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Salesforce.com, Inc. (NYSE:CRM)

F2Q09 Earnings Call

August 20, 2008 5:00 pm ET

Executives

David Havlek - Investor Relations

Marc Benioff - Chairman of the Board, Chief Executive Officer

Graham V. Smith - Chief Financial Officer, Executive Vice President

Analysts

Kash Rangan - Merrill Lynch

Laura Lederman - William Blair

Thomas Ernst - Deutsche Bank

Analyst for Heather Bellini - UBS

Mark Murphy - Piper Jaffray

Brent Thill - Citigroup

Tom Roderick - Thomas Weisel Partners

Philip Winslow - Credit Suisse

Ross Macmillan - Jefferies & Company

Peter Goldmacher - Cowen & Company

Derrick Wood - Pacific Growth Equities

Sasa Zorovic - Goldman Sachs

Steven Koenig - Keybanc Capital Markets

Operator

Good day, ladies and gentlemen. My name is Gerald and I will be your conference operator. At this time, I would like to welcome everyone to the Salesforce.com Q2 2009 financial results conference call. (Operator Instructions) I would now like to turn the conference over to Mr. David Havlek, Vice President of Investor Relations. Sir, please go ahead.

David Havlek

Thanks, Gerald and I’d like to welcome everyone to today’s call. Earlier today, Salesforce.com released the results for its second fiscal quarter 2009. A full disclosure of those results can be found in our second quarter results press release as well as in our Form 8-K filed with the SEC. Additional financial information beyond what is provided in the press release can be found on our website.

Joining me today as always to discuss our second quarter performance are Chairman and Chief Executive Marc Benioff and Chief Financial Officer, Graham Smith. Following Mark and Graham’s prepared remarks, we’ll open things up to your questions.

Before we begin, let me remind you that all of our financial commentary today will refer to GAAP results unless otherwise stated. Also, please note that today’s call is being webcast and a replay will be available shortly following the conclusion of the call through the fifth of September.

The primary purpose of today’s call is to provide you with information regarding our second quarter fiscal year 2009 performance. However, some of our discussion or responses to your questions may contain forward-looking statements. These statements are subject to risks, uncertainties, and assumptions. Should any of these risks or uncertainties materialize, or should any of our assumptions prove to be incorrect, actual company results could differ materially from these forward-looking statements.

All of 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 most recent Form 10-K, particularly under the heading risk factors.

To access the press release, the additional financial detail, the webcast replay, or any of our SEC disclosures, I encourage you to visit our investor relations website at salesforce.com./investor.

Should you have any questions following the call, please contact me directly or send an e-mail to investor@salesforce.com.

Lastly, before I turn things over to Marc, please be reminded that any of our unreleased services or features referenced in today’s discussion or in any other public statements are not currently available and may not be delivered on time, or at all. Customers who purchase our services should make the purchase decisions based on features that are currently available.

With that, let me turn the call over to Marc to tell you about our outstanding second quarter.

Marc Benioff

Thanks, David. Our second quarter results make it official -- Salesforce.com has become the first ever software as a service company to achieve an annual revenue run-rate of more than $1 billion. This is an exciting milestone and fulfillment of our dream, not only for Salesforce.com but also for the entire software industry. It demonstrates that an important new model has taken hold as the future of software.

We are proud of our employees, who have set a new standard for delivery and innovation. We are proud of our technology, which sets a standard for enterprise software as a service. But most of all, we are proud of the unprecedented success of our customers. That success has been the common thread from the start and sets the tone for continued momentum of our new industry.

Passing this important milestone also sets the stage for a new dream. We are now laying the groundwork for the future, to join the elite group of software companies that have passed $2 billion in annual revenue. The first decade has been all about delivering enterprise software as a service, and we’ve established the standard for customer success in this new industry. As we look to the next level, we will continue to focus on CRM, software as a service, and our application product line. But now, we’re pioneering a new frontier as well -- our force.com platform as a service is an exciting new model that is energizing developers and inspiring ISVs to build their own applications using our services in the cloud. Along with our core strength in applications, force.com platform as a service will be the critical innovation to fuel the next level of success for our company, our partners, and most importantly, our customers.

Now, let’s review our spectacular second quarter. Second quarter revenue rose by 49% from a year ago to more than $263 million. Our growth powered record earnings and cash generation as well. GAAP EPS of $0.08 was at the high-end of our outlook and more than twice what it was a year ago. Those earnings translated into roughly $53 million in operating cash generation during the second quarter.

Over the past 12 months, we’ve generated roughly $270 million in operating cash and more than $210 million in free cash. On a per share basis, that translates into operating cash of more than $2.00 per share and free cash of more than $1.70 per share.

Underlying that financial performance is a breakthrough quarter for customer success. In the second quarter, we added a record 4100 net new customers. Today, roughly 47,700 customers around the globe are using our services and platform to run their businesses using our applications and platform services in the cloud.

