Salesforce's billing, sales productivity spur worries

Salesforce.com's third quarter was better than expected, but confusion over the company’s deferred revenue shortfall, billings and sales productivity sparked a bevy of questions from analysts.

The company reported third quarter deferred revenue of $918 million, down from $935.3 million in the second quarter. This deferred revenue tally was a disappointment given the third quarter featured Dreamforce, a conference that's supposed to be a sales booster. Wall Street was looking for deferred revenue of about $953 million.

Overall, the company reported a third quarter loss of $3.76 million, or 3 cents a share, on revenue of $584.3 million. Non-GAAP earnings for the quarter ended Oct. 31 were 34 cents a share.

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On Salesforce's conference call, CFO Graham Smith explained that unbilled revenue---an off-balance sheet calculation---was running higher than actual billings. This unbilled revenue figure allowed Salesforce to raise its revenue outlook---but not earnings---for the fourth quarter.

Smith said:

I think we have good visibility, as you know, into our revenue for next year because of our business model, and the sales capacity that we have added during the course of this year and we plan to add in the fourth quarter. So I think we have great visibility into our revenue.

Add it up and Salesforce.com's third quarter is either just a blip because Wall Street needs a new metric or something more worrisome.

In any case, analysts are beginning to wonder about Salesforce's margins. In the third quarter, operating expenses were $465.8 million, up from $311.8 million a year ago. Of that sum, sales and marketing expenses were $304 million in the quarter, up from $200.5 million a year ago. In other words, Salesforce is hiring sales people and marketing evangelists at a rapid clip.

Here's a look at the analyst reaction:

Peter Goldmacher, an analyst at Cowen & Co., said:

Sales productivity in 3Q went negative and guide for 4Q implies further degradation. The fiscal 2013 guide implies a further 10% decline in sales productivity. We interpret aggressive hiring in sales without margin improvement as stimulating demand well above natural levels. Saleforce is still struggling to sell larger deals into the enterprise. Absent success in this critical endeavor, productivity will continue to decline. We are further concerned that Salesforce's messaging is getting too fragmented between SFA, Service Cloud, Social, PaaS, etc. and this lack of focus is creating challenges for sales execution. We believe investors will struggle with management credibility relative to fiscal 2013, and even if Salesforce is able to grow revenue in the 30% range, at some point, investors will demand that a $3 billion software company deliver better than low teens margins.

Atlantic Equities analyst Christopher Hickey said:

Salesforce.com’s Q3 bookings proxy missed consensus by 3%, contrary to expectations given the company beat bookings consensus by an average 8% in the prior six quarters. The metric can be skewed by various factors and management argued that "it couldn’t be happier with where the business is", but it does appear that momentum slowed in the quarter, with bookings growth in the high 20s from mid 30s previously.

Macquarie analyst Brad Zelnick said:

In the past, Salesforce has cautioned investors on the limitations of calculated billings and F3Q results demonstrate this point. While billings appear disappointing, we consider it in the context of management commentary for overachieving its internal plan, above-Street guidance for F4Q and F2013, and commentary for off-balance-sheet business exceeding billings growth. We also note the company’s plan to hire a record number of heads in F4Q, which can be perceived as either reckless or appropriate. We choose the latter give management’s visibility to the business.