ZSCALER
What they do: Cybersecurity firm that provides services secure user-to-app, app-to-app, and machine-to-machine communications over any network and any location
Confidence tier: Contender
Type of revenue: Subscription-based
Trend to profitability: Yes
Cash: $1.82B
Revenue: $355.5M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 61.7% | 62.7% | 62.6% | 61.4% |
| 2023 | 54.2% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 17.0% | 10.9% | 12.2% | 10.9% |
| 2023 | 11.8% |
Calculated billings: $340.1M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 71.2% | 58.5% | 53.6% | 56.6% |
| 2023 | 37.3% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | -25.4% | 48.4% | -6.0% | 50.6% |
| 2023 | -34.6% |
Free Cash Flow: $95.6m
| % Revenues | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 36.2% | 11.5% | 15.3% | 23.5% |
| 2023 | 26.9% |
Customers $100k+: 2,217
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 60.6% | 60.9% | 62.2% | 63.6% |
| 2022 | 55.7% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 17.1% | 10.7% | 12.5% | 12.2% |
| 2022 | 11.5% |
Dollar-based net retention rate: 125+ %
| DBNRR | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 125+% | 125+% | 125+% | 125+% |
| 2023 | 125+% |
My thoughts:
Highlights
- Revenue came in at $356M, 54 % year-over-year, 11.8 % quarter-over-quarter
- Billings came in at $340M, 37 % year-over-year against tough comps, still something to watch closely
- Raised FY guide by 2 %, though no billings raise; FY guide: $1.530M; Billings: $1.940M
- Operating cash flow came in at $129M, up from $93M a year ago.
- Free cash flow came in at $95.6M, up from $83M a year ago
- Operating margin was 12 % and free cash flow margin was 27 %
- Operating income came in at $42M, up from $24M a year ago
- Net income came in at $44M, up from $21 a year ago
- Strong dollar-based net retention rate of 125+ %
- Solid Gross margin of 81.4 %
Room for improvement
- Less $100K+ customers added than a year ago: 1Q23: 128 vs 1Q22: 136
- Less $1M+ customers added than a year ago: 1Q23: 21 vs 1Q23: 22
- RPO grew 57% from one year ago to $2.7B, disappointing due to the low sequential growth of only 2.9 %
Additional insights
- SMB segment is below 10%; SMBs did better than enterprises → Surprising since most companies like Snowflake reported a contrary picture → Still, on the higher end of the large enterprise segment, they haven’t seen many competitive changes at all → Perhaps their SMBs are concentrated in verticals (i.e. financial services) which are less affected
- They are not competing against firewall companies like Palo Alto when they talk to their larger deals
- Americas represented 52% of revenue, EMEA was 33% and APJ was 15%.
- Their guidance is based on historical performance → they saw a slowdown in October. But: November started to tick back up again
- They say performance is more driven by macro than anything else → Elongation of sales cycles; previously 9-12 months, now 12 months range → CIOs and CXOs state, they don’t see security budget getting reduced much (compared to IT budgets) but deals have to get approved by C-level which impacts sales cycles
- They are confident in growing their big target of $5 billion ARR
- Deal sizes are getting bigger
- Customers are buying more of their platform
- Pipeline is increasing in all five regions, very strong, Q2 will be a record pipeline→ They mentioned confidence in their pipeline multiple times
- They do well with the fed business; have landed 12 of the 15 cabinet-level agencies which are at a small level but have been growing at a decent pace → it’s early stage.
- None of the deals are going away, they feel well-positioned and winning already
- They made some changes at the start of Q1 in their sales org which caused some slowdown, but it’s done and already showing improvements
- Positive COVID effects ended by mid of 2020, since then, the growth of their business is driven by the need for security, transformation, digital transformation
- They say the service they are selling is more mission-critical than Office 365 since they connect everything to everything
- They have not seen pricing pressure from the competitive side → Customers told Zscaler, other vendors tried to offer a third price but they decided against it because it doesn’t meet requirements
- In most cases, their service is showing more than 200 % ROI due to the displacement of eight-point security and networking products
- They feel very confident and comfortable with the business (including billings) → If anything, it’s seasonality and macro, i.e. the decline in deferred revenue from Q4 to Q1 (-1.5 % quarter-over-quarter) is due to the seasonality of their business
My investment decision
Fewer customers added against the previous year for both $1M- and $100K cohorts is disappointing. But Crowdstrike draws a similar picture. I am keen to see Sentinel One’s customer additions after they report next week. I assume, they will show weakness as well. If not, I will buy more of S - instantly.
