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Salesforce.com, Inc. (NYSE:CRM)

F3Q07 Earnings Call

November 15, 2006 5:00 pm ET

Executives

David Havlek - Vice President, Investor Relations

Marc Benioff - Chairman of the Board, Chief Executive Officer

Steve Cakebread - Principal Financial Officer, Executive Vice President, Principal Accounting Officer

Analysts

Laura Lederman - William Blair & Co.

Thomas Ernst - Deutsche Bank

Jason Maynard - Credit Suisse

Kash Rangan - Merrill Lynch

Daniel Cummins - Banc of America Securities

Rick Sherlund - Goldman Sachs

Heather Bellini - UBS

Philip Rueppel - Wachovia Securities

Matthew Kossen - Pacific Crest Securities

Nathan Schneiderman - Roth Capital Partners

Peter Goldmacher - Cowen & Co.

Brent Thill - Citigroup

Robert Schwartz - Jefferies & Company

Mark Verbeck - Cantor Fitzgerald

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Operator

Good afternoon. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the salesforce.com third quarter fiscal year 2007 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session.

(Operator Instructions)

I would now like to turn the call over to Mr. David Havlek, Vice President of Investor Relations. Please go ahead, sir.

David Havlek

Thanks, Michelle, and welcome, everyone, to salesforce.com's third quarter fiscal year 2007 financial results conference call. Joining me today are Chairman and CEO Marc Benioff and CFO Steve Cakebread.

Before we begin, please be advised that all of our financial commentary will be in GAAP terms. Please consider this important change as you evaluate our results, particularly against fiscal estimates which exclude certain recurring items. Steve will provide more detail on this in his discussion.

A full disclosure of our Q3 financial performance can be found in our Q3 results press release, issued earlier today and also in our Form 8-K filed with the SEC. Additional financial information beyond what is provided in the press release may be found on our website.

Today’s call is being webcast and a replay will be available shortly following the conclusion of the call through December 1st. To access the press release, the financial detail, or the webcast replay, please consult our investor relations website at www.salesforce.com/investor.

Finally, let me remind you that the primary purpose of today’s call is to provide you with information regarding our third quarter fiscal year 2007 performance. However, some of our discussions or response to your questions will contain forward-looking statements. These statements may include projected financial milestones, anticipated growth, goals and results, subscriber, financial, and operating metrics, business strategy, the timing of future services, products or platform releases and their capabilities, demand for on-demand services generally or our products, DSX platform, or the app-exchange directory specifically, market opportunities, expected implementation of our services by certain customers, data centers, hardware or software initiatives, future system and service availability, the decline of the enterprise application market or other business related topics.

These statements are subject to risks, uncertainties and assumptions. Should any of those risks or uncertainties materialize or should our assumptions prove to be incorrect, actual company results could differ materially from these forward-looking statements.

These risks, uncertainties and assumptions, as well as other information on potential factors that could affect our financial results are included in our reports filed with the SEC, including our Form 10-Q for the quarter ended July 31, 2006. The 10-Q is available on our investor relations website.

Finally, please be reminded that any unreleased services or features referenced in today’s discussion or other public statements that are not currently available and may not be delivered on time or at all. Customers who purchase our services should make the purchase decision based on features that are currently available.

With that, let me turn the call over to Marc.

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Marc Benioff

Thank you, David, and good afternoon, everyone. Our third quarter was our most spectacular quarter ever. As we predicted, we became the first on-demand company to exceed the $0.5 billion annual revenue run-rate. At this new level, salesforce.com has become one of the 40 largest software companies in the world today. This accomplishment has been one of our primary goals for this fiscal year, and it sets up our next dream, to become the first billion dollar on-demand company.

Salesforce.com’s revenue for the third quarter was $130 million, well above our outlook and up 57% versus the same period last year. There are not too many other half-billion dollar software companies growing at greater than 50% -- in fact, there aren’t any. We are the fastest growing software company of our size, driven as always by unparalleled customer success achieved through our innovative on-demand model.

Our GAAP net profit was $339,000, our best performance of the year. On a per share basis, our break-even GAAP EPS was at the high-end of the outlook we provided you at the beginning of the quarter. The performance included approximately $11 million of stock-based compensation and amortization of purchased intangibles, which reduced EPS by approximately $0.06.

Operating cash flow was $31 million, an increase of 25% from the year-ago quarter and the second-best cash flow performance in our history. Our balance of cash and cash equivalents now stands at roughly $371 million.

Total net paying subscribers rose by 61,000 in the third quarter, the biggest quarterly increase in our history. Total net paying subscribers increased by 163,000 through the first three quarters of this year, for a total of 556,000 subscribers.

We closed a lot of business in the third quarter, unabated by competition. Our marquee deal this quarter represents a major accomplishment on many fronts. Cisco systems has signed on for an additional 7,500 subscribers of salesforce.com, becoming our largest customer at a total of a remarkable 15,000 subscribers.

This has been one of our great customer success stories. Our flagship sales force automation application now powers Cisco’s formidable worldwide sales team. It is a clear proof that the world’s largest and most technically demanding companies can easily manage and share their information using the on-demand model.

We also started a partner relationship management program with Cisco this quarter, and we expect further subscriber expansion with their partners over the next year.

