Salesforce.com F4Q06 (Qtr Ending Jan 31, 2006) Earnings Conference Call Transcript (CRM)

| About: Salesforce.com, Inc. (CRM)
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Salesforce.com (NYSE:CRM) Q4 2006 Earnings Conference Call February 22, 2006 5:00 PM ET

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Executives

Marc Benioff, Chairman & Chief Executive Officer

Jim Steele, President, Worldwide Sales & Distribution

John Freeland, President, Worldwide Operations

Steve Cakebread, Chief Financial Officer

Parker Harris, EVP, Technology

Kenneth I. Juster, EVP, Law, Policy, and Corporate Strategy

Analysts

Jason Maynard, Credit Suisse

Kash Rangan, Merrill Lynch

Laura Lederman, William Blair

Brent Thill, Prudential

Rick Sherlund, Goldman Sachs

Philip Rueppel, Wachovia Securities

Greg, (for Tom Ernst) Deutsche Bank

Peter Goldmacher, SG Cowen

Brendan Barnicle, Pacific Crest

Operator

Good day everyone and welcome to the Salesforce.com Fourth Quarter 2006 Financial conference call. As a reminder today's call is being recorded. For opening remarks and introductions I would like to turn the call over to David Havlek, Vice President of Investor Relations for Salesforce.com. Please go ahead sir.

David Havlek, Vice President of Investor Relations

Thank you Lisa. I would like to welcome everyone to the Salesforce.com's Fourth Quarter Fiscal Year 2006 Financial Results Conference Call. Joining me as always today, our CEO and Chairman, Marc Benioff; and CFO, Steve Cakebread. Marc will begin today's discussion with a brief review of our fourth quarter performance, and update you on some of our key achievements and initiatives. Steve will follow with a detailed discussion of the numbers for the fourth quarter before discussing our outlook for fiscal year 2007. Following our prepared remarks, we'll open things up to all of you for questions and answer.

Before we get started today let me quickly take a few minutes for some formalities. First, in order to provide a better understanding of our business we will reference certain non-GAAP measures during today's call, a reconciliation of GAAP and non-GAAP results is available in the earnings press release issued earlier today, and filed on Form 8-k with the SEC. The press release contains a complete review of our financial performance for Q4, additional financial information's beyond what is provided in the press release maybe found on our website.

Second, today's call is being webcast and a replay will be available shortly following the conclusion of the call through March 3rd. To access the press release, the financial detail or the webcast replay, please consult our Investor Relations website at: www.salesforce.com/investor.

Before I turn over to Marc, please be reminded that the primary purpose of today's call is to provide you with information regarding our fourth quarter fiscal year 2006 performance. However, some of our discussion or responses to your questions will contain forward-looking statements. These statements may include projected financial results, subscriber, financial and operating metrics, business strategy, the timing of future services, product or platform releases, and their capabilities. Demand for On-Demand services generally or our products services or the AppExchange specifically, anticipated growth, market opportunities, expected implementation of our services by certain customers, data center hardware or software initiatives, future systems and service availability, the decline of the enterprise applications market or other business related topics.

These statements are subject to risks, uncertainties and assumptions, should any of these risks and uncertainties materialize or should our assumptions prove to be incorrect, actual company results could differ materially from these forward-looking statements. These risk and uncertainties and assumptions as well as other information on potential factors that could effect our financial results are included in our reports filed with the SEC, including our Form 10-Q for the period ended October 31st 2005, and our Form10-K for the fiscal year ended January 31st 2005, both of which are available on our IR website.

Finally, please be reminded that any unreleased services or features referenced in today's discussion or other public statements are not currently available and may not be delivered on time or at all. Customers who purchased our services should make their purchase decisions based upon features that are currently available. So with that said, let me turn call over to Marc.

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Marc Benioff, Chairman & Chief Executive Officer

Thank you, David. This was an amazing quarter for Salesforce.com, our best quarter ever. Let me begin the review of our accomplishments with our financial results. Revenue for our fiscal fourth quarter was $91.1 million, up 10% from last quarter, and up a remarkable 67% from the same period last year. This was an outstanding performance and reflected strength across all aspects of our business.

To put this revenue accomplishment in context we achieved almost as much revenue this quarter as we achieved in all of our fiscal year 2004. GAAP net income for the quarter was roughly $6 million, up 66% from the fourth quarter of last year. Fully diluted earnings per share finished $0.05 for the quarter, as said above the high end of the outlook we provided you at the beginning of the quarter, and cash from operations, during the quarter was spectacular, $39 million, the highest results in our history by far.

Driving our financial performance was another terrific customer and subscriber quarter. We added 1800 customers to end the quarter with approximately 20,500 customers worldwide. Worldwide customer account grew a record 48,000 to end the fourth quarter at 399,000 subscribers. Of these 399,000 worldwide subscribers, we now have over 52,000 European subscribers. Now from a competitive prospective, 28 months after Siebel entered the On-Demand business with a much publicized partnership with IBM, we are still adding subscribers at nearly 10 times the rate of the 5000 that they added in their most recently reported quarter and our European business is larger by 3,000 than their entire worldwide base.

That is amazing, this is really a testimony to the innovator’s dilemma that plagues our competitors when they follow us into this new technology business model called On-Demand. Our biggest win in this quarter came at Sprint, which we expect we'll soon have over 5,000 users on salesforce.com. They already have over 4500 active subscribers today.

Sprint joins Merrill Lynch, Cisco, ADP, Symantec, Aon and Corporate Express as customers with over 4000 users. At quarter end we had 26 customers with a 1000 or more subscribers among them CIT, which roughly doubled it's subscribers account this quarter to 2700. It is hard to believed but it was just 3 years ago there we were talking about our first 1000 seat, customer with SunGard, and now we have 26.

