Customer relationship management (hence the ticker) software provider Salesforce.com (NYSE:CRM) has reported earnings exactly eight times since it became a publicly traded company. Exactly half of those times, it exactly matched analysts consensus predictions for its profits; exactly half of those times, it "beat by a penny." No matter what happens when the company reports fiscal Q2 2007 earnings tomorrow, this balance will be upset.

What analysts say:

  • Buy, sell, or waffle? Twenty-eight analysts follow Salesforce.com. Half say buy it; 11 would rather hold; and three more counsel selling.
  • Revenues. On average, analysts will be looking for 59% sales growth to $114.3 million.
  • Earnings. But they expect flat profits of $0.04 per share.

What management says:
Trolling the SEC files on Salesforce.com is like (I imagine) wandering in the desert in search of water -- except instead of sand, all you see around you are miles upon miles of Form 4 "Statements of changes in beneficial ownership of securities." I did find a couple oases of useful information, however:

On June 2, Salesforce Chief Financial Officer Steve Cakebread announced that he will retire at the end of this calendar year. Although the departure of a high-level executive rarely bodes well for a company, in this case I don't see any real reason for concern. Cakebread announced his retirement long before his departure date and intends to actively help find a successor. This is not a Bob Irsay-like, sneak-out-of-town-in-the-dead-of-night departure. (For you non-football fans, that's a reference to Irsay moving the Colts out of Baltimore many years ago.)

In other news, Cakebread won't be leaving empty-handed. Barely a week before the announcement, Salesforce granted him (and two other officers) an extra batch of restricted stock. Cakebread's slice amounted to 3,333 shares.

What management does:
Now let's look at the condition of the company Cakebread will be leaving. Over the past 18 months, we've seen two trends here: an up one, and then a down one. As is often the case, it's the gross margins that were first to go -- the trailing-12-month tallies have been falling for four quarters straight now. Rolling operating and net margins are also on the downtrend, and both have been sliding for the past two quarters.

Margins %

1/05

4/05

7/05

10/05

1/06

4/06

Gross

81

81.1

80.2

78.9

77.7

77

Op.

3.7

5.3

5.9

6.8

6.4

6.4

Net

4.2

5.5

6.4

9.5

9.2

6.8


All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
The primary factors determining Salesforce's margins -- which are sales; cost of sales; and selling, general, and administrative expenses (SG&A) --explain what's happening in the table above. Over the last six-month period, for example, sales have grown 65%, while SG&A costs rose only 52%; that's good. The problem is that the cost of providing services has doubled during that time, and that's depressing gross margins a bit.

Fortunately for Salesforce, its cost of sales is just a fraction of its SG&A costs. So long as the firm continues to exercise restraint with operating costs, the rapid rise in cost of sales shouldn't prevent it from expanding its net profit margin and dropping ever more pennies, from each dollar of sales, to the bottom line.

That will be key to the question of whether this company can ever reward investors at today's prices. With a trailing P/E ratio pushing 140, and long-term profits growth projected at "just" (although in this context, those quotes might not be necessary) 40% per annum, the company trades at a valuation that many investors would agree is way ahead of its fair price. To justify the premium, Salesforce needs to grow its profit margins faster than anyone expects, and keep them growing longer, to boot.

Competitors:

  • Accenture (NYSE:ACN)
  • Amdocs (NYSE:DOX)
  • BearingPoint (NYSE:BE)
  • IBM (NYSE:IBM)
  • Microsoft (NASDAQ:MSFT)
  • Oracle (NASDAQ:ORCL)

Learn more about the company that aims to break the rules by which the software industry plays:

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Fool contributor Rich Smith does not own shares of any company named above.