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Salesforce Strategy Paying Off

Wall Street responds to 78% revenue growth.
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Updated from Nov. 16

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grew its top line by a torrid 78% during the third quarter, but margins and the bottom line won't grow very fast in the near future, as the on-demand software vendor continues to spend heavily to win market share.

"We're in a market share war," says CEO Marc Benioff. "We need to invest and invest heavily," he said in an interview after his company's earnings announcement.

That strategy appears to be just fine with Wall Street; in recent trading shares of the upstart, on-demand software vendor were up $1.66, or 6%, to $28.59.

The San Francisco-based company said late Wednesday that it earned a profit of $13.1 million, or 11 cents a share, in the third quarter, compared with $2.15 million, or 2 cents a share, in the October quarter of last year. Revenue was $82.7 million vs. $46.3 million.

Excluding a one-time tax benefit of 6 cents a share, Salesforce earned a 5-cent profit. On the same basis, analysts polled by Thomson First Call were looking for a profit of 4 cents a share on sales of $80.45 million.

The company's heavy investments in technology and marketing are clearly winning customers. During the quarter, the Salesforce added 1,800 customers, and 43,000 subscribers, representing sequential increases of 11% and 14%, respectively. "Customers" refers to companies at which Salesforce software is used; subscribers are employees of those companies who pay to use the software.

A year ago, Salesforce had 11,100 customers and 168,000 subscribers; today it has 18,700 customers and 351,000 paying subscribers.

Of particular note, the large Northern California technology company signed in the second quarter turns out to


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, where deployment nearly doubled to 3,900 users in the quarter, the company said.

Cash from operations in the October quarter was $24.6 million, a year-over-year increase of 87% and 75%, sequentially. But gross margins declined by 5% year over year to 76%, due primarily to heavy spending in technology, including the construction of two new data centers, and R&D.

CFO Steve Cakebread said that hiring was relatively light in the last quarter, but the company will be expanding its workforce significantly in the near future.

Salesforce said it expects revenue in the fourth quarter to range from $88 million to $90 million, with a non-GAAP profit of 2 cents to 4 cents. Wall Street was forecasting a 5-cent profit on sales of $89.6 million.

Prudential Securities analyst Brent Thill, said the guidance appears conservative, "given the upside achieved in the last six quarters." On the sales side, the guidance implies year over year growth of 63%, which would represent a slowdown from the 77%-84% of the last 3 quarters," he added. Thill, whose company does not have an investment banking relationship with Salesforce, rates the stock overweight and raised his target price to $27.

For fiscal 2006, the company now expects a profit of 15 cents to 17 cents a share, on sales of $307 million to $309 million. It had forecast sales of $298 million to $303 million and a profit of 13 cents to 16 cents a share.

Analysts were expecting a profit of 17 cents on sales of $306.2 million.

Cakebread issued what he called a preliminary forecast for 2007, saying he expects sales to range from $460 million to $465 million. Non-GAAP earnings will range from about 20 cents to 22 cents a share excluding the impact of expensing stock options.

Analysts were forecasting sales of $456.5 million and a profit of 31 cents.

Benioff was very upbeat on the call, and expressed satisfaction that

Siebel Systems


had "capitulated" to


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He doesn't expect them to be a significant competitor once they are integrated with the much-large database vendor. The $5.85 billion acquisition gained regulatory approval this week and is expected to close in early 2006.

Benioff was also dismissive of


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efforts to build on-demand software, saying Big Blue advertises but has failed to build any products.

The CEO said his company has tried to work more closely with IBM, but few parts of that company (with the notable exception of IBM's middleware group) understand Salesforce, or the nature of on-demand software.

His remarks are significant because IBM has been a major ally of Siebel's on-demand efforts. But with Siebel about to become part of Oracle -- a company whose database products compete head to head with IBM's -- that relationship clearly has no future.