Bio-Rad Laboratories has joined our customer ranks with nearly 1,000 subscribers, and AmeriCredit has selected Saleforce.com for roughly 750 subscribers. In addition, our services partnerships with Accenture led to a sizable implementation during the quarter with energy giant, Chevron. We also had customer success internationally. In Europe our wins included implementations at Prudential and Alcatel. And in Asia, Matsushita more commonly known as Panasonic and Softbank became salesforce.com customers during the quarter. We have also seen acceleration in a variety of important industries. Hi-tech financial services and media have become strong opportunities for us. For example, in the media industry, a wide variety of publications now rely on us to manage their customer data. Our media customers include AOL, C-Net, Dow Jones Newswires, The Wall Street Journal, Business Week, Sports Illustrated, The Washington Post, Newsweek, The New York Times, The Los Angeles Times, InfoWorld, Computer World and The Chicago Tribune, and that’s only a sampling of our media customers. And we are certainly not standing still.

On January 15th we released the winter '06 version of our application, this version incorporates more than 200 new features including a new user interface, greater customizability, and then improved offline mobile capability. We also launched our Sandbox Edition, which enables testing and development in a separate environment by customers including actual production data. Already a number of our customers have added Sandbox Edition to their deployment including Double Click, Chevron and Charter Business Networks.

Winter '06 brought with it the official launch of AppExchange, our own eBay of enterprises applications that you can find at www.appexchange.com. Since going live 6 weeks ago, the response has been nothing sort of amazing, we now have 163 applications and components in AppExchange including Voice Over IP communication from Skype, and On-Demand PDF generator from Adobe, and On-Demand reporting with Crystal Reports from our customer Business Objects who have 2,000 users on Salesforce.com.

We are also seeing a variety of exciting applications in project management, product management and Real Estate markets. In Japan, we now have 25 applications in the Japanese version of AppExchange to bring our worldwide total to 188. The AppExchange has inspired a wave of creativity in our partner and developer community which now totals more than 200 ISD's and roughly 15,000 independent developers. And this innovation is found in either markets with more than 97,000 test trials and more than 4400 applications installations to date.

We are also seeing a variety of venture capitalists from Silicon Valley making a major investment in companies who are now delivering AppExchange applications, a trend that we see expanding. Earlier this month, a large East Coast financial institution became a Salesforce.com customer. What was exciting about this new customer, Morgan Stanley was not that they have signed up for 400 subscribers, but it was that they have decided to deploy On-Demand recruiting in HR application from the AppExchange. This exciting movement really demonstrates to us and gives us added confidence that customers small and large will find tremendous value for their enterprises on the AppExchange. The only platform we are deploying scalable secure On-Demand applications. In addition, Tata Consultancy Services, India's largest systems integrator has formed a partnership with us for AppExchange development and is planning to post their own applications there as well. We believe the AppExchange platform will become the center of what we call the business web.

A wide variety of web services seamlessly integrated into unique customer solutions. The era of huge monolithic proprietary single-tenant systems is over. And the reaction of customers in this business is now more than ever that businesses are tired of the complexity, cost and time requirements of the traditional software model in trying to maintain the single-tenant approaches. Customization, flexibility and seamless integration, these are the attributes of the AppExchange and the hallmarks of computing and the age of the business web. I encourage you to take a look for yourself at AppExchange at www.appexchange.com and try out some of these exciting new applications.

Now on to usage, usage of the Salesforce platform has never been greater, during the fourth quarter, we saw unprecedented usage of our application in nearly 2 billion transactions, which includes the combination of web pages and API calls. That is roughly two and half times the transaction volume we saw just one year ago. Subscribers are using our application more than ever, not just to manage their CRM data as in the examples that I gave, with AppExchange but increasingly as a fully integrated web services, application development and delivery platform for a wide variety of On-Demand applications. API call transactions are exploding as users are integrating at a faster rate than ever, our application into their existing environment and the introduction of AppExchange that is accelerating that trend in both the desktop as well as throughout the enterprise.

Now I would like to spend a few minutes on a topic that is very important to us and also to our customers, "System availability and reliability". For the past seven years Salesforece.com and our customers have come to expect the very best from our systems, and we have responded by delivering unmatched reliability and availability, year after year, month after month, day after day. Customers have relied on us to run their CRM business structure every day, every hour, every minute. We have been a pioneer, not just in our product offering and how we deliver our service but in how we use and manage technology in our data centers. It is why we spend over $50 million last year on a new mirrorforce architecture that we have been deploying since early November.

Now as you know, to deploy mirrorforce, we essentially changed our entire hardware architecture, software and data centers and then late in the quarter, we unveiled our most ambitious software release ever which included Winter '06 and AppExchange. Essentially for all attempted purposes we replaced all of our technology. This vast amount of change caused us to have several challenging days during the quarter and especially during the month of January. This has been very uncharacteristic of our system, which has had seven years of excellent reliability and performance. And with all the challenges and changes to our environment we anticipated some issues but this was more than we expected.

To improve performance, we have been working our server, cluster, and disc drive manufacturers and of course with all our software vendors, with teams led by their respective CEOs. This alleviative level of focus and commitment from our hardware and software partners has resulted in better product reliability and also a reduction in the recovery times following a down system, both important contributors to better service availability. And our focus on tuning and optimizing our environment is allowing us to achieve record levels of speed for both web pages and API calls. In fact just yesterday we delivered more than 36 million transactions at an average speed per transaction of 297 milliseconds. Now I will explain why it is so significant, this is the most transactions we have ever delivered in a single day, and our system speed was the highest for this level of throughput in any day in our company history. So, essentially we are delivering more pages faster than ever before.

