Highlights From CRM's Q3 Conference Call: Revenues Rose 36%; Issues Good Guidance

Salesforce.com, Inc. (NYSE: CRM) reported Q3 EPS of $0.34, $0.03 better than the analyst estimate of $0.31. Revenue for the quarter came in at $584 million versus the consensus estimate of $571.42 million. Shares are selling off today, down almost 11% (-$13.72)

Highlights From CRM's Q3 Conference Call:

• Sees Q4 adj-EPS of 39-40c, vs. the consensus of 40 cents. See sales of $620-$624 million, vs. the consensus of $609.8 million.
  
• Sees FY2012 revenue of $2.26-$2.6 billion, versus the consensus of $2.23 billion.
  
• Sees FY2013 revenue of $2.88-$2.92 billion, versus the consensus of $2.79 billion.
  
• (Marc Benioff) First, revenue of $584 million rose by, amazingly, 36%. Our annual revenue run rate is now more than $2.3 billion. And it makes us the first enterprise cloud company to reach this milestone.
  
• Non-GAAP EPS of $0.34 was absolutely above our guided range, and we delivered that while hosting a world-class Dreamforce here in San Francisco that now is the largest enterprise software event in the world with more than 46,000 registered attendees.
  
• Deferred revenues increased by 32% to finish the quarter at $918 million. And third quarter operating cash flow rose by 74% year over year to $129 million in the quarter. We exited the quarter with approximately $1.3 billion of cash and equivalents on our balance sheet.
  
• Now in fiscal year 2012, we became the first enterprise cloud company to surpass a $2 billion annual revenue run rate. And today I'm delighted to announce that we expect to reach a $3 billion annual revenue run rate during our next fiscal year.
  
• Our financial success in the third quarter was powered by a tremendous response from customers to our new social enterprise strategy. We're now engaging customers at a higher, more strategic level than ever before.
  
• At Dreamforce, we showed how some of the world's best companies such as Burberry, Toyota, Verizon are all transforming into social enterprises. In fact, I'm delighted to share with you that one of our largest transactions in the quarter was Verizon, who signed up for 80,000 subscribers to Chatter, 7,000 subscribers to the Sales Cloud and Data.com.
  
• For the Sales Cloud we signed Maersk, one of the world's largest shipping companies in the world based in Europe. And they swapped out Oracle and selected Salesforce for their entire global sales team. We also won deals against Oracle with Bayer, Eli Lilly, Telstra, Fuji Xerox, Japan Post, Unisys, PTC Parametric, and Diebold Security, all strong wins against Oracle.
  
• As exciting as our Sales Cloud momentum is, perhaps nowhere is the social enterprise message as critical as it is in customer service. In fact, five of our top ten transactions for the quarter included the Service Cloud. A great example is Electronic Arts, who wanted to create a next-generation customer service center before the release of their highly anticipated videogame, Battlefield 3. Electronic Arts (Nasdaq: ERTS) was able to deploy an employee social network with 1,200 agents in just six weeks, allowing them to manage dozens of portals, serving up over 20 million site page views, and handling 150,000 cases in the first week alone, a really great win for salesforce.com against Oracle (Nasdaq: ORCL).
  
• Chatter, which is the heart of our social enterprise strategy, continued to drive our success in the third quarter. Another great example is Avaya, who plans to deploy more than 17,000 subscribers to Chatter and the Sales Cloud.
  
• And GE (NYSE: GE) signed up for 20,000 subscribers of Chatter. In just three weeks, GE created a private customer social network called GE Edge, where their customers can collaborate with peers and get access to experts in research.
  
• Other Chatter wins in the quarter included Toyota (NYSE: TM) with 10,000 subscribers of Chatter, and Bechtel with 5,000 subscribers of Chatter.
  
• We're thrilled with the success that Radian6 has seen with major customers around the world. Wins from the quarter included Cond Nast, Delta Airlines (NYSE: DAL), LinkedIn (Nasdaq: LNKD), Nestl, The New York Times, and Warner Bros.
  
