For a long time, almost all companies focused on growth above all else. Then, as the economy began to turn last year, that focus shifted dramatically toward profitability and greater financial strength. Salesforce was no different.
Salesforce had been spending big in previous years, acquiring companies like Slack for $27.700 billion, Tableau for $15.700 billion, and MuleSoft for $6.500 billion, buying growth in the process. Additionally, during the pandemic, like other big tech companies that believed the remote work phenomenon would drive long-term cloud benefits, Salesforce hired large numbers of staff. 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 headwinds, it had an impact on the revenue growth of almost every company, including Salesforce.
Then last year, mainstream investors began taking a closer look at Salesforce, forcing the company to rethink its growth strategy in the wake of a changing economic landscape and those investors' demands for greater financial discipline.
CEO Marc Benioff led the company through that turbulence by shifting its focus from its previous growth orientation to one more focused on profitability. This meant cutting costs, which unfortunately resulted in 10% of the workforce being laid off. Additionally, the company announced in March that it was dissolving its mergers and acquisitions committee a strong sign 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. Circle investors backed off in March after a quarter in which the company reported 14% year-over-year growth. This quarter wasn't as good at 11% growth, but it far exceeded Wall Street's expectations and even Salesforce's own projections, leaving Benioff very pleased during his earnings presentation with analysts.
"So, listen, as we've shared with you in the last two earnings presentations, Salesforce has really accelerated its transformation to profitable growth." he said during the presentation. "I think that's very clear in the numbers, and I couldn't be more excited, especially about this big step up in revenue and what our margin looks like today."
A closer look at the numbers
Salesforce showed that it exceeded expectations in terms of both revenue and profits. The company reported $8,60 billion in total revenue, ahead of an anticipated result of $8,53 billion. And it earned $2,12 per share, ahead of an expected adjusted earnings per share of $1,90.
That revenue result represented year-over-year growth of 11%. However, what was most impressive was how much it showed its profitability. Net income soared from $68 million in the year-earlier period to $1.270 billion in Salesforce's most recent quarter.
That huge profitability growth was not based on one-time gains derived from non-operating results. In simpler terms, the company's huge increase in profits was achieved the old-fashioned way: by keeping costs down while increasing revenue.
By cutting its operating costs from $5,40 billion in the prior-year quarter to $5,01 billion in its most recent three-month period (the quarter ended July 31, 2023, the second in its fiscal year 2024), Salesforce facilitated the recovery of its revenues in addition to covering its costs. And with higher disposable income leading to a higher gross profit bottom line, operating income soared from $193 million in the year-ago period to $1,480 billion in its most recent quarter.
That led Salesforce to report a staggering 14,7% year-over-year change in its Generally Accepted Accounting Principles (GAAP) operating margin to 17,2% in the July 31 quarter. The company's operating cash flow also skyrocketed, gaining 142% compared to the prior-year quarter to about $808 million. Free cash flow increased further, gaining 379% to $628 million in the period.
It demonstrated that it can make a lot more money, and quickly, by cutting costs (translation: laying off thousands of employees), allowing its revenue and gross profits to increase, and demonstrating operating leverage.
The strong investor reaction it received was helped by the fact that the company raised its forecasts in the same report. Salesforce now expects between $34,7 billion and $34,8 billion in total revenue for its current fiscal year (2024), up from the $34,5 billion to $34,7 billion it previously projected. It also expects its GAAP operating margin to reach about 13,3% in its fiscal year, up from the 11,4% it previously forecast.
So why didn't Salesforce cut costs sooner?
The spectacular quarterly report makes us wonder: if Salesforce could reduce spending and keep growth flowing while becoming more profitable, why didn't it do so before coming under pressure from investors? Put another way, why has Salesforce been so busy with its checkbook in the past?
It's a bit difficult to disaggregate Salesforce's top line revenue and revenue growth from the impact of its previous acquisitions. But given that MuleSoft, Tableau, and Slack continue to grow faster than the pace of their own parent company (17%, 13%, and 16% year over year, respectively), we can infer that Salesforce's current growth would have been much slower without having bought those companies. And its scale would also be smaller. Plus point for the mergers and acquisitions team.
For startups looking to cut costs to demonstrate their ability to be more profitable, Salesforce's example could be encouraging.
However, believing that all the cuts at Salesforce involved cutting fat and not muscle is a strange way to view the company. If we take that perspective, all the previous work done by the cost centers that Salesforce cut was wasted. We doubt it.
So while Salesforce certainly had a better-than-expected quarter and the company was able to boost its growth expectations while generating more profitability going forward, it is reporting and forecasting those results based on past work, to a real degree. The question before us is not whether its past efforts helped put it on firmer financial footing, but rather whether its current cost-cutting streak will eventually lead to slower revenue growth and more moderate profitability in the future.
Investors seem to think the answer is no. However, before being cornered by cost-cutting, Salesforce thought the answer was yes. After all, I wouldn't have spent that money without an early return. Today we see a company that spent a lot of money and is now reaping the results of those efforts. We'll see later what a more conservative, and perhaps even less acquisitive, Salesforce is like, and whether positive vibes can persist into the future from a smaller spending base for new product innovation.
