Recession resistant or just late to the pain?

On the surface,'s third quarter was impressive.

On the surface,'s third quarter was impressive. The company hit or exceeded its targets and noted that its "value proposition" was resonating among enterprise software buyers. But worries abound under the surface. reported income of $10.1 million, or 8 cents per share, on revenue of $276.5 million for the third quarter. Both tallies beat Wall Street estimates. The quarter also gave CEO Marc Benioff a little reason to show off some confidence--not that he's short on it or anything. On the conference call, Benioff said:

As we look at our own fundamentals, we believe that we have the right model for times like these. The key elements of this model include:

  • A core value proposition that emphasizes low upfront cost, low risk, and fast results;
  • Customers on long-term contracts generating predictable recurring revenue;
  • An attrition rate that continues to be less than 1% per month, which to date has not been materially impacted by the challenging business climate;
  • A diverse and growing customer base of small, medium and large businesses spread across many industries, with a healthy percentage coming internationally, and a diverse base of small, medium and large transactions, regardless of customer size, that is not reliant on big end of quarter license deals;
  • A growing Salesforce CRM applications product line that continues to expand beyond core Salesforce Automation; and
  • An accompanying platform strategy that is leading the new platform as a service industry.

We saw confirmation of our value proposition in our strong quarterly close, where our business strengthened through the quarter...We believe that the current economic environment will continue to draw sharp contrasts between the traditional enterprise software model and our cloud computing model. The technology contraction earlier in this decade threw a spotlight on the value of cloud computing for many customers, and we believe that will be the case this time around as well.

In many respects, Benioff was echoing what numerous research firms like Gartner and Forrester have indicated. Software as a service should hold up in a downturn. Why? Your CFO likes the payment model much better.

Analysts, however, aren't buying Benioff's argument completely. Oppenheimer analyst Brad Reback noted's quarter wasn't a lump of coal, but wasn't a diamond either. Forecast subscriptions billing and cash flow was lighter than expected, said Reback in a research note. Third quarter operating cash flow for was $17 million--a sum that fell short of most expectations. In fact, Merrill Lynch was expecting to deliver cash flow of $50 million. Management noted the downward trend since the first quarter, but added that is becoming more seasonal. Big contracts are signed in its fourth quarter and the money starts rolling in during the first quarter. From there it declines throughout the year.

The cash flow worry is this: could be seeing renewals fall. However, Pacific Crest analyst Brendan Barnicle noted that there's nothing in's results that would indicate slowing renewals. For now, management's expectation of seasonal adjustments holds. is becoming a fourth quarter and first quarter company with not much happening in the middle.

The problem in this market--as with every other company that claims it can weather a downturn well--is that you're guilty until proven otherwise. We've seen these claims before.

Cowen analyst Peter Goldmacher notes:

We remain frustrated by management’s opaque commentary on the business and concerned that the company is being run with an overly optimistic view of its ability to sell a highly discretionary product in a recessionary environment. We expect increasing competition at the high end and churn at the low end to keep the model under pressure. While we do believe software as a service sold as a subscription will help the company in a softening demand environment, our Siebel circa 2003 flashbacks keep us skeptical of the value prop of in a recession.

Those worries are pretty evident in shares today. An optimistic open was sold hard.