SUMMARY. Risk Level *

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1 February 03, 2015 Salesforce.com, Inc. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 09/18/2012 Current Price (02/02/15) $57.28 Target Price $ Week High $ Week Low $49.13 One-Year Return (%) Beta 0.93 Average Daily Volume (sh) 4,012,421 Shares Outstanding (mil) 631 Market Capitalization ($mil) $36,144 Short Interest Ratio (days) 7.82 Institutional Ownership (%) 94 Insider Ownership (%) 6 SUMMARY Risk Level * (CRM-NYSE) CRM platform provider, salesforce.com posted better-than-expected third-quarter fiscal 2015 results. Further, the company provided positive fourth-quarter revenue guidance and raised the fiscal 2015 guidance as well. We consider the rapid adoption of the Salesforce1 Customer Platform to be a positive. Overall, the company s diverse cloud offerings and strong spending on digital marketing remain catalysts. Although the company is growing reasonably in the cloud market, growth prospects have been rationalized to a considerable extent due to intensifying competition. Currency fluctuations and an increase in investments for international expansions and data centers could impact nearterm results. Thus, we reiterate our Neutral recommendation on the stock. Average, Type of Stock Large-Growth Industry Comp-Software Zacks Industry Rank * 158 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Apr) (Jul) (Oct) (Jan) (Jan) Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 34.0 Earnings Per Share (%) Dividend (%) N/A P/E using TTM EPS N/A P/E using 2016 Estimate P/E using 2017 Estimate A 957 A 1,076 A 1,145 A 4,071 A ,227 A 1,319 A 1,384 A 1,441 E 5,370 E ,506 E 1,595 E 1,670 E 1,743 E 6,514 E ,900 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Apr) (Jul) (Oct) (Jan) (Jan) $0.07 A -$0.09 A -$0.12 A -$0.11 A -$0.38 A $0.07 A -$0.05 A -$0.02 A $0.00 E -$0.03 E 2016 $0.01 E $0.02 E $0.02 E $0.03 E $0.08 E 2017 $0.26 E Zacks Rank *: Short Term 1 3 months outlook 4 - Sell Projected EPS Growth - Next 5 Years % 21 * Definition / Disclosure on last page (Note: Qtly. fig. may not add up to annual fig. due to rounding off and certain adjustments.) 2015 Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Headquartered in San Francisco, salesforce.com is the leading provider of on-demand Customer Relationship Management (CRM) software, which enables organizations to better manage critical operations, such as sales force automation, customer service and support, marketing automation, document management, analytics and custom application development. Founded in 1999, Salesforce began offering its on-demand application service on a subscription basis in Feb The company has leveraged its expertise in on-demand software to increase the scale of operations. It also offers a technology platform for customers and developers to build and run business applications. There are two main revenue streams Subscription and Professional Services & Other. Subscription revenues come from a couple of sources. The primary source is subscription fees received by the company from customers for accessing its enterprise cloud computing application service. The second source is subscription fees generated from customers for providing additional support beyond the standard support given by the company. This segment accounted for roughly 94% of Salesforce s 2014 revenues. Professional Services & Other revenues consist of fees that the company derives from consulting and implementation services and training. Consulting and implementation engagements typically generate one-time payments. Training includes classes on implementation, usability and administration of service provided by the company that are billed per session. This segment accounted for the remaining 6% of Salesforce s 2014 revenues. Geographically, in 2014, Americas contributed approximately 71% of total revenue, Europe accounted for roughly 18%, while Asia Pacific contributed the remaining 11%. Equity Research CRM Page 2

3 Salesforce faces increased competition within the on-demand CRM market from Microsoft Corp., SAP, International Business Management and Oracle. REASONS TO BUY Salesforce is among the top three Customer Relationship Management (CRM) vendors, in the Software-as-a-Service (SaaS) enterprise application market. The company was the first to sign up large customer accounts, which helped it build a strong market position. Given increasing customer adoption and satisfactory performances, market research firm Gartner acknowledged Salesforce as the leading CRM solutions provider, with a market share of 16.1% in 2013, ahead of SAP with 13% market share and Oracle with 10% share. According to Gartner, the SaaS market is expected to grow 19.5% to $32.8 billion in 2016 from $13.5 billion in Moreover, the research firm stated that Salesforce recorded the fastest growth, breaking into the list of top 10 SaaS providers for the first time from the 12th position in Gartner s most recent report stated that the global CRM market grew 13.7% to $20.4 billion in 2013 from $18.0 billion in 2012, with 41% CRM systems being SaaS-based in Apart from this, the firm expects global spending for enterprise software to increase 7.3% year over year to $344.0 billion in The key markets expected to benefit from this spending are security, storage management and CRM. We believe that Salesforce is well-positioned to capitalize on the opportunity. Salesforce s on-demand SaaS business model underscores its focus on sales force automation, marketing, customer responsiveness and support, improved personnel collaboration within an organization, software tools for developers, social media monitoring and marketing, and other social enterprise areas. The company has various SaaS applications and platforms to serve its focus areas. The Sales Cloud, Service Cloud and Chatter applications allow its customers to improve communication and sales to their respective customers. With the Radian6 application, customers can monitor social networking sites, which provide better insight to their product acceptability. Salesforce also provides The Force.com Platform, Heroku Platform and two other developer tools (Database.com and The AppExchange), which allow its customers to develop customized applications using languages of their own choice and convenience. SaaS deployments are easy and help to reduce ownership costs for customers. For this reason, business application and IT operations managers continue to explore and deploy SaaS, leading to exponential growth of the market. According to the latest Gartner report, IT spending is expected to grow 2.6% in 2014 to $3.8 Equity Research CRM Page 3