In many ways our position is similar to what major internet companies like eBay and Amazon, both of which are customers of Salesforce.com went through during their hyper growth phases. We have compared notes and shared best practices on what is necessary to deliver best-in-class reliability, and availability, and communications.

And finally, we are setting a new standard for transparency in our industry. Customers and prospects and analysts alike can access the trust.salesforce.com site for up-to-the minute real-time reports on service performance, transaction volume and transaction speed for each of our data centers – each of our database servers, this is unprecedented in our industry and like so many of the best innovations we got the idea by talking to our customers. We think this level of transparency is important to our customers and to - for entire industry, and we encourage all of our competitors to report their performance by server, and by day, in transaction volume and in transaction speed. We believe that this level of transparency is essential to taking the industry to the very next level of performance. If you look at this level of performance for the February for example, you will see, that our reliability has returned in the month of February to approximately 99.7%. With this transparency, is something that you will be able to watch yourself, minute by minute, day by day, at trust.salesforce.com and we are very proud of this innovation.

Now of course for many years, we have talked about how we want to become the eBay of enterprise applications. And we think about that again, taking the best of eBay and taking the best of traditional enterprise computing like SAP or Oracle and combining it into a new model, into to a new company, into a new technology. And so, it should be no surprise that the ideas that we have for trust.salesforce.com came from the community reliability stages at eBay. More and more we are looking to companies like eBay and Amazon as our models for trust, for communication, for reliability for us to really deliver on our vision of transforming the enterprise software industry to become the eBay of enterprise applications. We want to adopt their best practices so that we can deliver the highest reliability and best practices possible in this industry transformation.

From the very beginning we set out to create a service that customers will not only buy but also use and love. The growth in our customer base and in the usage of our service is testament that we are succeeding. In our fundamental vision of success as revolutionary as it is simple, is carving huge changes in the industry, and we intend to continue to lead those changes with concepts like AppExchange and the Business Web and trust.salesforce.com. So, we can't help if you are amused by the some of the weak impersonations of On-Demand that we have seen from our competitors.

Now just two days after Siebel disappeared from our industry, SAP offered on On-Demand that was strikingly similar to Siebel's product from several years ago. The sales pitch was the same too. We think in the On-Demand products, there is an anagram to existing legacy enterprise application. But as the many former Siebel executives that we have now hired will tell you on-ramps tend to make Roadkill out of your business model. At Salesforece.com we are watching closely the changes in our industry, and while we wait for Microsoft to figure out what live applications are, so that they can say, they are dead software and technology model. We are delivering real success On-Demand to over 20,000 customers everyday. On a platform that is exploding with creativity, innovation and energy that defines the Business Web. So with that let me turn things over to Steve for a more detailed, financial review of the quarter and some details on outlook.

Steve Cakebread, Chief Financial Officer

Thank you Marc. Let me begin my comments with a quick financial recap of our outstanding fourth quarter, starting with the P&L. Revenue for the fourth quarter was $91.1 million, an increase of 10% from Q3, and up 67% from last year. Revenue for the full fiscal year was $309.9 million. This figure represented a remarkable 76% growth from fiscal year '05, and it is more than three times the revenue we have recorded from fiscal year '04.

Geographically fourth quarter revenue in the Americas rose 69% from the year ago quarter to $72.4 million. This is well represents 10% sequential growth. In Europe, revenue was $12.8 million, and was up 57% year-over-year and 13% sequentially. In constant dollars growth in Europe was 73% from last year and 15% from the prior quarter. In Asia-Pacific, revenue grew 66% from last year to $5.9 million, an increase of 11% sequentially. That as well in constant dollars topline growth in Asia was up 82%, from the year ago quarter, and 14% from Q3.

Subscription as deferred revenues finished at $82.4 million. This represents growth of 67% from last year and 11% from Q3. This performance was driven by continued outstanding subscriber growth, that we have seen in recent quarters. And as Marc had indicated earlier, our subscriber growth continued it's upward phase in Q4. We exited the quarter with 399,000 subscribers, up more than 170,000 from where we began the year, and our customer base is 20,500, was up over 6,500 for the same period. On an average these results were up – represent roughly 25 new customers and almost 700 new subscribers every business day last year, truly remarkable.

Our strong subscriber performance this quarter was once again driven by a highly diversified portfolio of businesses, with strength across customers of all sizes in all industry verticals. And consistently, our mix of subscribers continues to be split roughly, equally across small, medium and large businesses. While our Q4 subscription revenue performance was excellent, we did benefit from some year-end effects. Not only were our sales people working hard to close deals before yearend, to assure an invitation to our annual club event, the customers were also spending unused year-end budget dollars.

As we said before, forecasting our subscriber additions on a quarterly basis is not an exact science. In predicting the timing of major account additions or subscriber additions within existing accounts is impossible. Smaller accounts have extremely short sale cycles and provide little visibility and for those reasons we continue to expect some lumpiness in our subscriber number going forward. Let me conclude my topline discussion with professional services, where revenue ended the quarter at $8.6 million, up 66% from last year, and 4% from Q3. Now on to the rest of the P&L.

Overall gross margins finished the quarter at 77%, up from 66% last quarter, down from last year's 82%. And while subscription margins remain flat quarter-to-quarter, year-over-year results reflected the incremental IT investments we have been discussing with you the past couple of quarters. And as Marc noted earlier, we have efficiently deployed an entirely new hardware and software architecture during the last quarter because customer satisfaction is so intricate to our business model our top priority, we will continue to make these investments to ensure our customer the best possible experience going forward. With that our professional services business continues headcount growth in the effects of the holiday season customer billing days, pressured margins.

