Two positive months for the portfolio in a row! At this point, I’ll take it!

It’s fair to say that despite my gloomy prediction at the end of last month’s post, August has been by far the best month of 2022 in which to own shares of software businesses (not that the companies themselves have been setting the world alight…). [Q2 2022 SaaS Beats & Raises.png]Source: Jamin Ball’s ‘Clouded Judgement’ newsletter

For the most part, the SaaS flywheel has continued to churn out beats and raises in spite of the difficult macro conditions. Whether this remains the case if we head into a prolonged recession and C-level executives are forced to make tough decisions about which line item to cut is still very much up for debate. As is the likelihood of such a recession. I found this excerpt from Jerome Powell’s Jackson Hole speech (that tanked the market last week) interesting in this regard:

Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.

For a Fed Chair, that seems fairly forthright! Anyway, back to business.

Business Updates

Amazon

Never having covered Amazon’s earnings before, this was a good learning experience! Turns out that when you’re CEO of a company this size, earnings calls aren’t a good use of time. I suppose that’s fair enough given Amazon did $121 billion in net sales in Q2. Overall, the quarter was a good reminder of just how much AWS is currently propping up the rest of Amazon’s business.

Earnings call notes

  • Prime Day occurred in Q2 last year versus Q3 this year (included in guidance).
  • Slowed ‘22 and ‘23 expansion plans to align better with demand.
  • LOTR series releases in Q3 as part of Prime.
  • 3rd party sellers 57% of all units sold in Q2, highest ever.
  • Inflationary costs, fulfilment network productivity and fixed cost deleverage accounted for $6 billion in Q1 2022 (YoY) and $4 billion in Q2 22.
  • Saw better optimisation of fulfilment network (route density, deliveries per hour).
  • AWS annualised run rate (ARR) almost $79 billion. “We believe we’re still in the early stages of enterprise and public sector adoption of the cloud.” New agreements include Riot Games, BT. AWS Operating Income of $5.7 billion.
  • In 2021, $60 billion spent in CapEx: 40% tech infrastructure, 30% fulfilment network, ~25% for transportation. 5% for corporate space and physical stores. Expect to spend slightly more on CapEx this year, with tech infra > 50%, fulfilment and transportation lower.
  • Net loss of $2 billion includes Rivian valuation loss.
  • 390bps baked into revenue guide for Q3 due to FX impact.
  • Assumed $1.5 billion in cost improvements in fulfilment network operations - offset by AWS investments and Prime content.

Q&A

  • “We’re not seeing some of the pressures that other people are seeing right now.” “Seeing strong growth in sales through the quarter in Q2.”
  • Stock-based-compensation (SBC) up 150 bps since Q1 - “that’s where a lot of our wage inflation is for, particularly our technical employees.”
  • Sings virtues of moving to cloud during tough economic periods, such as now - shows its value versus building your own data centre.
  • AWS backlog (RPO?) up 65% YoY and 13% QoQ. Weighted average remaining commitment length is 3.9 years.
  • Majority of advertising revenue is in North America but not specifically broken out.
  • ~14% of Operating loss due to FX headwinds.
  • Continuing to invest in local-language video content to drive Prime flywheel.
  • ‘Grudgingly’ added a selling fee in May to ‘compensate for inflationary pressures’.
  • Headcount is almost double the amount in early 2020 even after job cuts…

Cloudflare

Cloudflare and consistent 50% growth quarters. Name a better duo. Cloudflare reported along with Datadog after the closing bell on August 4th and it was almost a boring quarter, in the best way possible.

Steady net retention (DBNRR) of 126%, breakeven cash flow, gross margins maintained at mid-high 70’s. On the macro front, longer sales cycles were highlighted but with ‘conservatism’ baked into the outlook for the rest of the year, guidance was still raised.

