately 70 basis points to stand at 79.5% for the quarter. Similarly, non-GAAP margins for Salesforce’s income from operations declined from 10.5% in Q1’14 to 9.7% in Q1’15, mainly due to an increase in operational expenses such as R&D expenses and S&M expenses. For the upcoming Q2’15, we expect to see a further contraction in margins in the second quarter of fiscal 2015, from 10.2% in Q2’14.

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See our full analysis for Salesforce.com

Expanding Addressable Market for CRM Suites Drives Salesforce’s Top Line

Salesforce initially started out in 1999 by offering sales automation software using the Software-as-a-Service (SaaS) model. However, the company has diversified itself across the entire CRM domain, mainly through acquisitions. This inorganic growth strategy has greatly expanded Salesforce’s addressable market from their initial SaaS sales automation software, which was the driving factor behind Salesforce’s impressive revenue growth. Salesforce now provides various other product offerings such as the Service Cloud, Marketing Cloud and the Salesforce platform apart from the sales automation suite, Sales Cloud.

Recently, Salesforce announced a strategic alliance with Dutch-based technology solutions company, Royal Philips, to deliver an open, cloud-based healthcare platform. [1] Through the combined alliance, Salesforce expects to leverage Philips’ strong footprint in medical technology, clinical applications and clinical informatics and provide a platform for patient relationship management. With this alliance, we believe Salesforce intends to strengthen its presence in the global telemedicine solutions industry.

Last month, Salesforce acquired RelateIQ, in a bid to strengthen its Marketing Cloud offering and simplify the sales automation process. RelateIQ is a big data analytics start-up that uses searches of unstructured data from email, social networks and calendars to automate large portions of the sales process. [2] We believe the acquisition strengthens Salesforce’s core Sales Cloud platform in addition to streamlining its Marketing Cloud through its analytics-based platform and machine learning algorithms.

Going forward, we believe new market opportunities created through partnerships and inorganic channels are expected to have an increasing contribution in sustaining Salesforce’s strong revenue growth rate.

Margins to Remain Depressed Throughout FY15

Traditionally, Salesforce invests heavily to fuel revenue growth in the highly competitive cloud computing market. This has resulted in non-GAAP operating profit margins ranging between 10%-15%, while non-GAAP gross margins were over 75% historically. However, in recent times, margins for Salesforce have further contracted due to growing competition in the SaaS market from large software vendors such as Oracle and SAP. Much of this margin contraction is a result of increased investments into sales and marketing activities.

Additionally, margins are likely to remain subdued in fiscal year 2015 from the ongoing organizational transformation. Salesforce recently announced a strategic shift to offer specific solutions across industry verticals such as financial services/insurance, healthcare/life sciences, retail/consumer products, communications/media, public sector and automotive/manufacturing. While this strategy allows the company to charge a premium and derive greater value from delivering specific solutions to customer needs, the decentralization of the sales team into individualized, industry specific sales teams requires added investments for hiring and training purposes, thereby shrinking margins in the near term.

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Notes:
  1. Philips and Salesforce.com Announce a Strategic Alliance to Deliver Cloud-Based Healthcare Information Technology, Salesforce Newsroom, June 26, 2014 []
  2. Salesforce Buys Big Data Startup RelateIQ For Up To $390M, TechCrunch, July 2014 []