Operating expenses were well managed during the quarter finishing at 71% of revenue, down to full 5 points from the same period last year. Marketing and sales and G&A also showed year-on-year decline as the percentage of revenue. We did however ratchet up our R&D spend this quarter; to support the hardware and software initiatives we've already discussed and to fund our new test and development data center.

And finally our tax rate ended the quarter at about 18%, slightly below the 20% we expected. But this was primarily the result the "true-up" our estimated yearend tax provisions. The net result was a GAAP EPS of $0.05, slightly above the high end of the outlook we provided you at the beginning of the quarter. Before I outline the cash flow in the balance sheet let me quickly talk about headcount.

We exited the quarter with 1304 full-time employees, up a 188 from Q3. And we are adding people on all part of the organizations to support our growth and also assure our customers the best possible On-Demand experience in the world.

Let me move on the cash flows in the balance sheet then. Q4 was another excellent cash generation quarter, with total cash from operations up roughly $39 million. This record quarter was up 60% from an outstanding Q3, and up 86 % from the fourth quarter of last year. This strong cash generation quarter was the primary driver of unending cash, cash equivalent and marketable securities balance of roughly $296.8 million. This amount is up $100 million from last year.

Deferred revenue on the balance sheet, also continued it's strong growth, ending the quarter at $169 million. This is up 33% from Q3, and 76% from a year ago quarter. Together with our subscriber growth this figure is a good indicator of our near-term future revenue performance. Keep in mind, we report balance sheet deferred revenue only from business sense as to influence to customer, and then we recognize that revenue on the daily basis as we earn it on our P&L. Non-invoice (No audio, Line broken)

Steve Cakebread, Chief Financial Officer

Hey everyone, sorry for the line problem, but let me quickly just review the results, we were not exactly sure where dropped off totally, and then we will move back to questions, so if you’ll just bear with us, we will get through this fairly quickly.

As you know the revenues for the fourth quarter were 91.9 million, and increased 10% from Q3, and that was up 67% from last year. Revenue for the full fiscal quarter was 309 million, and this figure represented a remarkable 76% growth from fiscal year ’05, and is more than three times the revenue we recorded in fiscal year ’04. Geographically fourth quarter revenues in the America has rose 69% from year ago quarter to 72.4 million, and this represents a 10% sequential growth. European revenues were 12.8 million, and were up 57% year-over-year, and 13% sequentially.

And in constant dollars growth in Europe was 73% from last year, and 15% from the prior quarter. In Asia-Pacific revenues grew 66% from last year and $5.9 million to an increase of 11% from Q3, but in constant dollars topline growth in Asia was up 82% from a year ago quarter and 14% from Q3. Subscription and support revenue finished at $82.4 million, and this represents growth of 67% from last year, and 11% from Q3. This performance was driven by continued outstanding subscriber growth than we have seen in recent quarters.

As Marc indicated earlier, our subscriber growth continued its forward pace in Q4. We exited the quarter with 399,000 subscribers, up more than 170,000 from where we began the year. And our customer base, up 20,500 was up over 6500 for the same period. On average these results represent roughly 25 new customers, and almost 700 new subscribers every business day last year, truly remarkable. Our strong subscriber performance this quarter was once again driven by highly diversified portfolio of business, which strengths customers of all sizes in all industry verticals.

Our mix of subscribers continues to be split roughly equally across small, medium and large businesses. While our Q4 subscription revenue performance was excellent, we did benefit from some yearend effects. Not only were sales people working extra hard to close deals before yearend, and to assure invitations at our annual club event, the customers were also spending unused yearend budget. As we said before, we are forecasting our subscriber edition on a quarterly basis is not an exact science, predicting the timing of a major account addition or subscriber additions within existing accounts is impossible. Since smaller accounts have extremely short sales cycle to provide little visibility. For these reasons we continue to expect some lumpiness in our subscriber number going forward.

Let me conclude my topline discussion with professional services, where revenue ended the quarter at $8.6 million, up 66% from last year, and 4% from Q3. Moving on to the rest of the P&L, gross margins finished the quarter at 77%, and that’s up 76% from last quarter, but down from last year’s 82%. While subscription margins remain flat quarter-to-quarter, year-over-year results reflected the incremental IT investments we have been discussing with you the past couple of quarters. And as Mark noted earlier, we essentially deployed an entirely new hardware software architecture during this quarter, because customer satisfaction is intricate to our business model, and our top priority will continue to make these investments to assure our customers the best custom possible experience going forward.

Within our professional services business, continue head count growth and the affects of a holiday season on customer billing days continued to pressure margin. Operating expense were well managed during the quarter, finishing at 71% of revenue, down 4 or 5 points from the same period last year. Marketing, sales and G&A all showed year-on-year decline as a percentage of revenue. We did however ratchet up our R&D spending this quarter to support the hardware and software initiatives we’ve already discussed, and to fund our new custom development data center. And finally our tax rate ended the quarter at 18%, slightly below the 20% we expected. This was primarily the result of a true-up our estimated yearend tax provision. The net result was GAAP EPS of $0.05, slightly above the high end of our outlook we provided you at the beginning of the quarter.

