Salesforce, Inc. (CRM) Q3 2010 Earnings Report, Transcript and Summary

Welcome everyone to the Salesforce.com Q3 fiscal 2010 financial results conference call. (Operator Instructions) Mr. David Havlek, Vice President of Investor Relations, you may begin your conference.

Thank you. I would like to personally welcome everyone to Salesforce.com’s third quarter financial results call. After a few opening comments to make today’s call official, I will turn things over to our Chairman and Chief Executive Officer, Marc Benioff, to review the highlights of the quarter. Graham Smith, our Chief Financial Officer, will then provide some detail on the financial performance of the quarter before we open things up to your questions. Tomorrow is the kick off of Dream Force, our biggest user conference of the year. We will try to keep our call a bit more brief than past calls. In that context if we are unable to get to your question today please be advised that both Marc Benioff and Graham Smith will be hosting an in-person Q&A session at 1:00 PT tomorrow. If you are unable to attend that session in person it will be webcast. With that let me quickly remind you that a full disclosure of our third quarter results can be found in a press release issued about an hour ago as well as in our Form 8-K filed with the SEC. Additional financial information, including historical financial detail beyond what is provided in the press release will also be made available on our website. Today's call is being live Web cast. A dial-in replay will be available shortly following the conclusion of the call until December 8, 2009, and a web cast replay will be made available for approximately 90 days. To access the press release, the additional financial detail, the Web cast replay, or any of our SEC disclosures, or simply to learn more about Salesforce.com, I encourage you to visit our Investor Relations Web site at Salesforce.com/Investor. All of our financial commentary today will be in GAAP terms unless otherwise…

Thank you David and welcome everyone to our call. We are very excited to share our results on the first fiscal third quarter and let me just begin with some of these exciting financial highlights. Revenue grew 20% from a year ago to approximately $331 million and this result was well above our outlook entering the quarter primarily as a result of improvement in new business demand and lower attrition. At this level our annual revenue run rate is now more than $1.3 billion and we continue to be the fastest growing software company of our size in the world today. GAAP EPS of $0.16 as double the $0.08 we reported a year ago. Operating cash flow of $36 million was over 100%, actually it was 107% from a year ago and we now have nearly $1.1 billion in cash and marketable securities on our balance sheet. By virtually every financial metric Q3 was an amazing quarter. Graham will have more to say about all of the financial details in just a moment. Now while our financial results were outstanding, perhaps the most exciting part of our quarter was the improvement we saw in some of the key growth drivers of our business. On our second quarter call in August we discussed seeing signs of stabilization in our business, if you remember the call. However, based on our third quarter performance we now believe we are seeing some very early signs of improvement in some very key areas. That is really causing us to enter a growth stance in our company. First, on a year-over-year basis new business performance was up in the third quarter and was our best growth quarter of the year. As a result we now expect new business for the full year to be flat to…

Thank you Marc. Solid execution and an improved demand environment enabled us to once again report excellent results for our fiscal third quarter. We saw continued strong revenue growth while earnings and cash flow growth doubled from a year ago. Let me begin with a brief review of the P&L. As Marc indicated revenue for the third quarter was approximately $331 million, an increase of 20% from the year-ago quarter and well above our previous outlook. Three factors contributed to the performance. First, as Marc mentioned our new business growth rate in the third quarter was our best this year. On upgrade business, which is an important component of overall new business saw a significant improvement too, particularly in our SMB business. However, although the demand environment felt better in Q3 than it did in Q2 it is important to understand we are still managing in a generally tough environment with longer sales cycles and smaller average deal cycles. Second, although our dollar attrition rate remains in the high teens, it did decline for the first time in several quarters. Third, a weaker dollar clearly helped the top line. Excluding the effects of roughly $4 million year-over-year currency benefit, revenue growth in constant currency was 18% or 2 points less than our reported growth rate of 20%. International revenues grew more rapidly than North America. International reached 30% of total revenues for the first time in Salesforce.com’s history. Americas revenue was approximately $233 million, a year-over-year increase of 16%. Europe revenue was approximately $61 million, a year-over-year increase of 26% in dollars and 24% in local currency. In Asia revenue was approximately $37 million representing dollar growth of 31% and local currency growth of 21%. GAAP gross margin for the quarter was approximately 18.2% up roughly 60 basis points from…

