Salesforce Rights the Ship

In this podcast, Motley Fool analyst Tim Beyers and host Deidre Woollard discuss:

• How Salesforce improved its margins.
• What role AI will play in Salesforce's future.
• CrowdStrike's land-and-expand model for growth.

Deidre interviews ThredUp CEO James Reinhart about resale as a service and the company's plans for growth.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Aug. 31, 2023.

Deidre Woollard: Salesforce finds responsibility, but it still has AI dreams. Motley Fool Money starts now. Welcome to Motley Fool Money. I'm Deidre Woollard. I'm here with Motley Fool analyst Tim Beyers. We're doing another tech Thursday with earnings from Salesforce and CrowdStrike to go through. Hi Tim? How are you?

Tim Beyers: Fully caffeinated ready to go.

Deidre Woollard: Glad to hear it. Well, Tim, I'm kind of an earnings call person. I like to check the vibes, so I listened to the Salesforce call last night. CEO Marc Benioff he sounded like a man who had been through a war. He emerged out the other side. He said the phrase, couldn't be happier, about five times. That seems pretty good. The company did raise guidance and margins, are doing great. Is Salesforce back?

Tim Beyers: He's feeling it, isn't he?

Deidre Woollard: He is feeling it.

Tim Beyers: He is and that's good to see because Salesforce has had some rough moments. I think you're right to say that they have been through the war. I'll say they're starting to come out the other side. This is the second consecutive quarter I think we have seen a new Salesforce. What I mean by a new Salesforce, Deidre, is that it's a Salesforce that is a bit more focused on cost management, efficiency, efficient growth, generating capital that they believe they can put to work organically and I know we're going to talk about AI and so they have some things they're talking about and they're doing things as a company that are theirs not just something that they went out, through a lot of money at and brought it into the fold and said now it's ours. We went out, [laughs] and grabbed it instead of building it. There's a bit of building and I think that too lend some internal confidence to the Salesforce story. But let's quickly hit some numbers because there are some good ones.

Overall, GAAP operating margin was at 17.2%. I want to highlight just for a second if we can appreciate Deidre, that that's a GAAP operating margin, meaning that it's not adjusted to look better. They did give an adjusted number that was over 31% filing we need that. I think we could just say at 17.2%, yes, could be higher for a software company, there is no doubt, but that's still a very healthy margin for a company that does as much business as Salesforce does. That's an excellent number and it is going up. Part of the reason it's going up is efficiencies both on the top line. We're going to talk about the gross margin, then we're going to talk about the operating margin. At the gross margin line I thought this was really interesting Deidre, $883 million year-over-year increase in revenue, the gross profit. That is the profit remaining after you pay just what it costs to deliver the products that Salesforce delivers. Gross profit was up 897 million year over year. The gross margin went up a little bit, meaning that they are doing good work. They are building products and they are building more profitable products and then in addition, overall operating expenses were down 7.1% year over year, leading to that much bigger operating margin, leading to much bigger earnings. Again, this is a really interesting efficiency story. This is I would say, a bit of a renaissance for Salesforce in what they're showing the market is. We told you that we could be as profitable as we want to be, when we want to bprofitable, and now they're making good on it and that's very interesting to see.

Deidre Woollard: I keep coming back to that Zuckerberg year of efficiency thing because we're seeing it really all over tech and Salesforce they were spending a lot of money buying stuff, they were throwing everything all over the place and they really figured out like, we're going to focus on what we have now and we're going to link it up and we're going to make it stronger and better, which is nice to see. But I want to talk just for a second about buybacks because I know that's something you always have an opinion on. They've been buying back a lot of shares over the past couple of quarters. They did it again, 1.9 billion in shares. What are you thinking about this?

Tim Beyers: I think we give them some credit. It's one of those partial credit things because they do issue a lot of equity to their employees. Now, to be fair, if you look at the cash flow statement, what you're going to see is that they are still issuing quite a lot of stock-based compensation. However, it is lower year over year than it used to be and that's nice to see. Let me just get my numbers turn and talk about this. Overall stock-based compensation expense was 724 million for the three months ended July 31st, 2023. That is down from 851 million in the year prior period. If you just subtract that out, let's say 750 million out of 1.9 billion, you level about $1.15 billion worth of actual buybacks. It's like you really have to put it in context. It's not really 1.9 billion that they're spending the buyback shares when they're issuing so much in shares, but they're issuing less than they used to. That buyback amount does have an effect and both basic and diluted shares were down year over year.