Topping our list of customer success this quarter, I am thrilled to report that we have expanded our relationships with several of our largest and most important global customers, including Dell, Citi, and Canon. Of note, Dell has signed a three-year agreement through 2011 to use the force.com platform to build and deploy applications to their entire global workforce. This was the single largest transaction in our history and makes Dell one of our most diverse customers. Dell will use Salesforce services for sales force automation, partner relationship management, innovation management through their Dell ideastorm.com website, customer support, and full enterprise wide application and deployment using force.com platform as a service.

Dell and many of our other large customers are establishing a new benchmark of success in enterprise cloud computing. In fact, our growing portfolio of application services, together with our platform as a service, resulted in expansion at a long list of customers in the second quarter, including Hitachi, Paychex, Moody’s, Liberty Mutual, [Sportzilla], [Dunn & Bradstreet], [Air Liquide], GMAC, Chevron, Qualcomm, and General Electric.

And among the more than 4,000 new customers in the second quarter, we are happy to welcome the following industry leading companies to our customer community -- [Harrah’s], AT&T, Alcan Cable, Cap Gemini, Pioneer, and Nikon.

Significantly, many of these new customers are using applications or platform services outside of our traditional Salesforce automation quarter. Customers expanded their use of our application family by adding marketing automation, partner relationship management, customer call center, customer portals, innovation management with [ideas websites], content management, and our mobile offerings as well.

A great example of this trend is the momentum we are seeing in partner relationship management, or PRM. This service continues to gain momentum and is fast becoming a standard for our customers managing their indirect channels. Among more than the 250 new PRM customers in the second quarter, the highlight was a significant new agreement with VMWare. VMWare eventually plans to manage a global network of more than 75,000 subscribers using our PRM service, our largest PRM deployment to date. Other notable PRM wins in the second quarter included Bell Mobility, Harley Davidson, Motorola, Red Hat, Sony, and Websense.

In addition to this record-setting level of new customers, we deepened our relationship with our strategic partner, Google, in the second quarter. We have worked with Google to integrate with search ads and apps. We are currently working on deeper integration of our two cloud computing platforms, starting with the announcement of the force.com toolkit for Google’s APIs.

As more enterprises seek to take advantage of the power of cloud computing, it’s important for leaders like Salesforce.com and Google to constantly collaborate on these new tools and standards.

We are also expanding our partnership with Apple. We are pleased to be the exclusive CRM offering at Apple’s launch of the new iPhone 3G and app store last month. Salesforce customers and developers were immediately able to not only run our Salesforce automation application on the new iPhone but also deploy customer force.com applications on it as well.

We are seeing customers develop exciting new mobile apps for the enterprise using this important new device, all of them running natively on force.com with no new code. Already, the Salesforce.com iPhone edition has been downloaded more than 40,000 times in less than six weeks. We believe this is just the beginning for Salesforce.com and the iPhone.

In our core CRM service, we successfully launched our summer ’08 service in the second quarter to all of our subscribers worldwide. We updated all customizations, applications, and integrations in the process, leaving no customer behind. The experts continue to recognize this tradition of excellence. In July, Gardner placed Salesforce SFA in the leaders section of the magic quadrant and E-Week gave us an excellence award for best business application.

Many of you joined us on the road in the second quarter with our global developer road show, Tour de Force. We traveled from San Francisco to Atlanta to Chicago to Boston to New York to London to Dublin to Tokyo and back to San Jose with our message of cloud computing and platform as a service. More then 5,000 attendees joined us for our full day event. Customers, developers, and ISVs are realizing that they can become the next [Salesforce.com] by building natively on our force.com platform.

The proof is in the numbers. Just a few days ago, we logged our 100,000th developer registration. That is roughly double the 50,000 we had at Dream Force less than a year ago.

Adoption of our native platform technologies has been tremendous and nothing illustrates that better than the [inaudible] statistics our customers are creating with the force.com platform. Developers have now created more than 10.5 million customizations in our services, more than 125,000 custom workflow rules, more than 6 million lines of APEX code are now in production, and more than 28,000 custom interfaces using our new visual course, user interface as a service, up from 11,000 just one quarter ago.

These customizations have resulted in the development of more than 80,000 custom applications on force.com. Most importantly, these applications resulted in a record 11 billion transactions delivered at approximately a third of a second each in the quarter. Why do these statistics matter? We believe that every customization, every line of code, every new interface that our customers create makes them not only more successful but also more loyal. When we see usage of our system growing faster than our subscriber base, we see powerful evidence of customer success at work and successful customers stay with Salesforce.com.

A great example of this innovation is [Pattrazo], a small Bay area start-up focusing on eco-friendly building materials. Last week I invited President James Sheppard to show my global management team how his company has leveraged the force.com platform to build ERP and MRP services using our technology. James demonstrated customer service and order management, finished goods inventory management, production planning and scheduling, raw materials and management, shipping and logistics, document management, and warranty management.

As always, our customers are demonstrating the power of our platform better than we can. [Pattrazo] is proof that the force.com platform can be used by companies of any size to manage virtually every aspect of their businesses. Custom apps that add unique value to business no longer have to be expensive, multi-year projects for big corporations. The force.com platform as a service empowers every company of every size in every geography.

The strength of our platform is also helping our partners build impressive businesses and the market is paying attention. A great example is Ribbit, which launched on the app exchange just a year ago. Last week, Ribbit was acquired by British Telecom and published reports put the price at over $100 million.