Also, the light growth in remaining performance obligations and no raise in the billings guide is not increasing my confidence.
That said, they are still growing strong at above 50 % year-over-year at $356M quarterly revenue, and profitability (operating cash flow, free cash flow, operating income, net income) continues to improve which looks great. Customers continue to love them, reflected by the 125+ % dollar-based net retention rate.
They sound very confident, see themselves as mission-critical, indicate a record pipeline in Q2, no competitive threats, and are just (I bolded that on purpose!) affected by the macro environment:
Remo Canessa, CFO Zscaler:
we’re in a position now that the macro environment is not favorable, but it will turn, it will turn.
I will finish my thoughts and decisions for this quarter after Sentinel one will report on Dec 6th. Based on all the information I have, I might adjust the allocation.
But for now, I plan to do the same, as I did with Crowdstrike: Nothing.
Bill
What they do: Simplifies, digitizes, and automates complex back-office financial operations
Confidence tier: Contender
Type of revenue: Transaction- and Subscription-based
Trend to profitability: Yes
Cash: $2.6b
Revenue: $229.9M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 156.1% | 189.5% | 179.4% | 155.8% |
| 2023 | 94.3% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 51.2% | 32.2% | 6.7% | 20.0% |
| 2023 | 14.8% |
Revenue (core): $214.6M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 168.3% | 197.1% | 182.3% | 151.3% |
| 2023 | 82.6% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 51.6% | 32.3% | 6.4% | 17.7% |
| 2023 | 10.2% |
Revenue (standalone): $125.6M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 71.0% | |||
| 2023 | 61.6% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 15.6% | 25.0% | 5.1% | 12.5% |
| 2023 | 9.3% |
Customers Bill (standalone): 172,000
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 22.4% | 23.6% | 26.8% | 30.2% |
| 2023 | 35.6% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | 4.6% | 6.5% | 8.6% | 7.6% |
| 2023 | 9.0% |
Revenue per Transaction (standalone): $7.06
| 2021 | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2022 | $4.97 | $5.79 | $6.20 | $6.54 |
| 2023 | $7.06 |
Dollar-based Net Retention Rate: 131 %
| DBNRR | Q4 |
|---|---|
| 2021 | 124% |
| 2022 | 131% |
My thoughts:
Bill is a financial automation software for small and midsize businesses. And it’s one of the harder ones to understand in my portfolio. They acquired Divvy in 2021 and Q4 2021 was the first quarter they included divvy numbers, which is the reason for the jump in revenues in 2021.
Highlights
- Signed a definitive agreement to acquire Finmark, financial planning, and cash flow
an insights software company. - Added Google Cloud Chief Marketing Officer, Alison Wagonfeld, to our board of
directors. - Total revenue was $229.9 million, an increase of 94% year-over-year and 14.8 % quarter-over-quarter.
- Added 14,200 customers to bill standalone, an increase of 9 % quarter-over-quarter, the highest sequential increase to date. My personal highlight for the quarter.
- Dollar-based Net Retention Rate is only reported in Q4, but I assume it to be at similar levels around 131 %.
- Revenue per Transaction was $7.06, an increase of 8 % quarter-over-quarter, faster than the previous quarter at 5.5 %. Good, that tells us that customers continue to use their platform. They leverage it to run their financial operations even if they’re spending less in terms of overall operating expenses in TPV through the platform.
- Gross Margin was 85.8 %, up from 83.6 % in the same quarter a year ago.
- The first quarter of non-GAAP profitability
- Operating Income was $9.1; or 4 % of revenues, their highest ever.
- Net income was $16.9M or 7.4 % of revenues, their highest ever.
- Operating Cash Flow was $18.15 or 7.9 % of revenues, up from -$21.13 in the same quarter a year ago.