Before I move on to cash flow and balance sheet, let me talk about head count. We exited the quarter with 1300 full-time employees, up 188 from Q3. We are having people on all parts of the organization to support our growth, and to assure our customers the best possible on-demand experience in the world. So with regards to cash flow and balance sheet, Q4 was another excellent cash generation quarter, with total cash from operations of roughly $39 million. This record quarter was up 60% from our outstanding Q3 performance and 86% from fourth quarter of last year. The strong cash generation quarter was the primary driver for unending cash, cash equivalents and marketable securities balance of roughly $296 million. This amounted up almost $100 million from last year. Deferred revenue on the balance sheet also continued its strong growth, ending the quarter at $169 million, up 33% from Q3, and 76% from a year ago. Together with our subscriber growth this figure is a good indicator of our near-term future revenue performance.

As a reminder, we record balance sheet deferred revenue only for that business set as an invoice to customers, and then we’ve recognized the revenue on a daily basis as we earn it on our P&L. Non-invoice to contracted future business is not recorded on the balance sheet. This off balance sheet deferred revenue has been growing slightly faster than our on-balance sheet deferred revenue, and as a result our off balance sheet deferred revenue is currently a bit higher than what we show on the balance sheet. All very encouraging for our future business.

So concluding remarks around outlook. As you are all aware, we will begin expensing stock options next quarter for the requirements of FAS 123R. Our reported non-GAAP earnings will exclude these stock-based compensation charges. Ultimately, we believe our non-GAAP earnings are the best measure of our performance. We’ve measuring ourselves that way, and we hope that you’ll measure us that way as well. With that, let me offer our outlook for Q1 and the full year fiscal year ’07.

As I mentioned earlier, Q1 won’t bring with it the benefits of the yearend sales of budget cycle. So as such, we expect subscriber growth to be more inline with the trend lines we saw in Q1 through Q3 of this past year. We now project first quarter revenue to be in the range of $99 million to $101 million. Operating margins will continue to be flat, the pressure of the growing head count, and our unrelenting focus on building the most highly available on-demand platform in the world. As Marc indicated, we are accelerating our plans to add technology, people on infrastructure to assure that we can deliver the best customer experience. Incrementally, we expect this to add approximately 1 to 1.5 million per quarter in IT costs. Assuming that non-GAAP tax rate of 45%, average share account of 122 million, and excluding the affects of stock-based compensation, we now expect Q1 non-GAAP EPS to be in the range of $0.02 to $0.04.

With regards to full year fiscal year ’07, last quarter on our results we projected that number to be between $460 million and $465 million. Given our outstanding subscriber performance and continued strong momentum, we now expect revenue for our full fiscal year ’07 to be in the range of $470 million to $475 million. And as I mentioned we are investing an incremental 1 to 1.5 million in each quarter in IT, but even with this incremental costs we expect non-GAAP EPS which excludes the affects of stock-based compensation to be in the range of $0.20 to $0.22. This estimate again assumes the non-GAAP tax rate of 45% with an average share account of $124 million.

Finally, many of you have asked about our cash tax rate for next year. While this number can move around from quarter-to-quarter, we expect cash taxes to be something slightly less than 10% of non-GAAP taxable income for the full year. So to close, once again, Q4 was an excellent quarter financially. During the quarter we continued to build the most available web services platform in the world by adding the right technology, the right infrastructure and the right people. And at the same time, we grew faster than any company comparably sized software company in the world, and our financial results continued to improve. We are executing for the long-term, because that’s what is best for our customers and for our shareholders. So I want to thank you again for joining us, I appreciate your patience on the phone line – and with that I’ll pass it back to the Operator and we’ll start our questions.

Question-and-Answer Session

Operator

Thank you sir. Operator Instructions We will go first to Jason Maynard with Credit Suisse.

Q – Jason Maynard

Hi good afternoon guys. Sorry to follow-up Steve on your comments around expects subs growth that you want to be more inline with Q1 Q3 trends of last year. Is there any influence on some of these outages or you know service level issues that you think might be influencing that? Or is that just sort of more realization of normal seasonality in your business outlook?

A – Steve Cakebread

Jason, our sub growth over this past year has gone from high 30s in Q4 almost few years ago into the 40s, and we are now at the high 40s now. Our customers expect this performance from us. We continue to deliver that, we don’t anticipate any impacts at all from this, but we need to get out and sell those customers and cater them, show them the advantages of the AppExchange, maybe Marc you have some follow-up information or.

A – Marc Benioff

Well of course this quarter as you know is our best quarter ever, and it is also our best quarter ever for subscribers. In fact it is substantially above the previous three quarters. As you know, the sequential subscriber growth for fiscal year ’06, which is now being reported in the first quarter we did 40,000 subscribers, in the second quarter we did 41,000 subscribers and in the third quarter we did 43,000 subscribers, and now as we have reported in the fourth quarter with 48,000 subscribers. And this has been an outstanding fiscal year ’06. So in the fourth quarter of course you see that the subscriber number is substantially above our trend line and that does not necessarily give us confidence that in the first quarter our subscriber growth is going to be at that level. So we are conservative in our estimates for the first quarter. We believe strongly in the quality of our customer base and in the quality of our technology, and as I’ve mentioned in my comments, January is certainly was not our best month ever, it was far from it. And that was very disappointing for the company, but also as I’ve said, February currently has 99.7% availability, in the last 36,000 minutes of availability, we had only 100 minutes of reported downtime and that was only on one of our servers. So we are very optimistic about getting back to high levels of availability and are delivering that now. And we are also optimistic that we will reach even higher levels of reliability in the long-term.

Q – Jason Maynard

And I’ve one follow-up, you are obviously raising total revenue guidance by $10 million on the low and the high end of the range. The incremental 1 to 1.5 million in IT, can you guys just talk a little bit about where that’s going to be deployed and how we should kind of think about that hitting either the P&L or we are going to see any additional CapEx, maybe the current value of?