The innovative spirit of our customers and partners will be in full force in November at the SAS event of the year, Dream Force 2008. This year’s event will be in San Francisco, from November 2nd through the 5th. We are expecting approximately 10,000 attendees with exciting keynotes from Michael Dell, Google’s Larry [Brillian], musician Neil Young, and author Malcolm Gladwell and many others. Rock legends Journey will be our musical guest. I encourage all of you in the financial analyst community to contact David Havlek to reserve your seat today.

For further information, take a look at our website, www.dreamforce.com.

Finally, I would like to close my comments today by discussing the strategic acquisition of InStranet, which we announced earlier today. We believe this exciting addition to the Salesforce.com family will make our service and support applications the clear market and technology leader. InStranet is the choice for knowledge-based management and many of the world’s largest and most important call centers, including those at Orange, Comcast, and T-Mobile. They are a great track record of customer success. Their best-in-class technology, and their superlative team made InStranet a great fit for Salesforce.com and our customers. A robust knowledge based application is a top request from our customer service and support customers, and we’re confident that this new capability will help accelerate our growth in that business and put Salesforce.com into larger service and support deployment.

Service and support remains one of our biggest opportunities and this acquisition signals our most aggressive assault to date on this $3 billion market. The InStranet acquisition is another major step towards our goal of creating the same level of success for customer service that we are known for in sales organizations, and while we’ve already started to build a community of successful call center and [portal] customers at great companies like Frontier, [inaudible], Qualcomm, and TDAmeritrade, the InStranet acquisition positions us to fully exploit this massive market, one that rivals our core Salesforce automation market in size.

To tell you more about the specifics on the accounting for the InStranet acquisition, as well as provide more detail on our outstanding second quarter record financial performance, let me turn over the call over to Graham.

Graham V. Smith

Thanks, Marc. Q2 was another excellent quarter for Salesforce.com. Second quarter revenue of $263 million rose 49% from the year-ago quarter. To put that in perspective, we’ve already achieved more revenue in the first two quarters of this year than we did in all of fiscal 2007.

Our revenue continues to diversify across several dimensions. First, customer [size] -- our revenue continues to reflect a roughly equal mix among small, medium, and large enterprise customers. Selling to customers of all sizes remains a core part of our strategy.

Next, as Marc mentioned, we are selling a broader mix of our services than ever before. Our growing portfolio of application and platform services is creating a range of opportunities for our account executives to pursue. As a result, we sold more non-SFA services in Q2 than in any previous quarter, and we believe this trend will continue.

And as Marc also mentioned, we are selling these services to customers in many different industry verticals -- from technology to financial services to hospitality.

Finally, our geographic revenue diversification continues to improve. Revenue in Europe rose by 69% year over year, while revenue in Asia increased by 79%. As a result, our international business now represents 28% of revenue, up from 24% a year ago. Our overall year-on-year revenue growth of 49% benefited by roughly five points from currency rate. This highly diversified revenue stream, together with its recurring nature, gives us great confidence in our business going forward.

Turning next to gross margins, gross margin for the second quarter was 79%. That’s flat with Q1 but up almost 300 basis points from a year ago. Our professional services business had its second consecutive quarter of more or less break-even performance, which is really encouraging.

Operating expenses were well controlled at 73% of revenue, again flat with Q1 levels. Within the expense categories, G&A declined by roughly one percentage point from Q1, and this decrease was offset by a one-point increase in R&D spend. Sales and marketing as a percentage of revenue remained unchanged.

We added roughly 180 heads during the second quarter to finish with just under 3,050 full-time employees. That brings our total additions for the first half of this year to 440 employees, and that compares with an increase of roughly 230 in the first half of last year. Because growth remains our top priority, and because adding sales and development capacity remains our biggest growth task, we will continue this aggressive hiring.

On a GAAP basis, flat gross margins and operating expenses naturally led to flat operating margins in the second quarter. Nevertheless, at just over 6%, Q2 operating margins were more than 400 basis points higher than they were in the second quarter of last year. Excluding the effects of nearly $90 million in stock-based compensation, our operating expense margin for the second quarter was roughly 13%.

Interest income was flat sequentially and continues to reflect both a low interest rate environment and our [inaudible], which is very much focused on preservation of capital.

Our tax rate was 48% for the quarter, in line with our forecast rate for the year.

Turning to cash flow, as we have discussed before, our ratable revenue recognition model affects our income statement significantly. With the exception of sales commissions, all of our sales and marketing expenses associated with acquiring new customers are recognized as incurred. Our amazing success in adding new customers means that we are constantly adding expenses to fuel our growth but the revenue from those customer relationships is recognized over many years, similar to an annuity.

However, from a cash point of view, almost all of our customers are billed quarterly or annually in advance, and hence we believe that our cash flow performance is a far better measure of our operating performance.

The second quarter, as Marc mentioned, we generated approximately $53 million of operating cash. That’s an increase of 53% from Q2 of last year and year-to-date operating cash of roughly $137 million is up more than 90% from the first half of last year.

