Salesforce, Of Course

Salesforce posted a loss of $145,000, break-even on a per-share basis, for its fiscal second quarter, ended July 31. The San Francisco specialist in on-demand and subscription software for businesses would've earned six cents a share before items that included employee stock option expenses and merger costs. That beat the Wall Street forecast of four cents a share. Revenue climbed to $118.1 million from $71.9 million.

The company also raised its fiscal 2007 earnings and revenue guidance, saying it expected full-year earnings of 21 to 22 cents a share on sales of $488 million to $493 million. In May, it offered a range of 17 to 19 cents a share on sales of $478 million to $483 million. It estimated third-quarter earnings at a nickel a share, in line with Street estimates. Its quarterly revenue range of $126 million to $128 million was slightly above the $126 million consensus figure compiled by earnings tracker Thomson First Call.

That sounded great to Wall Street, but the size of the stock's intraday jump was juiced by its huge boost in new subscribers, a 26.6% sequential increase and a sharp reversal of its 9.3% fourth- to first-quarter decline.

Salesforce.com operates on a more genteel, high-tech plane than the gritty, profane hucksters of "Glengarry Glen Ross" fame, but the company showed the same instinct for sealing the deal when it announced the addition of 57,000 new customers in the quarter. That was 39% higher than the number of new subscribers added in the year-ago quarter, and well ahead of Wall Street expectations of an increase in the mid-40,000 range.

Wedbush Morgan analyst Michael Nemeroff calls it an "eye popping" number, but says new products helped boost the total.

The company also announced that Chief Financial Officer Steve Cakebread had decided to stay with the company instead of retiring, as he had earlier announced. This means, of course, that Salesforce benefits from the continuity that comes from having its Cakebread and keeping him, too.

The Analysis
The second-quarter results helped settle the market view of Salesforce.com, which went through a series of technical glitches and service interruptions at the end of last year through this spring, triggering a massive selloff. The robust guidance and increased new subscriptions prompted investor enthusiasm for a company that's in the right place at the right time.

Companies are increasingly taking their needs for customer-relationship-management software, which helps businesses better interact with customers, to outside players such as Salesforce. That's because rather than selling the software outright Salesforce offers access to applications of varying complexity for monthly subscription fees between $25 and $195. Until Microsoft (MSFT) gets into the business, as it vows to do soon, Salesforce is sitting pretty, and the numbers bear out the bulls.

"The on-demand software as a service market has really taken off over the last couple of years, and Salesforce.com is on the leading edge of that shift," says Nemeroff. "They may have more mind share than market share, but they're clearly leading the charge. They have led a number of other companies to shift their business models to something similar."

With a market cap of $3.1 billion, Salesforce is much larger than rivals such as Rightnow Technologies (RNOW), Ultimate Software (ULTI) and Concur Technologies (CNQR), the largest of which is about one-sixth the size of the market leader.

David Koning, an analyst at Robert W. Baird & Co., a Milwaukee investment bank, says the Street was looking for results that show some performance-based substance to back up positive sentiment, which was a serious issue earlier this year.

"This is a stock that in early '06 reached about $43 [$42.99, a 52-week high, on Jan. 30] and sold off to $22 or so [$21.85, on July 17], because there was a lot of nervousness around the outages and interruptions that happened six to nine months ago," he says, adding that there's been little instance of tech trouble in the last six months.

"We just now have squelched the worries about these outages, and now it's done the same with worries about subscriber growth slowing a lot," he says. "Because the stock sold off so much, we're having this huge rebound."

The company's one big worry is the 800-pound gorilla that's walking slowly and surely to the room, wearing a mask that looks a lot like Bill Gates.

Microsoft has made no secret of its plans to get into the subscription software business, but it's been roughed up in the market a bit because of delays, says Nemeroff. When it does happen, it'll be an issue for Salesforce.

"Those guys in Redmond are spending billions of dollars on data centers and server farms to support the on-demand market in the future," he says. "We haven't seen that competition come up against Salesforce.com in any meaningful way, yet."

The Bottom Line
When a market leader stumbles, it falls pretty hard, and in the case of Salesforce, whose problems were based largely on an inability to offer on-demand software, well, on demand, that's a fair response from the market.

The climb back up looks rapid, and the biggest question for the next few quarters is where the summit is. New customer growth looks solid again, and the company now has 501,000 total subscribers. In a note published Thursday, Deutsche Bank analyst Tom Ernst estimated yearly new subscriber growth of about 220,000 in 2007, 260,000 in 2008 and 272,000 in 2009.

Its current churn rate of about 10%, by Koning's estimate, "is great for an enterprise software company."

Its growth rate will inevitably trail off, says Nemeroff, but it's working in a maturing market, not a saturated one, which should keep it in double digits for a while.

At this point, Salesforce has clearly absorbed the principal lesson of Blake, the foul-mouthed protagonist of David Mamet's stark play and film: "Because only one thing counts in this world: Get them to sign on the line which is dotted."

This company knows it, and investors can certainly appreciate it.