Reason for Report: 3Q18 Earnings Update

December 6, 2017

salesforce.com, Inc. (CRM - NASDAQ) $102.92

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Prev. Ed.: Sep 8, 2017; 2Q18 Earnings Update

Brokers’ Recommendations: Positive: 91.2% (31 firms); Neutral: 8.8% (3 firms); Negative: 0.0% (0)

Prev. Ed: 26, 2, 0

Brokers’ Target Price: $120.23 (↑$13.88 from last edition; 30 firms) Brokers’ Avg. Expected Return: 16.8%

Note: A Flash update on 3Q18 earnings was done on Nov 22, 2017

Portfolio Manager Executive Summary

Headquartered in San Francisco, salesforce.com, Inc. (CRM) is an enterprise cloud computing company, which distributes business software on a subscription basis. Salesforce hosts the applications offsite and is best known for its Customer Relationship Management (CRM) products. The company also offers a technology platform for customers and developers to build and run business applications. Salesforce faces increased competition within the on-demand CRM market from Microsoft Corp., SAP, International Business Management and Oracle.

Firms’ Opinions: Of the 34 firms in the Digest group covering the stock, 91.2% (31 firms) had a positive stance, while the remaining 8.8% (three firms) were neutral. Target prices range from a low of $96.00 to a high of $135.00, with the average being $120.23.

Bullish (Buy or equivalent outlook) – 31 firms or 91.2% – These firms remain encouraged by the company’s secular shift to the software-as-a-service (SaaS) platform, which will likely facilitate higher acceptance of its core products while the newer products gain momentum. The company has been expanding its presence in Europe. Some firms believe that the demand for data centers will help the company to expand its business in different geographic regions. The firms are bullish on the company’s solid reputation and its firm footing within the cloud computing industry. Notably, Salesforce’s partnership agreements with Amazon’s Amazon Web Services (AWS), entered over the past year, have been helping it expand international operations. They further believe that the higher number of deal wins and the rapid adoption of Salesforce1 Customer Platform are positives. Also, the release of the latest IoT platform will help the company to gain additional market share going forward. Moreover, the firms believe that the ExactTarget acquisition and its recently introduced Salesforce1 Community Cloud and Salesforce Wave will strengthen its market position and boost revenues.

© Copyright 2017, Zacks Investment Research. All Rights Reserved. Cautious (Neutral or equivalent outlook) – 3 firms or 8.8% – Though these firms are positive about the company’s fundamentals and growth outlook, they remain concerned about intensifying competition in the cloud-based CRM market. Moreover, they remain concerned about slowing billing growth, the risk of saturation in the sales force automation (SFA) market, as well as margin contraction due to increased investments. These firms prefer to remain cautious as the company remains vulnerable to a market pullback or even to a slight shortfall compared to expectations (particularly revenue shortfall).

Dec 6, 2017

Overview

Salesforce is a provider of on-demand Customer Relationship Management (CRM) software, which enables organizations to manage critical operations in a better way, 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 services on a subscription basis in Feb 2000. The company has leveraged its expertise in on-demand software to increase the scale of operations and also offers a technology platform for customers and developers to build and run business applications.

Salesforce derives revenues from two sources: (1) Subscription revenues, which comprises subscription fees from customers accessing enterprise cloud computing application service, as well as from those purchasing additional support beyond the standard support that is included in the basic subscription fee.

(2) Professional services and other revenues consisting primarily of training fees.

Key investment considerations as identified by the firms are as follows:

Key Positive Arguments Key Negative Arguments  The company is expected to benefit from the  Increasing competition in the on-demand CRM, secular trend in on-demand CRM applications. SaaS, and PaaS markets could impact renewal  Salesforce broke through the $10-billion run rate pricing of new products. and named itself the first company in the history  Any potential service outage may result in client of enterprise cloud software industry to have loss or reduced interest by prospects. achieved this milestone so fast, including its  Ramp up in hiring could put margins under closest rivals like Microsoft, Oracle and SAP SE. pressure.  Salesforce Chatter is expected to become a  Uncertainty and seasonality in billings. revenue earner.  Salesforce faces stiff competition from Microsoft  The cloud service is easy to deploy, as clients Corp. and Oracle in the cloud-based CRM market. do not need to spend time on procuring, installing or maintaining servers, storage, networking equipment, security products or other infrastructure, hardware and software.