We also closed signficiant expansion transactions with Dun & Bradstreet, who now have 2,100 subscribers of our unlimited edition, and TD Ameritrade, who expanded with our service and support offering to now have over 1,000 subscribers. In Europe, Cone Elevators expanded their deployment for more than 1,000 subscribers.

We also won significant new transactions in new and existing accounts, including Toyota, Siemens, Prudential, Sharp, Standard & Poor’s, Hartford Life, Borland, [Servers Anamex], Astra Tech, Rentokil, [Verixel], Aveta Health, [Azura] Bank in Japan, Mizuho in Japan, Choice Point, Thompson Financial, and the third-largest software company in the world, Symantec. In fact, Symantec now has over 4,500 subscribers.

We closed our largest transaction ever in our Asia-Pacific region, which does not include Japan, with a telecommunications provider in New Zealand of 1,000 users. We now have more than 27,100 customers around the world. That represents an increase of a record 2,300 customers over the last quarter and, compared to a year ago, we have added roughly 8,300 customers, remarkable when you consider it took us five years to add our first 8,000 customers.

Just as we are seeing continued success across all our customer segments, the same is true within our alliances. We are very excited to announce that we have entered into a partnership with IBM Corporation. We are very optimistic about this newly signed partnership that will focus both on the SMB and enterprise segments with a goal of delivering on-demand solutions that expand beyond CRM capabilities by utilizing our new Apex platform. Together with IBM, we will leverage each other’s strengths to take the best solutions to market and expand our tradition of customer success.

I am also pleased to announce we have signed a global alliance agreement with Deloitte, and during the quarter, enjoyed several joint wins together, including Intercontinental Hotel Group, amongst others around the world. Already in the early stages of this important partnership, we are seeing tremendous potential.

In addition, we expanded our partnership with Cisco Systems and have teamed up to create a business class solution designed especially for small- and medium-sized organizations. Cisco Unified Call Manager express connector for salesforce.com will offer SMBs and branch offices a complete user-friendly solution for improving employee productivity and delivering superior customer service.

These partners and many others are coming to us not just for CRM but for the power of AppExchange and Apex, our new on-demand programming language and platform. Apex will allow our customers and partners to build and run virtually any application on demand, and it dramatically expands the potential for the AppExchange and the benefits that our platform can deliver to our customers.

With the Apex language, we are essentially popping the top off our platform. Now everyone will have the same power to create applications as our own developers here in San Francisco.

Armed with the tools of the Apex platform and programming language, IT organizations and ISVs will soon be able to tackle even their most complex business challenges.

It is the combination of Apex and the AppExchange where things really get interesting. Anything created with Apex can now be published and installed via the AppExchange , so developers anywhere in the world can build and distribute everything from custom buttons to components to complete applications. Customers will be able to browse, download and install what works for them from the AppExchange .

It is hard to believe that the AppExchange went live just 11 months ago. Today there are more than 430 applications on the AppExchange , up from 70 when we first showed it to you about a year ago at Dream Force 2005. More than 23,000 developers and more than 230 ISVs are working on bringing their best ideas to the AppExchange , and customers are really starting to see the benefits.

To date, approximately 165,000 application test drives have resulted in more than 15,000 installations at roughly 7,000 customers, making the AppExchange one of the most successful software service solutions in our industry.

We expect that our new Apex offering will dramatically expand this already incredible adoption.

We are now offering a full portfolio of applications, platform capabilities and services to our customers. This includes our team, professional, enterprise and unlimited editions of our applications. All of these editions continue to grow dramatically.

Our unlimited edition has been chosen by over 280 of our customers, including new implementations and upgrades with Cisco, Dun & Bradstreet, Astra Tech, and Borland. Our introductory pricing of unlimited edition at $195 per user per month will end on December 31st. With the new year, the standard price of unlimited edition will be $250 per user per month.

Unlimited edition is our premier offering for our most engaged customers, and the most powerful path to success on the business web.

Our partner edition, which includes five users for $1500 for one year, has emerged as our next killer application. Offering our existing customers the ability to extend their salesforce.com investment to their partners. In fact, more than 100 customers have already selected our PRM service to manage their partner relationships.

The customer highlight of the third quarter was Dream Force, our annual global gathering for customers and partners. We exceeded our most ambitious goals for this conference, with over 5,000 members of our community sharing the unique experience of Dream Force. That is nearly 70% more than the roughly 3,000 who attended just a year ago.

I would like to thank our customers and partners for bringing their incredible ideas and energy to this unique event, and thank General Colin Powell and special surprise guest, Mike O’Dell, for making this gathering so memorable.

As announced at Dream Force, to further accelerate the innovative potential of Apex and the AppExchange , we will be launching our new AppExchange incubators early next year. For $20,000 a year, a developer can rent a cube at our new San Mateo AppExchange headquarters and get access to valuable technical marketing and sales expertise on the world’s most compelling on-demand platform.

In addition, we already have VCs interested in setting up shop in our incubators so that they can be there on the ground floor as these innovative new companies launch their ventures on AppExchange .

Finally, as we announced at Dream Force last month, later this quarter we plan to deliver the newest version of our service, Winner 07. This new release will include a fantastic mix of features from auto reminders to embedded match-ups, and in our tradition of rapid innovation, these new capabilities will help our customers to get more out of their implementations.