Capital spending declined [inaudible] Q1 to roughly $13 million in the second quarter. Our capitalized expenses were primarily leasehold improvements, along with some capitalized software, which is similar to past quarters.

Netting the effects of CapEx, free cash for the second quarter was approximately $40 million. That’s an increase of more than 60% from the year-ago quarter, and year-to-date, we have generated roughly $100 million in free cash, an increase of approximately 120% from the same period in fiscal ’08.

Our balance sheet continues to be rock solid. We executed the quarter with more than $823 million of cash and marketable securities. That’s up more than $70 million from Q1 and up more than $325 million from a year ago. We are fast approaching our next billion dollar mark -- that $1 billion in cash -- and that’s truly impressive.

Total deferred revenue grew by $9 million from Q1 to finish the quarter at roughly $480 million. That’s an increase of 49% from Q2 of last year. Deferred revenue including the off-balance sheet backlog of business that is contracted but not yet invoiced, has grown by more than 60% year over year for the past three quarters. Because our largest customers increasingly want to enter into long-term partnerships with multi-year agreements, we are seeing really strong growth in backlog.

To close on the balance sheet, we did a good job once again in managing our collection. For this reason, accounts receivable continues to grow less quickly than revenue, finishing up 2% sequentially and 29% from the year ago period. Our DSO was 50 days at the end of July. That’s down from 59 days a year ago.

Before I move to our outlook, I would like to discuss two important points that will definitely have an impact on our second half results, and a third point that may have an impact.

First, the InStranet acquisition, which we believe will provide game-changing technology for Salesforce CRM customer service and support. In the near-term, however, as we transition that product to the [FAS] model, our second half financials will be impacted. Specifically, we expect approximately a $0.05 reduction to our GAAP EPS. Cash flow will also be commensurate with the impact.

And while InStranet brings with it a vibrant customer community, purchase accounting rules require us to significantly write down the existing deferred maintenance revenue. As such, we anticipate almost no revenue to be recognized from InStranet in the second half. However, we do expect the InStranet acquisition to be EPS neutral in fiscal 2010.

Second, our November Dream Force event is in our fourth fiscal quarter this year. In prior years, we’ve hosted Dream Force in our third quarter. This is our biggest customer event of the year and the net cost after sponsorships and registration fees translates into approximately $0.01 of earnings per share.

As a result of moving Dream Force from Q3 to Q4, however, expenses that in prior years would have been recognized in Q3 will this year be recognized in Q4. This will have the effect of moving approximately $0.01 of EPS from Q4 to Q3 this year, and it’s important that you factor this timing change into your estimates as you model the back half of our year.

The third point is the recent unprecedented strengthening of the U.S. dollar. As I mentioned earlier, our year-over-year revenue growth rates in the first and second quarter both benefited from currency translation by approximately five points. As the dollar strengthens, it produces a drag effect on our revenue growth and to a lesser extent, profit growth.

We have factored in a reasonable view of FX rates in our second half outlook but clearly the volatility in these markets could have an impact on our revenue and EPS in the second half of the year.

Now on to our outlook -- for the third quarter, we are expecting revenue in the range of $273 million to $274 million. Excluding the effect of the InStranet acquisition, our EPS outlook is in the range of $0.08 to $0.09. However, including the effects of the InStranet acquisition, estimated at $0.02 for Q3, we estimate GAAP earnings per share to be in the range of approximately $0.06 to $0.07. These projections include an estimated $20 million of stock-based compensation, roughly $2 million of amortization of purchased intangibles, including InStranet.

In addition, we expect our GAAP tax rate to remain at 48% and our fully diluted shares outstanding to be approximately 127 million shares for the third quarter.

For the full year, we are raising our revenue outlook to $1.070 billion to $1.075 billion. Excluding the effect of the InStranet acquisition, our EPS outlook has improved to $0.34 to $0.35, as compared with our prior guidance of $0.33 to $0.34. However, including the effects of the InStranet acquisition estimated at $0.05 for the full year, we now estimate GAAP earnings per share to be in the range of approximately $0.29 to $0.30. This estimate assumes full year stock-based compensation expense of $83 million, amortization of purchased intangibles including InStranet of $6.6 million, a GAAP tax rate again of 48%, an average of approximately 126 million fully diluted shares outstanding.

To close, Q2 was another excellent quarter. We achieved all of our critical goals and are positioned for a very strong second half. We look forward to seeing you at Dream Force in early November and to discussing our progress with you on our third quarter results call later that month.

With that, let me turn the call back to the operator so that we can take your questions.

David Havlek

Jill, do you want to --

Question-and-Answer Session

Operator

(Operator Instructions)

David Havlek

Just quickly here before we take our first question, I would like to ask analysts to limit themselves to one question today. I can see that the queue is filling fast and we want to get to as many of you as possible. If you would like to ask a second question, we encourage you to go ahead and get back in the queue and we’ll do our very best to get back to you. I would like to thank you in advance for extending this courtesy to your fellow analysts.

So with that, let’s go ahead and take our first question.

Operator

Your first question comes from Kash Rangan with Merrill Lynch.