The basic shares outstanding were down to 975 million from 997 million and your diluted shares were down to 986 million from just over a billion shares, which is, again, that is meaningful, has a meaningful drawdown in the shares outstanding. They're delivering some value back to shareholders. But we shouldn't say it's 1.9 billion. That is not true. It's still offset by what they give to employees and they give a lot and I am largely OK with that, Deidre, because that has been one of the values of Salesforce is when they recruit UN, they really want you to get on board, they want to give you a lot of equity. You get invested in the company and they try to get the most out of you because of that. If you're a Salesforce shareholder, you really should know that going in that they are going to give a lot of equity for their employees and what they expect out of their employees is that they are going to over-perform and deliver at a fairly big level. That has been the expectation, and they've done that in the past. Now they're still issuing that equity, but they're also buying back enough that they can still drawdown the outstanding share count above and beyond what they issued to employees, which is new and they've done it for a couple of quarters now so nice to see.

Deidre Woollard: Well, we've talked about the ways that Salesforce has been becoming more responsible, but it's still Marc Benioff. He's still eyes to the sky and you teased it earlier. We got to talk AI.

Tim Beyers: Of course we do.

Deidre Woollard: He's so super bullish. But it makes sense to me. You and I were both former PR people.

Tim Beyers: Yes.

Deidre Woollard: We have both lived and died by using a database and a CRM and talking about AI in a CRM to me makes a lot of sense.

Tim Beyers: Sure.

Deidre Woollard: In terms of how it can just really make things a lot less complicated. I know that they had their Dreamforce Conference coming. The Foo Fighters are playing, Dave Matthews is going to be there. It's a whole thing. We're going to hear more about that than, but what do you feel about the Salesforce AI component, especially with Slack in the mix and all the workflows that they're talking about?

Tim Beyers: Well, it can be useful. AI is only as useful as the data that it is bound to. If you point AI at a very specific problem with a very specific dataset, I think you can get value out of that. One of probably the most interesting use case for AI is this idea of co-piloting. This is where I think the Salesforce AI initiatives such as they are, I'm going to call them nascent right now. You really got to show me, you got to prove it to me that there is a lot of stuff happening and the Salesforce customers are using this in mass. I don't believe that that's happening yet and that is fine. It's still early. But as a co-piloting mechanism, I think it can be highly useful. Let's use the example that you gave here because we were both in PR and marketing. If you are let's say as a co-pilot, you are trying to build a list of qualified prospects who have very detailed requirements that we know about them inside the Salesforce environment, like very specific attributes. I want to build a list that is within. I'm going to ask the AI to say, I need you to build a list for me of qualified prospects that have CWIP within 30 miles of Durham, North Carolina. I'm just making stuff up here. That's the copiloting search that an AI should be able to automate that. Then what you take as you build that and that becomes an automated list. It's a data subset. Then maybe I can combine that with other things that are useful to me as a salesperson. But what I don't want to be, if I want to improve sales efficiency, I don't want to be the one that's doing data gathering. I want my AI to be doing data gathering, doing other types of work to automate my targeting work so that I can just be productive as a salesperson and go out and close deals, that's what I want. As a copiloting mechanism, I think AI can be very useful there, Deidre.

Deidre Woollard: Yeah, absolutely. Well, I want to leave time to talk CrowdStrike, so let's switch gears. Good quarter for them. CrowdStrike, that's cybersecurity, they saw revenue grow by 37%. They trumped the GAAP profitability for the second quarter in a row. Tim, I've been taught by wise Fools like you to think about profitability, not as like the most important thing sometimes. I know they're focused on profitability. Do we want that they also need to grow? Do we want them to be focused on profitability or growth, or I know both. But what do you think you've CrowdStrike now?

Tim Beyers: Well, you want them to be focused on growth. I think they are doing a very good job of growing at a profitable pace. I think they've done, you can see how they have started to dominate this market by virtue of what they've done to really marginalize their number 1 competitor in this space, which is SentinelOne. SentinelOne has essentially put itself up for sale because they've not really done a good job of outcompeting CrowdStrike. CrowdStrike instead has really come in and I would say, put a very large footprint into this. I mean, they've really put their foot down and asserted themselves in this market and they are hoovering up share at a blistering pace. Because of that, they are scaling quite well. To your point, they are generating profits and they don't have to over-invest in order to generate more share. I mean, they are increasing their investments here. There's no doubt about that. But, for example, let's just take a quick example here on sales and marketing. That was 283 million in the most recent quarter. That's up from about 225 million year over year. They were able to increase their spend, to increase their share and still generate some profits coming all the way through here, which is nice to see. Now, I will say this on an operating basis and this is important, they did get a loss. Let's be clear about this.

