Wall Street mistakenly overlooking Salesforce's solid quarter by focusing too much on co-CEO exit

Published Wed, Nov 30 20228:03 PM EST

Salesforce (CRM) reported a solid quarter after the closing bell Wednesday. But shares, not surprisingly, fell in reaction to the unexpected resignation of co-CEO Bret Taylor, a move that puts co-founder Marc Benioff back solely in the driver's seat. First, the numbers: Revenue in fiscal third-quarter 2023 grew 14% year over year, or 19% in constant currency, to $7.84 billion, edging expectations of $7.82 billion, according to Refinitiv. Non-GAAP earnings-per-share of $1.40, inclusive of a 2-cent benefit from mark-to-market accounting on strategic investments, beat estimates of $1.21. Perhaps most importantly, operating margins were great, coming in at 5.9% on a GAAP (generally accepted accounting principles) basis, and expanding 290 basis points on a non-GAAP basis, to a record 22.7%. That also beat estimates of 21%. It's great to see because this market really cares about profitable growth at scale. Operating cash flow declined 23% from the previous year to $313 million, a big miss compared to estimates of $622 million. Free cash flow was $115 million, way short of the $418 million expected. Bottom line Salesforce issued quarterly results that we think the market would have liked in a vacuum. Sure, cRPO (current remaining performance obligation) was a little light and the fiscal fourth quarter revenue guide midpoint missed by a hair (some conservatism probably due to the uncertain macro environment). However, what the market wants to see most right now from tech companies is the pivot from growth to profitability. Salesforce delivered that with non-GAAP operating margins expanding to a new record. Overshadowing the results is the news that Taylor is stepping down. It's shocking news and sad to see because Taylor was an important leader at the company, the architect behind the Slack acquisition. Benioff being back as sole CEO isn't new for him. This isn't the first time a co-CEO has stepped down. But many had thought of Taylor as a successor. We think the main reason for Salesforce's nearly 7% drop after-hours is the Taylor news. But we see this as an overreaction. Taylor will be missed, but Benioff is still in charge, and he has a great history of developing talent. Our last question is, will the commitment to profitability be enough to keep the activist hedge fund Starboard Value off Salesforce's back? It remains to be seen, but management sounded very serious on the earnings call Wednesday evening that more progress will be made in the future. Companywide results Breaking down quarterly subscription and support revenue results by cloud: Sales cloud revenue increased 17% in constant currency to $1.7 billion. Some new wins in the quarter include Snowflake (SNOW) and Thermo Fisher (TMO). Service cloud revenue increased 16% in constant currency to $1.9 billion. Some new wins in the quarter include Carl Zeiss, Dell (DELL), and Fujitsu. Platform and other (including Slack, which Salesforce acquired on July 21, 2021) revenue increased 22% in constant currency to $1.5 billion. Some wins in the quarter include Japan Airlines, WorkSafe Victoria, and Zoom. Revenue from Slack increased 46% year over year. Marketing and commerce revenue increased 18% in constant currency to $1.1 billion. A few wins in the quarter include Banco Bradesco, Hugo Boss, and Saks. Revenue in Data (which includes past acquisitions of Tableau and Mulesoft) increased 16% in constant currency to $1 billion. A few big Mulesoft wins in the quarter were Western Union, SmileDirectClub (SDC), and Kona, while Tableu added Inter and McLaren Racing. On a geographic basis, in constant currency, sales increased 16% year over year in the Americas, 23% in Europe, the Middle East, and Africa (EMEA), and 30% in the Asia Pacific region (APAC). Regarding a few other closely watched industry metrics that provide visibility into Salesforce's revenue in the future: The RPO, which represents all future revenue under contract that has not yet been recognized as revenue, ended the quarter at $40 billion, up 10% year over year. The cRPO, which represents future revenue under contract that is expected to be recognized as revenue in the next 12 months, ended the quarter at $20.9 billion, up 15% in constant currency but below estimates of $21.07 billion Revenue attrition remained below 7.5%, a sign that customers cannot operate without Salesforce's mission-critical service despite the difficult operating environment. Other Notes As mentioned above, Taylor announced Wednesday evening he will step down on Jan. 31, 2023 as co-CEO, a role he was promoted to exactly one year ago. That leaves co-founder Benioff as sole CEO. Benioff told Jim Cramer that Taylor's exit is a "gut punch." Salesforce made good use of its $10 billion share buyback program, repurchasing $1.7 billion of stock to reduce dilution. This more than offset the $843 million of stock-based compensation expense. Management reiterated its commitment to profitable growth and increasing operating margins several times. They sounded acutely aware of the current economic situation and what investors want. Like many others in software, Salesforce is seeing measured customer buying behavior, characterized by elongated sales cycles, additional deal approval layers, and smaller deals. Guidance For their fiscal fourth quarter, Salesforce management sees revenues increasing 8% to 10% year over year to $7.93 billion to $8.03 billion. This midpoint of $7.98 billion is a small miss versus estimates of $8.02 billion. The guide includes a headwind from foreign exchange of approximately $250 million year over year. Non-GAAP earnings-per-share in Q4 is expected to be $1.35 to $1.37, above estimates of $1.34. Q4 current RPO is expected to grow 7% year over year, implying roughly $23.54 billion versus estimates of $24.49 billion. Foreign exchange is expected to be a 3 percentage point headwind. Turning to the full year, Salesforce maintained its revenue outlook of $30.9 billion to $31 billion but increased its foreign exchange headwind to $900 million year over year from $800 million. On margins, management raised its full-year GAAP operating margin outlook to 3.8% from 3.6% and non-GAAP outlook to 20.7% from 20.4% (versus estimates of 20.35%). Management remains committed to its target of at least 25% margins by fiscal year 2026. Full-year non-GAAP earnings per share outlook was increased to $4.92 to $4.94 from $4.71 to $4.73 and well above estimates of $4.73. (Jim Cramer's Charitable Trust is long CRM. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. 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Bret Taylor of Salesforce in 2019.

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