Kash Rangan - Merrill Lynch

Thank you very much. It looks like we’re starting to get some good operating leverage and the cash flow seems to be coming pretty good, and also the number of net new customers seems to be a record high. So my question is on the financial side for you, Graham -- I’m wondering if you could give us some color on deferred revenue. It looks like certainly we’re starting to see a more seasonal, pronounced seasonal pattern in deferred revenue. Are we really set up for this continuation of what we’ve seen last year, where the bookings growth rate and deferred revenue sequential growth were clearly [inaudible] in the second half [inaudible] mainly it’s the nature of the larger deals that tend to get done towards the end of the year, maybe second half of the year --maybe if you give us some direction on how we should think about deferred revenue seasonality because it certainly grew by $9 million, which is a little bit slower than what people might have been expecting. Maybe if you could give us some thinking into how best to model this going forward, that would be great. That’s it for me.

Graham V. Smith

I think the important thing to remember in deferred is there’s a lot of moving parts. There’s new business, there’s renewals, there’s the timing of those invoices, there’s billing frequencies. And that’s why we don’t give guidance on deferred revenue, nor would we give guidance on deferred revenue.

We feel very good, as we mentioned, about what -- in terms of our second quarter and our first half. Indeed, we met all of our critical goals. We’ve raised our revenue guidance in the second half and that’s for the full year and that’s in the face of some currency headwinds as well. And with the InStranet acquisition, we feel really, really bullish about the second half.

So we did have a huge Q4, in terms of deferred revenue. I’m sure that’s caused some changes to the trends we’ve seen this year but I don’t really -- I don’t see there’s any -- there’s nothing else going on under the covers in terms of significant changes.

Operator

Your next question comes from Laura Lederman with William Blair.

Laura Lederman - William Blair

A follow-up to Kash -- can you talk a little bit about where the business was stronger in terms of new business booked, where it was a little weaker? Did you see any pockets that might have been weak due to the economy? And I guess related to that, when you see bookings slow down or perceived calculated bookings slow down to around 34% or so, one begins to wonder, is that what the business growth [rate going forward], so kind of [both following up] on what Kash asked. Thanks.

Marc Benioff

I’ll just speak briefly to the business quality. All of our business units, or I would say almost all of our business units met or certainly exceeded their goals in the first half and our goals, of course, were aggressive goals and we had strong performance in both our small, medium, and large business areas. We had spectacular transactions, which I mentioned, including the transaction with Dell and other transactions which were some of the very largest in our history. And in all of our segments that we do business, whether it’s a geographic or a vertical segment, we had a tremendous strength. And that really is the result of kind of tremendous acceleration of not only our product line and the quality of our products, both in the applications and the platform business but also a very strong acceleration in the capabilities and capacity of our distribution organization on a worldwide basis. And the result of all of that has been exemplary performance in all of our measures.

Operator

Your next question comes from Thomas Ernst with Deutsche Bank.

Thomas Ernst - Deutsche Bank

Good afternoon. Thanks for taking my question. Maybe to explore this just a little bit further, it seems like you have significantly increased your rate of investment in the business. If my math is right, it looks like the headcount so far this year has expanded 17% and you only expanded it 11% last year. And in fact, last year in total you only expanded headcount 26%, so you’ve gone three quarters of the way in what you did last year on a percentage basis. R&D and your cost of subscription are up over a third so far this year, so it looks like you are investing at a far faster clip as a percentage of your business this year. Is that -- what’s the strategy here? Is that based on you seeing a consistent kind of strength and demand in bookings, to follow-up here on the deferred question? Because I think Wall Street is focused in on that year-to-date deferred as your best metric, whereas it looks like the investment and the customer acquisitions seem to be telling a completely different story.

Marc Benioff

I can completely understand that, only that I can tell you that managing the deferred number is not something that we do internally. It’s not part of our goals. Our goals are to close as much business as we possibly can close and to have as many sales people on the street that we can have and deliver the best technology possible, and those three things together deliver the unparalleled customer success that we’ve had in the company.

This year, you’re right. We’ve hired about 440 people so far. Last year we hired about 230. We have very strong demand, both here domestically in the United States in all three segments -- small, medium, and large business, and we have a tremendous demand in Europe, Japan, and in Asia-Pacific as well, and we are continuing to hire into that demand.

As evidence of that to us internally is, as I said, we probably met or exceeded all of our goals in all of our regions and market segments and we are obviously based on the guidance that we are giving you today, we are increasing our revenue guidance for the year and we are getting ready to deliver a year with more than $1.070 billion in revenue, pretty awesome and we’re extremely excited about our performance for the year and we are getting very excited about where we want to go into the future. We’re modeling the company and looking at the potential and we are -- we’ve never been more excited and never been happier with how we are doing.

Operator

Your next question comes from Heather Bellini with UBS.

Analyst for Heather Bellini - UBS

This is [Abhi] for Heather. Any update on renewal rates, and if any [inaudible] you are seeing in terms of customers increasing their seats or attaching more applications, or are you seeing any kind of reduction in seats at the time of renewal?