Earnings call notes

  • $100k+ customers now account for 60% of revenue. 29% of F500 are customers.
  • Continued forecasting of positive FCF by 2H.
  • Sales cycles and bill payment timings stabilised in Q2: ‘metrics are trending in the right direction’
  • Harder ‘to sign up a new customer’ but easier to expand within existing customers.
  • ‘Time for prudence and caution’. ‘The road ahead is less certain, so it makes sense to keep our hands on the wheel, our eyes on the road and let up a bit on the accelerator.’
  • Gross renewal rates in every region hit all-time highs in 1H. ‘Wouldn’t trade places with any other CEO right now.’
  • Highlighted 6-figure win versus Zscaler. Specifically highlights that CF is better than ZS and PANW. ‘Going head-to-head against them more and more often’ in Zero Trust battles. “Successfully signed up half of ZS’s top channel partners as new Cloudflare partners”
  • “You don’t get fired for buying Cloudflare” - executive at large online recruiting firm ($5.5 million, 3-year deal)
  • Other security vendors chose CF in Q2, and even direct competitors for DDoS mitigation.
  • Error in total paying customer numbers last quarter - overestimated. Revenue impact less than $160k.
  • Area 1 contributed < 1% of revenue.
  • US 53% of revenue (35% YoY), EMEA 26% of revenue (54% YoY), APAC 14% of revenue (43% YoY).
  • Strong hiring quarter - headcount increased 49% YoY. Plan to slow hiring in 2H22.
  • Some conservatism in outlook for rest of year.

Q&A

  • Elongated sales cycles in $0.5 - $1 million customer bucket. Deterioration of performance in Europe over first and second quarter. Not factored in that things will improve from here.
  • Workers can be used to cut costs as it’s significantly cheaper versus traditional public cloud.
  • FedRAMP certification very close.
  • Feel currency headwinds in Europe due to the strength of the dollar.
  • Crypto customers represented < 5% of revenue for Q2.
  • Sales cycle still far below 90 days for the majority of the business.
  • Expect R2 to go into GA at the end of Q3. See Workers as ‘Act 3’ after infra protection and Zero Trust.
  • Due to long lead times (up to 9 months) on traditional on-premise firewalls and increasing costs, more cloud-phobic organisations starting to change tune.
  • On hiring: slowdown is in G&A and some R&D, not S&M.
  • Can improve FCF generation by moving more customers to annual billing - majority still monthly.
  • Area 1 has resulted in $1 million+ wins that close quickly due to the prevalence of customer phishing issues.

Datadog

If Cloudflare’s quarter was business as usual, Datadog’s was decidedly less so. $100K+ ARR customer additions slowed sequentially for the first time in 4 quarters (to 8%) and FCF margin hit its lowest level (15%) since Q4 2020.

Analysts used the Q&A section of the call to try to get to the bottom of (without much success) the weakness highlighted by management in enterprise customers versus SMBs, the polar opposite of the situation in other SaaS businesses this quarter. As DDOG has products that are priced based on usage rather than a set rate, Olivier and David made the case that larger customers had optimised usage throughout the quarter as the macro environment worsened. This reduced usage seems to have been baked into upcoming guidance.

Earnings call notes

  • 21,200 total customers up from 16,400 YoY. >$100k custs generated ~85% of ARR (grew 54% YoY).
  • Variability in growth. Larger customers grew at lower rate than historically. More pronounced in consumer discretionary (e-commerce and food & delivery) and specifically volume based products like logs & APM.
  • ‘We did not see this with our SMB and lower spending customers who continued growing with us as they have in the past.’
  • 200 customers in Russia and Belarus now turned off in Q2 (revenue contribution was described as ‘immaterial’ in Q1). Record customer adds even accounting for this.
  • 79%, 37%, 14% using 2, 4, or 6+ products respectively (2 or more dropped from previous quarter for the first time ever).
  • Observability Pipelines product now GA (based on Timber acquisition). Allows customers to control cost, volume and quality of data.
  • Acquisition of Seekret announced alongside earnings. Will enable better visibility for managing APIs.
  • Had sizable lands and expands within customers that have recently laid off staff.
  • Billings $397 million, up 47% YoY; RPO $881 million, up 51% YoY. Re-stress that both can fluctuate significantly and vary from revenue growth (even so, huge fluctuation from Q1). H1 22 billings grew 72% YoY.
  • $11 million in sequential OpEx was due to in-person office travel and events.
  • The usual ‘conservative’ assumptions.
  • Q2 guidance is 52% YoY rev growth at midpoint, 57% for FY.