- Free Cash Flow was $12.01M or 5.2 % of revenues, up from -$25.48M in the same quarter a year ago.
- EPS $0.14 cents, their best EPS to date.
- 12-month payback period, which is good to see. Usually, you want SaaS businesses with payback periods < 12 months.
Room for improvement
- Bill’s standalone revenue was $125.6M, an increase of 9.3 % quarter-over-quarter, slower than the previous quarter at 12.5 %.
- Divvy revenue was $86.8M, an increase of 8.6 % quarter-over-quarter, slower than the previous quarter at 26 %.
- The remaining performance obligations were $143.1M, a decrease of -6.3 % year-over-year.
Most of the analysts congratulated them for great results and the immediate after-hours action indicated happy investors. But during the call, the stock price went down. This could have been due to their comments around softness on TPV.
The market might be spooked by their comments around “softness” due to macro driving potentially down TPV throughout the fiscal year. Since Transaction revenue is 68% of total revenue and driven by TPV, it is a valid concern:
*During Q1, Bill stand-alone TPV per customer, excluding the FI channel, declined by 3% sequentially. In Q4, we saw mid-market businesses beginning to moderate their spending, and that trend is now visible with our micro and SMB customers as well. These trends are reflected in our outlook, which I will discuss later.
(…)
We anticipate the trends we’ve observed with businesses moderating their spend will continue throughout fiscal 2023. And we expect that this will translate into lower year-over-year payment volume growth in the quarters ahead.
(…)
****We are expecting some of the trends that we’ve observed over the last, call it, 4 months or so of moderating spend from customers ex FI channel to continue. What that means for us is really lower growth going forward is our current expectation. We factored that into our outlook for the year. (…) We’ve assumed some of the trends that we’ve seen recently are going to continue.
(…)
We have generally seen businesses, all businesses moderate their spend in this economy. And so what you see in Divvy is that it is just growing much faster, it’s a smaller base to start with – and so we’ve continued to have strong growth in TPV year-over-year there. But we do see, I would say, softer spend across all of our customers.
(…)
****we’re seeing some softness across most of the customer segments now. It still appears to be concentrated in some of the discretionary spend categories. (…) So things like advertising spend would be a good example. We looked at a lot of the top advertisers that small businesses – or advertising channels that small businesses use to drive customer acquisition and other things.
So we looked on a vendor-specific basis and found that across really the whole segment, spend is down. And that’s something that is consistent with other data points that we’ve looked at externally. And so I think it just says that our small business customers across the size range are reacting to the external environment and being a bit more cautious about their operating expenses, and we’re seeing that across the spend habits of our customers.*
Still, they remain very bullish:
At the same time, in this environment, the value proposition of our platform is resonating more than ever with SMBs, and we have seen strong engagement from existing customers continued high retention and healthy new customer demand.
(…)
So what this tells us is that people are pulling back the spend, but they are actively engaged in using the product and the platform and really managing their business.
(…)
Customers can’t choose not to do this. The digital transformation wave is happening.
In an inflationary world choosing our platform acts as a deflationary force.
→ Well said by it’s CEO and founder Rene Lacerte. Bill saves businesses time and money.
Additionally, having so many of our vendors on the Bill network helps us reduce payment transit time and gain more control of our cash flow.
→ And I like Bill having a network effect. The more vendors are using Bill, the more other businesses will use it.
My investment decision
I believe this was a strong report. The market might lack confidence due to Bill’s uncertainty on macro effects going forward. Still, we should expect headwinds for all of our companies. I don’t see an isolated (execution) issue with Bill. And I added it after the report.
The Trade Desk
What they do: Provides a platform for Ad Buyers (Agencies, Brands, and other technology companies)
Confidence tier: Bench
Type of revenue: Long-term master service level agreements (similar to recurring)
Trend to profitability: Yes
Cash: $1.3B
Revenue: $395M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 36.8% | 100.9% | 39.3% | 23.7% |
| 2022 | 43.5% | 34.6% | 31.2% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | -31.3% | 27.4% | 7.5% | 31.4% |
| 2022 | -20.3% | 19.5% | 4.8% |
Non-GAAP Net Income: $128.59M
| % Revenue | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 31.8% | 31.5% | 29.6% | 52.6% |
| 2022 | 49.5% | 11.8% | 44.1% |
Operating Cash Flow: $137.30M
| OCF Margin | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 34.2% | 3.7% | 43.1% | 41.3% |
| 2022 | 46.4% | 24.3% | 34.8% |
My thoughts:
- Revenue came in at $395M, an increase of 31% year-over-year.