Our customers are using the system with record throughput, performance, and reliability. On October 31st, for the first time, we delivered over 60 million transactions in a single day in approximately 269 milliseconds per transaction. In the third quarter, we delivered more than 3.7 billion transactions, up 20% quarter over quarter. Our customers are using our system more often and more deeply for all aspects of their business.

We are now providing 1.6 million transactions per hour, or almost 500 transactions per second to our customer base. We did it all at greater than 99.9% reliability.

Driving much of this increased transaction growth was our AppExchange API volume, which for the first time represented more than half of our total transactions in the quarter. There is no better indication of our ability to integrate on demand with other applications and web services than this API volume. This level of deep, comprehensive use of our application programming interface is establishing a new standard for integration on the business web.

Speaking of standards, all of our performance data continues to be available in real-time at http://trust.salesforce.com. We believe that transparency is a core value of all multi-

tenant on-demand services for business.

The future of our industry will be delivered on demand. Gartner now estimates that 25% of enterprise applications will be delivered on demand by 2011. That is just within five years. Gartner predicts that more than 50% of all sales force automation will be delivered on demand by 2009, just three years from now.

These are amazing accelerations in the movement to on-demand computing, accelerations that salesforce.com is benefiting from as the largest supplier of on-demand business services.

Many will benefit from this change, but they will be following the leadership path we have been setting for the past seven years, with our world-class suite of products, our Apex platform and language, the AppExchange, and our unwavering focus on our customer success, we are leading the way in this new important marketplace. It is an obligation to continue leadership and innovation in on-demand computing.

With that, let me turn things over to Steve Cakebread, our Chief Financial Officer.

Steve Cakebread

Thanks, Marc, and welcome, everyone. As Marc mentioned, it was a great quarter. Strong revenue at $130 million, outstanding cash flow of more than $30 million, break-even GAAP EPS that included approximately $0.06 of stock option expense and purchased intangibles, and 61,000 net new subscribers.

Before I review the numbers, let me remind you that all the financial commentary today will be provided on a GAAP basis. This represents a change from how we presented our results in the first-half, when we excluded stock-based compensation and purchased intangibles from our reported non-GAAP results. Going forward, we will no longer report non-GAAP results that exclude these items, nor will we provide outlook on a non-GAAP basis, unless there is a material, non-recurring charge during the quarter.

On to my review of Q3 performance.

Our $130 million revenue performance was the best in company history, and represents an increase of 15% versus a year-ago quarter -- 57%, sorry, versus a year-ago quarter.

Geographically, the investments we have been making in our international organization are starting to show in our performance. Overall international business is now 22% of our revenue mix, up from 20% a year ago. International revenue continues their rapid growth, with the European revenues up 75% from the prior year, and Asia revenues increasing 70% year over year. Our strong growth in the Americas continued as well, this quarter with 53% growth year over last year.

Subscription and support revenues finished the quarter at $118 million, up 59% year over year. Driving this increase was outstanding customer growth and continued adoption of our broad-based solutions lineup.

Our professional services business posted another strong quarter, with roughly $12 million in revenue, representing a 40% growth from last year. As Marc noted, Q3 was the best subscriber addition quarter ever for the company, with 61,000 net new subscribers. We have added 163,000 subscribers in the last nine months, so you can tell we are very excited about our subscriber growth across all of our services.

You will notice that our reported cumulative total grew to 556,000 subscribers, from the 501,000 subscribers we reported in the second quarter.

In reviewing our subscriber reporting system, an error was discovered that caused us to adjust last fiscal year’s net paying subscribers downward by a total of approximately 6,000, or 1,000 in Q206, 3,000 in Q306, and 2,000 in Q406. This 556,000 aggregate subscribers we are reporting today is net of this adjustment.

It is important to note that this subscriber adjustment has no impact on our reported net subscriber additions for this fiscal year, and our reported revenue in any period. I call your attention to our detailed 8-K filing today, where we have provided you the adjusted subscriber totals.

While net paying subscriber additions remain a very important part of our overall strategy, they are becoming less correlated with our revenue performance. With six revenue generating service editions with a wide range of price points, a strategy of upgrading existing customers and a broad array of add-on products like Apex Mobile, Sandbox, and our new Salesforce for Google ad words, subscriber growth is just one part of our future revenue story. It is also why this small adjustment in subscribers is not material to our future revenue expectations.

Let’s go on to the rest of the P&L.

Gross margin continued to be relatively unchanged compared to last year. It is important to note that our year over year gross margin performance reflects an incremental stock-based compensation charge of more than $1.1 million in this quarter.

Operating expenses, GAAP operating expenses finished the quarter at 76% of revenue. While our GAAP operating margin declined roughly 8 points from last year, the comparison is not meaningful because of the more than $8 million in incremental stock-based compensation expense due to the implementation of FAS-123R.

As well this quarter, our effective GAAP tax rate of 79% fell five points sequentially. There is no meaningful year-over-year compare here, because you might recall that Q3 of last year brought with it a very large, one-time tax benefit of roughly $6.8 million. Given our growth and our profitability in various foreign tax jurisdictions, this number will continue to be somewhat difficult to forecast.

For GAAP net profit, it totaled $339,000 for the quarter, our best result for the year. It is important to note that comparing this quarter’s net profit performance to last year’s result is not especially meaningful because of the more than $9 million in incremental stock-based compensation brought on by FAS-123R reporting changes, and the large one-time tax benefit in Q3 of last year.

