Veeva Systems Inc Has Another Strong Quarter, but Slower Growth Could Be on the Horizon

This earnings season, Veeva Systems (VEEV -0.35%) once again demonstrated why it has become a mainstay in the pharmaceutical industry. The company, which provides a cloud platform for companies to track everything from sales to FDA trial data, clearly has a widening moat of high switching costs protecting it.

But management's revenue forecast calls for sales to grow less than 20% for the rest of the year. That's a marked slowdown for the company, and it immediately led some to question whether or not the heady days of growth were coming to an end sooner than expected.

Image source: Getty Images.

Is the slowdown something to be concerned about, or just the result of short-term anxiety on Wall Street? Let's investigate below.

Veeva earnings: The raw numbers

Data source: Veeva. 

Earnings grew at double the pace of revenue thanks in large part to operating leverage. While the company continues to pour money back into research and development -- a prudent long-term move -- overall operating expenses advanced just 21%. That, plus the fact that gross margins on subscription services expanded 200 basis points to over 80%, led to massive earnings growth.

The company's war chest is also expanding at an enviable rate. With free cash flow flying nearly 400% higher in the quarter, the company was able to add $61 million in cash to the balance sheet, bringing the total to $724 million.

Understanding all the pieces in play

As Veeva comes out with more and more subscription-based solutions for the pharmaceutical industry -- and expands beyond just life sciences companies -- it can be difficult to keep track of all the moving parts. Here's a quick overview to help keep it all straight.

On the commercial cloud side, there wasn't a ton to report. The CRM suite is the legacy line of business for the company, and as CEO Peter Gassner said on the conference call, it continues to be "a well-oiled machine."

Management spent a lot of time focusing on clinical and quality wins during the quarter for Vault. Of particular interest:

• Vault Clinical Trial Management Systems (CTMS) has signed up seven new customers since becoming available in Q1, and two went live during the quarter.
• Vault Electronic Data Capture (EDC) signed up its first two customers since becoming available just a few months ago.
• Vault electronic Trial Master Files (eTMFs) saw a 31% increase in customers year over year, as well as subscription revenue run rate growth of over 66%.
• Vault Quality Management Systems (QMS) added 10 new customers during the quarter, bringing the total to 30.

If all of that seems confusing, the bottom line is this: Veeva continues to offer unique software solutions to drug companies. As more and more customers sign on, and existing customers sign up for evermore subscriptions to these new solutions, Veeva's moat widens even more.

As Gassner said in the conference call, in some cases -- especially in offerings for smaller companies and outside of life sciences -- "[W]e are replacing a combination of paper and Excel." That means the time and money costs of potentially switching to another cloud provider are painfully high.

Looking ahead

Despite these wins, it appears that Wall Street was upset with the company's forecast moving forward.

Data source: Veeva. Q4 extrapolated using Q3 forecast and full fiscal year forecast.

Investors are used to slow growth in earnings as Veeva moves to capture more and more market share, but the slowdown in revenue growth appears to be catching some by surprise.

Analyst Richard Davis of Canaccord highlighted this in a question to Gassner during the conference call:

Everything sounded good, you have a lot of shots on goal... but is there any reason why you should not be able to grow this business at least 20% for the next several years? I mean I guess if that happens, would you just move margins up even higher or something?

The "shots on goal" is a reference to the fact that Veeva has a dizzying array of offerings for companies to use. All it takes is one or two of these new offerings to be a big hit and the top and bottom lines could be influenced substantially.

Gassner responded by saying:

We are really not giving guidance beyond this year. Of course we are still ahead of our targets for our 2020 $1 billion revenue run rate, and I like that word you used about shots on goal. We usually say the term planting seeds for growth.

CTMS [is a] very large market. We just have seven customers. I don't know exactly the number of potential customers in CTMS, but it's probably in the area of 700, not seven. And then we actually have new applications we could build on Vault too and then we have the whole outside of life sciences. So yes, I am confident.

The takeaway for investors is that it is very difficult for Veeva to clock in uber-high revenue growth because of its subscription model. Even when new customers sign on, that revenue isn't recognized until months later. That means management's forecast is probably spot on.

But that shouldn't take away from the longer-term outlook: As Veeva continues to innovate, the company will have more opportunities to win over customers. That, combined with margins that will only improve over the decadeslong time frame, should provide significant pricing power for the years ahead.