Shares of Domo (DOMO 18.62, +2.99, +19.13%) are surging today after the
company reported significant margin improvement last night.
Domo offers a cloud software platform with a scalable integration layer. The company states that its mission is “to be the operating system for business, digitally connecting people, data and systems, empowering people to collaborate better, make better decisions and be more efficient, right from their phones.”
Domo beat quarterly estimates and offered upside EPS and revenue guidance for the following quarter, the second quarter in a row in which it has done so. The company sold 9.2 mln shares at $21 in an IPO six months ago.
Management said that demand remains solid. The company added 21 enterprise customers during the quarter as clients with more than $1 bln in revenue rose 23% year/year to 430.
With a $500 mln valuation, Domo trades at ~3.5x sales estimates. That represents a notable discount to most recent enterprise software IPOs, many of which trade with a double-digit sales multiple.
The reason? Poor economics.
In fiscal 2018, revenue grew 46% to $108.5 mln, but the accompanying gross margin was just 55%, and the operating profit margin was negative 245%. Young software companies get a pass on operating margins because they are still trying to scale, but most have gross margins of at least 70%.
In the third quarter of last year, gross margin was 56%, and operating margin was negative 154%. What's more, sales and marketing expenses of $33.6 mln actually exceeded revenue of $28.3 mln. Skeptics see revenue being generated by spending, not from demand, which usually doesn't end well.
This year, third quarter results show marked improvement. Gross margin expanded 870 basis points to 64.9%, and operating margins improved to -82% from -154%. Sales and marketing expense actually fell 17% to $23.9 mln as revenue grew 30% to $36.8 mln. Domo guided fourth quarter operating expense growth in-line with sales.
These improved economics suddenly make the stock look cheap relative to most of the recent cloud software IPOs. Some 12% of the 18 mln share float was recently sold short.
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