Our GAAP break-even EPS for the quarter was at the high-end of our expectations. Included in this result was roughly $10.2 million in stock-based compensation expense, and approximately $600,000 of purchased intangibles. Together, these items impacted our reported GAAP earnings by roughly $0.06 per share.

Average diluted shares outstanding during the quarter were 120 million shares.

Our cash generation continues to be outstanding. Cash flow from operations for the quarter was $30.6 million, the second-highest total in our history, and up 25% from last year. After our second consecutive quarter of $30 million plus operating cash flow, we have now generated more than $112 million in operating cash over the past four quarters.

The balance sheet continues to be rock solid as well. Total cash, cash equivalents and marketable securities finished the quarter at roughly $371 million, up 45% versus Q3 of last year.

Deferred revenue on the balance sheet grew to $219 million, a 73% increase from last year. This was the second quarter in a row with 70%-plus year on year growth in deferred revenue.

Let me conclude my remarks with our outlook for Q4, and an early indication for fiscal year ’08.

Given our strong Q3 performance and our continued strong business momentum, we now expect to exit the year with revenues of $493 million to $495 million. This translates into a Q4 revenue forecast of approximately $140 million to $142 million.

GAAP EPS is expected to be in the range of break-even to a $0.02 loss. This estimate includes approximately $10 million to $12 million of stock-based compensation and approximately $600,000 of purchased intangibles. Together, these items will reduce reported GAAP EPS by approximately $0.06 to $0.07 per share.

Average diluted shares outstanding are projected to be about 122 million shares.

On looking ahead to fiscal ’08, we believe the transition in our industry from on-premise to on-demand is clearly accelerating. Given our industry leading vision, best-in-class products, and customer and partner enthusiasm, we now expect revenue of approximately $700 million to $710 million for our full fiscal year ’08.

We plan to provide you with our GAAP EPS expectations for fiscal year ’08 on our Q4 results call, scheduled for mid-February, 2007. However, a couple of things to keep in mind. Our fiscal year ’08 GAAP EPS will continue to be reduced by stock-based compensation and the amortization of purchased intangibles. Our $60 million to $70 million in estimated stock-based compensation expense is projected to reduce reported GAAP EPS by roughly $0.32 to $0.37 per share next year.

Similarly, our $2 million in estimated amortization of purchased intangibles is expected to reduce reported GAAP EPS by approximately $0.01 per share.

To close, Q3 was an excellent quarter all around.

That concludes our call today. Thank you all for joining us, and I would like to open up things now for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from Laura Lederman of William Blair.

Laura Lederman - William Blair & Co.

Good morning. Great quarter. A few questions. Could you talk a little bit about churn? Has it changed at all in terms of the subscriber churn?

Steve Cakebread

We do not routinely talk about churn, and I do not think we will talk about it this quarter. Clearly we have done that traditionally in our Q4 results, so just stay tuned.

Laura Lederman - William Blair & Co.

Great. What about sales headcount, in terms of what you are seeing? A lot of the companies that I cover have seen some increase in churn and sales head, simply because it is a stronger environment out there. I was wondering what you were seeing.

Separately, could you just give us a quick update on the competitive environment? Are you seeing SAP at all? What about Siebel’s presence year over year, that sort of thing? Thank you, and then I will just pass it on.

Marc Benioff

In regards to sales leadership churn, I am sure you know that we really have not changed any of our sales leadership in any of our --

Laura Lederman - William Blair & Co.

I do not mean the leadership. I mean the actual feet on the street.

Marc Benioff

Yes, in terms of the feet on the street, or really the sales leadership, we are not seeing any dramatic changes one way or the other in terms of anything against the industry standard.

In our sales leadership in all of our major regions, that has been a very persistent team, which is really the key to our excellence sales performance, as we have a very experienced worldwide team in selling these solutions.

In this quarter, we also added a couple of other very senior executives into our sales team, including a new Co-President in Europe, as well as bringing online two more Senior Vice Presidents in the United States, and we are very excited about where we are from a sales leadership perspective, as well as from a worldwide sales capacity and sales distribution perspective, as well as demonstrated success in both small, medium and even the largest companies in the world.

From a competitive standpoint, I guess the big change has been the disappearing of Siebel from the marketplace. Our information is that Siebel on demand had approximately less than the number of subscribers after four or five years of being in business now than we have in total for this quarter. That is the 61,000 net paying subscribers exceeds what Siebel has been able to do.

Microsoft CRM 3.0 has been out there now for a while. This quarter was significant for us because we are starting to replace existing Microsoft CRM 3.0 implementations, and I hope that we will be able to give you actual account names soon. These accounts have tried to implement all this huge octopus of software but was not able to do that.

With SAP on demand, their two customers that they announced on launch in February, our information is neither one has been able to get it to run, so we feel very good about our overall competitive situation in terms of proven customer success, as well as the diversity and scale of our customer base. Does that answer your question, Laura? Okay.

Operator

Your next question comes from Thomas Ernst of Deutsche Bank.

