Salesforce’s Latest Slight of Hand

We have talked a bunch here in the past about $CRM simply changing the way they account for items when those items, if accounted for on a consistent basis illustrate the deterioration of their business….

WELL, they are at it again….

First we documented how the company, when making a GAAP profit regularly touted GAAP earnings to investors. Then, as profitability slowed and those very GAAP results they loved to thump their collective chests over collapsed, they seamlessly switched to “non-GAAP” EPS. That “non-gaap” EPS eliminated certain things like “expenses” that were causing the losses and enabled $CRM to show a nice little profit. We also have noted how mgmt has now decided that they ought to be compensated off “non-GAAP” rather than GAAP earnings like they have in the past. The reasoning they gave was:

As such, supplementing GAAP disclosure with non-GAAP disclosure using the non-GAAP measures provides management with an additional view of operational performance by excluding expenses that are not directly related to performance in any particular period, and management uses both GAAP and non-GAAP measures when planning, monitoring, and evaluating the company’s performance.

In addition, the majority of the company’s industry peers report non-GAAP operating results that exclude certain non-cash or non-recurring items. Management believes that the provision of supplemental non-GAAP information will enable a more complete comparison of the company’s relative performance.

Did you get that? Now, I wonder what the “non-cash or non-recurring” items were? Well the #1 one in “stock based comp”. That is when the company doles out million in free shares to mgmt and they dump them (early in the case of $CRM) and dilute the hell out of shareholders. To see the effect of this we have to note that $CRM is basing its GAAP LOSS of ($.55) share for FY ’13 of 135M shares. BUT, the fully diluted share count is 142.8M shares. So, once $CRM manages to make a penny (assuming they do this decade) the >142M shares will be the # EPS is based off (that number will continue to grow).

Yea but, how much stock are we talking? Well, consider that in the past two years CFO Smith has dumped $34M in shares (most of these were options exercised 1-2 yrs EARLY) and bought, um……let me see…..oh, I got it….ZERO. CEO Beniof, $218M in sales ZERO buys …pick any Director or Senior Manager and the pattern is the same. Now, insider sales aren’t necessarily a huge deal, but when they all are doing it, and exercising the options years before they expire, that has to raise more than a few red flags.

But, lets get back to the logic.

Why is it that these “non-GAAP” metrics all of a sudden more accurately reflect the health of the company? Why didn’t they reflect it in the past when they have positive GAAP EPS? The fact that this metric better reflects the business at the exact time GAAP EPS turns negative means ONLY one thing…..$CRM is finding a way to massage reported results to make them look better than what they are. Period

Try that with your bank. Go for a mortgage and tell them you are reporting “non gaap” financials to them and “eliminating credit card debt” on your personal balance sheet. See how it works for you……

So, what are doing now?

Here is what $CRM reported:

Calculated billings grew 58% and new billings grew 88%. Operating cash flow grew 45%

Wow….right. But those numbers are due to an accounting change, not necessarily all “new business”. By switching to annual from quarterly billing on some accounts, $CRM was able to book the revenues up front rather than over time. There isn’t any additional revenue (in fact prob. less as annual plans tend to be discounted over quarterly) involved with this change, the change is just in the timing of its recognition. So they are not legit comps. To wit, one quick mention on the earnings call. This was NOT MENTIONED on the earnings release or the 8K:

With the operational excellence around the annual invoicing contributing to our strong growth in current deferred revenue, the multiyear invoice caused the increase in long-term deferred revenue. If you exclude these 2 factors, we estimate that the total revenue on the balance sheet increased approximately 31% year-over-year.

Looking ahead, because of the seasonal nature of invoicing and with Q4 being, by far, our largest invoicing quarter, we expect to see a sequential drop as we have in several previous years in deferred revenue in Q1 of approximately $40 million to $50 million on a constant currency basis.

That is more than a little less. After the euphoria wore off, it seems others are catching on..

