Salesforce Rally Looks Short-Lived as AI Play Underwhelms

Salesforce released the firm's fiscal third quarter financial results on Tuesday evening. They were solid, but unspectacular. There was hardly any contribution to that quarter, at least on the revenue or backorder sides, from the firm's latest AI offering, Agentforce, yet that product is what had traders and investors falling over themselves trying to buy the stock overnight.

For the three-month period ended October 31, Salesforce posted an adjusted EPS of $2.41 (GAAP EPS: $1.58) on revenue of $9.444 billion. The top-line print exceeded Wall Street's expectations and was good enough for year-over-year growth of 8.3%. The adjusted earnings number fell a few pennies short of consensus. Adjustments were made for the amortization of purchased intangibles, stock-based compensation expense, restructuring costs and income tax effects. Current remaining performance obligation grew 10% to $26.4 billion.

What Is Agentforce?

Agentforce is basically the firm's platform for AI-powered assistants that, on behalf of clients, will make autonomous decisions and perform assigned tasks. There had been concerns over demand for Salesforce's services as the firm had, in the past, driven revenue through the sale of software licenses on a per employee basis. Agentforce sort of becomes the employee. Agentforce was revealed at the Dreamforce conference in September but only launched as a service in the last week of October.

Therefore, Agentforce, despite being what investors are excited about, is not really in the numbers this quarter. I don't know if you watch Jim Cramer's show on CNBC. I was out at that time, and like any red-blooded American man, I had to go to McDonald's MCD for dinner on the first night of the firm's seasonal relaunch of its McRib sandwich. I had worked at my local McDonald's when the McRib was created and I have nostalgia for that sandwich. Eating my grub in the parking lot, I had old Jim on Sirius SIRI radio and he had Salesforce CEO Marc Benioff on his show.

"We have become a supplier of digital labor," Benioff said. "This digital labor opportunity is incredible, and we could not be more excited." 

Benioff is given to overuse the words "incredible" or "excited." What came next was not directly from the TV network interview handbook. 

"The results, starting in this quarter, are already showing what is going to be possible for the future," Benioff added. "We closed over 200 Agentforce deals the first week of it being available." 

Read that last sentence twice if you have to. It was a game changer.

Back to the Quarter

GAAP operating margin printed at 20%, while the firm's adjusted operating margin landed at 33.1%. Both numbers easily beat expectations and grew dramatically from the year-ago comparisons. Free cash flow came ro $1.779 billion, also better than expected, and up 30% from a year ago, of which the firm returned $1.6 billion to shareholders in the form of share repurchases ($1.2 billion) and cash dividends ($0.4 billion) paid out to shareholders.

Guidance

For the current quarter, Salesforce sees revenue of $9.9 billion to $10.1 billion, which would be good for growth of 7% to 9%. Wall Street had been looking for $10.4 billion, so the midpoint is a hair light. The firm also sees GAAP EPS of $1.55 to $1.60 and adjusted EPS of $2.57 to $2.62. Wall Street had been looking for something close to $2.6, so again, the guidance is a tad light.

For the full year, the firm expects to drive revenue of $37.8 billion to $38 billion, also putting the midpoint slightly below the $37.92 billion that Wall Street had in mind. GAAP full-year EPS is seen at $6.15 to $6.20, while adjusted EPS is seen at $9.98 to $10.03. Consensus had been for $10.04. Again, disappointing guidance.

Segment Sales

• Subscription & Support generated revenue of $8.879 billion (+9%), beating estimates.
• Sales Cloud generated revenue of $2.119 billion (+11%), beating estimates.
• Services Cloud generated revenue of $2.288 billion (+10%), beating estimates.
• Platform & Other generated revenue of $1.825 billion (+8%), beating estimates.
• Marketing & Commerce generated revenue of $1.334 billion (+8%), beating estimates.
• Integration Analytics generated revenue of $1.313 billion (+5%), short of estimates.
• Professional Services generated revenue of $565 million (-2%), beating estimates.

Balance Sheet

At quarter's end, Salesforce ran with a cash position of $12.757 billion and current assets of $21.425 billion. Current liabilities add up to $19.375 billion, including no short-term debt, but unearned revenue of $13.472 billion, which you know if you follow me, that I do not consider to be a true financial obligation, but one of goods or services owed. That leaves the firm with a headline current ratio of 1.11, which is fine. However, if one adjusts for all of that unearned revenue, the current ratio rises to a herculean 3.63.

Total assets amount to $91.395 billion, including goodwill and other intangibles of $53.212 billion. At 58% of total assets, I think that might be a bit gaudy and probably unnecessary. This is already a better than good balance sheet. Total liabilities less equity come to $32.87 billion, including longer-term debt of $8.432 billion, which is something the firm could take care of out of pocket if it needed to.

Wall Street

Very little reaction to this release from Wall Street. There was more action from Wall Street ahead of earnings, in mid- to late November. Most of that was positive. Since Tuesday night, I only see three highly rated sell-side analysts that have opined on CRM. Dan Ives of Wedbush and Patrick Walravens of JMP Securities both reiterated "buy" ratings and respectively, their $450 and $375 target prices. Brian White of Monness reiterated a "hold" rating without setting a target price. Talk about a lack of professional enthusiasm. Even as the stock has run wild.

My Thoughts

I don't see it. The balance sheet is in great shape, and so are cash flows. I have no problem there. The community of Wall Street analysts certainly is not all that excited. Sales growth is less than amazing. Operating margins are improving. I'll give Benioff that, but I have a question:

If Agentforce is kicking so much tail and the quarter is off to a great start, then how come the current quarter guidance is below consensus view? Maybe I'm crazy, but shouldn't a great start for the firm's latest and greatest offering be a big enough deal to boost guidance? I would definitely keep my powder dry if I were tempted to chase Wednesday's rally in the shares of Salesforce.

The technical picture is positive, which throws a monkey in the plans that I had been running over in my head to short this rally. Readers will see that CRM is now breaking out from a cup-with-a-handle pattern bearing a $349 pivot. While there obviously now is a gap that could fill at some point in the future, relative strength has popped but the daily MACD, which was and is still moderately bearish in posture, has improved. It would be easy to sit this one out.

That said, I just don't see how the disconnect between what was said about Agentforce and the weakish forward guidance can co-exist. I am very tempted to go with a small- to medium-sized trade in CRM from the short side.

Trade Idea

• Sell short 100 shares of CRM at or above $360
• Purchase one December 13 $370 CRM call for a rough $2.85.

Net Basis: $357.15

Note: Buying the protection by next Friday at $370, takes the net basis for the short position down to $357.15, but creates a safety valve for the trade that while expensive is needed, would prevent catastrophe.

At the time of publication, Guilfoyle had no positions in any securities mentioned.