Graham V. Smith

No, in fact, we’re very happy with our renewal rates. They are still well under the 1% that we talk about and so there’s been no change to that trend. And we haven’t disclosed the specific percentages of our add-on business but I think we definitely had good follow-up business. Some of those transactions Marc talked about were clearly follow-on and add-on types of transactions, so we feel good about the balance of the business.

Operator

Your next question comes from Mark Murphy with Piper Jaffray.

Mark Murphy - Piper Jaffray

Thank you. I have a question in InStranet. We’ve seen some commentary that it is deployed on premise with some big customers but it’s also an app exchange offering. Could you just clarify how that product is deployed or what the revenue mix is between subscription and other? And then why are you comfortable introducing on-premise technology into the portfolio?

Marc Benioff

Thank you for that question. When we look at doing an acquisition, what we look for is core intellectual property that is best of class, not if it’s on-premise or available as a service. And in fact, most of the acquisitions that we’ve done, if you’ve followed them, have actually been on-premise software companies.

Based on the quality of our force.com platform, we are able to rapidly redeploy that intellectual property into a multi-tenant architecture and then deliver that as a service. You’ve seen us do that several different times already, most recently, of course, with our ideas application and also with our content management capability, and you are going to see us do it again now with InStranet.

InStranet has spectacular technology in the knowledge base area. We have partnered with them. They have integration between our core call center and customer service offerings in their technology and our customers really drove us to this acquisition as we saw them really point the way and say that this was the right technology for them but they wanted it in the multi-tenant architecture, and so that development is now underway and we are very excited about the acquisition and we think we’ve picked up a real gem.

Operator

Your next question comes from Brent Thill with Citi.

Brent Thill - Citigroup

Just on the deferred, not to beat a dead horse, but when you look at the sequential increase, you have to go back to April of ’05 and I think there’s a lot of questions around -- you mentioned you’re not managing the business to that but I guess how do you look at your off-balance sheet backlog? Can you give us a sense of how that’s been building? And certainly I think in the past it’s been equal or not bigger than your actual reported deferred revenues. Can you comment just directionally on that?

Graham V. Smith

Off-balance sheet backlog is now actually substantially bigger than our on-balance sheet deferred number. As I mentioned overall, the combination of the two has been growing the last three quarters at more than 60%, and so if you extract out the deferred and say okay, that means the off-balance sheet backlog has been growing even faster.

So you can’t manage a business around the deferred revenue number. As Marc said, you’ve go to focus on new bookings, customer success, new products, all those kinds of things. The deferred revenue will be what it will be, and I do just point out, Q4 was an unseasonably large quarter which put an unseasonably large amount of deferred revenue on the balance sheet. That’s now all coming off the balance sheet. It helps us raise our guidance because we’ve got all that extra revenue that -- I’ll just remind you, our initial guidance back in Q3 last year was just over $1 billion. We’ve now raised that guidance by $50 million. Some of that was due to that big slug of deferred revenue that went on the balance sheet in Q4.

So I just don’t -- you know, I think we all feel great about the fundamentals of the business and we should not get hung up on this one balance sheet number, but that’s for you to decide.

Operator

Your next question comes from Tom Roderick with Thomas Weisel Partners.

Tom Roderick - Thomas Weisel Partners

Thanks and good afternoon. One of the customer pieces of commentary you talked about was a three-year deal with Dell. It seems to be certainly the most important force.com deal you’ve done to date. Can we just go into a little bit more detail with respect to the traction you are seeing on force.com? What pushed Dell over the edge to get them to move on to the platform? And are you seeing a similar type of ventures from other large corporations out there? Thank you.

Marc Benioff

Thank you for the question. I appreciate being able to speak to the customer success and the product strategy. You know, what we originally started with Dell, as I’m sure you know, is we built the ideastorm.com website for them using our Ideas technology. We deployed the Salesforce automation system for them, for all of their sales force worldwide, which is a substantial organization. And then we also helped them enter the indirect channel through delivering the Dell wall, which is their partner portal based entirely on our partner relationship management technology. And then we saw them having interest in customer support. Then they came to Dream Force last year and got very excited about building on force.com and building custom applications. We also have been working with some of their key software providers to port some of the applications that they have internally natively onto force.com for them to use. And all of that together, suddenly we were one of their key technology vendors and it really gave them the ability to sign what we call an enterprise license agreement with us. And that is a three-year agreement that goes through 2011, and it is for their entire global workforce. And as I said, it is the largest transaction that we’ve done.

But it was not the only one like that that we did in the quarter. There were others of a similar tone and nature. And we see that strategy as a core strategy for us going forward. And this idea, we’ve talked about it before I think on other calls. I have called it kind of our Trojan horse strategy where we find the way to get into the company through one of our key pieces of technology, and then by building relationships with the customer over time using our direct sales force, we add more products until the point where we become really the enterprise standard for that organization. And that strategy you can see play out in an organization like Dell, which of course is known for its premiere use of technology on a global basis and we are really delighted to be one of their key providers.

And I think that you will see that continue into the future with us. Our sales force has given us feedback that other customers are interested in moving in the same direction with us, and it’s a strategy of incrementalism that over time, we build that capability within the customer and it’s a strategy based on customer success, and then we are able to monetize that.