4 trillion. The improvement in spending will mostly be driven by enterprise software. Moreover, International Data Corporation estimates public IT cloud services spending to increase at a 4-year compound annual growth rate (CAGR) ( ) of 23.5%. With its SaaS-based CRM and social enterprise applications, we think that Salesforce is well-positioned to lead the market. Salesforce is also focusing on strategic acquisitions to expand its market share. In fiscal 2014, the company acquired three companies and in fiscal 2013 it acquired five other companies of which the most prominent was ExactTarget. The company acquired ExactTarget for approximately $2.5 billion in Jul 2013 to expand its cloud-based platform. The digital marketing capability of ExactTarget will help Salesforce to create a strong marketing platform through , social networking and the web. This acquisition has made it easy for Salesforce to tap the online marketing business. Salesforce also acquired EdgeSpring, Inc. in Jun 2013 for roughly $133.7 million. Other notable acquisitions by Salesforce in the last couple of years include browser startup, GoInstant for roughly $51.0 million in Sep 2012 and a social media marketing company, Buddy Media for roughly $735.0 million in Aug In Feb 2012, the company acquired Rypple, a provider of a cloud-based platform that offers feedback to employees regarding their performance and provides management with suitable tools for employee evaluation. We believe that these acquisitions will add value to Salesforce s existing portfolio and the resultant synergies will benefit the company in the long run. In keeping with its strategy of growing in Europe, Salesforce opened its first data center in the U.K. in Aug 2014 and plans to open data centers in France and Germany by 2015, to cater to international customers. Moreover, the company is aiming to increase its headcount across Europe by 500 during the same period. The opening of data centers in these countries will help Salesforce to reach local small and medium businesses as well as government agencies. These investments come at an opportune moment as a study by Computer Weekly and Tech Target forecasts that IT budgets in U.K. are expected to increase 3.6% in 2014 and by 3% in rest of Europe. The study also revealed that the increase would be spearheaded by investments in cloud computing and data analytics segments. Moreover, expansion in Europe would enable Salesforce to diversify its international revenues, going forward. Notably, in fiscal 2014, Salesforce s revenues from Europe increased 41% year over year and constituted 18% of total revenue (17% in fiscal 2013). Salesforce also intends to open two data centers in Canada, to cater to international customers, thereby strengthening its presence in the country. Salesforce s investments in Canada also come at the right time as a study by Gartner forecasts that the software market in the country is expected to increase 8.7% in Moreover, the study revealed that data center revenues will amount to $3.4 billion in We believe that the company s entry into new markets like Canada would provide it a significant growth opportunity beyond U.K., France and Germany. The Salesforce Chatter platform is the enterprise social collaboration application platform introduced by the company after its Salesforce 2 platform. We believe that free add-on offerings like Chatter will enable Salesforce to differentiate its core offerings, making them more attractive for customers. This should therefore generate additional business volume. Some of its clients include Burberry, Comcast, Kelly Services, Charles Schwab, Chipotle, Bausch & Lomb, Dell, Kimberly-Clark, Unilever and Philips. Also, the company introduced Salesforce ExactTarget Marketing Cloud platform, which is part of the Salesforce1 Customer Platform. The Salesforce1 platform provides social, mobile and cloud networking features for building business applications, including data models and objects to manage data. It also helps application developers to build and deploy social and mobile applications. In Jan 2014, the company announced that the number of active users of the Salesforce1 mobile app increased 96% while that of its custom mobile apps increased 46%, primarily driven by the Salesforce1 Customer Platform. Moreover, companies like Valspar, Design Within Reach, and Fisher & Paykel selected the Salesforce1 platform to maintain improved relationships with their customers and enable users to connect and share information securely. The rapid adoption of Salesforce platforms demonstrates its growing opportunities in the ever-growing cloud computing segment. Equity Research CRM Page 4

