Bernstein Research analyst Mark Moerdler asserts in a research note that Salesforce.com has substantially increased its reported results on both a GAAP and non-GAAP basis with the use of both aggressive accounting practices and a riskier-than-average approach to investing corporate cash. As Moerdler makes clear, nothing the software-as-a-service company is doing is illegal, their practices are well disclosed, and the company's approach has been approved by its auditor. But the Bernstein analyst makes clear that Salesforce certainly does appear to be taking an approach to financial reporting that is less conservative than some peers.
By Moerdler's calculation, Salesforce.com's results for the July 2011 fiscal year would have been 79% lower on a GAAP basis and 30% lower on a non-GAAP basis if the company used the most conservative accounting and investment practices used by other large software companies.He contends that using more conservative accounting, the company would have reported 10 cents of GAAP profits, rather than 37 cents, and 86 cents in non-GAAP profits, down from $1.22.
Here's how he gets there:
- Salesforce.com, he notes, capitalizes sales commissions instead of expensing them as incurred. If the company had expensed those costs, he writes, operating profit would be 42% lower. Moerdler says a sample of 21 software-as-a-service and traditional software companies found that a third capitalized sales commissions. Moerdler notes that FASB is discussing rules that will address the issue of when to recognize commission expenses on subscription contracts, with a final statement due at the end of next year.
- Salesforce.com capitalizes software development, "even though there is little delay between technical feasibility and implementation" due to the SaaS model the company employs. If the company expensed software development costs, FY 2011 operating profit would be 7% lower, he finds. Of that same sample of 21 companies, about half expense software development as incurred or say that capitalization is not material. He notes that most of the companies that capitalize software development have longer cycles with new releases every few years; Salesforce.com updates quarterly.
- He notes that the company will get a $20 million tailwind for revenues in FY 2012 from adoption of a new accounting standard that allows faster recognition of consulting revenues.
- Moerdler also notes that the company appears to take far more risk with its corporate cash than comparable companies. Had Salesforce generated the same yield on cash in FY 2011 as in 2010, he notes, both GAAP and non-GAAP results would have been 14 cents a share lower. Among other things, he notes that Salesforce.com is the only software company among those surveyed that holds collateralized mortgage obligations. He notes that the company held $104 million of CMOs at the end of FY 2011, up from $41 million and the end of FY 2010. At the end of the July fiscal year, CMOs were 7.5% of the company's cash and investments. He adds that if you define risk as those investments not in short-term or U.S. government guaranteed notes, then Salesforce.com had the second highest share of risky holdings of the companies he surveyed.
Meanwhile, Moerdler notes that CEO Marc Benioff has said that investors should evaluate the company on non-GAAP results, rather than GAAP profits. But the analyst disagrees, noting in particular that current FY 2012 guidance implies stock-based compensation growth will grow 100% this year, compared with 34% revenue growth.
Moerdler maintains his Underperform rating and $112 target on the stock, which today is down $3.53, or 2.2%, to $113.89.