The earnings that Intuit Inc. (NASDAQ:INTU) reports on Thursday after the market close may be difficult to compare to prior quarters, due to operational and accounting changes the company announced in August at the end of its fiscal 2014 year. What specifically has changed, and how should investors interpret Intuit's first quarter 2015 report?
Three magic words
The primary change Intuit communicated last quarter was a restructuring in its small business unit, to accelerate growth in its online, subscription-based services. The investment is driven by the company's flagship cloud software: QuickBooks Online, or QBO.
QBO boasts more than 683,000 subscribers and, last quarter, the division recorded new subscriber growth rates of 40% in the U.S., and more impressively, 150% outside the U.S. Last quarter also marked what the company calls an "inflection point" -- for the first time, more new customers preferred QBO to the company's legacy desktop QuickBooks software.
The restructuring to pour resources into QBO is a testament to its current growth rates and potential, but it's also supported by a key operational and accounting consideration. CEO Brad Smith summed up the company's rationale nicely during last quarter's earnings conference call: "The benefits are clear: online experiences are simply better for the customer. They expand our total addressable market and they generate more predictable recurring revenue strength."
"Predictable recurring revenue" is a phrase of three magic words for Intuit. When customers purchase the company's desktop software, they may or may not upgrade to newer versions, or they may simply delay upgrades. QBO's subscription model, in which the majority of customers pay monthly, provides a more stable and predictable base of revenue. This has implications not only for Intuit's earnings, but its cash flow, as well: The company cited predictable revenue streams as a factor behind the decision to increase the 2015 dividend by 32%, to $1.00 per share.
A new operational metric to track progress
With the tweak in its business model, Intuit is now reporting a measure it calls "annualized recurring revenue," defined as "four times the most recent quarterly revenue for online offerings serving small business customers." In other words, Intuit assumes that most of its subscribers paying monthly can be counted on to use its small business cloud offerings year after year. Thus, if you multiply the small business cloud revenue in any given quarter by four, you'll get an approximate idea of Intuit's built-in, predictable (recurring) revenue base. From this quarter forward, investors will want to track the growth of this number, and we'll discuss the initial metric in our analysis of the earnings release.
Watch the deferred revenue account
To characterize QuickBooks' desktop software sales in a manner more in line with QBO, Intuit announced an accounting change at the end of last quarter. Starting with the first quarter report, instead of recognizing QuickBooks software revenue at the time of sale, the company will recognize it as services are delivered. This will increase the deferred revenue account on the balance sheet and, consequently, will lower earnings in the near term. Investors should see the deferred revenue account -- which showed a balance of $526 million at the end of last quarter -- increase substantially.
Impact on revenue and earnings
The accounting change will put a damper on Intuit's first-quarter reported earnings. The company is projecting revenue of between $620 to $630 million. This compares with $622 million of revenue in the first quarter of 2014 -- a basically flat outlook. Gains in QBO, and the company's fast-growing individual and corporate tax software segments, will be offset by the deferred QuickBooks revenue.
The revenue deferral will also hit the bottom line. Intuit's guidance for Q1 suggests an operating loss of between $155 and $160 million. The changes to both revenue and earnings will take some time to work their way through the company's accounting cycle. Management predicts a return to double-digit revenue and earnings growth in fiscal 2016 and 2017.
While it may be somewhat difficult to compare Thursday's results with the prior year, we'll provide some apples-to-apples analysis in our post-release coverage. We'll also provide commentary on how well the company is succeeding in accelerating its cloud-based business to tap into the magic of predictable, recurring revenue.