For more information, please visit the company’s website www.salesforce .com

Note: Salesforce’s fiscal year ends on Jan 31. Dec 6, 2017

Zacks Investment Research Page 2 www.zackspro.com Long-Term Growth

The company’s foray into the highly profitable cloud-computing space should generate additional revenues. Salesforce has opened Force.com to the value-added reseller (VAR). This is expected to win additional customers for the company and consequently increase growth opportunities of the Sales Cloud.

Salesforce is the world’s leading CRM company in the Software-as-a-Service (SaaS) enterprise application market. The company was first to sign up large customer accounts, which enabled it to attain a strong market position. Given increasing customer adoption and satisfactory performances, market research firm Gartner has acknowledged Salesforce as the world’s #1 CRM company in 2015, with a market share of 19.7% in 2015, ahead of SAP with 10.2% market share and Oracle with 7.8% share. Per Gartner, 2016 marked Salsforce’s 11th consecutive year of holding the world’s #1 CRM company position. According to Gartner, the CRM market is expected to grow from $26.3 billion in 2015 to $36 billion in 2017. Firms believe that Salesforce is well-positioned to capitalize on the opportunity.

Acquisitions have always been one of Salesforce’s key growth strategies. Over the last two years, the company has closed a number of takeovers worth a combined deal value of over $4 billion. Last year alone, the company made as many as twelve takeover deals, including its biggest ever buyout – Demandware – concluded in Jul 2016. Firms believe that Salesforce’s sustained focus on expanding its business through strategic acquisitions and investments will drive growth over the long run.

In keeping with its strategy of growing in Europe, in Aug 2015, Salesforce’s investment arm, Salesforce Ventures, announced its decision to invest $100 million specifically in European start-ups. Over the past few years, Salesforce has invested in several start-ups, be it through acquisitions or partnerships. In Europe, the company opened its first data center in the U.K in Aug 2014. In 2015, it opened two more datacenters, one each in France and Germany, which has helped Salesforce to reach local small and medium businesses as well as government agencies. Notably, in fiscal 2017, Salesforce’s revenues from Europe increased 18% y/y and accounted for 16% of the total revenue. Firms believe expansion in Europe would enable Salesforce to diversify its international revenues, going forward.

The Salesforce Chatter platform is the enterprise social collaboration application platform introduced by the company after its Salesforce 2 platform. We believe that the 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. Moreover, the company has also introduced Salesforce ExactTarget Marketing Cloud platform, which is part of the Salesforce1 Customer Platform that 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. The rapid adoption of Salesforce platforms demonstrates its growing opportunities in the ever-growing cloud computing segment.

Dec 6, 2017

Zacks Investment Research Page 3 www.zackspro.com Target Price/Valuation

Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest:

Rating Distribution Positive 91.2%↓ Neutral 8.8%↑ Negative 0.0% Avg. Target Price $120.23↑ Digest High $135.00↑ Digest Low $96.00↑ No. of Brokers with Target Price/Total 30/34

Risks to the target price include big deal dependence, challenges managing growth, global economic pressure; integration of acquired entities, managing Wall Street expectations, potential pricing pressure, rich valuation, increased competition within the on-demand CRM market, lack of adoption of newer solutions and increasing customer churn rates.

Recent Events

On Nov 21, 2017, Salesforce announced fiscal 3Q18 results. Highlights are as follows:

 Total revenues were $2.68 billion, up 24.9% from the year-ago quarter.

 Non-GAAP EPS were 39 cents compared with 24 cents in fiscal 3Q17.

Revenue

Per the press release, total revenues were $2.68 billion in 3Q18, up 24.9% from the year-ago quarter. Furthermore, reported revenues came above the guided range of $2.64-$2.65 billion (mid-point: $2.645 billion).

The improvement can primarily be attributed to rapid adoption of the company’s cloud-based solutions. Also, higher demand for the Salesforce ExactTarget Marketing Cloud platform, part of the Salesforce1 Customer Platform, drove the y/y upside in revenues.

Geographically, the company witnessed constant currency revenue growth of 21%, 33% and 27% in the Americas, EMEA and APAC, respectively, on a y/y basis.