They were profitable but in terms of their core operations, that was about a $15.4 million loss, Deidre, versus a $48.3 million loss in the year prior. Where this gets profitable is, wait for it, $36.6 million in interest income because interest rates are through the roof. None of this is bad. I'm not saying it's bad. I'm saying that CrowdStrike is getting better. They are reducing their operating losses. They are continuing to invest. They are doing the right thing to hoover up market share here. But the profits, let's not call them artificial, but they're getting some steroids here. Look, that's what it is. There's nothing really wrong with that. They have a fat balance sheet and they're getting some benefits from that. On a core operating basis, they are still running a loss. But it is right to say that they are getting more efficient. They're growing well, they're hoovering up share and I think that's what they should be doing.

Deidre Woollard: I love it when you break it down like that because it always helps me see beyond the headlines of what profitability really is. Let's talk about their modules, because this is land and expand. One of the things that they do is they get you in with a few different things and then they add on different modules. One of the things they talked about a lot in the press release is how many customers are getting more module. They talked about the 63% have more than five modules. With CrowdStrike, its land and expand, do they have to keep landing more or expanding more and just putting more and more modules on more and more customers as things evolve?

Tim Beyers: Well, they have to do both. But I think what's more important is the landing part. You want a long tail of customers, because it's OK to have just a boatload of customers and then the vast majority of them have like one or two modules. But then over time, as they get more embedded or they're growing as an enterprise and CrowdStrike is in there, then it's a very natural experience for them to add the second module, the third module, the fourth module. You don't have to resell that customer at that point. That's a very profitable customer that grows with you. The land is way more important, but the expand part is almost as important in this one sense. At the largest level, the companies that are really going to drive cash flow for CrowdStrike are those big companies that have really embedded CrowdStrike and they're having 6, 7, 8 plus modules. They have made essentially CrowdStrike their outsourced chief information security officer. The entire security operation is essentially outsourced to CrowdStrike. Those customers, they're going to be a big driver of cash flow for the company. But to like feed the flywheel, Deidre, to answer your question, the land is more important, but the expand is very close behind, because the land feeds the flywheel. But when the flywheel spins and the large customers are really generating a lot of interest, a lot of spend, that's what feeds the cash flow.

Deidre Woollard: Yeah, absolutely. Well, you've mentioned that they're really hoovering up market share. You talked a little bit about SentinelOne. Are there any other competitors out there with CrowdStrike, or is it just dominating the competition now?

Tim Beyers: No. There are big names that are in security like Microsoft is one that we should be paying a lot of attention to because Microsoft has huge interests in security and they're not the only ones. Datadog is a company that is very interested in providing more security. But CrowdStrike is partnered up with Zscaler. I think that is a very profitable partnership. They operate at different parts of the security spectrum and I think that helps both of them. I think it gives both of them some interesting tailwinds. It's not like they just own this space. What's happening is that, in the part of the space they really started at protecting devices, your iPhone, your computer. Then they've expanded beyond that, and they've done it very well. Then they have a partnership with Zscaler and that is very profitable for both of them. At scale, there aren't that many companies that are really fighting at the same level CrowdStrike is, but Microsoft is certainly one of them. It's not like CrowdStrike is going to get this space to itself. But the point competitors like SentinelOne said, hey, no, look, we can do endpoint security just as well and we can give you a lot of the same capabilities that are native to CrowdStrike and we can just do it better because we're doing AI that has fallen completely flat.

CrowdStrike has given itself a lot of runway to grow by beating its primary competitors in endpoint security. They've really scaled up quite well. But I will say this, it would be better if CrowdStrike was being more specific in their earnings announcements about how they are scaling and gaining that traction because they used to be really specific in the earnings release, Deidre, about like, hey, here's how many customers have six plus modules. Here's the number that has seven plus, here's the number that has eight plus and that used to be in the supplemental information. It used to be in the press release. Now, you have to go and listen to the call to get that. Maybe it's a minor quibble Deidre. But man, do not miss the earnings call, because this got this data that we were used to seeing in the published document, it's gone. It's not in there anymore. You have to go listen to the earnings call to get that detail. There's good detail. But I have to admit that was a cold cup of coffee when I read the CrowdStrike earnings release and I didn't see the key metrics I'm used to seeing.