Just quickly while the operator is queuing your calls, let me quickly provide some detail on some of the planned activities we have tomorrow at Dream Force for the analyst community. First, as a member of the financial community you are a VIP attendee. On arrival please proceed to VIP Check In, get your badge and information. As Marc noted, you are entitled to special VIP seating at his keynote at 9 a.m. tomorrow morning. Go to the VIP sign at the front of the main stage. Please plan to get there early because we are expecting a packed house. After the keynote you are invited to a special VIP luncheon with company execs, customers and partners. That lunch is in [inaudible] North, Room 135 and then there will be a Q&A session with Marc and Graham at 1 p.m. following the lunch. All of these sessions will be web cast. Those of you who pre-registered we have pre-populated your calendars complete with meetings [inaudible] or iPhone the details. You should have also received an email and you can contact any of your IR folks here at Salesforce. If you haven’t registered it is not too late. Walk up’s are welcome. I look forward to seeing you tomorrow. With that…

Let me just add one thing to that. I think it is extremely important for the financial analysts, the technology analysts and the press that are attending tomorrow and listening to this call and others who are not, unlike a lot of other vendors who tend to herd the analysts or control the analysts into certain rooms or certain programs, ask them to attend only certain things or create a controlled environment for them, that is not our position in our company. You are free to attend every keynote. You are free to attend every breakout session and there is a huge trade show floor of several hundred ISV’s who are building on our platform where you can assess the quality of their applications and the momentum of the market, as well as we have mentioned over 18,000, maybe 20,000 attendees there tomorrow. We want you with them. We want you talking to them. You are free to attend the lunch. No hard feelings if you don’t want to because we really want to emphasize you are free to do whatever you want. It is a key part of who we are as a company. We know other companies are not like that. We just want to reinforce to you it is not a controlled environment for financial or industry analysts or press or bloggers. You have free reign of the conference. We will make all things available to you including the Black Crowe concert tomorrow night.

(Operator Instructions) The first question comes from the line of Mark Murphy - Piper Jaffray.

We are occasionally running into customers that are indicating Salesforce.com has become a top three or top five line item in their IT budgets. In many cases they say they are not scrutinizing it because of the value it has created. I am just wondering if you can comment on the role that Force.com is playing in terms of driving customers to purchase those kinds of VLA’s or creating other kinds of stickiness within the customer base?

You are really touching on really our fundamental core product strategy which is to cement ourselves as the standard in the enterprise of our customers. Of course in many cases we have started a small implementation or what we refer to as “seed.” We then talk about how we want to grow those implementations. Then we tried and turn those implementations into what we call ELA’s or enterprise wide agreements. The technology you will see announced tomorrow and released in the first part of next year, that you will see when we announce it and when we release it I will just give you a little preview. The strategy behind it is an expansion strategy. It is all about we have looked at the category that we think will accelerate users into the enterprise. How do we go from a Trojan horse strategy where we have gotten through the doors and the horse is there in the middle of the city but we want lots and lots of guys to come out of the horse. To do that of course we have the sales cloud with the service cloud with a lot of customer applications. That is what you are seeing with these customers who have built these custom applications so we are beyond sales and service users and then to other things like recruiting and project management or so forth we have built an application we believe will take us much, much further and as we have detailed conversations about this which I am looking forward tomorrow at lunch, you will see and keep in mind during my keynote the whole fundamental strategy; the product strategy, the packaging strategy, the pricing strategy, the feature strategy, the branding strategy, is to move our approximately 70,000 customers to be enterprise wide…

The next question comes from the line of Sarah Friar - Goldman Sachs.

I wanted to ask about the forward guide for fiscal year 2011. I appreciate you putting a stake in the ground but as I look at it suggests that bookings and probably revenue growth are going to probably decelerate from where we are this year, which has been a much tougher year. So, given your commentary you think we are shifting back to better growth why aren’t we seeing that more in the revenue guide for next year?

I think really this comes down to Q4, it is as you know our biggest quarter ahead of us and it is also our biggest renewal quarter ahead of us. I think we feel good about giving the guidance in the range we have. I think before we can give any more precision around next year’s top line growth rate we have to see if we have sustained improvement that we saw the beginnings of in Q3 and then we have also seen good signs on the attrition front but as you know that is a big variable in our top line equation as well. So I want to get through Q4 and then sort of assess where we are.

I would really like to just add to that if it would be alright with you. You know we are in the third quarter. We just finished the third quarter. If you look back a year ago finishing up the third quarter was not necessarily as much clarity not just for us but for all companies over the next six months, right? In terms of what was about to happen in the world. I think because of that we are just being mindful and I think appropriately so. In kind of giving you a preview of where we think we are going to be next year. That is really very much how we view this. We think it is important to give you these numbers. We are giving you these numbers. We are being mindful and we are being appropriate I think because we still are in a very volatile world and while we certainly felt like in the second quarter we got our sea legs and in the third quarter we have resumed a growth stance and in the fourth quarter we are getting our excitement back, we are really in a position now while we really want to give you numbers because we have always given you numbers in the third quarter we recognize the last time we did that in the fourth quarter the entire planet, the world changed, and we moved into one of the most unusual economic situations in the world. All of us have lived through that. Then we had to start to make changes for our business like many companies did. So because we are still basically several months away from finishing our fourth quarter which is our biggest quarter of the year, we are not yet through Dream Force. We haven’t made this product announcement. We are just giving you numbers we feel are appropriate. I hope that is important and that you can understand our mindfulness around that.