Now, coming to business segments, revenues at Subscription and Support climbed about 25.3% from the year-ago quarter to $2.486 billion. Professional Services and Other revenues surged almost 20.5% to $193.7 million.

Q3 Business Highlights

Zacks Investment Research Page 4 www.zackspro.com The company still generates only about 30% of total revenues from international operations, which is much lower than its rivals like Microsoft’s or Oracle’s composition of around 50%. Nonetheless, Salesforce noted that its partnership agreements with Amazon’s Amazon Web Services (AWS) last year have been helping it expand international operations.

Earlier, the company used to run its software at its own data centers, which was curbing growth potentials. However, the company decided to utilize the AWS data center’s geographical reach to expand international business in the previous year. Additionally, Salesforce has planned to invest about $400 million on AWS’ cloud platform, over the next four years.

Of late, Salesforce also entered into an agreement with AWS to run its software in the latter’s Canadian and Australian data centers. This in turn, has opened up fresh prospects in the Canadian and Asia-Pacific markets.

During the fiscal third quarter, the company won several deals backed by its international expansion initiatives. Companies like Hilton, DuPont, National Australia Bank and Hitachi picked Salesforce’s solutions to fuel digital transformation.

Outlook

For the fiscal fourth quarter, the company anticipates revenues in the range of $2.801-$2.811 billion (mid-point: $2.806 billion), representing a y/y increase of 22-23%.

Additionally, Salesforce raised its revenues outlook for FY18. Revenues are now anticipated to come in the range of $10.43-$10.44 billion (mid-point $10.435 billion), up from the previous projection of $10.35-$10.40 billion (mid-point $10.375 billion), representing a 24% y/y increase.

By completing this target, the company is anticipated to achieve the $10 billion mark in revenues faster than any other enterprise software company.

Salesforce and Alphabet recently announced a strategic partnership, according to which the two tech giants will integrate their software solutions and cloud-computing services. Firms believe the move is part of the companies’ broader infrastructure expansion plans.

The firms expect SaaS to be beneficial for both customers and service providers. Customers are not required to make any upfront investments and hence return on investment (ROI) is generated quickly.

The service providers will benefit from greater visibility, better utilization of hardware, smooth cash flow and lower costs due to multi-tenant architectures. Hence, the firms are positive about Salesforce’s expertise as well as its leadership position in SaaS technology.

IBM Corporation and Salesforce joined forces to solidify their footprint in the rapidly growing artificial intelligence (AI) market. Firms believe that Salesforce’s CRM platform will greatly benefit from this collaboration. Moreover, IBM has agreed to use some of Salesforce’s products internally as well, which will strengthen their relationship.

Salesforce had entered into an agreement with AWS to run its software in the latter’s Canadian data center. This has opened up fresh prospects in the Canadian market. Similarly, Salesforce is planning to do similar thing in Australia, in order to tap growing opportunity in the Asia-Pacific region.

The company still generates only about 30% of total revenues from international operations, which is much lower than its rivals like Microsoft or Oracle composition of around 50%. Nonetheless, Salesforce

Zacks Investment Research Page 5 www.zackspro.com noted that its partnership agreements with Amazon’s Amazon Web Services (AWS), entered over the past year, have been helping it expand international operations.

Earlier, the company used to run its software at its own data centers which was curbing its growth potentials. However, last year the company decided to utilize the AWS data center’s geographical reach to expand international business. In addition, Salesforce has planned to invest about $400 million on AWS’ cloud platform, over the next four years.

During the fiscal second quarter, the company won several deals due to its international expansion initiatives. Companies like Toshiba, Nomura, Queensland Urban Utilities and Australia Post picked Salesforce’s solutions to fuel digital transformation.

These firms are positive on new product launches due to heavy investments in the same to increase its market share compared to other vendors. Salesforce unveiled the Salesforce1 Community Cloud, which is a solution to suit individual customer needs. Additionally, it had also unveiled its new product named Salesforce Wave, an analytics platform, which aims at fulfilling Big Data requirements. The firms believe that the rapid adoption of Salesforce platforms will benefit the company in the long run. Another new offering, Social Enterprise Vision, also looks promising as it possesses the ability to compete against major players including Microsoft’s Outlook, Twitter and Facebook.