- Certainly, it gets into a territory I don’t like. Still, also TTD has to take its toll in the current environment. Plus they are growing at more than 3x than the total ad market, as mentioned by Green on the earnings call - while others like Pubmatic are tumbling. So, we have a category leader here and I expect them to do very well. But I would like to have them keep growth above 30%.
- Profitability continues to be the strongest aspect with:
- $163M adjusted EBITDA, 33% of revenue, up from $123M a year ago and a strong guide of $229M.
- $137M operating cash flow, 35% of revenue, up from $130M a year ago.
- $112M free cash flow, 28% of revenue.
- $1.3B cash and no debt.
- Strong Customer Retention: Customer retention remained over 95% during the third quarter, as it has for the past eight consecutive years.
- Procter & Gamble, one of the world’s largest advertisers, announced its support and adoption of UID2.
- Industry Recognition:
- Customers’ Choice for Ad Tech on Gartner® Peer Insights™
- BIG Innovation Award for Technology Product (Solimar)
- Sales and Marketing Technology Awards: Product of the Year for User Optimization Experience
- Crain’s 100 Best Places to Work in NYC 2022 (9th consecutive year)
- Stevie Awards for Great Employers - Employer of the Year, Computer Software
- Stevie Awards for Customer Service Success - Silver, Technology Industries
- Forbes Global 2000
- Samantha Jacobson, Chief Strategy Officer, named to AdAge 40 under 40
- Key growth drivers: CTV, shopper marketing spend, political midterm elections
- Revenue split: US: 90% of spend, International: 10% of spend
- Channels:
- Connected TV: 40 %, now their fastest-growing segment
- Mobile: 30 %
- Audio: 5 %
- Display: 10+ %
As usual, they sounded very confident in their earnings call:
I believe that through the first 9 months of the year, we have gained more market share, grabbed more land than at any point in our history.
CTV spending grew in the majority of our international markets faster than it did in the United States.
Disney+ platform in December and they are incredibly progressive in how they are enabling advertisers to leverage their own first-party data via UID2.
I do think it’s worth noting again that in an environment where many of our competitors have contracted or grown in the single-digit range, we grew 31%.
we’ve got Disney+ and Netflix, they get a lot of the word count in the ecosystem right now. But let’s not forget, HBO Max, Paramount NBCU, Fox, the rest of Disney, Hulu, ESPN, ABC, etcetera are continuing to lean into programmatic.
So UID2, through our partnership with Disney, I think, is going to be a major catalyst for the CTV category.
My investment decision
The Trade Desk is a story stock. Jeff Green is great at selling it to investors. Some of their “marketing” statements like "The Trade Desk is an investment in the whole internet” in their presentations sound desperate and weak. Also, why do they never disclose some information, like: How fast is CTV growing? Growth is becoming borderline low for my taste, which I will watch closely in the upcoming quarters.
But I have to admit, the TAM is very large ($816b vs $175b traditional linear TV), and mid-term elections, connected TV tailwinds, and the opening of Netflix should support a reacceleration of revenue. They don’t own content, so they can partner with anyone. Ad dollars spent per thousand impressions (CPM) is double as high as on linear TV since programmatic targeting is better on connected devices. And they are very profitable.
Still, I am following the numbers: They tell a different story as of now. Because of that, I have no plans of increasing my position but I feel comfortable with its current size.