A – Marc Benioff

Yes, well as you know, when we implemented our new mirrorforce data center technology in November, and why that range of hardware and software investments that we made last year, we felt very comfortable with our architecture, both our software architecture, hardware architecture and network architecture. As we deployed that data center technology, we have had some issues win regards to installation with in early November, and then of course we had a service interruption in December that was a surprise to us. And what kind of foreshadows a very weak January for us in regards to reliability. As we have gone deeper looking at those reliability issues in January, we want to make a stronger investment in the research and development necessary for future architectures because we now have a vision for ourselves of even higher reliability than we even expected before. What we realize is something very interesting. We have been talking for a while about how well we want to be the eBay’s enterprise applications, but we as a company realized that for that to happen we have to deliver not just the best feature and functionality, and of course according to every major software viewer, and Editors’ Choice Award and technology award, we’ve received all of those. But we also want to get to a level of reliability that’s not just great but excel and exceeds even the best consumer services that are available today. And that’s really our long-term vision, for our reliability, and that’s really been influenced by how we look at our company now in a new way after January, and we have done some extensive mediums, I’ve done the mediums myself, not only with our hardware and software vendors but also with major internet service company, and we believe that we can get to well with reliability that have never been seen before in enterprise software, but to do that we need to make this additional investment. And that’s very much what we’re doing. And Jason, the money set that we are going to spend will show up primarily in cost of sales for subscription, you won’t see that as in the past a lot in CapEx per se because keep in mind we at lease saw a majority of our gear or so, anticipate that in the gross margin range but again our gross margins has been in the high 70s, low 80s, we don’t anticipate any changes there.

Operator

We’ll go next to Kash Rangan with Merrill Lynch.

Q – Kash Rangan

Hi thank you very much. Just a clarification on the new subscriber growth that you are expecting with Q1 and Q2, I want to ensure if you talked about the new subscriber growth to be in the range of 40, 41, 43,000 subs, which you reported in Q1 Q2 Q3 of this year? Or where you talking about the kind of sequential growth there were getting in Q1 Q2 Q3 meaning the order of 1000 or 2000 new sub so, the question to you is, should we be expecting new subs to be in the 49,000-50,000 kind of range? Or should we be expecting new subs in the 40,000-41,000 range, just a simple practical question for you?

A – Steve Cakebread

Well, I’d like to really address that very specifically, as you know our salesforce.com has shown very strong incremental subscriber growth over our 7-year history, and this year of course was no exception with outstanding subscriber growth resulting in this very incredible subscriber number at 48,000. When you compare that to our publicly reported competitors, of course only Siebel reports to their subscriber number, not of our other on-demand competitors will even report it. They, Siebel basically I think is, last three quarters they have done 5000 users a quarter, and I think that they have a total now about 49,000 total subscribers versus our 399,000 total subscribers. I believe that they added 5000 last quarter compared to the quarter that we are adding here at 48,000. Now, when we look at subscribers going forward, and we saw the huge leap from 30 to 41, and 41 to 43, and then the huge leap, which is kind of not sequential to 48. It makes us nervous that the management team what would all be Q1 subscriber growth number be. During the quarter we see of course in the press or in various analyst report, all kinds of crazy subscriber numbers, and we don’t know where those are coming from, because we know how much distribution capacity we have, and how much that distribution capacity can deliver in terms of subscribers. Subscriber growth is directly related to distribution capacity minus customer attrition. And the net of that of course will be – the net subscriber number, and that subscriber number has continually grown up, but when we look at this first quarter, we want to be conservative in that estimate and we don’t want to set expectations of something that we cannot achieve.

Operator

We’ll go next to Laura Lederman with William Blair.

Q – Laura Lederman

Just a few follow-up questions. One is in your assumptions going forward, when you think you are in business, are you assuming a slight increase in your attrition rates given what’s happened with the outages in kind of – in that number, and I just kind of get a feel for what you are kind of assuming if you are willing to chat about that?

A – Steve Cakebread

Well, Laura, still far our attrition has basically remained constant over the last – for our entire history, it really has never risen above, it hasn’t in recent history risen above 1% per month as we’ve stated before, and attrition has remained relatively constant, and then your specific answer, the reliability issues that we suffered in January, we have not seen impact of a company in any type of attrition specifically.

Operator

We’ll go next to Brent Thill with Prudential

Q – Brent Thill

Marc, just on that point, the attrition, have you seen lengthen enterprise contracts related to some issues? And then you could also follow-up, you made a number of changes in infrastructure. Are the bulk of these changes completed if not to be your essential when it will be completed?

A – Marc Benioff

Okay, well there’s two different questions there, and in regard to attrition. We have not seen any of our reliability issues affect attrition in January or in the current month, and we also have not seen any lengthening of sales cycle either. You know we are still the leader in this industry, and our product quality, our brand, our distribution capacity, all is dramatically above where all of our competitors are of course. So our ability to execute is very strong and powerful, and the only issue that we’ve had with attrition are perhaps we have seen it basically the same number. We monitor it very very closely, obviously because it’s core to our business process and business model that we know what that is, but we have not seen that number fluctuate, and it has remained constant at the low 1% per month, so we feel very good about that. First of all, let me make sure I answer that question. Okay, and then second, let me answer your question regarding architecture. Architecture of course with salesforce.com as involving service in terms of scale, requirement, capacity, and as you’ll see from the trust.salesforce.com page, it is a constant evolution of growth, like even all our internet service peers. There is no fixed salesforce.com architecture, so we are continuing to make changes, improvements, addition, we are working on our new software release, we are working on the next generation of our hardware architecture, and we are evaluating all those things, and based on what we went through in January we doubled down and reviewed again, and went through every aspect of architecture, I personally have been involved in that to make sure that we can deliver a highest level of reliability possible.