• Force.com achieved some truly impressive milestones in the quarter, delivering triple-digit growth year over year. Today, nearly 450,000 developers have built and deployed more than 260,000 cloud apps on Force.com, and usage of the platform continues to increase. Force.com delivered 40 billion transactions, up 10% quarter over quarter and 62% from year ago, phenomenal. That's more than 600 million transactions on Force.com every business day.
  
• One of the great Force.com wins for the quarter is with USAA. They are standardizing on Force.com to power a range of employee-facing social apps such as property management, claim tracking, recruiting, and more.
  
• Over the last year, we extended our net platform strategy beyond Force.com with Database.com and Heroku and Data.com, giving developers solutions to replace legacy tools. This quarter Database.com became generally available, and Heroku added support for five additional languages including Java.
  
• Heroku also became the first and to date the only cloud platform built right into Facebook's development center. Right from within Facebook, you can start building Heroku applications in Java, in Python, in Ruby, in Clojure, or the language of your choice. Within 24 hours of the announcement at Facebook's f8 conference, Facebook developers had built more than 30,000 new apps on Heroku, phenomenal.
  
• (Graham V. Smith) We executed well to deliver strong revenue growth, outstanding cash flow, and earnings above guidance. Revenue for the quarter was $584 million, an increase of just over 36% year over year.
  
• And third, we continue to benefit from a weaker dollar, which in Q3 provided a tailwind of approximately $9 million. Constant currency revenue growth was 34%.
  
• In terms of our third quarter year-over-year revenue growth by geography, revenue in the Americas grew 36% to $397 million. In Europe, Q3 revenue was $104 million. That's up 36% in dollars and 29% in constant currency. And in Asia, Q3 revenue rose roughly 39% in dollars and 31% in constant currency to $83 million. Our Japan business continued on its recovery and posted strong new business growth in the third quarter.
  
• Moving on to the rest of the income statement, our non-GAAP gross margin was 82%, essentially unchanged from Q2 and from the year-ago quarter. Non-GAAP subscription and support gross margins were flat sequentially at 86% but down a couple of points from last year.
  
• Moving on to operating expenses, total non-GAAP operating expenses represented 71% of revenue in Q3, up four percentage points from last year. The increase was the result of two principal factors
  
• Within specific expense categories, sales and marketing continues to be our largest operating expense at roughly 47% of revenue. This was up about three points from last year.
  
• While sales and marketing remains our largest expense line item, warranty was our fastest growing expense category in Q3, increasing 47% from a year ago. With a broadening product portfolio and our goal to dominate enterprise cloud computing, ongoing investment in R&D is critical. As a result, R&D now represents 11% of revenue compared with 10% a year ago.
  
• Non-GAAP EPS was $0.34 compared with $0.32 in Q3 last year. EPS was higher than we guided for two main reasons. First, our effective non-GAAP tax rate for Q3 was 29%, lower than our guided rate of 33%. This was the result of favorable adjustments, driven by stock option exercises and additional tax benefits related to recent acquisitions.
  
• We currently expect our Q4 non-GAAP effective tax rate to increase to roughly 32%. Looking to FY 2013, we currently estimate that our effective tax rate will increase to approximately 40%.
  
• Turning next to cash flow, operating cash flow was $129 million during the quarter, up 74% from last year. Year-to-date cash flow from operations was up approximately 20% over the first nine months last year. We had a strong collections quarter and our Q3 DSO was 49 days, down from 55 days a year ago.
  
• For the full year, we expect operating cash flow in the mid-teens percentage range. This implies slower growth in Q4 than Q3, primarily as a result of the significant hiring ramp that we're seeing in the second half.
  
• For CapEx, we finished the quarter at roughly $35 million.
  
• Free cash flow, which we define as operating cash flow minus CapEx, was approximately $94 million for Q3. That's up 77% from last year. For the nine months year to date, we've generated $244 million in free cash flow.
  
• Moving on to the balance sheet, cash and marketable securities ended the quarter to just under $1.3 billion.
  
• After taking these factors into account, we now project Q4 revenues to be in the range of $620 million to $624 million and non-GAAP EPS in the range of $0.39 to $0.40.
  
• For full year 2012, we estimate revenue in the range of $2.255 billion to $2.259 billion, representing growth of approximately 36%.
  