The next question comes from the line of Analyst for Heather Bellini – ISI Group. Analyst for Heather Bellini – ISI Group : On financial force, what is your strategy there and how is it different from say Net Suite that has not been able to gain much traction in the space?

Thank you very much for that question. Financial Force is not part of Salesforce.com. It is a company that is an independent company that was started by a company in Europe called Unit 4 Aggresso and Unit 4 Aggresso and one of their subsidiaries, CODA, is one of the largest ERP providers in the European area. I think they are the second largest behind SAP. Unit 4 Aggresso took a product they were working on inside CODA called CODA To Go, which was a native, general ledger payable/receivable and has ported it onto Force.com. We have had them on stage a few times profiling it mostly so other software developers could get excited about building similar things, and they have had some very exciting customer traction which it is not appropriate for me to speak for their company. Hopefully when you go by their booth tomorrow at Dream Force they can tell you what their customer numbers are and you can look at their demonstration and analyze their growth rate and their competitiveness. We are so excited about this new company, Financial Force.com, we invested a relatively small amount of money, very small, to pick up a very small position because we view the company as doing things we want to encourage which is native Force.com development. But it is not part of us. I can’t speak for them. I actually have no details and that is really all I can say. You should go by their booth tomorrow and see them. Thanks for your question.

The next question comes from the line of Adam Holt – Morgan Stanley. Adam Holt – Morgan Stanley : My question is about sales capacity and investments on a go-forward basis. You all were pretty aggressive over the past 12-18 months in hiring sales capacity. I wanted to get an update as to where you think you are in winning that capacity to be productive and if anything do you feel like you have some excess capacity as you start to get into an economic recovery? Secondarily, how should we think about the balance of billings growth going forward and expense growth going forward?

I think this year has clearly been a tough year from a sales capacity point of view. We did add a lot of sales headcount last year as you point out. We have been much slower additions in the first half but certainly we are looking to pick that up in the second half. I think the way to think about this is we are still committed to improving margins. That is an important thing for the company. On the other hand we feel there are lots of regions in the US and other key markets internationally where we are very under-penetrated. We will look to continue to expand our distribution capacity as much as we can because that is clearly the key growth driver for the company.

I would just add to that we internally still see ourselves very much as a distribution-constrained organization in that is we would like to have more sales people on the street around the world in every major geography in every major region. What is unique about Salesforce.com is we are appropriate for a 100 employee company, a 1,000 employee company, a 10,000 employee company, a 100,000 employee company or a 400,000 employee company. We just don’t have as many people as we would like on hand to be able to appropriately cover, communicate and build relationships with that market. Of course we have segmented our sales force. We manage it extremely well. We have some of the top sales managers in the world. We continue to acquire new ones. But we want more. When you compare us against the much, much larger enterprise software companies our sales force is still between 1/10th and 1/20th their size of the largest players. We think our products are far more competitive, far more exciting, far more important and we need more people to get out there and explain it to them. We want to when it is appropriate and when it is appropriate to take on a growth stance, which is what we are doing now, work to on-board them as much as we can which is why you saw us increase headcount in the third quarter after holding basically back in the first and second quarter. We want to do that again in the fourth quarter and actually go into the year. At the same time we want to continue to do a great job with our margins. Of course, over the last few years we have done I think a spectacular job with our margins. I think on a fully annualized…

The next question comes from the line of Laura Lederman - William Blair & Company. Laura Lederman - William Blair & Company: You have built up a ton of cash. Can you talk about whether you are going to let it sit on the balance sheet, whether acquisitions become more interesting? Buybacks? Just give us a better sense on that. Also following up on the last question, obviously delivering 300 basis points of margin improvement year after year, you can’t obviously expect to keep that up but kind of ballpark would you expect to deliver maybe half of that? I realize it is tied to revenue growth but if you could just sort of give us some sort of band it would be helpful.

I think we are very happy with our cash balance. Clearly we focus a lot on cash generation. We believe that is a good proxy for the progress of the company. We don’t comment on M&A activity and clearly we have done acquisitions in the past; small ones. We continue to look at things. There is no specific news or forward thoughts there. I think in terms of the second question about how margins are going to move next year, I think I did say ultimately we have to complete our planning process and Marc has just spent a minute or two talking about that balance we are trying to strike between growth and profitability and adding distribution capacity remains the number one priority for the company and we just have to get that balance right so it would just be premature for me to try and give you a read on that. And Q4, as we have also said, is also such a huge quarter for us that will have an impact on our ability to deliver different margins next year.

