For a long time, just about every company was focused on growth over everything. Then, as the economy began to turn last year, that focus shifted pretty dramatically to profitability and being more financially sound. Salesforce was no different.
Salesforce had been spending big over the prior years, acquiring companies like Slack for $27.7 billion, Tableau for $15.7 billion and MuleSoft for $6.5 billion, effectively buying growth in the process. Meanwhile, during the pandemic, like other large tech companies believing the work-from-home phenomenon would drive cloud profits long-term, Salesforce hired big, increasing the number of employees by 30% between 2020 and 2022.
As the cost of doing business increased with higher interest rates combined with inflation and currency headwinds, it had an impact on just about every company’s revenue growth, including Salesforce’s.
Then last year, activist investors started taking a close look at Salesforce, forcing the company to rethink its growth strategy in the wake of a shifting economic landscape and activist demands for more financial discipline.
CEO Marc Benioff steered the company through that turbulence by shifting its approach from the earlier growth orientation to one more focused on profitability. That meant cutting costs, which unfortunately resulted in laying off 10% of the workforce. In addition, the company announced in March that it was disbanding its M&A committee, a strong signal that the days of buying growth were over (at least for now).
For better or worse, the approach appears to have worked, with three consecutive quarters of double-digit growth. The circling activists backed off in March after a quarter in which the company reported 14% growth year-over-year. This quarter wasn’t quite that good at 11% growth, but it beat Wall Street’s expectations and even Salesforce’s own projections by a fair amount, leaving Benioff very satisfied during the post-earnings call with analysts.
“So, listen, as we’ve shared with you over the last couple of earnings calls, Salesforce has really accelerated our transformation to profitable growth,” he said during the call. “I think that’s super clear from the numbers, and I couldn’t be more excited, especially on this huge top-line beat and what our margin is looking like today.”
A closer look at the numbers
Salesforce disclosed a top-and-bottom beat on Wednesday, besting expectations in terms of both revenue and profit. The company reported $8.60 billion in total top line, ahead of an anticipated $8.53 billion result. And it earned $2.12 per share, ahead of an expected $1.90 worth of adjusted per-share income.
That revenue result represented 11% year-over-year growth. More impressive, though, was how much Salesforce bolstered its profitability. Net income shot up from $68 million in the year-ago period to $1.27 billion in Salesforce’s most recent quarter.
That massive profitability gain was not predicated on one-time gains from nonoperating results. In simpler English, the company’s huge spike in profits was earned the old-fashioned way: keeping costs low while growing revenue.
By trimming its operating costs from $5.40 billion in the year-ago quarter to $5.01 billion in its most recent three-month period (the quarter ending July 31, 2023, the second of its fiscal 2024), Salesforce made it easier for its revenue to cover its costs. And with greater revenue in hand leading to a larger gross profit result, Salesforce’s operating income shot from $193 million in the year-ago period to $1.48 billion in its most recent quarter.
That led to Salesforce reporting a staggering 14.7% year-over-year change in its GAAP operating margin to 17.2% in the July 31 quarter. The company’s operating cash flow also shot higher, gaining 142% compared to the year-ago quarter to some $808 million. Free cash flow rose even more, gaining 379% to $628 million in the period.
Salesforce showed that it can make a lot more money, and quickly, by cutting costs (translation: by laying off thousands of employees), allowing its revenue and gross profit to swell, and demonstrating operating leverage.
The strong investor reaction that it earned was helped by the company raising its guidance in the same report. Salesforce now expects $34.7 billion to $34.8 billion in total revenue for its current fiscal year (2024), up from the $34.5 billion to $34.7 billion that it previously projected. It also expects its GAAP operating margin to land at around 13.3% in its fiscal year, up from the 11.4% it previously forecasted.
So why didn’t Salesforce slash costs before?
The blowout quarterly report makes us wonder: If Salesforce could cut spend and keep growth flowing while also being more profitable, why didn’t it do so before it came under activist pressure? Put another way, why did Salesforce get so very busy with its checkbook in the past?
It’s a little difficult to disaggregate core Salesforce revenue and revenue growth from the impact of its prior acquisitions. But with MuleSoft, Tableau and Slack all still growing faster than their parent company’s own pace (17%, 13% and 16% year-over-year, respectively), we can infer that Salesforce’s present-day growth would have been far slower without having purchased those companies. And its scale would be smaller to boot. Pour one out for the M&A team.
For startups looking to trim costs to show an ability to be more profitable, the Salesforce example could be cheering.
However, to believe that all the cuts at Salesforce involved trimming fat and not muscle is an odd way to perceive the company. If we take that perspective, all prior work done by the cost centers that Salesforce trimmed had was effectively wasted. We doubt that.
So, while Salesforce certainly had a better quarter than expected and the company was able to boost its growth expectations while also driving more profitability in the future, it is reporting and forecasting those results based on prior work, to a real degree. The question ahead of us is not whether Salesforce’s prior efforts helped put it on firmer financial footing, but rather whether its current bout of cost cutting will eventually lead to slower revenue growth and more muted profitability down the road.
Investors seem to think that the answer is no. However, before it was backed into a cost-cutting corner, Salesforce thought that the answer was yes. It would not have spent that money without anticipated return, after all. Today we see a company that spent a lot of cash and is now harvesting the results of those efforts. We’ll see later on what a more conservative, and perhaps even less acquisitive, Salesforce looks like and whether the positive vibes can persist in the future from a smaller spend base for new product innovation.
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