Thomas Ernst - Deutsche Bank

Good afternoon, gentlemen. Thank you. A question for you, I think if you look at the performance of the business, it is obviously extremely strong, 20% sequential usage growth. I have not finished the math but about 20% free cash margins. The thing that strikes me is that this is in the year that you have been rolling the platform, AppExchange, Apex, promoting partnerships with Accenture, IBM, Deloitte. The question is, how much of your resources is it taking to make this transition to platform and reinforced partnership versus the core business that is generating the results today?

If you do not want to quantify that, maybe give us a sense of how much of it is the focus of the company, how much effort is it taking of your people’s time?

Marc Benioff

Well, it is integrated, and what I mean by that is that our platform makes our CRM service what it is today. It makes it better. It makes it customizable. It makes it integrate-able. It allows us to add new functions for our existing customers easily. It is part of what every sales and service professional has to be an expert in in the company.

We are not just a CRM service anymore. We are truly a CRM platform.

But, since you have been covering our company very closely, you have recognized that this CRM platform has become extremely advanced and has evolved to become probably the world’s only on-demand platform. The ability for our customers, ISDs, developers, and as you have pointed out, systems integrators, can easily build new applications using our platform.

This is very exciting. We have seen a lot of success in this area. In fact, we saw a major expansion with one of our customers this quarter with Electronic Arts, who has rolled out a recruiting application based on our platform globally. But the news was that Electronic Arts does not use us for CRM at all.

Those types of successes are appearing on a more frequent basis, and it is becoming part of our core competency to manage all of our customers’ information on demand.

David Havlek

Next question, please.

Operator

Your next question comes from Jason Maynard of Credit Suisse.

Jason Maynard - Credit Suisse

Good afternoon, guys, congratulations on the quarter. I have two questions for you. First, can we maybe dive into a little bit of the details of this IBM relationship, and perhaps talk about what it means in terms of any type of minimum commitments in terms of joint marketing funds, or any color that you can share with us on the relationship?

Marc Benioff

As you know, it has been very important for us to reach out to these traditional integrators and services providers with our solution. We know that they have been struggling deploying the traditional client-server model to their customers. In some cases, even as internal users of this technology. They have found us, maybe through an acquisition such as IBM’s acquisition of [File Mat], or through a customer relationship.

Now, we are seeing almost every major systems integrator ranging from Accenture, where we have had tremendous success throughout our customer base, to Deloitte as I mentioned, to even IBM.

The pipeline is beginning to manifest itself with a lot of exciting opportunities with these integrators in hand.

What is exciting to me about this is that maybe only a year ago, this did not exist at all as part of our business, and has Siebel has disappeared from the marketplace, these systems integrators have come to us to become their technology provider for a customer relationship management, and specifically for the on-demand platform. We look to continue to broaden our relationship with them and work with them to deliver the customer success that we are known for today.

Jason Maynard - Credit Suisse

Okay, so is there any financial component to the relationship that you can talk about?

Marc Benioff

Not that we can disclose at this time, and in the future, we will have a formal announcement with them and we will provide further details then.

Operator

Your next question comes from Kash Rangan of Merrill Lynch.

Kash Rangan - Merrill Lynch

Thank you very much, nice quarter. I have a follow-up question on the IBM relationship as well. I am just curious if you have any thoughts on how you go to market. Is there a specific sales division within IBM, be it vertical or horizontal, that is going to be trained on selling the on-demand subscription from salesforce.com? Any color at all that you can give on how long it takes to train these people to sell CRM subscriptions?

Since I suspect that the operator might cut me off and not let me ask a second question, I will ask Steve this question. Steve, any color at all on the cap-ex? I noticed that there was a nice bump-up. Any color commentary compared to the prior go-round, where we saw a nice step function in cap-ex? Where are you directing your investments these days, and what should we expect as a result of productivity? Thank you.

Marc Benioff

To answer your question about the systems integrators, let me answer it first generically and then a little bit more specifically.

What we have seen with these systems integrators is that it required us over the last two years to develop a new core competency inside our organization to train them, to educate them, to show them how to sell and market this new on-demand model. It was not second nature for them.

But we have learned how to do that, and of course we have so many great examples. For example, with Accenture, where we have done major implementations like Kaiser and Cisco and Chevron and so many others.

That is becoming true of a lot of these other systems integrators as well. In fact, we discussed the major customer implementation with Deloitte and others that occurred this quarter, and even with IBM, they are perhaps coming up to speed faster than we expected. We are now working on a significant public sector opportunity with them. That is very exciting to us, the potential, because we still have a relatively small distribution organization here, and these systems integrators can really reach out in these organizations with relationships that we do not have yet, so they are becoming a tremendous virtual extension of us.

We are seeing the movement from what I would say almost a year ago was denial -- on-demand cannot scale, on-demand cannot integrate, on-demand cannot customize -- to the point where we are saying now the only way to do it is on-demand.

As we get more consciousness and more excitement around that within these systems integrators, we see much greater success happening, so we are very excited about the emerging of these integrators. It has taken a tremendous investment over the last few years to get to this critical point, what I would consider to be a tipping point with the systems integrator community.

Steve Cakebread

Kash, with respect to the cap-ex increases, there is nothing new there. The number is up this quarter, but you have to keep in mind there is typically three things we capitalize -- leasehold improvements, we have been very aggressive in taking on new leases, and that has had a driver. Certainly we capitalize from beta to general release for software, and then also we have some internal systems development for our internal systems that we are working on. All three of those contributed to this quarter’s increase, but it also continues to be lumpy, because it is primarily driven by our external releases and our leases, so I would not draw any dramatic conclusions there, other than it is business as usual for us.