$JPM put out a note that said (you’ll notice those questioning $CRM were not on the earnings call). Only “homers” allowed?:

Assessment of New Business Momentum. We calculate new subscription billings grew about 15% from a year ago after adjusting for longer invoicing periods and acquisitions. We view adjusted new subscription billings as the best gauge on new business momentum, similar to how most investors gauge license growth for companies with a traditional software model, such as Oracle, TIBCO, and many others. A simple calculation of subscription billings (assuming deferred revenue changes are primarily due to changes in deferred subscriptions) yields new subscription billings growth of 88% and total subscription billings growth of 58%. However, management noted that billings benefited from the company’s efforts to move more customers to annual invoicing from shorter durations, and from at least one large deal that apparently paid for a multi-year deal in advance. We believe it is appropriate to adjust for these changes in business practices as they do not represent a fair apples-to-apples comparison from last year. Adjusting for these factors along with modest FX effects, new subscription billings grew 15% and total subscription billings grew 30%.

Cash Flow Analyzed. Operating cash flow grew 45% from a year ago to $240 million, but adjusting for the changes in business practices to longer invoicing periods, operating cash flow would have increased 7% from a year ago. Free cash flow to equity (excluding costs associated with the campus build and acquisitions) increased 56% to $184 million, but applying similar adjustments, free cash flow would have increased 3% from a year ago.

We offer the following analysis. Management noted that about 16% (= 47% – 31%) growth in deferred revenue was due to the changes in business practices above. This represents about $156 million in reported incremental deferred revenue, where the offsetting assets to this liability are Accounts Receivable and Cash. Management also noted that if it weren’t for these changes in business practices, DSOs of about 100 days would have been about equal to DSOs of a year ago, or 84 days. Therefore, we can back into what Accounts Receivable would have been excluding the changes in business practices, which is about $591 million (versus the $684 million reported AR). We can assume the difference between these two numbers, or $93 million, is the portion of the change in deferred revenue from the change in business practices ($156 million) that went into AR with the remaining $63 million (= 156 – 93) going to cash flow. Adjusting for the change in business practice (driving to longer invoicing periods), operating cash flow would have increased 7% from a year ago, while free cash flow to equity would have grown 3%.

The Wall St. Journal reported:

Strip out some changes in the way the company gets paid, which boosted deferred revenue, and billings growth was 35%. That isn’t a number to sneeze
at, although it suggests the productivity of the company’s sales force is weakening, according to estimates from Peter Goldmacher, an analyst at Cowen & Co.

Considering that the company’s sales and marketing expense was equal to a hefty 52% of last quarter’s revenue, the return from that investment is important to track. Using the reported billings figure for the fourth quarter, Salesforce generated $5.13 of billings for every dollar invested in sales and marketing. That compares with $4.44 a year ago.

But adjusting for the quarter’s changes, Mr. Goldmacher estimates that this year’s figure falls to $4.40, down 1% from last year. If that downtrend continues, it may be tough to drive billings growth without investing even more in sales and marketing. That could eat into profit growth.

What seems the most troubling (other than the fact only a few Wall St firms get/report this) is the utter lack of honest comparison $CRM’s gives investors. Most companies, when there is a significant change will rum “pro forma” numbers for investors that give them a look into what previous results would have been had the current policy been in place for the past two years or so. Not $CRM. If fact they barely recognize there is even a change to the current period much less older ones.

What is also disturbing is the way the new “numbers” are touted as growth over the previous ones that were accounted for differently. It is like holding 4 apples that are decaying and then when the new Q is released coming out and trumpeting “our 4 gorgeous oranges!!!” . What? Wait?!? What happened?

So the closer you look, when we compare same to same the company’s results were marginally better that before in some areas and not a good in others. For this the company added $2B to its market cap??

Now, is $CRM doing anything illegal? Technically no. But it sure as hell does not pass the smell test. When all I hear is how “wonderful, great, amazing, spectacular and unbelievable” both the current results and the future looks for a company, I REALLY have to wonder why both CFO, CEO, COO and the Directors are dumping share as fast as they can. What I have to wonder about even more is why are they cashing in options YEARS early to do so if the future is so bright? Now, if one of them were doing it, I could see it (maybe college, new home, whatever). But when this is a pattern across the Board, I really have to wonder if their view of the future is truly as bright as they are describing. Their actions sure as hell don’t match their words.

My guess is they do believe the company has a bright future but even they realize there is just no way they can continue to justify this insane stock price so “let’s get out while the gettins’ good”

The true shame of this is people are going to get hurt. Eventually the music will stop and $CRM will not have any more way to fudge comparisons that aren’t blatantly obvious. Then investors en mass will question why they are paying $19B for a company that will lose ($80M) – ($90M) this year on top of the ($12M) it lost in the past year. The last people in are going to be taught the hard way that valuation always eventually matters…