And it’s no one product by itself is the key to that. It’s not sales force automation by itself. It’s not the ideas, it’s not TRM, it’s not customer support, it’s not force.com -- it’s all of those things working together to ultimately be able to provide our customers with a total strategy for managing all of their information on demand.

Operator

Your next question comes from Philip Winslow with Credit Suisse.

Philip Winslow - Credit Suisse

I just wanted to get a sense for what you saw sort of by company size, if there was any difference between large enterprises versus small or mid-sized businesses this quarter.

Marc Benioff

Well, we had a great success in all market segments. Our small business sales force, medium, and large business in this quarter and really through the first half of the year, all of them have had excellent performance and we are extremely happy with them, both domestically and internationally.

And I wanted in the script to highlight both a small customer, [Pattrazo], and a large customer, Dell, because it really highlights our ability to deal with companies that are just starting to companies that are of tremendous size and global leaders. And that remains a key part of our strategy. We of course have a distribution organization that meets those customers exactly where they are and has allowed us to deliver a spectacular quarter for you today.

Operator

Your next question comes from Ross Macmillan with Jefferies.

Ross Macmillan - Jefferies & Company

Thanks. The bookings growth, [inaudible] [core billings implied], suggest consistent growth with last quarter year over year. But the slightly lower than expected deferred growth maybe implies something about seasonality. Was there anything in the quarter that would suggest there was a little bit more front-end loading to linearity?

Marc Benioff

You know, when it comes to deferred, it was really in the last quarter that we started to get a lot of questions on it because that was the quarter where all of a sudden it looked like we had our first sequential decline. And it was really when we went back and it kind of caught us by surprise because of course we had a great first and second quarter, and we looked at the deferred -- you know, we had a hard time internally modeling exactly how do those trends play out?

As Graham said, we had such a spectacular and unparalleled fourth quarter that it ended up delivering a deferred revenue that was off trend. And that of course was -- that was great. And then when we got into the first quarter, we saw that sequential decline, which we really attributed to that fourth quarter and now, in the second quarter, we tried to model where deferred would end out this year so that we can talk to you about it on the call, and our models for being able to understand exactly how those rates impact deferred over time for us are just very difficult, that really the core things that we manage this business by are first-year contracts, our total contract value, the number of sales reps that we have. The quality of our products, the low attrition rate that we’ve been able to maintain over a long period of time. And we build all of that into our business model, so for us to look at the deferred, that’s not really -- you know, we’re not looking at that when we look at next year’s revenue target, for example.

We look at what is our total ability to deliver this year, total capacity, what do we think that we are going to do in terms of total contract value, and then we can model next year’s revenue.

So it’s not a metric that we use internally and we don’t have a lot of good breakdown on exactly how to show you how -- direct it where it’s going and I’m not sure that we are going to really be able to provide that for you in the future either. As Graham said, it’s just a very hard number to model, and if we could give you the model, we would. And I think for those of you who are trying to figure out well, the fourth quarter number was this number and the first quarter number was this quarter and the number this quarter -- I would look to our guidance in terms of the direction of the company and kind of where we are going, because as you know, we don’t give deferred guidance because we can’t because we don’t see that as a predictor of our future revenue over the next two or three years, which is kind of where our mind is at.

Operator

Your next question comes from Peter Goldmacher with Cowen & Company.

Peter Goldmacher - Cowen & Company

Marc, I never though proprietary toolsets and development platforms would be en vogue again but here we are. Can you talk a little bit about force.com and how you think about the space relative to some of the other low cost cloud development platforms like Amazon and some of the other vague, as yet vague initiatives from Google and Microsoft and IBM for a [inaudible] platform?

Marc Benioff

I think we are really about to see something unprecedented in our industry, which is really the manifestation of a whole new development paradigm. And you see it emerging from a lot of different places. You know, you’ve seen it kind of come out of initial application offering because our customers demanded more customization and more integration to the point where they were building custom applications, to the point now where they can build any application.

And we have also seen customers want to be able to use some of the traditional Internet sites, like Amazon and Google and others to be able to deploy their applications. That’s pretty amazing, that the rapid acceleration of the cloud as an application development and deployment paradigm. And we want to ride that paradigm and we want to be experts in the enterprise. That’s really where we see the traction. We can very rapidly build applications for our customers and when those custom applications are done, unlike other kind of rad models, we get a lot of scale, security, reliability, availability instantly built right into the app.

So that really means that this kind of development environment gives the ability to have any application, any company, any developer, they can deploy it anywhere and as new devices emerge, even like the iPhone, they immediately get deployed to that.

Now, different companies will offer different capabilities, like Amazon, EZ2, and S3, so kind of like commodity hardware and commodity storage to deploy applications in many cases built on the last generation of software, which is the [LAN stack]. And that is more about delivering very low cost, raw processing power.

Google has a different approach, which is the Google app engine, which you could -- if you are a python developer, you can write these python scripts and just run them in their servers and on their cloud. And our approach there is you are going to see us offering our customers natively Google app engine and other cloud computing paradigms directly from our APIs.

You see it already where some of our ISVs build the majority of their application in force.com but maybe will reach out to S2, reach out to EZ2, reach out to Google app engine or others, we’re going to collapse that access into our API to make it as easy as possible for them. And that kind of integration of development environment is extremely unusual.