David Havlek

Next question, please.

Operator

Your next question comes from Daniel Cummins of Banc of America.

Daniel Cummins - Banc of America Securities

Thank you. I had a couple of questions about the acquisitions, if you could just give us an update on the two acquisitions, and I had a question about mobile. You mentioned partner edition, Marc, but mobile has been out there a little bit longer. If you could give us a sense of how that is doing.

Marc Benioff

Sure, I would be delighted to. First of all, in regard to the two acquisitions, as you know, our first acquisition was with Ascendia Corporation out of Santa Monica, California. We repurposed their technology and developed our AppExchange Mobile, allowing for any application built with our AppExchange technology, or even our core CRM offering, to run on any mobile device.

This has been very well-received by our customers. In fact, I even have it running on my own BlackBerry here, but perhaps the most important part of that is that we bundled it into our unlimited edition, and it became one of the driving factors that so many of our customers are teed up to upgrade to unlimited edition.

By bundling AppExchange Mobile and Sandbox and our premium support into unlimited edition, we really provided the critical threshold to get our customers to move from our dominant edition on the larger accounts, which was enterprise edition, to unlimited edition. The higher ASP of unlimited edition and its price increase, which is going to happen at the end of this calendar year, we believe is critical for our overall ASP growth in our largest customers.

From that perspective, and from the perspective of having an outstanding technology that further differentiates us in the mobile space with both the core CRM offering and the AppExchange technology, the Ascendia acquisition was a home run.

The second acquisition, of course, was Kieden, who had developed a critical technology that integrated salesforce.com with Google. This product, which we then repurposed and re-delivered as Salesforce for Google Ad Words, has really been another tremendous success. In fact, it has had over 700 AppExchange installs already, and over 250 of our customers have activated this product.

It lets them create ads in Google directly from salesforce.com, place those ads, and then monitor the success of those ads using our Dashboard technology, but most interesting, allows them to move leads generated from Google automatically into salesforce.com. In fact, they bought over 185,000 keywords on Google, managing a collective $20 million annual ad budget with this product. Pretty interesting for such a new offering, and something that we are learning a lot about.

Our customers tell us it helps them to reduce click fraud and get a much higher level of efficiency with their advertising campaigns, both things that we are very excited about and we believe that will lead to greater levels of customer success.

Operator

Your next question comes from Rick Sherlund at Goldman Sachs.

Rick Sherlund - Goldman Sachs

A couple quick questions. First, any thoughts on net new subscribers for this next quarter? There was Cisco, 7,500, a bubble, so would you caution us about extrapolating too much going into Q4? Also, just any comments on the stock comp charge for next year. It seems like it is up quite a bit from this year. What is happening there? Any comments on tax rate or cash flow guidance going forward?

Marc Benioff

Let me answer the first part of your question, and then I will lead it over to Steve. Of course, Rick, as you know, we do not give guidance or forecasts on our subscriber number, just because it is so hard to do so.

Of course, we have been excited to see the subscriber growth increase over the last several quarters, especially with the introduction of so many of our new editions and the uptake from our customers. Of course, we are going in to our fourth quarter right now, so of course we are very optimistic about the potential.

But what that specifically will mean and how the number will, what the specific number will shake out, I cannot tell you. Of course, we were very happy with the 57,000 subscribers last quarter. This quarter, we are very happy with the 61,000 subscribers. To know exactly what that will be for the following quarter, we are not very good at predicting the future because it is a lot about what happens during that period, but we have a lot of exciting opportunities, so we are optimistic.

Steve Cakebread

Rick, with regard to the stock comp, the stock comp expense is driven by the number of shares or option grants that you give. Of course, we continue to hire fairly aggressively, so we are going to continue to grant options. I will remind you, however, that our stock option program only allows us to dilute our shares by about 4% next year.

The other driver is stock price, and so there are always estimates and expectations around that.

We are going to continue to hire aggressively and that is going to cause us to have increasing stock option expenses.

Operator

Your next question comes from Heather Bellini of UBS.

Heather Bellini - UBS

This is [Abdul] for Heather. Two questions, actually. Marc, could you talk a little bit about the adoption of the OEM edition and what type of feedback you are getting for that edition?

Then I have a question for you, Steve. Regarding this adjustment to subscriber numbers, could you elaborate a little bit on what caused that? Is there a change in definition of subscribers? Was there an error in the system, which has been fixed and the numbers should all be clean from now on?

Marc Benioff

In regard to the OEM edition, we are very focused on increasing the adoption and success of that. Of course, that is about customers who are building applications entirely on our platform. We believe with Apex that is going to accelerate next year.

In fact, we are getting ready to open our new AppExchange incubator in San Mateo. That will allow us to work closely with these developers to build a variety of new applications that we believe will run on this new OEM edition.

We are very excited about the potential for the OEM edition and how it will play out. We hope to be able to announce some major new ISV successes with the OEM edition over the coming year.

Steve Cakebread

With regard to the subscribers, as you know, it is a pretty small adjustment. We have been working on a new internal application to report subscribers with all our new editions and add-ons. When we implemented it, we discovered there was a small anomaly and we talked about that today. We corrected that. You can get the details in our 8-K. This anomaly did not have any impact on our financials.