Q&A

  • Variability in usage growth became more apparent deeper into the quarter.
  • ‘Not a sharp (covid) pullback’. Saw an improvement in those trends in July. Reason for the conservative nature of guidance is the macro uncertainty.
  • APM mentioned as part of ‘volume-based’ slowdown products due to reduction in customers making use of longer-duration data retention.
  • Seeing several customers optimise in the same quarter, caused by macro.
  • Business is managed to usage rather than billings to align with customers.
  • ‘Aggressively’ recruiting.
  • Slightly contradict earlier statement by saying across enterprise, mid market and SMB, they saw a more ‘conservative’ mentality. Gross retention stayed the same at all levels.
  • Worth it for the larger customers to optimise versus SMBs.
  • Analysts really focused on the SMB versus enterprise slowdown. Olivier and David basically saying, NBD guys, we’re just being conservative on guidance and billings/rpo isn’t a good indicator for the business.

TakeTwo

Another new portfolio entry since they last reported, this earnings call highlighted the magnitude of TTWO’s Zynga acquisition (on a full-year basis, Zynga will be contributing the majority of the revenue of the combined business).

Earnings call notes

  • Net bookings jumped 41% (this includes newly added Zynga titles)
  • Won’t have clear comparison until Q1 24
  • Zynga has effectively added $2.05 billion in net bookings judging from full year guidance. As the acquisition closed mid-year, this suggests that Zynga will contribute the majority of bookings for FY24.
  • Without Zynga, bookings dropped $114 million sequentially to $731 million but grew ~3% YoY. With, bookings were $1 billion.
  • Long term vision is to introduce mobile games for some of their most popular IPs.
  • Net bookings driven by ‘outperformance’ of NBA 2k and WWE 2k. NBA has sold 12 million units to date, exceeding last year and average games played per user increased 16% YoY. NBA 2K22 arcade remains #1 in Apple Arcade since its launch in Oct 2021. 2K23 launches in September.
  • Latest generation (console) GTA Online players monetising 36% higher than previous gen and total latest gen players grew 40% sequentially. Audience size is 49% higher than pre-pandemic quarter 3 years ago (Q1 2020).
  • Development of GTA VI ‘well underway’.
  • With Zynga inclusion, recurrent spending accounted for 73% of net bookings. Zynga delivered significant growth in advertising net bookings.
  • This appears to be the rough strategy from my perspective:
    • Ad-supported ‘Free-to-play’ mobile offerings through Zynga integration will provide a stable recurring revenue base along with NBA and WWE 2K, meaning lower variation in earnings in between marquee IP releases (GTA VI, KSP 2). This creates less timing pressure around big launches and allows prioritisation of quality.
  • Rollerdrome looks very fun!
  • Digitally delivered bookings accounted for 95% of total bookings. 77% of console games delivered digitally (73% last year).
  • $20 million impairment charge related to decision not to proceed with further development from unannounced new franchise. Will be interesting to see how often this happens. Found one other example in the past 4 quarters ($50 million charge Q2 22)
  • $1.3 billion in cash and $3.3 billion in debt.
  • Guidance includes Zynga for approximately 10 months of the fiscal year. $5.8-5.9 billion in bookings expected.
  • Expected bookings breakdown:
    • Zynga: 45%
    • 2K: 37%
    • Rockstar Games: 17%
    • Private Division: 1%
  • 60% US, 40% International
  • Second quarter guidance of $1.5 - $1.55 billion net bookings, recurrent consumer spending (RCS) to grow ~85%, digitally delivered (DD) net bookings to grow 70%. GAAP revenue $1.37 - $1.42 billion and cost of revenue from $700 - $719 million.

