Salesforce.com Shows Strength

Salesforce.com (NYSE: CRM), the leading SaaS vendor, yet again, reported strong third quarter results on November 20 that beat Street estimates in an increasingly gloomy economic environment: yesterday the National Bureau of Economic Research officially declared that the U.S. has been in a recession since December 2007. Despite the challenging market conditions, Salesforce.com is set to cross the $1 billion revenue milestone. I believe the SaaS sector is relatively recession proof, and Salesforce.com’s performance this quarter is more evidence of the sector’s strength.

Revenue was up 43% y-o-y and 5% q-o-q to $276 million versus Street estimates of $273.5 million. Year-to-date revenue was $787.1 million. Net income was $10.12 million or $0.08 per share (up 60% y-o-y) versus Street estimates of $0.07 per share.

Subscription and support revenues were $253.4 million, up 44% y-o-y and 6% q-o-q. Professional services and other revenues were up 41% y-o-y and 1% q-o-q to $23.1 million. Total customers are up 36% to 51,800 with 4,100 new customer additions. The company’s churn rate continues to be less than 1% per month despite worsening economic conditions.

Deferred revenue, an important metric for gauging new business for SaaS companies, was up 38% but down 2% q-o-q to $470 million. The sequential decline was mainly due to the impact of the strengthening dollar. It is also due to the seasonality trend that the business has started displaying as discussed in the earnings call: Salesforce.com signs more business in Q4, which leads to a big deferred revenue balance in that quarter. Q1 is down sequentially while Q2 and Q3 are relatively flat.

This seasonality also affects cash flow. Cash from operations in the quarter was approximately $17 million, versus $52 million last year and $53 million in Q2. Total cash, cash equivalents and marketable securities at the end of the quarter was $805 million, down 2% q-o-q but up 22% y-o-y. The sequential decrease is attributed to the acquisition of InStranet, a provider of multi-channel knowledge applications, and to the purchase of shares in Salesforce.com’s Japanese majority-owned joint venture.

Gross margin was 80%, up slightly from last quarter and up three points from 77% last year, driven by better margins in the professional services business. Salesforce.com ended the quarter with 3,300 employees, up 270 over last quarter including 40 employees from InStranet.

For the fourth quarter, Salesforce.com expects revenue in the range of $284 to $285 million. GAAP EPS is expected in the range of $0.06 to $0.07. Analysts expected EPS of $0.07 on revenue of $289 million.

For fiscal year 2010, Salesforce.com initiated revenue guidance in the range of $1.35 to $1.36 billion or 27% growth over 2009. At the time of writing, the stock was trading around $27 with a market cap of about $3.3 billion. It hit a 52-week low of $20.82 on November 21, after the results were announced.

In the last few years, almost 600 SaaS companies have come into the market, including many that have sprung on the Force.com platform. Next year, I expect the acquisition spree of these companies to begin. The $800 million plus in cash and equivalent reserves will certainly help Salesforce.com pull together a wonderful portfolio of applications.

By the time we come out of the recession, Salesforce.com should look very solid.

Disclosure: None

Comments

[stocklafamilia:]

You must be assuming a short recession and v-shaped recovery and not a protracted recession with lingering stagnant growth. I believe that CRM is over-priced, and now that it's trading at 20-21x 2009E adjusted fcf, I believe that it is setting up for a large drop, especially since the median sector multiple is 11-12x.

Corporate spending on IT and non-essential initiatives is falling off of a cliff, and with so many other companies that actually have substantial earnings trading at fractions of their previous values with strong balance sheets, I see no reason why the market would find value in salesforce.com, which seems to be another growth story "cult" stock whose bubble has burst.

They probably will survive the current recession due to their strong balance sheet, however this stock will most likely end up in the low teens as they fail to attract new business and burn through their cash trying to fight off the intensifying competition. After that they might be acquired by another software company or remain on their own, but as the market realizes that they cannot meet their current growth projections in this environment this stock will be crushed.

It appears that CRM is up more as a result of market manipulation than any operationally-related factors, as businesses are spending less and cutting back more.

I guess we'll be watching that declining deferred revenue q/q growth number in their next report to see if "seasonality" and "foriegn currency" are an even larger factor this time around.

2008 Dec 03 05:00 PM

[sdrawkcab77:]

The only part of your analysis that was seemingly accurate was your multiple calculation, for which I give you kudos, especially considering that you use the correct metric - adjusted free cash flow. However, any multiple needs to be compared against potential growth and this is where I believe your analysis is flawed. Make no mistake, the entire SaaS industry will face intensified competition as you astutely comment and due to the reduced barriers to entry and lower switching costs (relative to on-premise models), will face enormous pricing pressure - pressure which will erode leverage for essentially the entire industry. Those businesses which are able to inexpensively acquire customers and generate a profit on each customer acquired will maintain the greatest amount of leverage and will therefore experience the greatest margin expansion - the most powerful driver of growth in adjusted free cash flow! And what's the business in the SaaS space with the greatest amount of leverage (operating not financial)? It's Salesforce.com. Maybe you have been short this last run-up and are looking for anybody to get back to shorting this stock so you can cover at a lower price. Maybe your investing career pre-dates the 2002-2003 tech fall-out and you are jaded on high-growth, high-multiple tech stocks (and who could blame you). And while I am not a fan of all high-multiple tech companies or even all of the SaaS vendors, this one (Salesforce.com) is legit.