Deidre Woollard: Good reminder to always look at all of the materials when you're looking at a company's results.

Tim Beyers: Absolutely.

Deidre Woollard: Awesome. Thanks for your time today, Tim.

Tim Beyers: Thanks, Deidre. 

Deidre Woollard: Secondhand, sales are booming. I talked to James Reinhart, CEO of ThredUp, about how his company is taking on the world of clothing resale. I feel like you've got the classic founder story. You founded the company after having this experience of taking clothes to a local consignment shop, they didn't want them, you got turned down, you thought there must be a better way. Tell us about the better way

James Reinhart: The idea was we all have clothes in our closets that we don't wear, the ways that we get rid of them, have never been something where people are like, you know what, it's been such a great consumer experience, getting rid of the clothes I'm no longer wearing, we just end up giving them away. The insight was to reinvent how people got rid of the things they were no longer wearing and then build what we thought would be a modern thrift store. If you think back 15 years ago, you had eBay, you had Craigslist. That was really it. The iPhone has just been invented. People were staying in Airbnb and Spotify, with all these consumer experiences that we're evolving. We thought thrift had a whole new act to play out and we wanted to figure that out for customers.

Deidre Woollard: Interesting, well, I don't start my interviews with Google, but I did Google ThredUp. One of the questions that came up was, what is unique about ThredUp? I was curious. How would you answer that question?

James Reinhart: I think defining uniqueness for us is that historically in resale or a second hand, you either had to go to a dingy thrift store, right at Goodwill store with racks and racks that smelled like use clothing. Or you had to do everything yourself. On eBay. You had to take a photo and describe the item and deal with customer service and ship the item. I think what's unique about us is we take all of the work out of the process for you as a seller so you fill all your clothing in a clean-out kit and send it to us. We take care of the photography, the itemization, the pricing, customer service holding. We are fully soup to nuts on the seller side. Then for buyers, unlike a traditional thrift store experience or an eBay experience, it's this very elegant, nice buying experience where that's equivalent to shopping on any e-commerce site or shopping in Nordstrom. Where it's great product photos and descriptions and it's easy to navigate. I think the discrete difference for us is really removing all the friction from buyers and sellers and that's proved to be successful.

Deidre Woollard: Well, you've got that two-sided marketplace, you talked about eBay and about others, certainly with Airbnb and everything. With two-sided marketplaces, the challenge is always balancing things out. How do you do that when you've got the buyers who want to buy and things sellers are going to get rid of, they're not always the same. How does that work?

James Reinhart: At the end of the day, two-sided marketplaces, generally speaking, are always supply constrained. If you think about what constraints Airbnb is growth. It's people listing their homes or OpenTable was an example we use for a long time where what constraint OpenTable's growth. I was getting new restaurants on the platform. Generally speaking, supply is the name of the game. We've always started there, which is how do we make sure that we're creating an elegant, easy, valuable supply experience? We start there, Deidre, which is how do we make it so easy for us to get supply? Once we have the quantity of supply that we want, we then start sculpting that supply a little bit. On the margin, we are trying to make sure that our sellers are sending us things that are in season, that are in style, that are in great shape, that would meet the bid of a buyer. Then we work from there to the buyer population where we're trying to figure out what's on-trend, what's in season, what would delight our buyers at a given price points? It's a constant iterative cycle, but the defining feature is really the seller piece.

Deidre Woollard: Well, you publish a retail report every year on ThredUp. I think it's a great resource for understanding just how big things are. In the report you noted resale grew five times as much as broader retail clothing. We see a lot of Gen Z. It's a big thing for them. What else is growing resale right now?

James Reinhart: Gen Z is definitely a driver, but I would say it's really across age spectrum and demographics. I think you're seeing people who really over the last 10-15 years have grown up with feel climate and sustainability on the mind. I think that has made people change behaviors across a number of areas. I think you're seeing the growth of electric cars. You're seeing the growth of solar, you're seeing mobile penetration continues. I think all of those are indicators of more technology for consumer and the consumer who cares more about the planet. When you think about where resale sits, it's technology-enabled because everything needs to be done through your smartphone or in our distribution centers is all tech enabled and it needs to be a consumer mind-shift. It's happening where shopping sustainably, shopping thrift makes a lot of sense. I think that second piece of how the consumer is evolving is the most important. Because more than ever now I think consumers are indicating sustainability and resale as a preference.