5 We believe that Salesforce s cloud-partnership with its fierce competitor Oracle Corp. will be a key growth driver. Under the terms of the deal, Salesforce software will run on Oracle s Linux (replacing Red Hat s Linux platform). It will also use Oracle s cloud-based human resources and financial applications. Apart from this, Oracle s Exadata hardware will run on Salesforce s cloud based applications. The partnership is also expected to ensure tighter integration between Oracle and Salesforce clouds, which will help customers to easily move their data between the two platforms. Salesforce also entered into a strategic alliance with Hewlett-Packard Co. to offer CRM services on HP s Converged Infrastructure. This new offering, namely Salesforce Superpod is intended for companies that have an extensive IT infrastructure and require a certain level of compliance and enterprise integration. Most recently, Salesforce entered into a strategic alliance with the world s largest software maker, Microsoft, to offer Salesforce s CRM services on Microsoft Azure. Microsoft s customer relationship management software equips organizations with advanced cloud-based technologies that increase the efficiency of their operations, solve complex business challenges and improve resource allocation. Salesforce also offers similar capabilities. Thus, the agreement will improve ties between the two companies. Considering the exponential growth in transitioning to the cloud environment, we believe that these partnerships add value to Salesforce s existing portfolio and the resultant synergies will benefit the company over the long run. REASONS TO SELL Salesforce faces stiff competition from Microsoft Corp. and Oracle in the cloud-based CRM market. Oracle has strengthened its cloud position through the acquisitions of Nimbula (Mar 2013), Eloqua Inc. (Dec 2012), RightNow Technologies (in Jan 2012) and Taleo Corp (Apr 2012). Microsoft has also added MarketingPilot (Oct 2012) and Netbreeze (Mar 2013) to beef up its Dynamic CRM platform. Additionally, Microsoft offers special pricing for its Dynamics CRM Online service, which is helping it to snatch Salesforce s customers. Competition is expected to intensify further, as Microsoft Dynamics CRM software (code-named Titan) gains ground. Titan has been designed to offer direct competition to Salesforce s on-demand CRM software model. Moreover, IBM is strengthening its grip on the cloud computing software market with its web-based collaboration software for businesses, including contact management, instant messaging and file sharing programs. Switching from customized on-premise software to an on-demand solution can be difficult, raising barriers of entry for the company. Furthermore, being the market leader, it is more difficult for Salesforce to find prospective customer companies, where competitors may be dislodged. On the other hand, it is easier for others to formulate a strategy to snatch customers away. Although cloud computing offers great business potential, taking into consideration some security breaches at several large global corporations, some clients/prospects are also in the process of developing an internal system that will give them greater control over data. Moreover, lingering macroeconomic weakness could weaken renewals and delay sales cycles for Salesforce. In addition, increasing competition in the software-as-a-service, customer relationship management, and platform-as-a-service (PaaS) markets could impact new and renewal pricing of new products. Increased focus on acquisitions could negatively impact Salesforce s balance sheet in the form of a high level of goodwill and intangible assets, which totaled $3.78 billion, or 40.2% of its total assets as of Oct 31, Furthermore, acquisitions add to integration risks, which may dilute earnings. Also, frequent acquisitions are a distraction for management and may impact organic growth. It also makes comparisons more difficult over the long term. Equity Research CRM Page 5

