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Salesforce.com, Inc. (CRM) reports earnings Wednesday after the market closes.  At this point the consensus expectations are for revenues of $260 million and earnings of 8 cents per share.  But regardless of what the company reports for the second quarter, investors of all kind will be paying much more attention to what type of guidance is given by management.  In the current environment where fears of an economic slowdown prevail, it is much less important to understand what has happened in previous quarters, and much more important to gain a clearer understanding of what forces will drive future performance.

A recent note out from Raymond James painted the company in a somewhat negative light anticipating a “meaningful downtick” in free cash flow for the second quarter.  The analyst has a cautious view on the rest of the year and suspects that we will see a “deceleration in growth” heading into next year.  Not only is there concern in regards to a slowdown in economic growth, but the prospect of market saturation could begin to play a hand in dampening investor enthusiasm.

Management of Salesforce.com appears to have a history of giving conservative guidance.  This allows the company to set the bar somewhat low and then impress stockholders by beating their arguably artificially low target.  But this game can become more difficult when low guidance begins to anticipate much slower growth, or if actual numbers only beat the previously issued guidance by a small amount.  In a report issued Tuesday, RBC stated that the company would need to increase full year guidance in order to keep up with an ever optimistic consensus expectation.

The report also mentioned that fundamental metrics beyond the headline revenue and earnings numbers would play an important role this quarter.  An increasingly more difficult business environment has made investors more skeptical and so the company will likely be required to show “proof” of their strong operations and disclose positive metrics such as deferred revenue statistics and number of active customers.  Since the long-term subscription model yields more visibility in regards to future revenues, there will be special attention given to the number of new customers which RBC estimates near 3,000.

For my part, I remain skeptical that this stock can trade much higher.  With a multiple of 185 times this years expected earnings the valuation seems absurd.  A few have suggested looking at the price to sales ratios, but this type of ratio only makes sense when a company can convert the sales to true economic earnings.  However, timing has made shorting this stock difficult and there is certainly risk that it will gap higher if management paints a rosy picture after the close.  But with the stock unable to make a new high in the last two months, a price that is well below the 50 day average, and strong volume on several days in which the stock traded lower; I believe the time is fast approaching where profits can be made on the short side.  I would approach the earnings announcement with caution.

CRM Notes

FD: Author has a short position in CRM

Additional Reading:

TechTrader Daily previews CRM Earnings

Trader Mark asks “Does Valuation Really Matter?“