On Dec 03 05:00 PM stocklafamilia wrote:

> You must be assuming a short recession and v-shaped recovery and
> not a protracted recession with lingering stagnant growth. I believe
> that CRM is over-priced, and now that it's trading at 20-21x 2009E
> adjusted fcf, I believe that it is setting up for a large drop, especially
> since the median sector multiple is 11-12x.
>
> Corporate spending on IT and non-essential initiatives is falling
> off of a cliff, and with so many other companies that actually have
> substantial earnings trading at fractions of their previous values
> with strong balance sheets, I see no reason why the market would
> find value in salesforce.com, which seems to be another growth story
> "cult" stock whose bubble has burst.
>
> They probably will survive the current recession due to their strong
> balance sheet, however this stock will most likely end up in the
> low teens as they fail to attract new business and burn through their
> cash trying to fight off the intensifying competition. After that
> they might be acquired by another software company or remain on their
> own, but as the market realizes that they cannot meet their current
> growth projections in this environment this stock will be crushed.
>
>
> It appears that CRM is up more as a result of market manipulation
> than any operationally-related factors, as businesses are spending
> less and cutting back more.
>
> I guess we'll be watching that declining deferred revenue q/q growth
> number in their next report to see if "seasonality"... and "foriegn
> currency" are an even larger factor this time around.

2008 Dec 04 11:30 AM

[stocklafamilia:]

Wow you seemed to take my comment very personally. You should try to remain a little more professional and objective in your responses instead of making personal attacks and accusations. Especially since open discussion and one being challenged to back up their assertions is a key component to learning and making a complete analysis.

However, you failed to mention what your economic outlook is. Are you expecting a short lived recession and a V-shaped recovery? If not, what are your assumptions about the future economic environment and growth in capital expenditures by businesses? The answers to these questions should be the foundation of your analysis.

If you are expecting global economic growth to return to the levels seen in the last 6 years in 2009, then CRM may very well be a good long-term investment. However, if the current recession, which most economists agree is MUCH worse than your normal run-of-the-mill recession, turns out to be a longer more protracted recession with subsequent stagnant economic growth, then CRM may be extremely overpriced at these levels.

It is hard for me to believe that CRM can maintain the levels of growth that they have seen thus far in 2008 over the next few years. It is also hard for me to accept that the churn rate will not increase given the extreme pressure that businesses are under as evidenced by the large amount of layoffs that are occurring. Today alone, DuPont, AT&T, Viacom and Belden announced a combined 21,150 layoffs. The number of Americans collecting unemployment checks is 56.5% higher than this time last year at 4.087 million, and the unemployment rate is most likely headed to double digits. The amount of Americans on unemployment is at its highest level in 26 years. This will inevitably flow through to all businesses as individuals and businesses alike have less discretionary income. Businesses WILL decide to delay capital investment programs until economic times are more certain. Why do you not address this issue in your analysis? How can CRM maintain their growth levels in this type of environment?

Also, doesn't CRM begin projects with companies months before they begin to recognize revenue and earnings from them? In other words, wouldn't their be a lag time between when the economy slows and CRM's revenue and profits are affected?

2008 Dec 04 01:59 PM

[Perki:]

Salesforce has a long lag for revenue contraction. Client companies sign a 12 month contract, so even after you layoff half of your sales staff, you still pay the full amount until your contract expires.

The effects of the massive layoffs in the last 90 days will be hitting Salesforce's revenue next year. Additionally, with the high fixed costs of SaaS infrastructure, revenue reduction has a disproportional impact on gross margins.

Given the 93% institutional ownership and the herd mentality of same, when Salesforce's price does fall it will be fast and furious.

2008 Dec 07 08:33 AM

[stocklafamilia:]

perki,

Thanks for the response about the lag time between a downturn and when it will reflect in CRM's financials. Your information was very helpful and insightful. I agree that CRM is going to be reporting deteriorating numbers as this recession plays out. It would take an act of blind ignorance to think otherwise. They will eventually begin warning that estimates are too high and provide all kinds of excuses.

It seems to me as if the author of this article is relying on analyst estimates to be an accurate representation of what is actually going to happen over the next few years for this company. However, if anything else has been learned from the collapse of the market over the past year, it is that the analysts who are writing company reports are nothing more than cheerleaders. Their analysis is for the most part completely lacking substance, and is almost always completely income statement focused and ignores the importance of balance sheet and cash flow analysis.

As for CRM, it is undoubtedly overvalued for this type of environment, one in which capex spending is coming to a screeching halt and companies are slashing employees. CRM will correct and retest its lows, as will the rest of the market.

2008 Dec 08 05:28 PM

[Ames Tiedeman:]

Many are now suggesting that software sales are not going to be anywhere near as bad as others first suggested...

2008 Dec 13 12:16 PM