Monday
What they do: Provides collaboration software based on low-code and no-code building blocks
Confidence tier: Bench
Type of revenue: Subscription-based (seats)
Trend to profitability: Yes
Cash: $853M
Revenue: $136.9M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 84.7% | 93.7% | 94.9% | 90.5% |
| 2022 | 84.0% | 75.2% | 64.9% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 17.6% | 19.7% | 17.6% | 15.1% |
| 2022 | 13.6% | 14.0% | 10.7% |
Free Cash Flow: $13.96M
| FCF margin | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | -2.7% | -2.1% | 3.5% | 10.6% |
| 2022 | -14.9% | -15.6% | 10.2% |
Customers $50k+: 1,323
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 219.0% | 226.4% | 231.4% | 200.4% |
| 2022 | 186.6% | 146.8% | 115.8% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 26.9% | 40.3% | 30.4% | 29.4% |
| 2022 | 21.1% | 20.8% | 14.1% |
Dollar-based net retention rate 10+ customers: 135+ %
| DBNRR | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 121% | 125% | 130%+ | 135+% |
| 2022 | 135+% | 135+% | 135+% |
My thoughts:
-
Third quarter revenue of $136.9 million grew 65% year over year (68% FX-adjusted), slowing from 75 % in Q2, and will continue to slow to approximately 56 % in Q4. → Macro.
-
QoQ slowdown from 14 % in Q2 to 10.7 % in Q3 (and will continue to slow in Q4 at approximately 8.7 %) → Macro. Here’s hoping it will stabilize. Watching this closely.
-
Expecting them to come in at $148.8M revenue (8.7% QoQ) in Q4.
-
FCF positive at $13.96M - their highest ever, improved from $2.87M in 3Q21.
-
Operating cash flow at $20.03M - their highest ever, improved from $3.79M in 3Q21.
-
Non-GAAP net income at $2.58M - a first-time positive, improved from -$11.37M in 3Q21.
-
They have achieved most of their profitability by reducing S&M from 70% of revenues to 60% of revenues compared to last quarter. At the same time, they rented more office spaces.
- I am a friend of the home office and see the money better invested in S&M than in office space. Office spaces will not generate customers, sales and marketing will. On the flip side, office spaces might make employees happier. And happy employees generate more revenue. Which is what we want, right? This is why I personally don’t judge this move and let the management make me show their - hopefully - strong numbers in a few quarters.
- Gross Margin improved slightly to a very strong 88.9
- $853M cash gives them plenty of runways.
-
Dollar-based Net Retention Rate for all customers declined to 120+ % from 125+ % in Q2, likely due to large customers (>$50K) pulling back spending since DBNRR for that cohort declined to 145+ % from 150+ % in Q2. For Customer 10 + it was stable at 135+ % - and I believe this is the main DBNRR metric we should look at.
-
Large customers $50K+ came in at 163 compared to 200 in Q2 and 143 in Q3 2021. That’s a slowdown when looking at quarter-over-quarter at 14.1 % from 20.8 %in Q3. → Macro. Still, they doubled the large number of customers when looking at year-over-year (+116 %).
-
10+ users: 76% of ARR (up from 70% 3Q21), 50k+ customers: 26% of ARR (up from 18% 3Q21)
-
3000+ customers adopted one new work OS product 5 months after the launch
While I would have liked to see stronger growth, the slowdown is likely due to the macro environment.
A year ago, Monday was growing 18-20% sequentially.
Let’s compare that to other companies:
- DataDog was growing from 16% to 21% sequentially. Now: 7.6%
- Cloudflare was growing from 10% to 13% sequentially. Now: 8.3%
Should we sell them? I will not.
Will I add to MDAY? Unlikely, as I see stronger alternatives.
Yes, Cloudflare and DataDog generate more revenue in absolute numbers. But I have a hard time selling out a company that just became profitable while still growing 50% YoY.
Additionally, there is Monday’s subscription model. From Cloudflare’s last earnings call:
I think that if you are a usage-based, a purely usage-based model, it is a place where people are looking for areas to save money. Similarly, if you are a seat-based model, as you’re seeing some companies do layoffs or, at a minimum, not expand their seats, that is something that is challenging in the current environment. I think we are fortunate that today, most of our revenue is not usage-based and not seat-based.
Monday’s subscription model is seat-based and therefore more fragile in this environment. That doesn’t mean, there is an issue with the business itself. I don’t believe so. But I have to admit, there are better, less fragile, mission-critical companies.
