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Low Margins Haunt Salesforce But Investment Paves Way For Later SaaS Companies

Posted on Monday, May 23rd 2011

Leading SaaS customer relationship management (CRM) vendor, Salesforce.com recently reported its first quarter results that topped analyst estimates even as profits slumped 97%. Salesforce.com continues to report record revenues, but margins have been a concern. Let’s take a closer look.

Salesforce.com’s Financials
Salesforce.com (NYSE:CRM) recently reported first quarter revenue of $504 million, up 34%. Net income was $530,000 or breakeven on a per share basis, down from $17.7 million or $0.13 per share last year. That equates to a margin of just 1.1% of its revenue. Non-GAAP EPS was down 7% year-over-year to $0.28. Analysts expected non-GAAP earnings of $0.27 on revenue of $482.3 million.

The company ended the quarter with $1.5 billion cash balance. The cost of revenues increased 44% to $103 million, while operating expenses, including R&D, marketing, and admin, increased 48% to $404 million.

Subscription and support revenue in the fourth quarter was $474 million, up 35%, while professional services and other revenue was up 18% to $31 million. Salesforce.com added 5,400 customers, bringing its total customer count to 97,700, up 26% or 20,400 from last year. Deferred revenue was $915 million, an increase of 38% y-o-y.

Over the past year, Salesforce.com has made seven acquisitions. On March 30, Salesforce.com agreed to buy Radian6 Technologies Inc. for about $340 million. Radian6 is the leader in social media management. Radian6 is expected to bolster its social networking focus. Salesforce.com has been focusing on social networking with its new product, Chatter, and other acquisitions like Manymoon. Radian6 is expected by the company to bring in about $45 million to $50 million and reduce earnings per share, excluding some items, by about $0.11. Salesforce.com reported revenue of $1.66 billion in 2010.

For the first quarter, Salesorce.com expects revenue in the range of $526 million to $528 million, EPS of negative $0.01 to breakeven and non-GAAP EPS of $0.29 to $0.30. Analysts expect second quarter earnings to be $0.27 on revenue of $505.2 million. It raised its fiscal 2012 revenue guidance to a range of $2.15 billion to $2.17 billion from its earlier guidance of $2.03 billion to $2.05 billion. For the full year, it lowered its earnings guidance. It now expects GAAP net loss of ($0.03) to ($0.01) and non-GAAP EPS of $1.30 to $1.32. The stock is trading around $146.61 with a market cap of about $19.63 billion. It hit a 52-week high of $151.26 on December 9.

Chart forSalesforce.com (CRM)

RightNow’s Financials
Another SaaS CRM company, RightNow (NASDAQ:RNOW), recently reported first quarter revenue of $52.3 million, up 24%. Net income was $1.4 million or $0.04 per share versus $0.585 million or $0.02 per share last year. Non-GAAP EPS was $0.10 versus analyst estimates of $0.08 on revenue of $52.1 million.

Recurring revenue in the first quarter of 2011 increased 27% to $41.9 million from $33.0 million in the first quarter of 2010. The company ended the quarter with about $250 million in cash and investments.

RightNow added 71 new customers in the quarter. Its recent $34 million acquisition Q-go brought 51 additional customers. Q-go is a natural languages search solutions provider and is expected to add $8 million in annual revenue. RightNow reported annual revenue of $185.5 million in 2010.

For the second quarter, RightNow expects revenue to be about $54 million, EPS of negative $0.02 and non-GAAP EPS of $0.12. Analysts were expecting earnings of $0.09 on revenue of $52.68 million. For the full year of 2011, RightNow expects revenue of $226 million and EPS of $0.06. It is currently trading around $32.91 with a market cap of about $1.1 billion. It hit a 52-week high of $32.43 on March 14.

Chart forRightnow Technologies Inc. (RNOW)

Low Margins: A Challenge for the SaaS Sector
Low margins are a challenge that the entire SaaS sector faces to some extent. Salesforce.com has often been criticized for having high sales and marketing expenses, but this is a necessary evil. And it is not without results: the company reached its $1 billion revenue milestone two years ago and is set to cross the $2 billion revenue milestone this year.

Salesforce.com spent $25.4 million on sales and marketing (S&M) in its first year and earned revenue of $5.4 million. In the first quarter this year, it spent $254 million on sales and marketing and earned $504 million.

The massive investment that Salesforce.com has made over the past decade on sales and marketing to educate customers about the cloud/SaaS model, has effectively paved the way for other SaaS companies that have come later. You can read my discussion with Phil Fernandez of Marketo for more on the subject. Marketo has been able to reach $30 million in revenue in four years because it is selling into a large customer base that Salesforce.com has created, educated, and prepared for much more extensive cloud adoption.

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Fascinating, among the best infrastructures and platforms for SaaS and weak margins…makes one suspicious of the top COTS package vendors' SaaS pursuits – where the software is not "architected" for SaaS…how can COTS vendors' SaaS offers have a chance at comparable margins as traditional software licensing? The truth is that they don't because the increased labor and operating costs are dragging them down; most of their applications are poor performers on top of even the best of today's virtualized platforms and infrastructures -resulting in poor scalability results.

Ted Corbett Tuesday, May 24, 2011 at 2:09 PM PT