The next question comes from the line of Kash Rangan - Merrill Lynch.

A clarification for you, Graham and then a question for Marc. You said similar growth in deferred revenue to last year. I guess you were referring to percentage growth Q3 to Q4 right?

No, actually my words were quite specifically chosen. We expect the deferred revenue to grow roughly by the same amount, the dollar amount. I stressed the word roughly because as I gave you some reasons that you know it is a tough number for us to estimate with a great deal of accuracy. We are just trying to give you a ballpark number of what we are expecting and that is the same dollar kind of increase we saw in Q4 of last year.

Does that imply the same kind of dollar amount. I respect the fact you are trying to be conservative but it signifies a deceleration in bookings growth of 12-13% so I was trying to be sure I wasn’t wrong-headed in the way I interpreted your comments and that is why I asked that question.

Actually I am not trying to be conservative. I am just trying to give you a read on how I see the numbers as they are. I think it is what we think, clearly just remember in that bookings number you all calculate it is a combination of a couple of things. It is new business that we sign in the quarter. It is also based around the billings of renewals. So there are two factors that go in there. That is sort of our best read on it at the moment. That is where we think we are. It is a tough number to calculate or estimate.

A question for you Marc, adding the fourth pillar, which you are going to be announcing tomorrow. How are you thinking about segmenting the sales force to get the best productivity within the account? Any changes to management you are likely to be making? Adding new people? Or creating new business unit structures? Anything at all you can help us get comfortable with as you scale this company? What are you going to be doing differently as you add on new products?

We have made a lot of those changes already. We have been driving those changes forward. We think we are currently appropriately structured. We will continue to of course enhance our structure as the business changes but you won’t see us announce any major change regarding product organization tomorrow. We are going to be listening very, very closely to our customers as we announce this product and based upon what they say we of course make changes at that point.

The next question comes from the line of Analyst for Michael Nemeroff – Wedbush.

Can you go over the Q4 cash flow again and your expectations for CapEx and cash flows in 2011?

Well, we said we expect Q4 operating cash flow to be slightly above the level of Q4 operating cash flows last fiscal year. We did not give any forward guidance on cash flow or CapEx. I will say on CapEx if you look at our CapEx additions over the last few quarters they have sort of run along at a relatively steady run rate so I think that is sort of pretty clear what the trend is on CapEx but we didn’t give any specific forward guidance around those numbers.

The next question comes from the line of Brent Thill – UBS.

The improvement you mentioned you saw in the quarter, do you see that evenly across the small and mid segments or was one category potentially stronger than other categories?

We saw across many of our categories, of the eight major categories that I measure more than five of them, I think it was 5-6 improved. So we are very positive about that. By the way, those categories included the specifics to your question, the small and medium business had a spectacular quarter actually. We don’t normally call them out but they just completely blew us away.

Operator, we are going to go ahead and take one more question. Again, for those of you we didn’t get to in the queue, we look forward to seeing you tomorrow at Dream Force and also we will have the Q&A session with Marc and Graham. Let’s go ahead and take our last question today.

The next question comes from the line of Robert Breza - RBC Capital Markets.

Can you talk a little bit about, you talked about adding sales capacity. Can you talk about maybe where you are making other additional investments or where you might be making investments whether that be in specific geographies? Anything would be helpful.

Well the headcount we have added to date this year a lot of it is focused on development. You are going to see the fruits of that at Dream Force tomorrow and hopefully you will be as excited as we are. I think going forward we will switch that emphasis to much more on distribution capacity for the fourth quarter and next year because as I mentioned earlier we have definitely held that back a bit until we saw clearer signs of an improving execution and demand environment. So I don’t think we want to be more specific than that. I think certainly we will be looking to focus most of it on distribution capacity in the U.S. and internationally across our top markets.

I would just add to that I think after an unusual year, a year of some downs and some ups that as we finish up the fourth quarter by the end of January and as we get ready to talk to you again on a formal basis in February we are going to have a lot more clarity about the kind of investments we are making and the level of growth we are able to take on, the confidence we have in the business. We wanted to give you these early indicators because we think it is appropriate but we are being mindful and we are being thoughtful about what the numbers are we should be giving you. A lot based on the global environment that we are all existing in. Although Salesforce.com has had, I think, a spectacular year, certainly against any of our peers or competitors that could be said, we have had that great year because of this process that we undertake.

That is a great note to end on. We want to thank everybody for joining us today. We look forward to seeing you at Dream Force. If you still want to get in on the festivities tomorrow please contact me directly, David Havlek at dhavlek@salesforce.com or contact my team. Thanks for joining us. Have a good day.

This concludes today’s conference call. You may now disconnect.