On Monday’s marketing:
You can find my thoughts on Monday’s marketing here.
My investment decision
As I already have trimmed the position before earnings, I decided to hold the rest for now since I don’t see many issues. Yes, their revenue is slowing down sharply at only $137M which is way lower than my other companies. But it’s still growing at 65 % and is likely to stay above 50 %.
From my perspective, this is driven by macro and is not a company-specific execution issue. Since Monday’s subscription model is seat-based, they are more prone to suffer immediately. Companies are less likely to expand seats or even cancel them due to layoffs. At the same time they just became profitable, and still have a strong DBNRR of 135 %+ (!) while growing above 50 %.
I might change my mind at any time based on available information, but this is how I see it.
ZoomInfo
What they do: Provides tools for Sales & Marketing teams to find and generate more customers
Confidence tier: - (Sold)
Type of revenue: Subscription-based (seats)
Trend to profitability: Yes
Cash: $445M
Revenue: $287.6M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 50.0% | 56.9% | 60.1% | 59.1% |
| 2022 | 57.7% | 53.5% | 45.5% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 9.7% | 13.5% | 13.6% | 12.5% |
| 2022 | 8.7% | 10.5% | 7.7% |
Free Cash Flow: $99.8m
| FCF margin | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 63.6% | 52.8% | 37.1% | 38.0% |
| 2022 | 52.1% | 40.5% | 34.7% |
Customers $100k+: 1,848
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 50.8% | 69.2% | 73.6% | 70.8% |
| 2022 | 70.8% | 60.3% | 47.8% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 11.8% | 15.8% | 13.6% | 16.2% |
| 2022 | 11.8% | 8.6% | 4.8% |
Dollar-based net retention rate:
| DBNRR | Q4 |
|---|---|
| 2021 | 116% |
| 2022 | ? |
My thoughts:
Highlights
- Operating income improved to $118.40 from $78.40 Year-over-Year.
- Net income improved to $96.80 from $50.70 Year-over-Year.
- Free Cashflow improved to $99.80 from $73.30 Year-over-Year.
- Free Cashflow margin keeps decreasing from an average of 48% in the past 3 years to 34.7%, which is still excellent.
- They raised guidance by just 0.5 % from $1.09b to $1.096b - which is negligible.
Room for improvement
- They generated $287.6M in revenue, which is 45.5 % Year-over-Year. That is only 7.7 % Quarter-over-Quarter growth. They beat by just 3% while they usually beat by ~6 %.
- They guided to $300M in Q4 which translates to $309.25M if they beat by 3% which will be again only 7.5% Quarter-over-Quarter.
- Customers $100k+ growth slowed to 48% Year-over-Year from 60% Year-over-Year the previous quarter and slowed also to just 4.8% Quarter-over-Quarter.
- They decreased guidance for Free Cashflow by -2 % from $446m to $435m.
- Low Dollar-based Net Retention Rate is going to retract, which is already relatively weak at 116 % when comparing it to other companies.
- Remaining Performance Obligations are slowing:
Snippets from their earnings call:
While this was consistent with seasonal patterns, we are adjusting our cash flow expectations in the short term to reflect the potential for more flexibility in payment terms related to a worsening macro environment.
(…)
Deals taking longer just means more meetings, more reviews with leadership more calls and e-mails to drive the same outcome that we were getting historically. And so while our gross retention has stayed largely the same, our upsell motion has seen those more macro headwinds.
(…)
But ultimately, the macroeconomic situation creates sales elongation, sales elongation creates more time spent by our sellers. And ultimately, that’s a capacity drag. And so we’re trying to make sure that we’re making the right decisions from an organization perspective to make sure that we’re relieving as much of that drag as possible.
→ Similar to other companies, they are affected by the macro environment.
*(…) as we made our way through Q3, we began to see increased macro pressure on deals, causing the level of deal review to increase and sales cycles to elongate further.
Since this started very late in the quarter, it only modestly impacted Q3 results. This elongation trend has continued into Q4, and we do expect it to impact growth in the short term.*
→ If Q3 is only modestly impacted, it will only become worse.