Operator

We’ll go next to Rick Sherlund with Goldman Sachs.

Q – Rick Sherlund

Just if could get first some clarification, the question about the subscribers, I am not sure I understood what your response was, are you saying that we should be down a bit sequentially from 48,000 but I don't think you are saying it should be back to 40,000 of last year, is that correct?

A – Steve Cakebread

We don’t expect the Q4 subscriber number to be sustainable in Q1.

Q – Rick Sherlund

Well I can’t remember exactly what you said, I can go back to the transcript though.

A – John Freeland

Well we said was, the Q, we expected subscribers to be in the trend line to Q1 to Q3 of last year because Q4 was the selling cycles that we are in yearend, tend to have a fairly high number that we think is going forward, we just want to be conservative with.

Q – Rick Sherlund

Was does that mean within the trend line of Q1?

A – John Freeland

Well, we take a look at it Rick.

A – Marc Benioff

It was I think John between Q3 and Q4 revenue, right Rick.

Q – Rick Sherlund

Right.

A – John Freeland

I mean if you look at the trend line, it was, we did not expect 48,000 honestly, that was not where we thought we were going to end up, and we look at something like 40, 41, 43s and we expect its like 44 maybe 45 because what we were doing Rick is, we of course hire more people every quarter, and some of those people that we were hiring are sale people, as we get more distribution capacity aggregated overtime, we can then direct that distribution capacity to expect more subscribers, and if you look at our history that’s what happened we had tremendous subscriber growth over the last 7 years, right. So when we see kind of it jumped from 43 to 48, and we say okay wow, what do we expecting for the next quarter and the first one is everyone is expecting for the next quarter, and that’s what we wanted to bring it up on the call that we see it more inline with our first three quarters, not our fourth quarter because we believe that the fourth quarter was heavily influenced by end of year phenomena.

Q – Rick Sherlund

I got, right, so not inline with the first quarter last but with the trend line, but that would imply 46 or something like that?

A – Steve Cakebread

As you know its not easy to predict when subscribers want for years, so we are just trying to reinforce the fact yet again that subscribers are tough to call, that we think as Marc said is the function of distribution and how we grow the business, and sometimes you get these crazy number out there, they are just not capable.

A – Marc Benioff

And also I would add to that, we feel good about is able to predict our revenue growth and the kind of transparency of our model, and the ability to look in the long-term, and you know honestly when we invented this model the business and technology model that we are in now, we thought that we would not be under kind of a quarter-to-quarter to screw the on any specific metric because we’d created this model that offers a lot of transparency and visibility going forward. But of course now we are kind of, we never actually got out of that. And we are in, what subscriber number are you going to do, this quarter end of course the subscriber is plus or minus 2000, its just not material, than you have – got off the subscribers. So, we are hunting two really exciting numbers this quarter, we are having subscriber number in the 400,000s which for us is really exciting that we are heading towards half a million subscribers that you not the word “hunting�?. Then the second thing that we are hunting is our first $100 million revenue quarter, we are really excited about that. Those are things that we are looking at, we are looking at these general trends, and we are looking at general revenue, trends, and you know something of course is very little bit hard to control, and one of those number is, what is the quarter to quarter subscriber number, and its been great, fantastic over the last several years, but whatever we see a book like this, and this is not the first call that we have done this. We also did this in the first quarter of last year, we get conservative and say wow, maybe our distribution capacity really is in a new or maybe there’s another phenomena unlike end of your phenomena. Does that answer your question, Rick?

A – Steve Cakebread

And keep in mind we are driving some of the revenue guidance and EPS guidance, that’s how we manage the business.

Operator

We’ll go next to Philip Rueppel of Wachovia Securities.

Q - Philip Rueppel

Great, thanks. Couple of questions, maybe I missed it Steve, but did you comment on what you estimate option expense to be for fiscal 2007? Second, maybe more general question about the competitive environment, now that some of your competitors have new owners or new demand products out there, could you talk a little bit about the pricing environment, does that change at all in the near-term? Thanks.

A – Steve Cakebread

Let me talk about the option expense, I’ll let Marc talk about pricing for a minute. As you know we have a fairly complicated model that we opt to use – we’ll do our calculation for Q1, currently we are estimating stock option expense or compensation cost through stock option, to be roughly in the $45 million for the full year, so that will give you some idea of what we were looking at here. So we are going to stay focused on non-GAAP EPS because we think that’s good comparables for ’06 as we are not obviously going back and putting numbers in ’06, and how we run the company going forward. On competitive pricing pressures Marc?

A – Marc Benioff

Well, certainly the competitive dynamic has changed a while in the last 12 months and each competitor it’s a slightly different situation. First of course our primary competitor in the last 7 years has been Siebel Systems, which no longer exists as a company, and as you know they had a product called Siebel on Demand, which we don’t see as much see in the marketplace anymore. We expected Oracle to relaunch that product when they acquired Siebel but what we have heard is that they are rewriting that product, but we don’t know, we are not inside Oracle, so we don’t know the specifics, but we don’t see the intensity in marketing and distribution around that offering.