Q&A

  • Some softness in mobile but ‘doing better than most, if not all’. Shifts in game release pipeline more meaningful to numbers than FX rates.
  • RCS not broken out pre-combination anymore. Apparently this is the norm for TTWO acquisitions.
  • Pipeline shifts not taken ‘lightly, generally speaking’. ‘The most important thing for us is always to put up the best game we possibly can’. ‘Typically, that is the best economic decision that we can make’.
  • ~11,000 employees currently with no plan to significantly increase headcount in the near future however have ‘an expectation to grow very significantly in the next 3 years’ which will likely increase development headcount.
  • Game launches sometimes moved a week or 2 for marketing windows but generally released ‘when it’s ready’.
  • ‘Over and over again, I said I don’t believe the entertainment business is recession proof or even necessarily recession resistant’ - Strauss on his stance over the last 15 years of fielding questions about the effect of recessions on the sector. Flatly states that we’re already seeing the effects of a decline in consumer spending.
  • ‘Not really concerned about this post-IDFA world’. Thinks Zynga’s ad-tech platform, including Chartboost will help their marketing.
  • Zelnick thinks explanation for higher engagement on latest-gen platforms may not just be down to excitement over new hardware: ‘historically has been the case, that our business has grown coincident with the growth and exploitation of increasingly robust technology’
  • Evidence is that the next generation of gamers ‘play more’.
  • Don’t sound overly concerned by debt reduction. Still on the look out for acquisition opportunities.

Snowflake

A mixed bag. It’s hard to complain about a business with a 171% dollar-based net retention rate (DBNRR) but I’m going to do it anyway.

Sequential revenue increased by the lowest amount recorded as public company (10%), operating expenses were 67% of revenues and FCF margin was 11%, down from (admittedly, an exceptionally high) 41% in Q1.

Earnings call notes

  • Added 12 Global 2000 (G2K customers).
  • 590 Powered by Snowflake partners - 35% QoQ.
  • Snowpark for Python now in public preview.
  • Announces intent to acquire Applica, a document automation business - looks like an acquisition for the underlying tech.
  • 57% of RPO ($1.53 billion) to be recognised in the next 12 months.
  • 15 new $1 million TTM product revenue customers as part of NRR.
  • G2K tech company now top 10 product revenue customer having only signed up < 2 years ago.
  • Not seeing key metrics soften across customer base. EMEA contributed 4 of top 10 new customer wins.
  • FY outlook includes OpEx related to Applica acquisition.
  • YTD added ~1,000 net new employees. Hiring plans for the year remain unaltered.

Q&A

  • Q3 last year ‘unusually high’. ‘Not a good’ YoY comparison.
  • Snowflake more expensive on one cloud than another. Most aggressive pricing on AWS, where there is concentration of deployment. 80+% run in AWS, 18% Azure, 2% GCP.
  • A lot of annual renewals are moving towards Q4.
  • “I don’t even look at billings because it’s a meaningless thing for our business because we’re not a SaaS company.”
  • Expect a big increase in RPO in Q4 following renewals. No guide.
  • Not feeling the macro headwinds in Europe - in general, the further East, the more it is being felt.
  • Differentiate from Databricks by ease of use, getting value out of their data and not dealing with the infrastructure. Databricks users generally have a far more technical background.
  • Frank, when asked about ~60% of customers that come from an on-premise environment: “in the last week, I’ve heard some – 2 very, very iconic names in 2 different industries that were staunch on-premise people who would never ever go cloud and that are now going.”
  • “data science and the promise of data science, the ability to generate predictive insights and prescriptive solutions really depends on your ability to join and blend and overlay data regardless of data types, data source or where it’s coming from.”
  • Average revenue from their 510 G2K customers is $1.2 million, up from $1.05 million in Q1.
  • ‘Principally, headcount is the main investment we’re doing in the business because that’s what drives R&D. That’s what drives sale.’
  • 20-21% of revenue comes from financial services vertical. Media and Entertainment, Technology close behind. Of the big lands in EMEA, telco, bank, insurance company.
  • Land small, build workloads over years, versus SaaS that land users by account.
  • Snowflake for Python demand is ‘red-hot’ - customers waiting for it to go GA, which is expected at the end of this year. ‘Meaningful contribution to consumption will happen next year’ as a result.