As a result of the more challenging environment, we now expect dollar-based net retention in 2022 to retrace the gains that we were able to achieve in 2021. In short, we are taking a prudent view of the near-term growth expectations for Q4 and 2023 until we see more definitive signs that the economic environment is improving. That said, we are still raising our guidance for the year and are confident in the value proposition that we deliver to our customers.
→ The net retention rate will worsen due to fewer seats per customer sold. Nice to see a rise in their guidance but the amount is negligible.
One of the things that we’re seeing in this macroeconomic environment is that there are industries and companies that are much more immune to the macro changes. You see that in insurance, you see it in financial services. You see it in banking and transportation and logistics.
→ Interesting insight about industries like Insurance, Financial Services, Banking, Transporation, and Logistics being immune to the macro changes. Wondering if Bill fits into the Financial Services industry.
So we still have customers that are renewing, and we have seen an acceleration in terms of functionality upsells. Where we’re seeing more pressure is with respect to the seat expansions and data expansions that we had seen historically. That’s the area where we feel our team isn’t able to go after as much of the upsell opportunity given the incremental time that they’re spending on renewals and deals in general.
→ This might affect other companies which have a seat-based model as well. Monday?
All deals, including straight renewals, are requiring more effort to reach an outcome, which stretches our sales team and capacity.
→ If ZoomInfo would be mission-critical, why do they have trouble with renewals?
My investment decision
Overall they sound confident in their business but expect macro headwinds in the near term primarily due to pressure in Europe and larger deals. There is no area of specific concentration but there are industries that are largely immune to this such as transportation, logistics, media, insurance, and financial services.
Deals are getting done by C Level (CFO) instead of VP Level. That drags time out which means less time to go for up- and cross-sell opportunities for sales reps and “elongates” deal cycles.
It might be unjustified, but I never lost this “fishy” feeling with ZoomInfo. This is based on how they are aggregating data from everywhere, how privacy might become another headwind going forward and other data providers like LinkedIn could block them from crawling data.
I brought ZoomInfo into the company I work at and Sales like to. Still, ZoomInfo was never able to address all privacy concerns properly. That’s why I never owned a big position.
Still, I have to acknowledge their very strong profitability when looking at a 34.7 % Free Cash Flow Margin and 33.7 % Net Income Margin.
But to keep ZI, they would have to deliver excellent results and grow at similar rates as i.e. DataDog does (>60%; oh, and DataDog generates 50% more revenue in absolute numbers) - but they were far from that this quarter. Which is why I sold my 4% position after earnings.
That said, Bert Hochfeld remains bullish on ZoomInfo. Over the course of the next 12 months, he expects the shares to generate positive alpha.
Upstart
What they do: AI ending platform that makes automated credit decisions and identifies risk more accurately and approves more applicants than traditional, credit-score-based lending models
Confidence tier: - (Sold)
Cash: $830M
Revenue: $157M
| YoY | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 90% | 1018% | 250% | 252% |
| 2022 | 156% | 18% | -31% |
| QoQ | Q1 | Q2 | Q3 | Q4 |
|---|---|---|---|---|
| 2021 | 40% | 60% | 18% | 33% |
| 2022 | 2% | -26% | -31% |
My thoughts:
Let’s keep the numbers part short: -34% revenue growth, profitability moving in the wrong direction. And they didn’t reduce the loans on their own balance sheet… It’s all bad.
Hopefully, Upstart was my last “half-assed” (as Stocknovice likes to say) investment. I held it by telling myself “to keep it on my radar”.
Let’s be honest: Those “keeping on the radar” positions are nothing but distractions. If you want to start a position, that’s fine. But don’t keep tiny positions on your radar, because you want to keep your skin in the game for irrational reasons.
Now I am sitting here wasting time, thinking and writing about a position that is not worth holding anymore (as a concentrated hyper-growth investor) for quite a while already!
That said, I still believe Upstart will do well over the next decade. I still believe in their business model and their advantage of being ahead of their competition. I even believe the current environment will speed up the learning for their algorithm.
They have a high chance of surviving this since they have $830M in cash and they don’t need to raise any additional capital.
