Should Investors Worry About Anaplan's Losses?

Cloud software planning platform Anaplan (PLAN) got hit by the pandemic last year, but its growth is reaccelerating. Some investors might still shy away because of losses, though. Motley Fool contributors Jason Hall and Nicholas Rossolillo and Motley Fool analyst Clay Bruning discuss the situation on this "The Five" segment from Motley Fool Live recorded on Sept. 16.

Jason Hall: The one thing that I think is important to talk about on the financial profile, again, [Anaplan] burning cash still operating margins are negative still at this point. But that's a typical of companies that are still high-growth, that are still at certain points of their growth profile. They don't hide from this, they're not dancing around this. In their presentation here you see this slide in particular talks about their free cash flow and then percentage of revenue, so the negative free cash flow, the trend is positive, the trend is improving and then you look at this big number here, operating expenses as a percentage of revenue, you go back a couple of fiscal years and total operating expenses were more than total revenues, and that's getting better. I'm going to pull up one more chart here. Nick, Clay, either one of you can weigh in on this, but I think to me, you mentioned Zoom, you think about a lot of these businesses, when they have high rates of revenue growth and these gross margins, at some point, this flips because those incremental revenues from that expansion of customers turns into really big cash flows and profits. Who wants to kick off that?

Nicholas Rossolillo: I think that's an important point you mentioned, Jason, about negative operating margins. It's important to remember that they do this by design, it's not that they couldn't be profitable if they didn't want to be.

Hall: It's a market grab at this point to a certain extent. Somebody is going to be in that customer's office. If it's not you, somebody else is.

Rossolillo: Exactly. It makes sense for them to spend more than they take in each quarter in revenue and sales, but the beauty with a company like Anaplan, they have plenty of cash and no debt, so it's not like it's hurting them that much to keep up this aggressive pace of expansion. They have over 300 million in cash and equivalents on the balance sheet, no debt, and from a free cash flow perspective, they are actually almost at breakeven. They're getting pretty close to hitting that breakeven point from that standpoint, so not really concerned on that front. And the gross margin profile is fantastic, it's what you would like to see from a Cloud-based SaaS platform.

Hall: Yeah. Clay, anything to add there?

Clay Bruning: Yeah. Just in terms of the gross profit margin that you pointed out, the thing that's really important to me and why I pointed out the subscription revenue growth over the last couple of quarters is if you see that subscription revenue gross profit margin, that's sitting out around 84 percent.

Hall: That's the green line here versus the blue line, which is total gross margins. This is where they want to push their customers.

Bruning: Yes. A couple of benefits there, it's way more predictable for the company to understand and look into the future as someone who owns businesses. Ideally, you don't want there to be as many unknown, so that's nice as an investor in the company. Then if they can increase their percentage of sales, I think over the last couple of quarters, subscription revenue is about 90 percent of their overall sales. As they increase that percentage over time, that should raise their gross profit margin to have a convergence between, I think it was 77 percent total company gross profit margin versus the 84 percent gross profit margin, specifically for subscription. So again, another encouraging sign there. But, of course, you always worry about profitability, but they do show some signs of economies of scale and being able to scale pretty efficiently here.

Hall: I'm going to bring that chart back up that I was creating there because I think it's just a good way to think about this business, maybe you guys can weigh in some insights there, but again, Zscaler (ZS -1.10%) and Anaplan do completely, entirely different things, but they're both businesses that are SaaS driven, they live in the Cloud, and you see this cadence of cash flows as Zscaler, where steady improvement into the positive. With Anaplan, not quiet as sharp as an improvement, but the trend is what you really want to follow because the idea gets back to the fact that these are investments that are being made to get to scale, to capture as much market as possible. Then with Zscaler, you see at some point, you get just a substantial amount of operating leverage when you add scale, where every incremental dollar that comes in at some point, we were talking about those 85 percent gross margins on its subscriptions, but it actually gets to a point where the first 100 customers or 85 percent gross margins, within the next 100 or 90 percent gross margins, and then the 100 after that or 95 percent, those incremental margins when you get to that operating leverage can be really impressive. Clay?

Bruning: Yeah, absolutely. I think one of the reasons you're seeing them consistently have negative operating margins. Just because you see that sales and marketing expense has to ramp up as they're growing their client base. As they plan to continue to grow at 20 percent to 30 percent, they need people to continue to sell for them because at a certain point you can't just stay stagnant with your sales and marketing team if you're expecting to grow your clients pretty substantially over the next couple of quarters and years. So very reasonable to see where they're operating expenses at the time being. Of course, in a year or two years, we'd like to see that level out, but pretty encouraging signs financially, at least for this company in the last couple of quarters.

Hall: Nick, I know this is one you cover super-duper closely. Do you have any last thoughts or points on it before we move onto intuitive surgical?

Rossolillo: Clay mentioned that ramp up of sales and marketing. Anaplan has done a lot just in the last two years. Even in the midst of the pandemic to bolster that, they signed some key deals with some of the top three cloud providers to get access to that platform and help enhance the value to customers. Lots of sales and marketing expense. But again, referring to that chart you showed comparing them to Zscaler you can see when a company starts to hit that point where every incremental dollar they get becomes almost pure profit. The growth from the bottom line can be exponential. Personally, I'd love investing in companies that are just nearing the cast of that point where they're not yet profitable, but they're close to it. Because if they do go on to become profitable, it can be dramatic in the performance there.

Hall: That's great and I agree, and there's a lot of those companies in our Foolish universe too, for good reason.