6 RECENT NEWS Salesforce to Grow in Japan IT Market with 2nd Data Center Dec 3, 2014 Going ahead with its strategy of global expansion, Salesforce in Dec 2014 announced that it intends to open a new data center in Japan. The new data center will help Salesforce to reach businesses and government agencies in the country while meeting the growing demand for cloud-based services across the Asia-Pacific region. This will be Salesforce s second data center in Japan, following the one opened in Nov The company started its international expansion in Jul 2009 with the opening of the first data center in Singapore from where it used to provide customer support across the Asia-Pacific region. Japan is one of the greatest consumers of technology, so there is significant scope for growth in the country. Salesforce has decided to tap this opportunity with the 20+ investments made by it in the Japanese technology market. Additionally, the company stated that Japan's Ministry of Internal Affairs and Communications is using its Salesforce1 Platform to develop a Big Data solution for road inspections. Salesforce Beats Q3 Earnings & Revenues, Outlook Raised Nov 19, 2014 Salesforce reported better-than-expected third-quarter fiscal 2015 results wherein both the top and bottom-line figures surpassed the Zacks Consensus Estimate and improved year over year. The improvement in earnings was primarily driven by strong revenue growth and lower operating expenses. Revenues Salesforce s revenues of $1.38 billion not only increased 28.6% from the year-ago quarter but also beat the Zacks Consensus Estimate of $1.37 billion. Reported revenues also beat management s guided range of $1.365 to $1.370 billion. The year-over-year improvement was primarily attributed to rapid adoption of the company s cloud-based solutions and the ExactTarget acquisition. Also, higher demand for Salesforce s ExactTarget Marketing Cloud platform, part of the Salesforce1 Customer Platform, contributed to the year-over-year revenue jump. During the quarter, the company s cloud-based solutions were selected by a number of companies including EMC Corporation, Verizon Communications Inc. and General Electric Company. Among its business segments, revenues from Subscription and Support increased 28.3% from the yearago quarter to $1.29 billion. Professional Services and Other revenues increased 33% on a year-overyear basis to $95.1 million. Geographically, the company witnessed revenue growth of 29.4% in the Americas, while revenues from Europe and Asia increased 29.8% and 21.2%, respectively, on a year-over-year basis. Operating Results Salesforce s adjusted gross profit (including stock-based compensation but excluding amortization expenses) came in at $1.07 billion, up 27.2% from the year-ago quarter. However, gross margin contracted 83 basis points (bps) to 77.4% from the year-ago quarter, primarily due to increased investment in infrastructure development which also include expansion of international data center. Equity Research CRM Page 6

7 Adjusted operating expenses (including stock-based compensation but excluding amortization of acquisition-related intangibles) increased 18.7% from the year-ago quarter to $1.06 billion, primarily due to higher investments in research and development, marketing and sales and general and administrative activities. However, as a percentage of revenues, operating expenses contracted 634 bps from the yearago quarter to 76.4%. Salesforce reported adjusted operating income (including stock-based compensation but excluding amortization of acquisition-related intangibles) of $13.4 million, comparing favorably with year-ago loss of $48.9 million primarily due to higher revenue base and a drop in operating expenses as a percentage of revenues. Salesforce s adjusted net income, including stock-based compensation but excluding all one-time items on a proportionate tax basis, came in at $8.3 million as against a net loss of $23.4 million reported in the year-ago quarter. Balance Sheet & Cash Flow Salesforce exited the quarter with cash and cash equivalents and marketable securities of $926.1 million compared with $838.8 million in the previous quarter. Accounts receivable were $794.6 million compared with $1.36 billion in the prior-year quarter. Total deferred revenue as of Oct 31, 2014 was $2.22 billion, which increased 28% on a year-over-year basis. During the third quarter, the company generated $122.5 million cash from operating activities and $841.5 million in the first nine months of fiscal Guidance For the fourth quarter of fiscal 2015, the company expects revenues in the range of $1.436 to $1.441 billion, reflecting a year-over-year increase of 25% to 26%. The company expects non-gaap earnings per share in the range of $0.13 to $0.14. Salesforce raised the lower-end of its full fiscal-year 2015 revenue guidance from $5.340 $5.370 billion to $5.365 $5.370 billion (up 32% year over year). The company also revised the non-gaap earnings per share guidance from the range of $0.50 $0.52 to $0.51 $0.52. Equity Research CRM Page 7

8 VALUATION Salesforce s price-to-book value ratio in the last quarter was 9.7x, compared to 8.4x for the industry and 5.1x for the S&P 500. Therefore, the shares are trading at a premium to the industry group and also near the mid-point of the historical range of 7.5x to 16.1x, which indicates limited possibility of an upward movement. Salesforce s 5-year earnings growth rate of 26.0% is significantly higher than the industry average of 15.4%. Given the mixed signals, we believe that the shares will trade in the current range (although there could be modest upside). Thus, we reiterate our Neutral recommendation on Salesforce with a target price of $ Key Indicators P/E F1 P/E F2 Est. 5-Yr EPS Gr% P/CF P/E P/E 5-Yr High P/E 5-Yr Low Salesforce.com, Inc (CRM) N/A Industry Average S&P VMware, Inc. (VMW) Symantec Corporation (SYMC) Intuit Inc. (INTU) CA Inc. (CA) TTM is trailing 12 months; F1 is 2016 and F2 is 2017, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Salesforce.com, Inc (CRM) Industry Average S&P N/A 2.0 N/A Equity Research CRM Page 8

9 Earnings Surprise and Estimate Revision History Equity Research CRM Page 9

10 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CRM. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will underperform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1117 companies covered: Outperform %, Neutral %, Underperform 6.5%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research CRM Page 10