Slack Q1 underwhelms - did it squander its lockdown opportunity?

Business messaging platform Slack saw its revenue growth pick up marginally to 50% year-over-year in its Q1 earnings released yesterday, but stock watchers had been expecting more in the wake of videoconferencing platform Zoom's hypergrowth of 169% in the same quarter. Subscriber growth was muted in comparison too. News of a partnership to use video and other services from Amazon Web Services, along with an enterprise-wide deal for Amazon to roll out Slack internally, did little to assuage investor concerns. Slack's stock price fell by as much as 20% this morning.

Nevertheless, despite the absence of an instant revenue spike, Slack CEO Stewart Butterfield believes the COVID-19 crisis has spurred an impact of "generational magnitude" on the way we work that bodes well for continued enterprise adoption of Slack. And there were intriguing hints of new product developments in the works as Slack refines its capabilities tuned to this new world of work. More on that in a separate story on Slack's Amazon partnership.

The quarter saw a surge of 90,000 in the number of organizations taking out either free or paid subscriptions, bringing the total to 750,000, while paying customers spiked by 12,000 to 122,000. While those rises of 14% and 11% respectively were not in the order of magnitude the market was hoping for, Butterfield believes they're a foundation for future growth as free accounts convert to paid and paying customers expand to more seats.

Meanwhile paying users increased the time they spend actively using Slack by around a third during the quarter, from just under 90 minutes to more than 120 minutes. There was also an increase in time spent connected to Slack, from around nine hours to "well over ten" per day. This indicates a shift in the number of users putting Slack at the center of their daily work, says Butterfield:

I think what you're seeing is a greater percentage of users coming to really rely on Slack for being where work happens, being that digital workplace ... There's always a population of people using Slack in a very intensive way. I think what we saw was a much bigger population moving into that more mature usage category.

Slack Q1 key numbers

More on what that might mean in a moment, but first a quick summary of the key numbers and customer counts:

• Total Q1 revenue was $201.7 million, up 50% year-over-year.
• GAAP operating loss was $76.2 million, or 37.8% of total revenue, compared to a $38.4 million loss a year ago, or 28.5% of total revenue. The non-GAAP equivalent was $16.6 million (8.3%) versus $33.8 million (25.0%) a year ago.
• Net cash from operations and free cash flow were positive, the former at $8.7 million (4% of total revenue), up from negative $14.1 million (10%) a year ago. Free cash flow was $3.7 million (2%), versus $(34.2) million (25)% a year ago.
• Over 122,000 paid customers in total, up 28% year-over-year and up 12,000 over the prior quarter. 132% net dollar retention rate, unchanged from the prior quarter.
• 963 customers with more than $100,000 in annual recurring revenue, up 49% year-over-year. This cohort now represents 49% of total revenue, up from 43% a year ago.
• Over 750,000 organizations on either a free or paid subscription plan, up from over 660,000 organizations at the end of last quarter.

Forward guidance for FY2021 revenue was revised up slightly to around $863 million, or 37% year-over-year growth. Projected operating losses were revised down but still remain above $100 million on a non-GAAP basis. The target to get within striking distance of positive free cash flow by year end remains unchanged. Meanwhile, the $750 million of new convertible debt raised in early April ensures Slack has plenty of runway available while it pursues that target.

"You can't adopt Slack quickly"

So what about Slack's failure to sign up new customers at the same rate as the likes of Zoom and Teams? According to Butterfield, that's a feature not a bug:

What you saw with Zoom, what you saw with Teams, is a great indication that this is not apples-to-apples and that the products are not truly competitive with one another. You just can't adopt Slack that quickly. You can't move from e-mail to channel-based messaging in that short amount of time. I wish that whole cultures could change overnight.

Rather than being a digital substitute for in-person meetings, Slack is a whole new way of working, Butterfield argues. It's not something you can just switch on and become productive with immediately — which he admits is a priority to improve, particularly in the small and medium-size business sector, where adoption is largely self-service:

If they come to our website and download Slack we want them to be successful, to have that 'a-ha' moment, and to get value from Slack as quickly as possible. This remains personally my biggest focus area.

In the larger enterprise market, though, getting value from Slack is all about having multiple channels and using the messaging platform as a means of linking work across different applications. Increasingly, it's about opening up channels to other organizations too, as adoption of shared channels continues to ripple through the customer base — and will soon be extended with the ability for shared channels to connect multiple organizations. It takes a fair bit of effort to put all of this in place and learn how to use it productively. But once it's up and running, it's difficult to switch off, as Butterfield explains:

One of the reasons Slack has such high retention I think is because it's a real cultural shift. You have a hundred thousand employees and people are using Slack for two hours a day, that's a million hours of employee time a week. So when you're talking about that kind of change, there's a lot of people have to understand, 'How many channels should we have, what should we set up channels for, what should be public, what should be private, how do the integrations work?'

My take

What Butterfield is saying here is that Slack isn't that easy to pick up — although there have been advances in the past few months, including the launch of a refreshed user experience just as lockdown started back in March. But its strength is that, once it has become a part of how an organization works, it's incredibly sticky.

So while it may look as though Slack has missed a huge opportunity to sign up a massive new user base as organizations around the world were catapulted into remote working by the COVID-19 lockdown, Butterfield's argument is that it's not that simple. Slack is an altogether more complex proposition than dialing up a videoconferencing tool — or even, in the case of Microsoft Teams, an online chat tool.

This argument stacks up when you look at the entirety of Slack's proposition, which I want to explore in a separate examination of its tie-up with Amazon, so I won't go into that here. What I will say, though, is that it's a very difficult argument to get across in a conversation with Wall St analysts who are looking at Slack in terms of established categories and worrying about its ability to retain SMB customers facing economic hardship. No wonder the stock price has tumbled today.

Butterfield won't be deterred, however, because he's playing a long game. When I wrote about Slack's last earnings report, I cited several risks the company might face as the COVID-19 crisis evolved. One was a spike in free account sign-ups that would become a drain on resources without contributing revenue. Slack has dodged that bullet. Another was its eye-watering operating losses. The new debt offering has effectively doubled Slack's cash reserves, buying runway and giving the company more freedom to double down on sales efforts.

The other risk was a slowdown in enterprise spending. This is where Slack is most vulnerable, but also where its opportunity lies if it can make its proposition compelling. That's why I'm so intrigued about the Amazon partnership, especially in the light of some of the comments Butterfield made during the earnings call. Now read why Slack's Amazon partnership is about apps, not video.