Crowdstrike

Crowdstrike’s quarter bore a striking resemblance to Cloudflare’s, with all the key metrics chugging along nicely and guidance looking particularly promising (implied re-acceleration in sequential growth).

FCF generation continues to be a strong-point with 25% FCF margins in the seasonally weakest quarter on top of the existing macro pressures leaving me very impressed.

Earnings call notes

  • Net new ARR growth of 45%, ending ARR 59%, down from 61% in Q1.
  • They believe this makes them the ‘second fastest software company reported to reach the $2 billion ARR milestone’ after Zoom. Made easier when the term didn’t exist 10 years ago but still impressive.
  • Record net new ARR for Identity Protection, Humio and cloud modules.
  • Gross retention ATH for second consecutive quarter. DBNRR highest level in 7 quarters.
  • Saw some extension in the time taken to close deals. This has been consistent among SaaS peers.
  • 5, 6, 7 module customers increased to 59%, 36% and 20% respectively.
  • Approx. 35% of customers now use Fusion workflows (automation and remediation engine)
  • Ending ARR growth from $1 million + ARR customers accelerated and is outperforming average customer growth. They are standardising on Falcon.
  • 20 of 37 U.S states are CS customers.
  • Falcon Go, SMB product (100 endpoints or less), launched during the quarter.
  • Managed Security Service Provider (MSSP) ARR grew >150% YoY.
  • ARR from ‘Emerging Products’ segment (Discover, Spotlight and Identity Protection, Humio) $219 million, up 129% YoY.
  • ‘Record Q2’ for Humio. Would still like to see these numbers broken out.
  • Public cloud ARR of $174 million.
  • 53%, 73% YoY growth in US, international respectively.
  • Record net new hires.
  • Committed to 30% FCF margin goal by year-end.

Q&A

  • ‘80% of attacks leverage compromised identities.’ Thinks module can be as big as XDR.
  • ‘Now is the time, given the current macro’ for CS to push the platform strategy. Answers largely focusing on the value proposition a 22 module security platform offers in the current environment. Customers are ‘not interested in adding a bunch of heads.’
  • From a sales perspective, got ahead of customer concerns around cost-cutting - focused on business value assessment (BVA).
  • Expect less pronounced sequential seasonality in comparison to previous years.
  • Customers in high-threat environments often activate and get immediate value from trial product before converting to paid.

MongoDB & SentinelOne are due to report after market close today.

YTD return vs benchmarks

(Index source: Koyfin)

Portfolio Nasdaq S&P 500 FTSE 100
-39.03% -24.80% -17.02% -2.94%

Portfolio

Holding Ticker(s) Weighting (%)
🐶 Datadog DDOG 20.4
❄️ Snowflake SNOW 18.5
🕸 Cloudflare NET 18.1
🦅 Crowdstrike CRWD 11.8
🔐 SentinelOne S 8.2
🔁 MongoDB MDB 7.5
🕹 TakeTwo TTWO 7.2
🛍 Amazon AMZN 5.4
💰 Cash - 2.9

Adjustments

While a quiet month overall on the buying/selling side of things, after writing: ‘this post has me itching to put that 3% cash position to work…’ I didn’t waste any time doing so, bumping up my position in Cloudflare after re-reviewing their last quarter.

When the market then rewarded what I deemed a mediocre Snowflake report with a 25% jump in stock price, I decided to trim back my position so that it remains a similar sizing to last month.

Closing Remarks

September looks blissfully quiet after the whirlwind of information to digest this month! As with most months so far this year the direction of travel is likely to hinge on comments made by senior Fed officials about the aggressiveness in their approach to tackling inflation. Until its effects start showing up in earnings reports though, I’m not inclined to pay them too much attention!

Until next time!