We also have a competitor that Oracle as you know and their CRM offering really has not been very competitive in the last 5 years, and you have seen it when major transactions against them like Aon and CIT and others. And we have not really seen them as a dominant force in the market. SAP CRM product certainly in the area where we compete in salesforce automation and in certain areas of customer service and support and then in the mid market really has not been much of a player, and in large I think the customers like we thought we’ve seen increased excitement about our offering, and we don’t see SAP at this point, about the CRM market, and specific to that I still try to find users who are using SAP CRM, I talk to people all the time trying to find who is that sales person using SAP CRM, but even SAP is as far as I can tell revenue SAP CRM, they have a new product called SAP CRM On-Demand, which looks even worse than their traditional SAP CRM offering, which is actually kind of hard to believe, and that was just something that we looked at and said that maybe will create more opportunity for us in their accounts. We have – if you look at Microsoft they have launched a new CRM 3.0 product but they have a lot of product quality issues as we look at in the blogs, and this kind of thing we are still waiting for reviews to come out in that product, and of course Microsoft is always a factor in the software industry but so far in the CRM industry, we have seen them mostly to be not very competitive.

And finally we have smaller on-demand competitors, companies like NetSuite and RightNow and others, and because they don’t report their traction by customers and subscriber numbers and reliability like we do, its hard to track but we don’t see that much in the market but we would like to see more transparency in our industry overall because we are a publicly traded company and because we are covered by financial analysts and because the press does cover us very well, we have a lot of transparency to our business, and we are trying to provide more transparency, more communication overtime. So in terms of the competitive situation, that’s our high level of customers.

Operator

We’ll go next to Tom Ernst with Deutsche Bank.

Q - Greg

Yes, actually this is Greg on behalf of Tom. I want to get back to efficacies and the platform strategy. You guys talk about some deals in terms of downloads and new applications that are being developed, but I wanted to get kind of what you have learned here in the past month in terms of kind of how to monetize that business and kind of next step you are taking there.

A – Marc Benioff

Well, we are very excited about efficacy – efficacy and to strategy. And if you had an opportunity to launch in January, we have a lot of customers talking about what they are doing with AppExchange as well as partners, not just small partners but new companies starting around our platform, but also large companies as well as Adobe and Skypes and business objects. But I guess the most surprising thing for us so far with AppExchange was when we got a call from Morgan Stanley and they wanted to buy 400 seats of our offering, it wasn’t was for our salesforce technology, it was for recruiting, which was an application in the AppExchange, and honestly at the time when the order came in, for me I didn’t even know we are recruiting application, it turns out we are recruiting good one, very customizable, very you know gradable, its very scalable, it’s very reliable, and they liked it so much that they gave it the very significant contract for it. That really shows how we think customers both small and medium and in the case of Morgan Stanley, large customer, will add additional seats based on AppExchange, they are going to find new application and new levels of value in the AppExchange, and they are going to work hard to deploy those seats inside their company and we feel that will bring us more subscribers overtime.

Operator

We’ll go next to Peter Goldmacher with SG Cowen.

Q - Peter Goldmacher

Hi, over the last year or so you had your investment in services, grow faster than your actual revenue from the services business. Can you talk a little bit about how you are thinking about the services business internally, and also how you think about your other go to market partners including the smaller SI’s you need tenders of the world?

A – Steve Cakebread

Well, we are making an investment in our services business, and perhaps that was more evident then about 90 days ago we hired John Freeland as our new President of worldwide operations. John, of course with 26 years at Accenture and the six most senior executive at Accenture, somebody we’ll work with very closely because he managed the 5000 CRM consultants at Accenture and he is an expert in CRM as well as in services. And we brought John in because we want an even more of a focus not just providing the services ourself but also in relationships, and now you see that build relationship with other services companies like Accenture and product consultancy and actually many many others worldwide, and we’ve seen expansion of our services ecosystem, a lot of our customers are very excited to work with these new service, vendors. We also see a lot of service companies come to us to understand how they can participate in AppExchange, not only building applications for the AppExchange like Tata also in helping our customers build their own custom application helping to manage and share information on-demand. Services partner is a great fit for a lot of these customers who may not have the IT experience available to them internally or through another external party. So we see an increased focus on services both delivered through ourselves as well as through our eco system going forward.

Operator

And due to time constraint, we have time for one more question. It comes from Brendan Barnicle with Pacific Crest.

Q - Brendan Barnicle

Thank you. Going back to AppExchange, can you give us a sense of what sort of contribution we may give for AppExchange in the ’07 numbers, and what are the metric should we be looking at to measure AppExchange progress?

A – Steve Cakebread

Well, the metric I think is most exciting for us in AppExchange progress is the number of applications, you know when we launched the AppExchange I think we launched it with 60 or 70 applications, now you see I think 168 applications in the US, and then in Japan I think we have another 20 something applications, that is getting close to 200 applications overall. The reason for this number of applications is important in AppExchange is because its really, the metric associated with the value. Today you see project management applications, product management applications, recruiting applications, Voice over IP, reporting, real estate management, crisis management, emergency data management, for disasters, on and on and on. And as we see those applications begun to emerge and we see those applications also translated in different languages and different currencies, we see the values of that AppExchange increase dramatically overtime. And we believe that that value increasing will therefore give our customers the ability to deploy those applications internally or in the case of a customer that I cited today bring us new opportunities as well.

Operator

And that concludes our question and answer session, I’d like to turn the conference back to Mr. Havlek for concluding remarks.

David Havlek, Vice President of Investor Relations

Okay thank you very much, and thank you all for joining us today. I want to apologize for some logistical issues that we faced today, I appreciate your patience as work through those. I also want to encourage you all to visit at: www.trust.salesforce.com site to take a look at how we are performing. Also encourage you to visit apexhange.com, take a look at some of the exciting new Aps out there. And you can contact Investor Relations directly if you can give anything – supply with follow-up information. With that, have a good day and thank you very much.

Operator

And this concludes today conference call, we thank you for your participation and you may disconnect your phone lines at this time.

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