Operator

Your next question comes from Phil Rueppel of Wachovia Securities.

Philip Rueppel - Wachovia Securities

Great, thank you, and good afternoon. First of all, a question on the AppExchange. You said you now have 15,000 installs. I was curious as to the applications that customers are using. Is that pretty widely distributed, i.e., does it have a long tail? Or are there just a handful of applications that are proving really popular? If that is the case, what are those applications?

Then, second would be just a clarification. Did the 7,500 new Cisco seats go live during the quarter, and therefore were included in the 61,000 new subscriber count? Thanks.

Marc Benioff

Sure, and let me answer your second question first, which is yes, the 7,500 incremental for Cisco that made it our largest customer with 15,000 total activated subscribers, occurred in the third quarter, which is why we are reporting it today that Cisco Systems is now our largest global customer with 15,000 subscribers.

In regard to your other question about AppExchange, the most popular application, I would really bring you to our AppExchange home page at appexchange.com. You will see in the top right-hand corner the most popular applications.

That of course is only part of the story. Our customers have built I believe over 60,000 custom objects which are custom applications themselves, which are wide-ranging and make up very much what you suggested, the long tail.

In our opinion, AppExchange is really exciting for two reasons.

First, yes, you can find a great application in the AppExchange for e-mail marketing or project management or even recruiting, like I mentioned with Electronic Arts. But also, you can find other objects and components, as well as all kinds of tools for building your own custom application inside your own implementation of Salesforce to deliver whatever you want.

We are seeing tremendous creativity and impact by our customers in building these custom AppExchange objects, so we are very excited about the long tail that this has created.

Also, that means the potential for the ISV across the globe is going to be just extraordinary.

Operator

Your next question comes from Brendan Barnicle of Pacific Crest Securities.

Matthew Kossen - Pacific Crest Securities

Hi, this is Matthew [Kossen] for Brendan Barnicle. Now that AppExchange and Apex have been well established and successful, are you thinking about going into other vertical applications, like human resources or financial? Also, how has pricing been in the marketplace?

Marc Benioff

Well, that is a great question and we are planning to go in two verticals. The first one, in fact, is now live on the AppExchange. It has not really been noticed very well, but it is actually in your industry. It is financial services. I would encourage you to take a look at this.

I am sure you know salesforce.com is really successful in the financial services vertical. We have large implementations with the largest banks in the world today, and they have asked us to do more.

In the AppExchange, we have now launched a financial services vertical. In that financial services vertical, you will find a variety of applications that have been built by us as well as by third parties. We are even working on a new workstation for the financial services marketplace that we call a Private Wealth Workstation, that we plan to be demonstrating more over the coming year, which will find a place right here in our financial services vertical inside the AppExchange, which I encourage you to look at.

As we continue to understand what our customers want us to do more of, you will see more of these verticals emerge and you will see them emerge through the AppExchange.

Operator

Your next question comes from Nathan Schneiderman at Roth Capital Partners.

Nathan Schneiderman - Roth Capital Partners

Hello, thanks very much. A couple questions for you. In the past, you have made some comments about off balance sheet backlog, suggesting that was about the same size or even a little bit greater than what is on the balance sheet. I was wondering about the trends there. Is that still the case, or has that increased?

Then also, in terms of your bookings mix, I am wondering if that is shifting a little more towards larger deals and if so, if you are becoming a little more back-end loaded in terms of your bookings.

Steve Cakebread

No, Nate, on the off balance sheet, again, that is one of those things we talk about on occasion but not this quarter.

Operator

Your next question comes from Peter Goldmacher of Cowen.

Peter Goldmacher - Cowen & Co.

Hi, I just wanted to confirm something you said, Marc. Did you say you have 280 customers using unlimited edition?

Marc Benioff

Yes, that is I believe what I said. That of course is at the end of the last quarter, so it probably has increased a little bit since then.

Peter Goldmacher - Cowen & Co.

Okay, so that is about 1% penetration into your customer base. What can we extrapolate from that about your success at the high-end of the enterprise? I would have thought that unlimited edition would have sold very well into the high-end.

Marc Benioff

Well, yes, it is selling very well into the high-end, so that is an excellent observation.

As you know, unlimited edition has only been available for a few months and it takes a while for our customers to get an offering like that into their purchasing cycle. Of course, a lot of them are already on contracts for other editions of the product, so in many cases they wait for those contracts to renew before they upgrade.

We are very impressed with the number of customers already on unlimited edition. As I mentioned, as part of the increase with Cisco Systems from 7,500 to 15,000, I believe approximately all 15,000 were unlimited edition. We also saw that with Dun & Bradstreet and many of the other transactions we did this quarter.

New upgrades this quarter, or new deals this quarter were really done on unlimited edition. Even Astra Tech in Europe, or even here, Borland in Silicon Valley, were unlimited edition wins. We expect unlimited edition to continue to be a real barn-burner for us in terms of increasing our ASP with these customers, which is a core to our strategy.

You will note also that unlimited edition's price will increase from $195 per month, per user, on December 31st to $250 per user, per month next calendar year.

Operator

Your next question comes from Brent Thill of Citigroup.