The firms expect that the marketing cloud will become the next billion-dollar opportunity for Salesforce. Further, they expect the company to address other emerging opportunities such as in enterprise resource planning (ERP) and HR applications as these could be the natural extensions of Salesforce’s capabilities.

The company acquired “relationship-intelligence” company RelateIQ Inc. which is believed to enhance its process efficiency and provide a platform to build its marketing intelligence system, according to the firms. It also acquired a startup smart calendar app called Tempo from Tempo AI Inc. The firms continue to expect that Salesforce’s rapid customer growth reflects higher adoption rate and market acceptance of enterprise cloud computing. They expect add-ons like Chatter to differentiate the company from its competitors and position it well for future growth.

Some firms are encouraged by the rising number of deal wins at Salesforce and the rapid adoption of the company’s cloud-based solutions (Service Cloud, Salesforce1 Platform, and Marketing Cloud).

Based on the company’s Thunder IoT platform, these are designed to help companies create Internet-connected smart products by using its hardware and software security products. The firms believe that by adding IoT cloud into its existing solutions, Salesforce will gain the most from the continued proliferation of IoT devices.

However, a few firms expect revenues to slow down as some companies are using their own internal systems and thereby reducing their IT spending. Salesforce is also facing severe competition from its peers, including Oracle, SAP and Microsoft. Its large deal wins may decline as they are capital intensive in nature and also due to the challenging economic environment. Further, rising competition from apps vendors and emerging Internet platforms may also decelerate revenue growth, going forward.

Zacks Investment Research Page 6 www.zackspro.com Margins

Salesforce’s non-GAAP gross profit came in at $2.038 billion, up 25.6%. Additionally, gross margin expanded 40 basis points (bps) to 76.1% primarily owing to solid revenue growth that was partially offset by increased investment in infrastructure development including the expansion of the international data centers.

Non-GAAP operating expenses increased up 18.6% from the prior-year quarter to $1.601 billion. However, as a percentage of revenues, operating expenses decreased to 59.8% from 63% in the year-ago quarter. This was primarily due to efficient cost management.

Salesforce posted non-GAAP operating income of $436.9 million compared with the year-ago figure of $272.6 million while operating margin advanced 360 bps to 16.3%. The y/y increase in non-GAAP operating margin was mainly driven by improved gross margin and lower operating expenses as a percentage of revenues.

Non-GAAP net income grew 66.4% y/y to $284.4 million while net income margin expanded 260 bps to 10.6%. The benefit from improved gross margin and lower operating expenses as a percentage of revenues on net income margin was partially offset by elevated interest and other expenses.

Outlook

Salesforce did not provide any margin guidance for either 4Q18 or FY18.

The company expects to continue investing in new technologies and key international markets, and expand through acquisitions. It continues to aggressively hire people and intends to expand sales distribution/engineering through FY18.

According to the firms, the immense market opportunity, planned investments, strategic acquisitions, (e.g., Buddy Media and GoInstant) and heavy focus on marketing make sense. However, they expect margins to be under pressure.

The firms continues to believe that significant investment in growth initiatives has increased the company’s costs, which in turn is putting margins under pressure.

Earnings per Share

Per the press release, non-GAAP EPS in 3Q18 was 39 cents compared with 24 cents in 3Q17. The y/y increase was mainly driven by strong top-line growth and efficient cost management, partially offset by increased number of outstanding shares.

Outlook

For the fiscal fourth quarter, the company expects non-GAAP earnings per share in the band of 32-33 cents. On a GAAP basis, the same is anticipated between 3 cents and 4 cents.

Additionally, Salesforce raised revenues and earnings outlook for FY18. Salesforce now projects non- GAAP earnings to lie between $1.32 and $1.33 while GAAP earnings are expected to be in the range

Zacks Investment Research Page 7 www.zackspro.com of 12-13 cents. This compares with the previous guidance range of $1.29-$1.31 on non-GAAP basis and 7-9 cents on GAAP basis.

The firms expect that the company’s heavy investments for growth put pressure on EPS.

Research Analyst Awantika Poddar Copy Editor Tuhin Roy Content Ed. No. of brokers reported/Total brokers Reason for Update 3Q18 Earnings Update Lead Analyst Anirudha Bhagat QCA Aniruddha Ganguly

Zacks Investment Research Page 8 www.zackspro.com