Tech Revenue Warnings
Five tech names whose accounting disclosures may be signaling an unexpected slowdown
Many tech companies exhibit two distinct features that distinguish them from many other types of companies. The first is they are trading largely on future results – sometimes years into the future. Second, the nuances of their accounting methods for revenue recognition make them less likely to miss forecasts but instead, they often see the stock price decline due to cutting growth forecasts.
Most software companies operate under a subscription model where they get paid in advance and then recognize revenue over the length of the subscription – often one year. There are two metrics to track for signs that growth may slow:
Deferred revenue or contract liabilities– this is the upfront cash payment that has yet to be earned and is recognized as a liability on the balance sheet. As the revenue related to the subscription is recognized this account gets smaller. Because much of this will become revenue within a year – guidance is heavily dependent on the level of deferred revenue. If the growth slows or the days outstanding declines – that is a red flag indicating slowing future growth in most cases.
Accounts receivable – this represents payments due from customers and can include unbilled receivables. This should remain fairly flat in terms of days of sales or be declining. When it rises, that can be an indication that current customers may end up canceling their service soon Rising DSOs can also mean that the sales cycle is getting longer which is a bad sign for future revenue growth. The increase can also indicate a back-loaded quarter – again highlighting a possible longer sales cycle or that the company may have pulled business from the next quarter into the current one leaving the customer pool smaller for the future.
In many cases, software companies experience a period with a “hot” product when customers call the company and book an unsolicited order. Salespeople love to sell something popular, and a case could be made that the phone receptionist is the most important “salesman.” As the market gets crowded or many customers have already grown from one subscription to twenty – the company may discover that many of its sales team really cannot sell anything. They may also find that incremental customers need more hand-holding and training on using the software. That is a more difficult sale that consumes more time before the customer signs up. Many of the sales team may leave for another company’s new product that has future customers calling in now. That can make it difficult to restart sales growth.
Examining the history of DocuSign (DOCU) in the 2019-2022 time frame provides an excellent example of the warning signs indicating a slowdown that eventually led to the stock price collapsing. The following chart shows DOCU’s price action in that period:
Now consider the following table showing accounts receivables DSO, deferred revenue days, and their components by quarter over that time frame. The bottom half of the table shows the low end of the forward annual revenue and billings guidance given with each quarter’s results.
Notice that despite the stock falling significantly during this time, revenues never declined. In fact, DOCU beat revenue forecasts in every quarter.
Until January 2021, DOCU saw DSOs on receivables remain fairly flat to even declining a few days and its Contract Liabilities in days stayed at 170 days +/1 two days.
Receivables looked seasonal with more outstanding in January than in other quarters.
The January 2021 quarter saw a big jump in guidance for fiscal 2022 vs. fiscal 2021 of over 32% for revenues and billings. The stock hit $265 in February. However, after posting billings of $535 million in January 2021 – DOCU only guided to $457 million in billings for April. That was a warning sign as management even said on the call that weaker business trends were driving that forecast.
These warning signs proved prescient in May of 2021 when the company’s April results featured disappointing billings and guidance leading to the first drop in stock price. The 9-day drop in deferred revenue days in April’s results didn’t help either.
The stock hit a new high in August after it appeared these issues had corrected. Deferred revenue days of sales increased and DOCU issued billings guidance for October of $585 million.
However, the big collapse hit in October 2021 when DOCU missed billings guidance issued after July 2021 results by $20 million and it lowered its annual forecast for billings. There were still some warning signs such as very low billings guidance in January after a strong quarter of billings. This happened again in July 2021. Billings guidance was below what was just posted.
The key to focus on is not only was billings guidance falling, but it was also forecast to be below sales. When Billings to Revenue falls below 1.0x – the company’s growth is contracting.
DOCU did not miss an earnings forecast until April 2022 when it missed by 8 cents.
We can see that there were ample signs of upcoming trouble with revenue growth for investors who were watching the numbers closely. Below we will examine the revenue-related disclosure of five tech companies whose recent results contain similar warning signs and whose stock prices are still flying high. These include:
· Synopsis, Inc. (SNPS)
· F5, Inc. (FFIV)
· Confluent, Inc. (CFLT)
· Unity Software, Inc. (U)
· Vertex, Inc. (VERX)
Let’s get behind the numbers…