The Dreamforce party dampener

While's Q2 exceeded market expectations, a collection of doubts over future growth meant the company's stock was punished. Should you be concerned?

SFdC results

Marc Benioff,'s ebullient CEO used yesterday's Q2 earnings call as an extended advert for the upcoming Dreamforce conference. (Disclosure: will settle part of my T&E for this event.) But none of his customary  excitement could disguise the fact that the forward outlook is soft or that despite winning its largest Chatter deal ever (whatever that means) the company is still losing money when its results are measured by GAAP standards. It is hardly a surprise then that the financial markets punished the company, shaving five percent off its stock price in after hours trading. Should buyers be concerned? That all depends on how you view the future. 

First let's look at some of the commentary:

Arik Hasseldahl at AllThingsD sets out the problem but in a somewhat unthinking manner:

The problem was with the EPS expectation, which one must remember is a non-GAAP profit to begin with. Salesforce says it will be 31 cents to 32 cents a share, versus a consensus of 34 cents. (On a GAAP basis, which no one pays attention to, Salesforce still expects to report losses in the range of 26 cents to 27 cents, and of 72 cents to 75 cents for the full year.)

[My emphasis added]

As I have said before , GAAP measures DO matter. In this case, the one measure it cannot avoid is cash flow. Run out of cash and you're dead. Not that's going to happen any time soon since is sitting on $1.8 billion. Howver, despite revenue at a record $732 million and a margin of over 80%, the company only generated $164 million in free cash flow in the last quarter. That's 22% of revenue. Can it do the same again in the succeeding quarters? That is hard to tell. 

What worries some analysts is that there doesn't seem to be an end in sight to the losses. According to a research note from Peter Goldmacher of Cowan & Co:

Sales productivity declined 11%. While we believe CRM is a mighty competitor in a number of compelling market opportunities, largely bc of the sheer size of its go to market effort, the fact is that this is a $3B company with 80%+ gross margins that is still losing money. At scale. Large deals continue to fail to provide upside to numbers and growth is getting more expensive for CRM.

Last year I was unconvinced that's enterprise 'all you can eat' licensing approach was well formed. Goldmacher's comments would appear to support that theory. However, in one recent large deal I know about, has no problem wheeling out its big guns and does so in a thoroughly professional manner. The problem with that is you can only have so many big guns and they don't scale. Even Marc Benioff can only be in one place at one time. 

Offsetting that, I notice that Benioff mentioned that Nestlé is deploying Chatter to 300,000 employees. If current information about the global Nestlé headcount is correct, then that is pretty much everyone. (Note: the numbers vary depending on which source you choose to read but 300K appears to be in the right ball park.)

Nestlé has a history of making long term technology bets. When you speak with SAP, they often talk about the longevity of their relationship with Nestlé and the fact it helped propel them into the top flight of enterprise application vendors. also announced renewed and/or extended contracts with some of its largest customers. That bodes well for the company. However, so far I don't see it capitalising on those large deals in a way that maximises the revenue potential from this part of the market in a profitable manner.

When I look at, I still see a company that continues to attract plenty of SMEs, the cost of supporting which can only rise rather than fall. That is despite the fact that when you add up all the modules a small company might need, starts to look pricey. How does overcome this problem without alienating customers? 

The other number that concerns is deferred revenue. While standing at a whopping  $1.34 billion, it only grew sequentially by something like one percent. Add in the fact that says that roughtly two thirds of its customers are now paying on annual billings and you can easily see that deferreds have to grow much more substantially to keep cash flow ticking along. Goldmacher envisages two likely outcomes:

  1. CRM [] over saturates the market near term with too much distribution and billings slow while expenses don't, or
  2. CRM decelerates its investments in distribution and growth declines appreciably.

He does have a third and, he says, unlikely outcome:

Salesforce makes a seamless transition from growth to margin.

I believe there is a fourth alternative. On the earnings call, Benioff said:

At Dreamforce, we're going to be announcing, which is our rebranding and redevelopment of Rypple. You'll be seeing the kind of the new version of that and our direction there. You'll -- we'll also have with us Aneel Bhusri is the CEO of Workday, and you'll see how we are working hard to integrate with them to deliver a full HR suite to our customers between's system and Workday. And you'll also see Workday's integration with Chatter as well. We're very excited about our initial focus here into HR.

See also delivers strong Q2, raises revenue outlook  (ZDNet), inc Management Discusses Q2 2013 Results - Earnings Call Transcript (Seeking Alpha)

 When acquired Rypple and hired ex-Oracle and SAP executive John Wookey I could not see how could use those assets to leverage a sensible HR/HCM offering in the marketplace anytime soon. First, Rypple is a simple niche solution and second, Salesforce had no real HR expertise in the developer outfit.

Since that time, Wookey has occasionally popped up talking about re-imagining HR. I have yet to see a compelling vision that tells me how this pans out from where he is standing. I hope to catch up with him at Dreamforce to get a better understanding of what he sees. However, the fact is planning to showcase its Workday relationship hints to me that the combined forces of and Workday will be brought to bear on the enterprise market. 

Provided the two companies can show a seamless yet loosely coupled integration, both parties win against SAP/Oracle in deals where they can play the white knight full ERP role against vendor lock-in AND offer compelling ROI. (Disclosure: Workday is a recent past product strategy client.)

There are of course a lot of interdependencies, potential potholes and as yet unseen barriers to making this strategy work. The flipside is that Workday brings considerable enterprise sales experience to the table along with world class HR/financials. It can help work out the wrinkles in its fledgling enterprise business. What's more, Workday is probably the only company in its space that cannot buy at this time which should mean the partnership has to work or everyone ends up with egg on their face. My sense is that both parties are far too smart to allow that to happen. 

What of Dreamforce itself? I reckon this could well be the last time we see a Dreamforce of this kind. If Benioff gets his claimed 70,000 on site attendees then he will have achieved his ambition of topping Oracle's on site numbers. That has always been something he wanted to achieve as a bragging rights issue. But I think the better clue comes in the line up of headline speakers. It's a re-run of past years. In enterprise, you ony get one chance to take your audience for a ride. Not serving up fresh meat is a bad idea.

Some will parlay this as a sign that is treading water. The forward outlook seem to confirm that is indeed what's happening. A revenue shot in the arm in Q3 or, more likely Q4 is needed to restore confidence.

As always, we live in interesting times. 

Image credit: Alex Williams