Salesforce, Inc. quarterly report, Q3 FY2011

Business context and reporting period

Salesforce, Inc. (then salesforce.com, inc.) filed this Form 10-Q for the quarter ended October 31, 2011, the third quarter of fiscal 2012, and the nine months then ended. The request metadata says “2010 Q3,” but the filing itself reports 2011 results and compares them with 2010. Salesforce provides subscription-based cloud applications and a platform for business applications.

Financial performance and liquidity

Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.

Metric	Three months ended Oct. 31, 2011	Comparable 2010 period	Nine months ended Oct. 31, 2011	Comparable 2010 period
Revenue	$584.3	$429.1	$1,634.6	$1,200.3
Operating income (loss)	($10.2)	$35.2	($28.7)	$97.9
Net income (loss) attributable to Salesforce	($3.8)	$21.1	($7.5)	$53.6
Diluted EPS	($0.03)	$0.15	($0.06)	$0.40
Operating cash flow	$128.7	$74.0	$351.2	$293.3

Subscription and support generated 94% of revenue. Third-quarter revenue increased 36% year over year; subscription and support revenue also grew 36%.
Gross margin was approximately 78% in the quarter and nine-month period, versus 81% in each comparable 2010 period. Operating margin was approximately negative 2%, versus positive 8%.
Nine-month investing cash outflow was $332.4 million, mainly reflecting acquisitions, capital expenditures, strategic investments, and marketable securities activity. Financing cash inflow was $63.4 million. Cash and cash equivalents increased $78.7 million over the nine months.
At October 31, cash, cash equivalents, and marketable securities totaled $1,296.7 million. Current assets were $1,148.2 million and current liabilities $1,832.6 million.
The $575 million face-value 0.75% convertible notes, due January 2015, were classified as current because holders could convert them; the balance-sheet carrying amount was $490.1 million. The company said they would remain current through January 31, 2012.

Material changes versus the prior comparable periods

Revenue rose 36% year over year in both the quarter and nine-month period, attributed mainly to new customers, upgrades, more subscriptions from existing customers, and improved renewals. International revenue growth also benefited from currency movements.
Operating results shifted to losses as expenses grew faster than revenue. Marketing and sales expense reached 52% of revenue, up from 47%; research and development rose to 13% from 11%. Gross margin declined three percentage points.
Stock-based compensation was $159.2 million for the nine months, compared with $78.7 million. Purchased-intangible amortization was $47.4 million, compared with $12.8 million.
Acquisitions increased goodwill to $732.1 million from $396.1 million, notably through Radian6 and Assistly. The company also acquired Manymoon and other smaller businesses during the period.
Cash and marketable securities totaled $1,296.7 million, down from $1,407.6 million at January 31, 2011. Deferred revenue, current and noncurrent, was $917.8 million versus $934.9 million at January 31.

Outlook, commentary, risks and unusual items

Management expected fiscal 2012 diluted EPS to be significantly below fiscal 2011 as the company reinvested incremental revenue in growth. No specific EPS or revenue forecast is provided in the supplied filing text.
Management expected continued investment in sales and marketing, hiring, research and development, data-center capacity, and international expansion. It expected marketing and sales to remain a substantial share of revenue, and said general and administrative expense as a percentage of revenue would remain flat for the next several quarters.
Management believed available cash, short-term investments, and operating cash flow would cover working-capital and capital-expenditure needs for the next 12 months. It also anticipated an approximately $40 million tax payment in fiscal 2013 related to Radian6.
A definitive agreement to acquire Model Metrics for approximately $57.6 million in cash, net of cash acquired, was announced after quarter-end; closing was expected in fiscal Q4, subject to customary conditions.
The California wage-and-hour lawsuit had a preliminary settlement subject to court approval. The estimated charge was approximately $0.04 per diluted share and was reflected in the nine-month results.
The nine-month effective tax rate was 71%, which management attributed to foreign tax differentials and nondeductible acquisition costs, among other items, applied to a small pretax loss. The filing also identifies uncertain tax positions and potential adverse audit outcomes.
Key risks include service outages, security breaches, reliance on third-party data centers and technology, competition, renewal and customer-spending variability, acquisition integration, stock-based compensation, foreign-exchange and interest-rate exposure, litigation, and execution and cost risks associated with growth and the new headquarters project.
Management reported disclosure controls were effective at a reasonable-assurance level and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Confirm the period: this is fiscal Q3 2012, ended October 31, 2011, despite the “2010 Q3” request metadata.
Assess whether rapid revenue growth can outpace rising operating expenses, particularly sales and marketing, stock compensation, data-center costs, and acquired-technology amortization.
Review the convertible notes’ conversion terms and current classification, including potential cash settlement and share dilution under the note and warrant arrangements.
Track acquisition integration and final purchase-price allocations for Radian6 and Assistly, and the status and cost of the planned Model Metrics acquisition.
Check court approval and final cost of the wage-and-hour settlement, as well as developments in other legal and tax matters.
Evaluate liquidity alongside current obligations, lease commitments, planned capital spending, and the expected fiscal 2013 tax payment.