How investors should think about Salesforce's mixed guidance

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Investing Club holding Salesforce (CRM) reported better-than-expected third-quarter results Tuesday after the closing bell. On the top line, revenue of $6.86 billion (+26% YoY) outpaced expectations of $6.79 billion. On the bottom line, non-GAAP earnings of $1.27 per share (-27% YoY) were better than the $0.92 per share consensus. However, it is important to note that the earnings results include a $0.28  per-share benefit related to the mark-to-market accounting for the company's strategic investments. Even without this boost, the core earnings result of $0.99 per share was still ahead of the consensus.

"We delivered another phenomenal quarter, fueling strong revenue growth, margin and cash flow," commented CEO Marc Benioff on the release. "Salesforce is more relevant and strategic than ever as every company accelerates their digital transformation journey. Just as we've helped our customers navigate the pandemic, we're now guiding them toward greater growth, customer success, health and safety, and trust. With the tremendous strength of our Customer 360 platform and Slack, we're on track to reach $50 billion revenue in FY26."

Additionally, along with the earnings release, the team announced that Bret Taylor — who has served as President and Chief Operating Officer since 2019 (and Chief Product Officer before that) — has been promoted to company Vice Chair and Co-CEO, effective immediately. 

"Bret is a phenomenal industry leader who has been instrumental in creating incredible success for our customers and driving innovation throughout our company," Benioff said regarding the decision. "He has been my trusted friend for years, and I couldn't be happier to welcome him as Co-CEO. We're in a new world and Salesforce has never been more relevant or strategic for our customers. Together, Bret and I will lead Salesforce through our next chapter, while living our shared values of trust, customer success, innovation and equality for all."

While the headline results were positive, shares came under pressure on the release as guidance came in mixed.

  • Looking to the fourth quarter's the top line, management sees sales between $7.224 billion to $7.234 billion, better than expectations of $7.216 billion. However, on the bottom line, the team expects earnings of $0.72 to $0.73 per share, below the $0.81 per share expected coming into the print.
  • That said, the strong performance in the third quarter means that FY22 guidance came in above expectations, with sales and earnings guidance of $26.39 billion to $26.40 billion and $4.68 to $4.69 per share, respectively. That outpaces expectations of $26.308 billion and $4.39 per share, respectively.
  • Looking further out, management also provided FY1Q23 and FY23 sales guidance. In the first quarter of FY23, management expects sales of $7.215 billion to $7.25 billion, which is below the $7.353 billion consensus. As for the full fiscal year, management reiterated their sales target of $31.7 billion to $31.8 billion, right in line with expectations at the midpoint.

Jumping back to the reported quarter, companywide profitability – which was a focus coming out of the company's September Investor Day – was solid, as operating margin of 19.8% came in ahead of the 18.3% consensus. Management attributed the strong margin performance to revenue outperformance, work-from-anywhere efficiencies and disciplined spending.

  • On the cash flow front, operating cash flow of $404 million was well ahead of estimates of $239 million. Subtracting $166 million of CapEx, and we got free cash flow of $238 million — which was much better than expectations for no net inflows/outflows.
  • Breaking down the topline result, subscription and support revenue of $6.379 billion (+25% YoY) edged out expectations of $6.357 billion, while professional services revenue — which includes results for Tableau and MuleSoft — of $480 million (+23% YoY) came in ahead of the $440 million estimate.
  • Within the subscription and support segment, sales cloud revenue increased 17% YoY to $1.5 billion; service cloud revenue grew 20% YoY to $1.7 billion; platform and other, where Slack results will be reported going forward, surged 51% YoY to $1.3 billion; marketing and commerce cloud revenue was up 25% YoY coming in at $1.0 billion; and data cloud, which was broken out for the first time this quarter and includes results for Tableau and MuleSoft, saw sales jump 20% YoY to $0.9 billion.
  • On the call, Taylor took a moment to acknowledge the incredible move the team is seeing toward mobile commerce, calling out that mobile push notifications for the company's marketing cloud were up over 94% YoY as smartphones "continue to transform commerce." The marketing and commerce cloud has been and remains a key beneficiary of the digitization the economy has undergone over the past 18 months.
  • Regarding multi-cloud deals, CFO Amy Weaver commented on the call that the number of deals containing 5 or more clouds was up a strong 33% versus the year ago period.

On a geographic basis, in constant currency, sales increased 23% YoY in the Americas, 35% in Europe, the Middle East, and Africa (EMEA) and 29% in the Asia Pacific region (APAC).

Regarding a few other closely watched industry metrics:

  • Billings and other – which measures the share of revenue generated from new business in the quarter as well as the impact of foreign currency translation – came in at $5.81 billion.
  • Additionally, the remaining performance obligation (RPO), which "represents all future revenue under contract that has not yet been recognized as revenue," came in at $36.3 billion (+20% YoY). Within that figure, the current RPO (cRPO), which "represents future revenue under contract that is expected to be recognized as revenue in the next 12 months" came in at $18.8 billion (+23% YoY), edging out the $18.7 billion consensus.
  • Revenue attrition continued to improve, coming in below 8% (between 7.5% and 8%) for the first time in company history.

On the call, Taylor took a moment to discuss the recent Slack acquisition, noting that "Slack outperformed our expectations in their first full quarter as a part of the Salesforce family. The number of customers on Slack who spent over $100,000 was up 44% year-over-year and adoption of Slack Connect was up an astonishing 176% year-over-year. Slack is not just a product, Slack is a network, and it's just incredible to see that growth." Additionally, Taylor and Benioff took some time to discuss the transformation the world is going through in terms of flexible work environment, commenting that "according to Slack's research, 93% of workers are looking for flexibility when they work, and 76% are looking for flexibility where they work. 

Slack combined with Customer 360 "are really powering this transformation" according to Taylor, who added "You can see in the results of the third quarter for Slack. Slack hit $280 million of revenue, $30 million ahead of guidance. Retailers like Saks and innovative companies like the Southeast Asian ridesharing and food delivery app, Grab, they're relying on Slack every day to collaborate to automate workflows and to connect with their partners."

All in, while the market may choose to focus on the mixed guidance in the near-term, we believe the results ultimately speak to strong underlying fundamentals and continued secular growth bolstered by the digital transformation that was accelerated by the COVID-19 pandemic. Salesforce's move to acquire Slack could not come at a better time as companies in every industry are rushing to adapt to the new work-from-anywhere world – or risk losing talent, something Taylor touched on briefly, commenting "you know what happens when [companies mandate a return to office]? Their employees leave and go to the company next door."

So, how do we think members need to approach the stock given the strong report and continued secular growth that was offset by mixed guidance? Let the sellers shake out. The current quarter's weak earnings guide coupled with the subsequent quarter's below consensus sales guide means that there is no rush to step in first thing tomorrow. Instead, wait for shares to settle and consolidate, allow the market to digest today's commentary from Federal Reserve Chair Jerome Powell and at that point, remember that Salesforce is proving to be a backbone of worker productivity (and therefore their customers' own success) and then step into pick up some shares.

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 (Jim Cramer's Charitable Trust is long CRM.)

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