Deidre Woollard: It's interesting because we want to do better. We wanted to save the planet, but we also don't necessarily want to stop our consumption. I think that is part of it as well. One of the things I find really fascinating about what ThredUp does is you've pioneered this idea of resale as a service I've been told you trademarked it, which is pretty cool. This is a brands and retailers trying to deliver resale experiences to their customers. This seems just like a huge opportunity. How big could it be?

James Reinhart: Resale as-a-service. That's just to be clear, that's us using our technology in our operations to power this for brands. We work with J.Crew and Kate Spade and Madewell and Athleta, really big brands. I think it's going to be a big part of the future. Because I think brands are starting to appreciate that this is where the consumer is moving. Great brands, what they do really well is reinvent themselves on behalf of the next-generation of consumers. I think if you're running on brand these days, you have to pay attention to resale. I think what will be interesting to watch over the next 3-5 years is that just how consumers start to navigate a world where they can shop resale across all these unique brands. We think a lot of ThredUp around, how does that fragmentation impact us? Where do we sit in that ecosystem, but I'm very bullish on resale becoming a primary channel for brands over time.

Deidre Woollard: I know you've been testing out charging a fee for your cleanup bags. Those are the bags that people fill up with everything and send off to ThredUp. I think it seems like a smart strategy to me because it's like online dating. When it's free you don't get the best-quality. Why did you make that pivot and how is it working out so far?

James Reinhart: Your instincts are great. That's exactly it. When things are free, you really do have this moral hazard of people wanting to just send you everything and being really indiscriminate about it. By charging a fee that we take out of your payout. We don't charge you upfront. We process all your goods and then we take a fee. It provides just a little bit of friction for sellers. It has been, by all measures, really a homerun because not only are we getting better sellers in the door, they are actually sending us more items. If you think about it, if you're going to spend 10 bucks or 12 blocks sending a bag of clothes to ThredUp. If you're going to spend 12 bucks, you might as well fill it to the bryn. You get more items in the bag. There's a psychology where once you're paying for something, you're just like a little bit more discerning. People are checking for quality, maybe they're doing an incremental wash. They're doing things that are improving the number of items we can accept out of the bag. It's one of those things, Deidre, where as the founder, I'm like, Man, why didn't we do this like five years ago? There's all reasons why. But it's been a real winner.

Deidre Woollard: Well, ThredUp spin on this journey of cost-cutting, dealing with a bit of a challenging macroeconomic environment the last couple of quarters. You're moving closer to breakeven. I'm glad to hear that. What metrics should investors in the company, and I am one, pay attention to as signs of success?

James Reinhart: I think on our last earnings call, we talked about double-digit growth that we've been seeing all year. We're guiding North of 20% growth in Q3, in Q4. Importantly with 1,000 bips of margin of EBITDA expansion. When I've been talking to investors as part of the earnings process, I challenge them to find another company out there that's growing at that rate with that type of margin expansion. We feel very good about how the businesses is being operated. We've been very public about breaking even in Q4. They were very good about that path. But it's just a waypoint, at the end of the day businesses have to generate free cash flow over time and we're committed to that. I give the team a lot of credit. I think we are operating as well as anybody out there in the broader ecosystem for consumers. Let's keep doing what we're doing.

Deidre Woollard: Last question for you, ThredUp in five years, do you think of the resale as a service be a larger part of the business? Will it still be the cleanup bags into direct-to-consumer? What do you see and what do you hope for?

James Reinhart: I think our consumer business will be much bigger than it is today. We've over the last 10 years, doubling the business every few years. I feel like the business will be significantly bigger from a consumer perspective. Then I think we will ultimately be powering rasp or more and more brands. I think the way I've often spoken about it is think about ThredUp as really the resale infrastructure on the Internet. It's the piping that I think resale is going to run on. I think that's going to be exciting place to watch.

Deidre Woollard: Fantastic. Thank you so much for your time today.

James Reinhart: Thank you. 

Deidre Woollard: As always, people on the program may have interest in the stocks they talk about. The Motley Fool may have formal recommendations for or against, so don't buy yourselves stocks based solely on what you hear. I'm Deidre Woollard. Thanks for listening. We'll see you tomorrow.