Will Salesforce Ever Make a Profit? (Hint: The long answer is "Maybe.")
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And The short answer is "No." To understand why Salesforce.com (NYSE: CRM) will never make a profit, (in this writer's opinion,) we need to consider two things: i) the difference between GAAP numbers (which Salesforce downplays) and non-GAAP numbers (which Salesforce trumpets every conference call;) and ii) the reason why Salesforce has such a huge disparity between these two sets of numbers.
GAAP is an acronym meaning "Generally Accepted Accounting Principles." These principles are set by the Financial Accounting Standards Board. At their most basic, GAAP mean simply that financial statements ought to be true and accurate summations of a company's financial condition. Non-GAAP means just that -- numbers that do not have to conform to conventional accounting principles. Presenting non-GAAP numbers is the equivalent of saying "We would have earned X cents per share, if only we hadn't spent X dollars on this or that." Non-GAAP earnings are supposed to help present a clear picture of a company's ongoing finances when the company has for one reason or another had a one-time event impact their earnings, such as a charge for building a new headquarters, or something like that. Non-GAAP numbers are not supposed to be used to obfuscate recurring charges, such as paying your employees in stock rather than cash, every year, year in year out, on a, ahem, recurring basis.
In the case of Salesforce, the numbers are these: According to the company press release for fiscal year 2012 ending January 31, 2012, Salesforce reported GAAP "earnings" of negative 9 cents a share, and non-GAAP "earnings" of $1.36 per share. What accounts for this discrepancy? Three items -- "$12 million in net non-cash interest expense," "$67 million in amortization of purchased intangibles," and, the extra, extra big one -- "approximately $229 million in stock-based compensation." That means that stock options account for over 74% of the discrepancy between the GAAP and the non-GAAP numbers. On a per-share basis, the $229 million in stock-based compensation over the 142 million share count used in the non-GAAP calculations works out to $1.61 per share. To put it another way, if Salesforce had not granted the $229 million in stock-based compensation, then GAAP earnings would have been $1.61 per share (the $229 million over the 135 million share count used in the GAAP calculations equals $1.70 per share attributable to the options, less the reported GAAP $.09 per share loss equals positive $1.61 per share.) In other words, Salesforce would make money, if only they didn't give all the potential profit away to their executives in the form of stock options.
Comparing the Salesforce press release to the latest quaterly earnings press release of competitor Microsoft (NASDAQ: MSFT), we find that Microsoft also released a non-GAAP earnings number last quarter. Only in the case of Microsoft, the discrepancy between the GAAP and the non-GAAP numbers was not due to stock options, but to "the previously announced non-cash, non-tax-deductible income statement charge of $6.19 billion for the impairment of good will and the deferral of $540 million of revenue related to the Windows Upgrade Offer." Hmm. Nothing in there about stock options. No, it's predominately a good will writedown. Also noteworthy is the different emphasis placed on the GAAP vs. the non-GAAP numbers by Microsoft and Salesforce. Microsoft is cautious in their presentation of non-GAAP numbers: "These non-GAAP financial measures should not be considered as a substitute for, or superior to, the measures of financial performance prepared in accordance with GAAP." Salesforce? Well, much has been written about their non-GAAP accounting, without, so far, any discernable impact on investors' appetite for the stock.
But delving into the numbers behind the numbers makes another high-priced stock, that of Amazon.com (NASDAQ: AMZN) look like a screaming bargain compared to Salesforce. After all, Amazon's lack of profitability can at least be attributed to their investment in their giant bricks-and-mortar warehouse build-out. What is Salesforce "investing" in? According to their earnings statements, they are "investing" in the bank accounts of their top executives.
Of course, there is a legitimate business reason to pay your top people so much in options grants -- you want to attract and retain top talent, right? Isn't that how the mantra goes? However, there is a big problem here, lurking like a whale beneath the surface of a calm sea: You can only pay your people with stock options when the stock price is high. When it starts falling, they will want cash instead. There is a rather obvious circularity here: The stock price can only stay up so long as the employees are paid in options rather than cash. If the employees were paid in cash rather than options, the GAP/non-GAAP differential would collapse, meaning that the fig leaf of non-GAAP "earnings" covering up the recurring expense of paying employees would fall away. That might make the stock price fall, which would decrease even more the ability of Salesforce to pay their executives in options rather than cash. And if you don't pay them lots and lots of money, in either options or cash, your top employees might leave.
Now, you may be wondering how it is that a recurring cost like paying your employees could ever be treated as a non-recurring cost in the first place. Presumably, paying your employees is as much a recurring cost as paying your rent, buying staples, etc, isn't it? Or am I missing something? Or is everyone else missing something, by choosing to focus on the cheerleading non-GAAP numbers rather than the GAAP numbers? Compensating key employees with huge options grants has long been an accepted way of paying key employees in start-ups, but Salesforce is no start-up. And they have been doing this for a long time. And the value of their options grants as a percentage of revenues is actually growing, from about 1% in 2006 to over 10% in 2012, a growth of 1000% in only six years.
I know this -- stock options are not play money; they really do exist, and they have a real impact on real money. If and when Salesforce ever were to make a profit, that profit would have to be spread out over all the shares issued pursuant to options grants, diluting such theoretical profit perhaps to the point of non-existence. If Salesforce were to stop paying their employees with options and pay them in cash instead, then the distinction between GAAP and non-GAAP earnings which presently exists would disappear. If that happened, and the company only reported GAAP earnings, then the market might come to see those "earnings" in a whole new light. I suppose Salesforce could always back out their top executives' cash compensation, and report the new, better-looking number as "Non-GAAP earnings." However, it seems unlikely that anyone, even today's Salesforce investors, would want to guzzle that particular barrel of kool-aid.
boriskabinov is short Salesforce via long-dated puts and have no positions in any of the other stocks mentioned has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and Microsoft and has the following options: short AUG 2012 $130.00 puts on Salesforce.com, long AUG 2012 $150.00 puts on Salesforce.com, short JAN 2013 $150.00 calls on Salesforce.com, and long JAN 2013 $150.00 puts on Salesforce.com. Motley Fool newsletter services recommend Amazon.com and Salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.