Brent Thill - Citigroup

Marc, you mentioned the price increase of unlimited. It seems to be a healthy 28% increase. Does this embed new features or is this just, given your comments in terms of the adoption rates running above plan, you feel like you can raise that price point at that level?

Marc Benioff

We feel very optimistic about increasing that price for two reasons.

First, we wanted to create an introductory price that gave us the reference base inside our own customers that our sales people could use to sell at this higher price, which we have now done with these 280 closed deals.

We also found feedback from a lot of our customers who said when we gave them the original $195 introductory price that they would have been willing to spend a lot more. When we ran through our focus groups, the $250 price, they did not blink.

We are very optimistic about the potential of the price increase. It is also, of course, timed towards the end of our fiscal year-end by triggering it at the end of December, so we think our sales people will be able to go back to a lot of our customers and talk to them about upgrading to unlimited edition as soon as possible.

Operator

Your next question comes from Rob Schwartz of Jefferies and Company.

Robert Schwartz - Jefferies & Company

Thanks so much. One question for Steve and one question for Marc.

Marc, I was wondering, given this price change, where do you think the ASPs will be trending for you? Will they be driven as much by upgrades or more by linearity on any one quarter, linearity of sales of the quarter?

Then, for Steve, it seems that the margin on professional services really took a dip this quarter. I am wondering what is behind that. Is that a trend we should think about modeling going forward?

Marc Benioff

Let me address your ASP question first. As you know, ASPs really have not changed that much because our mix of subscribers is so varied. How this new price for unlimited edition will affect our ASP going forward, it is kind of hard to tell, honestly, because we just do not have the model until we see some actual numbers.

It has been surprising that the ASP has been so solid. Some people might have said it likely would be going up with unlimited edition, other people might say it was going down because of the mix is including some lower-priced editions. The reality is it just kind of stayed about the same.

We are not very good at predicting what it will do. We are going to watch it closely but of course, for our largest customers and our most committed customers, we are going to work hard to move them up our edition ladder.

What that means is that we have a lot of customers who come in on team edition or a pilot on professional edition, and we try to move them up to enterprise edition. As they do more work on customizations and integration and using more of those features, then we go back to them and move them up to unlimited edition. That has been true of a lot of our customers.

We have this wonderful edition ladder and it gives our sales people the ability to work with these customers over time to move them up that ladder, and that is something that we want to do. It is a core part of our strategy, and it has worked well. If you talk to our customers, you will find they are receiving excellent value from our unlimited edition offering.

Steve Cakebread

With regard to the services margins, no, the services business has been growing fairly rapidly, as we described in the script. As well, the margins are impacted by what we call EITF-21, which is amortization of some of those services over time.

If we have a broader mix of services business that gets EITF-ed, you will have some impact on margin, but it is a combination of continuing to grow our resources in advance of our billings and then amortization of those expenses.

Then, on the last question, because sorry, Nate, I got cut off quickly, in terms of mix of our business, we are still in a small, medium and large mix of a third, a third, a third. You have heard us talk a lot about big deals this quarter. We are very excited about those large customers, but our business mix stays in that relative mix model. It has not changed over time at all.

David Havlek

One last question.

Operator

Your final question comes from Mark Verbeck of Cantor Fitzgerald.

Mark Verbeck - Cantor Fitzgerald

Thank you. Congratulations on the results. A question on the upgrade to unlimited edition. If people do not wait for their contract to renew, are they typically signing a new annual agreement at that point? If someone has signed up for this promotional rate, how long are they entitled to that rate before their pricing would reset to the new pricing? Thank you.

Marc Benioff

Well, it is a good question and every customer is a different situation, and that is one of the reasons that we have a global sales force.

As we go from country to country and industry to industry, as well as the difference between small and medium and large, or even Fortune 100 accounts, what we have found is because of the diversity of our market, we have to have a sales force that is able to reach out to that customer wherever they are.

Then, what that means is that pricing and that agreement with that customer needs to be put together exactly for them. You would be surprised how important that is in our overall success, and it has been a critical part of the company that we have built and one of our core competencies in executing globally.

As our customers put together an initial agreement, we put together the right price and performance for them. Then, as we see them succeed and grow, add users and get ready to move editions, we do exactly that. We help them renew their agreement. We help them change editions, and we will do everything necessary to make them successful. At salesforce.com, nothing is more important than our customers’ success.

Operator

I will now turn the call back over to David Havlek for a few closing comments.

David Havlek

Thanks, Michelle. Before we close up today, I would like to remind you of a couple of upcoming appearances by salesforce.com executives at some upcoming financial conferences.

First, Marc will be appearing as keynote at the Credit Suisse Tech Conference in Phoenix, Arizona, on November 29th. It should be a great event, so we will look forward to seeing you all there.

Second, George Hu, our newly appointed Chief Marketing Officer, will be appearing at the Lehman Tech Conference in December, on December 7th here in San Francisco. If you have never met George, I encourage you to come on out. I think you will find it a most useful event.

Finally, if you have any follow-up questions to today’s call, or any of our quarterly performance, please contact Investor Relations at investor@salesforce.com.

That concludes today's call. Thank you very much for joining us and have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today’s salesforce.com third quarter fiscal year 2007 financial results conference call. You may now disconnect.

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Source: Salesforce.com F3Q07 (Qtr End 10/31/06) Earnings Call Transcript

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