By Todd Sullivan of Value Plays
The first two high-flyers got some “valuation religion” in a fast way recently. I am going short $CRM for the same reason. Now, my distaste over the company is nothing new, I wrote about it in the past. With earnings coming out this week even a good quarter can’t save the rest of 2011 for them.
Here are the previous posts on it, here and here. Nothing has changed for the company since then other than a deal for Assistly ($50M). The company is still losing money on a GAAP basis, insiders still sell shares as fast as they get them and the company has still made the switch from reporting GAAP EPS to reporting “non GAAP” because well, that’s the only way they can show a profit that way and it still trades at over $120/share.
Regarding stock comp:
Stock-Based Awards. We recognize the fair value of our stock awards on a straight-line basis over the requisite service period of the award which is the vesting term of generally four years.
We recognized stock-based expense of $102.2 million during the six months ended July 31, 2011. The requirement to expense stock-based awards will continue to materially reduce our reported results of operations. As of July 31, 2011, we had an aggregate of $582.6 million of stock compensation remaining to be amortized to expense over the remaining requisite service period of the underlying awards. We currently expect this stock compensation balance to be amortized as follows: $114.0 million during the remaining six months of fiscal 2012; $193.3 million during fiscal 2013; $163.2 million during fiscal 2014; $106.0 million during fiscal 2015 and $6.1 million during fiscal 2016. These amounts reflect only outstanding stock awards as of July 31, 2011 and assume no forfeiture activity. We expect to continue to issue stock-based awards to our employees in future periods, which will increase the stock compensation amortization in such future periods.
We recognize as an operating expense the payroll and social tax costs, as applicable by jurisdiction, when stock options are exercised. The impact of stock-based expense in the future is dependent upon, among other things, the timing of when we hire additional employees, the effect of long-term incentive strategies involving stock awards in order to continue to attract and retain employees, the total number of stock awards granted, the fair value of the stock awards at the time of grant, changes in estimated forfeiture assumption rates and the tax benefit that we may or may not receive from stock-based expenses. Additionally, we are required to use an option-pricing model to determine the fair value of stock option awards. This determination of fair value is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards.
As of July 31, 2011, there were 3.2 million restricted stock awards and units outstanding. We plan to continue awarding restricted stock to our employees in the future. The restricted stock, which upon vesting entitles the holder to one share of common stock for each restricted stock, has an exercise price of $0.001 per share, which is equal to the par value of our common stock, and vests over four years. The fair value of the restricted stock is based on our closing stock price on the date of grant, and compensation expense, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period.
$3.2 additional shares comes to $400M of more stock comp expense in ADDITION to what is issued from here on out which, according to the company: “These charges have been significant in the past and we expect that they will increase as we hire more employees and seek to retain existing employees.” (Q2 10Q pg 35)
But wait, there’s more….
Deferred commissions are the incremental costs that are directly associated with non-cancelable subscription contracts with customers and consist of sales commissions paid to the Company’s direct sales force.
The commissions are deferred and amortized over the non-cancelable terms of the related customer contracts, which are typically 12 to 24 months. The commission payments are paid in full the month after the customer’s service commences. The deferred commission amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. The Company believes this is the preferable method of accounting as the commission charges are so closely related to the revenue from the non-cancelable customer contracts that they should be recorded as an asset and charged to expense over the same period that the subscription revenue is recognized. Amortization of deferred commissions is included in marketing and sales expense in the accompanying condensed consolidated statements of operations.
This is more hiding the true employee compensation costs. A customers signs an 24 month contract. $CRMpays the employees commission in full, yet they account for that payment over the full 24 months of the contract. In other words, in a 24 month contract, in each quarter $CRM will account for 1/8 of the full bonus it already paid. So, how much is this amounting to? As of July 31st, $131M is recognized as “accrued compensation” (10Q pg. 22). This is sneaky because it takes an expense paid, and moves it from the income statement to the balance sheet. $CRM is amortizing only $24M of that a quarter (up from $19M last year) as an actual expense despite the fact they have already paid it out (slide 3 below). Why does that matter? If they expensed the whole $130M this year (like they should) we would have to add ($.97) to this years GAAP losses ($131M/135M shares) meaning the $(.09) to ($.11) loss guidance would be revised to ($1.06) to ($1.08) loss. More than a little difference……and not standard procedure in the industry. You have to read the 10Q to find it as you’ll see the balance sheet they provide below conveniently lumps all liabilities into 1 line (slide 2)
But wait, there is still more….
Capitalized internal-use software amortization expense totaled $3.8 million and $3.2 million for the three months ended July 31, 2011 and 2010, respectively. Acquired developed technology amortization expense totaled $17.1 million and $3.9 million for the three months ended July 31, 2011 and 2010, respectively.
So, when $CRM develops software, rather than expensing that cost when it is incurred as is the industry norm, they again move the expense to the balance sheet and amortize it drip by drip to improve near term results (10Q pg21). As of July 31, $CRM had $198M of “capitalized costs” on the balance sheet that are in reality current expenses and took a total of….drumroll…. $20.9M of actual expenses in Q2. Again, $198M in unrecognized expenses comes to ($1.46) more in costs the company is putting off into the future.
And still more……
Market Risk and Market Interest Risk
In January 2010, we issued at par value $575.0 million of 0.75% Notes. Holders may convert their Notes prior to maturity upon the occurrence of certain circumstances. Upon conversion, we would pay the holder an amount of cash equal to the principal amount of the Notes. Amounts in excess of the