• Looking forward to fiscal 2013, we currently anticipate revenue to be in the range of $2.88 billion to $2.92 billion. Again, this assumes we close the acquisition of Model Metrics in Q4. The midpoint of this guidance range implies just over 28.5% revenue growth for FY 2013.
  
• (Q&A) I was just looking to get a little bit more clarity on the deferred revenue commentary, Graham. I think if you look at the billings calculation, the way we do it on the Street, that has been well above 30% the last four quarters, five quarters actually. Is something of a change with respect to the contract durations or invoicing terms that represents a new way in which we should be thinking about the so-called billings growth rate, or is there something of a temporary nature that explains why the billings may have been lower than what people's expectations were? And also if you could clarify, I think you said 30% growth in Q4. I wasn't sure if you meant revenue or deferred revenue growth rate. Thanks, that's it for me. (A) First, we think deferred revenue in Q4 will grow approximately 30%. Obviously, I've said for all the reasons that I listed, it's a tough number for us to predict accurately. I think first of all, just to put this in perspective, I think we've raised our guidance for Q4. We've obviously initiated I think pretty exciting guidance for next year. If you look at the trend of constant currency deferred revenue growth, Q1 33%, Q2 33%, Q3 was 31%. That's why we have avoided I think talking about your calculation of billings. I think your number is a lot more volatile. We tend to think deferred revenue is a number that goes on balance sheet. And we feel clearly that it's subject to this volatility for all those reasons that I listed around invoice duration and so on. And then the last thing I'd remind you, Kash, is that some of these newer businesses, like Radian6 and Heroku, they're not really contributing to deferred revenue balance. They contribute to the revenue number but they don't contribute to the deferred revenue number in any significant way. So we did highlight that at our analyst session at Dreamforce as something of a potential shift in how that billings calculation that you do may work. So we feel - we couldn't be happier with where our business is and where we're going in Q4 next year, so that's our commentary.
  (A) Yes, I think when you look at what is the best predictor of our future revenues, we're able to really take a strong look at our guidance. And you've seen for this year that we've really been right on that in terms of where we're going as an organization. And as we look to other metrics in our balance sheet like deferred revenue, the problem is, is that that's a metric that's rapidly evolving as we start to do more acquisitions, as there are fluctuations in invoicing periods, currency changes. But at the end of the day, our best predictor of where our revenue is going is our guidance. And when we get down to the deferred revenue, it's not a metric that we manage internally. It's really only a metric that we report at the end of the quarter. And in terms of our sales and our numbers for the quarter, our bookings for the quarter, we've stayed away from those quarterly numbers. And we can look at something like our customer counts, which for this quarter were above where we expected them to be and were actually a record number than we've ever had in the history the company.
  
• I just had a question following up on what Kash was talking about. At Dreamforce, I think one of the things that came out of it is that typically you guys have thought of it as a big deal closing event. And so I think that's what some of the confusion is given seasonality in deferred was a little bit below what you guys have done over the last couple quarters. I was just wondering how you saw the deal closing activity versus your expectations coming out of Dreamforce. Or is that still do think more of a Q4 event for you? (A) Our pipelines are fantastic, and we've added - Q3 was an amazing quarter for us. And we expect another amazing and spectacular quarter in the fourth quarter. Our pipelines have never been bigger. Our customer accounts have never been higher. The number of net new customers for the quarter was higher than it ever was. And we couldn't be more excited about our business, and a lot of that came out of the fourth quarter. And as we look to the next fiscal year, we look at hitting this $3 billion annual revenue run rate, which is critical for us. And really - and you can also see how we see the fourth quarter playing out in terms of revenue where we're raising our revenue guidance to $2.258 billion. All indications to us is that our business remains unbelievably strong and pipeline is strong and the number of deals that are closing are at record levels. If we zero back down to this deferred number, it's going to continue to fluctuate, and it's not a great indicator of the current performance of the company. The best performance indicator of the performance of the company, of course, is the revenue. And the best indicator of the future performance of the company is the guidance that we're giving on the call today. (A) And, Heather, I did mention earlier on in my comments that we did exceed our own expectation in terms of where our new business was going to close for the quarter in Q3.

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