The Security and Exchange Commission's concerns centre on the way Salesforce records expenses related to sales commissions, according to a source close to the San Francisco-based company who requested anonymity. The issue was first reported Friday in the San Francisco Chronicle.
Salesforce, which initiated the agency's review in December by filing regulatory paperwork for its initial public offering, declined to comment on its preparations for the IPO.
But according to its regulatory filing, Salesforce changed its accounting treatment of sales commissions last year, a move that enhanced its profitability on paper.
In previous years, Salesforce recorded sales commissions of multiyear contracts as an expense in the quarter in which the contract was signed. But in 2003, the company began to amortize those expenses over the life of the contract, a method that's in line with generally accepted accounting principles, sources said.
Though the company didn't actually change the way it compensates its salespeople, the impact of the accounting change on net income was dramatic. During fiscal 2003, when it began the change, the company's net loss shrank to $9.3m from $29.2m in the previous year. And during the first nine months of this fiscal year, Salesforce.com posted a $4.7m profit, compared with a $7.2m loss in the same period a year ago.
The SEC wants Salesforce to recalculate its financial statements and retroactively apply the new accounting method so that the public has a consistent view of its finances, sources said.
The SEC inquiry helped delay the company's IPO, originally anticipated for as early as March. The offering also is expected to rekindle the market for high-tech IPOs and is seen as a litmus test for a new business model that could shake up the software industry.
Salesforce is the poster child for a new subscription-based business model of selling software, a model that's gaining popularity among corporate buyers. Analysts predict the success of Salesforce and others like it could pose a challenge to old-guard software companies, including SAP, Siebel Systems, PeopleSoft and Oracle.
But concerns about Salesforce's accounting methods underscore one of the uncertainties about the company's business model, said Schwab SoundView securities analyst Peter Coleman.
The question is whether the Salesforce model, which spreads revenue collection over a long period of time, is more or less profitable than the traditional model, in which the software makers collect big upfront fees. "There's a lot about this model that hasn't yet played out," Coleman said.
