Things keep getting worse for Slack (NYSE: WORK). Since the company made its stock market debut in June via a direct listing at $38.50, its shares have fallen by about 30%, as investors' mood over its outlook has soured.
There's certainly a lot to like about this workplace-collaboration software provider -- based both on its product and how fast the business is growing. But there are concerns, too, and when it comes to making a purchase of its stock -- at the moment -- I think the negatives outweigh the positives after the company's first quarterly report as a publicly traded concern.
Total revenue during the second quarter of fiscal 2020 (which ended July 31) was $145 million, for a year-over-year increase of 58%. That included an $8.2 million expense from customer credits given due to a service disruption during the quarter. Through the first six months of fiscal 2020, Slack's revenue was up 52%. Those are great numbers by any measure.
Slack ended its Q2 with over 100,000 paying customers, a 37% year-over-year increase. And it had 720 customers worth more than $100,000 apiece in annual recurring revenue, up 75%. Its existing users keep getting more valuable, too. The net dollar retention rate was 136%, implying that the average Slack relationship increased spending by 36% compared with a year ago -- mainly due to businesses giving more employees access to the platform. Getting users to spend more is an important driver of profit margins. Kudos, Slack.
The type of office interaction collaboration software fixes. Share and discuss those charts on Slack! Image source: Getty Images.
Speaking of profit margins, gross margin (revenue less cost of the service itself, as a percentage of total revenue) during the first half of the fiscal year was an impressive 82.2%. Though Slack's bottom line is still in the red, this figure is a great indicator of Slack's longer-term potential once it reaches a profitable scale.
However good that figure was, though, it was down from 87.6% a year ago. Granted, some of the gross margin shrinkage was likely due to the rollout of a new service, Shared Channels, which allows businesses that use Slack to communicate and collaborate with external entities like suppliers and customers. Nevertheless, I like to see gross margin at least hold stable -- if not increase -- for small companies that are rapidly adding users.
And then there's the guidance. Management is forecasting full-year revenue will rise approximately 51% to a range of $603 million to $610 million. Again, that's nothing to balk at; most businesses can only dream of that kind of growth. But this is a young company, and decelerating sales growth is worth keeping an eye on. After all, with a price-to-sales ratio of 30.1, the stock is priced for at least a couple years of that level of torrid expansion.
The not so good
It's completely normal for a small tech outfit with big ambitions to spend its way into the red so as to maximize its potential. Slack's gross profits are being put to work via selling and admin expenses. In the second quarter, adjusted selling expenses (a figure that backs out stock-based compensation) were $66.7 million, and general and admin expenses were $60.6 million. During the fiscal third quarter, management said it expects selling and admin expenses to be 50% of revenue. Add in research and development costs (an adjusted $54.6 million in Q2), and you have total outlays that are more than enough to keep Slack deep in the red for quite some time -- both on an adjusted and GAAP basis.
Plus, though workplace-collaboration software is a fairly fresh product, and seen by many as an upgrade from email, it's not like Slack is alone in offering it. It has ample competition, including from Microsoft (NASDAQ: MSFT) and salesforce.com (NYSE: CRM), for example, which both offer larger suites of tools to complement their products. Slack does have a partnership with Atlassian (NASDAQ: TEAM), but the competition could mount in the years ahead and slow Slack's upward trajectory. That would be a problem for the sky-high valuation.
Don't get me wrong, this is a software company I plan on keeping an eye on. At the moment, though, its valuation is too high, losses too steep, and product offerings too narrow for my taste.
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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Nicholas Rossolillo and his clients own shares of Microsoft and Salesforce.com. The Motley Fool owns shares of and recommends Atlassian, Microsoft, Salesforce.com, and Slack Technologies. The Motley Fool has the following options: long January 2021 $85 calls on Microsoft and long January 2021 $100 calls on Salesforce.com. The Motley Fool has a disclosure policy.
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