You are going to see it go all the way up the stack, because customers aren’t going to buy their own data centers anymore. They are not going to buy their databases, they are not going to buy their application servers, they are not going to buy their toolsets. They are going to be receiving them through the cloud and we see tremendous interest from customers of all sizes to move into this new paradigm. And regardless of geography and I anticipate in coming calls with you that we will be talking about more exciting breakthrough transactions like we’ve talked about with Dell and others because we see in our pipelines tremendous interest in this paradigm.

Of course, we benefit from this paradigm because we have a full range of applications that developers can leverage when they build applications but at the end of the day, this is all about software as a service becoming a new standard, platform as a service becoming a new standard, which is a term that we only came up with here at this company about six months ago. It’s gotten tremendous traction but it’s really all about cloud computing and I think you are going to see customers of all sizes and also you are going to see ISVs who are building new applications, not building on the traditional stacks but building on these cloud platforms and the creation of a new industry, like we’ve seen with FAS over the last decade. You know, we’re going to continue with FAS for the next decade and on but you are going to see platform as a service become a major part of our offering, and I think become a major part of our customer base. And I think you are really going to see it at Dream Force and I really recommend you to come. Thank you for the question, Peter.

Operator

Your next question comes from Derrick Wood with Pacific Growth Equities.

Derrick Wood - Pacific Growth Equities

Aside from the customer encouragement you had around the acquisition, are there any new trends you are seeing in the customer service market that really propel you to make that acquisition?

And just kind of a follow-up on that -- should we anticipate any change in your thinking around acquisitions going forward?

Marc Benioff

Well, what we really saw in the last couple of years and really accelerating last year was increased customer excitement about the kind of call center and customer service and help desk applications we already had. And customers really were coming to us in increasing rate asking more and more about putting their call centers on to our offering. And you saw that when we announced some of those transactions in this space that were of consequence. You know, we saw some really exciting ones, as I mentioned, like Frontier and [Mysis] and Qualcomm and TDAmeritrade and others that the customers have asked us not to announce.

But we also recognize that our knowledge based management was not where our customers wanted it, so while they were really ready to step up for our whole applications suite, that was one area that they felt that we were deficient in and they asked us to partner with different companies to kind of complement what we were doing. And that’s really where we met InStranet. We were working on a large high tech transaction in our first quarter. It was a big call center opportunity and we partnered with InStranet on the opportunity and that’s when we said this is technology that we could redevelop into the multi-tenant platform on the force.com and deliver that as an integrated solution to our customers. And through a very good set of conversations, we found tremendous fidelity with their management team and we decided to buy the company, and I couldn’t be more excited about that.

In terms of how we think about acquisitions, well, I kind of just gave that to you in the story. We really look to the customer to help guide us, whether it was with ideas or whether it was with content management, whether it was mobility, whether it is with this knowledge base management or others, it really is all about the customer and what they want in terms of additional capabilities to our solutions and we are constantly listening to customers to understand that, and then working to deliver that total solution to customers.

Operator

Your next question comes from Sasa Zorovic with Goldman Sachs.

Sasa Zorovic - Goldman Sachs

Thank you. My question would be specifically if you look at the impact of the macro environment on your business through the quarter, have you noticed anything in terms of, particularly as far as the larger enterprise is concerning, sort of changes in linearity through the quarter, the length of the sales cycle, some of those kinds of metrics that I am sure you track.

Marc Benioff

We haven’t. As I said, we’ve met all of our internal goals and measurements at a broad range in the quarter, throughout many different geographies and we even, as I mentioned, expanded our customer base in financial services with a transaction with Citi. And of course, if you just turn on CNN, you are cautious about the economy but I really think that for our type of solutions and for what we are able to offer customers and the rapid value creation, that this is a technology -- you know, the right time, the right place. And so looking forward, we raised our guidance today for the fiscal year because we remain optimistic about how our business is doing.

David Havlek

We have time for it looks like one more question.

Operator

Your final question comes from Steven Koenig with Keybanc Capital.

Steven Koenig - Keybanc Capital Markets

Just following up on Ross’ question on linearity, or the last half of his question, were the lower DSOs strictly collections or was the quarter maybe a little more front-end loaded than usual?

Graham V. Smith

No, there was no real change in terms of linearity. Certainly wasn’t disproportionately front-end loaded or anything like that. I think I’ve said on a couple of calls, we’re very, very focused on managing our cash. We do put a lot of focus on our cash because we think that’s a good measure of our operating performance and so yeah, we’ve got a very good collections team and they do an outstanding job this quarter. So no, nothing unusual in the linearity.

David Havlek

Okay, great. That wraps up our call for today. We would like to thank everybody for joining us and if you have any follow-ups, please feel free to contact me directly in investor relations and we’ll looking forward to catching up with everybody in the next several months. Thank you very much.

Operator

Ladies and gentlemen, that does conclude today’s teleconference. You may now all disconnect.

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Source: Salesforce.com F2Q09 (Qtr End 7/31/08) Earnings Call Transcript
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