To me, it’s a question of: When is macro improving? Below you will find some comforting statements by the management to back that up.
So, if you are investing in an ETF or a portfolio with 50+ positions: Keep that 1% position.
But for me, it’s against my rules:
- Low, negative revenue growth
- Worsening profitability metrics
- Cyclical business
- Too complicated
Because of that, I sold my 1% to keep it on my radar position. And perhaps I shouldn’t have invested in this company in the first place.
Quotes from their earnings call
But I want to be clear, contraction in lending volume in a time of rising rates and elevated consumer risk is a feature of our platform, not a bug. In fact, it’s required in order to generate the returns lenders and investors expect. Whether due to an increase in expected loss rates, caution on the part of lenders, or higher yield demanded by credit investors, higher interest rates and reduced volumes mean that as unhappy as we are with the numbers, the system is working as intended.
While we don’t make predictions about the future, we’ve chosen to take a conservative position with respect to the direction of the economy in the coming quarters. In other words, we assume the worst is in front of us. We’ll be pleasantly surprised if this turns out not to be the case.
In recognition of the reduction in loan volume in our platform, we, unfortunately, eliminated approximately 140 hourly positions within our loan operations team, representing about 7% of our workforce.
While we dislike a weakened economy as much as you do, the increase in default rates that accompany this weakness serves to train our AI models faster. While other platforms continue to retreat to serving super-prime consumers, Upstart is rapidly learning how to price and serve mainstream Americans in all market conditions.
Third, automation. In the third quarter, we saw a record 75% of loans fully automated. This came from a variety of efforts, including an experiment to help applicants enter information more accurately that led to an absolute 1.8% lift in instant approvals.
Finally, while there’s no shortage of caution among banks and credit unions, I’m also happy to report that we deployed a record 17 new lenders onto our platform in Q3, including Alliant Credit Union, which is a top 10 credit union by asset size. This compares to 17 lenders launched in all of 2021. While these lenders are starting up cautiously, it’s encouraging that we’re planting seeds for funding capacity in our future. As of today, we have 83 lenders under contract on the Upstart platform.
We continue to be in a favorable liquidity position with $830 million of total cash and $431 million in net loan equity on our balance sheet.
And when I think we’re in a more normalized environment, we will very quickly see the benefit of things. Just by way of example, we have the highest-ever rate of automated loans, 75% of the loans on our platform in Q3 had no human intervention in them, and that’s a record high for us.
So our first goal is, of course, to retain solvency in the sort of solid footing the company is on. We have a large cash balance. We have relatively low fixed costs, and that’s really helped us all through our existence. But – so we don’t have any fear other than, look, the thing we want to keep doing, and thus far, we’re able to do so, is investing in the products.
Certainly, there are scenarios we could imagine that is so bad that we would have to cut back investment or pause products, et cetera. But we don’t see that today. I think today, we have enough volume and enough contribution margin to keep optimistically investing for the future, and that’s what we would hope.
Arvind Ramnani
Right. And as you think of your kind of, I would say, kind of existing cash burn and sort of projected cash burn in which country you’re making adjustments with – just on some of your expense line, when do you think you may need to go sort of raise kind of additional capital, whether in the form of equity or debt?
Dave Girouard
We don’t see any need to do that, Arvind. And honestly, our cash burn today is quite small even in the very constricted position we’re in. I mean, I think our volumes are pretty dramatically lower than they were, yet our cash burn is fairly minimal. So we don’t see a scenario where we have to raise cash. As Sanjay said, we have over $800 million in cash as well as loan assets on the balance sheet. So that’s just not something we anticipate at this time.
Sanjay Datta
I was just going to maybe put some quick back-of-the-envelope numbers to that. Our cash sort of fixed expense burn across payroll and OpEx every month is about $30 million. And even at zero origination scenario, we’re getting a servicing stream of revenue that’s about $15 million. So there’s sort of – maybe the sort of $15 million delta every month that we have to rely on contribution margin for to cover. So that’s sort of like on a downside scenario where the gap might be. And as you saw, we’ve got about $800 million in total cash on the balance sheet. So as Dave said, that can take us for quite some runway.
My investment decision
Bye Upstart,
wish you well.