WSM’s portfolio 1 July 2022

Investment Analysis Clubs Saul’s Investing Discussions
1

It’s been more than a month since my last confession :wink:

And like most in these parts, I have not had a sudden and fantastic change of fortune - I’m still down pretty much as much as I was last month. However that does count for progress: I’m not down (much) more than I was last month!

Below is my performance for the year. I’m down marginally vs last month.

2022 YTD RESULTS PER MONTH


Jan	 -27.1%
Feb	 -23.9%
Mar	 -33.8%
Apr	 -43.4%
May	 -59.0%
Jun	 -59.6%

POSITION SIZES

Below is the composition of my portfolio on 1 July, with the percentage end May in brackets.


**Datadog			25.7% (27.1%)**
**Crowdstrike		18.9% (16.0%)**
**Cloudflare		17.9% (4.4%)**
**Snowflake		14.5% (9.6%)**
**MongoDB			11.8% (-)**
**SentinelOne		9.8% (20.2%)**
**Cash			1.3% (12.6%)**

**Zscaler			- (10.2%)**

JUNE REVIEW

In June I sold out of Zscaler and reduced my SentinelOne position. I used the proceeds and my cash position to take a position in MongoDB and increased my positions in Cloudflare and Snowflake so that I was fully invested. I will limit my discussions to only SentinelOne and Zscaler as that is where I made big changes, and point to good summaries of my other portfolio holdings - where others have already said it better - at the end of the write-up.

SENTINELONE reported results on 1 June and the call confused me at the time.

I initially found the performance to have slipped and guidance unclear. I worried about the yoy comparison, especially relating to customer and revenue growth and cash flow. Customer growth, on the face of it, slowed (https://discussion.fool.com/jon-this-is-an-excellent-point-and-t…). That was poor thinking on my part though, as the prior year customer numbers included an acquisition, and excluding that one-time customer bump, their organic customer growth was actually a record. Same goes for revenue growth. Lastly, there were grumbles about guidance. So I asked (and got!) Saul’s view (https://discussion.fool.com/hi-saul-i-believe-this-forum-thrives…). After thinking this through a bit, I changed my view and kept my position fairly large.

So let’s take the issues one at a time:

Customer growth

This one is the easiest. They added 800 customers in the year ago quarter and “only” 750 in this quarter. But the year ago quarter included the customers acquired from Scalyr. I couldn’t find the exact number of customers acquired in any of their disclosures, presumably because it happenend before the IPO. However I did find that Scalyr had 140 customers around Nov 2017 (https://techcrunch.com/2017/11/20/scalyr-scores-20m-series-a…) and 175 about half a year later (https://www.businesswire.com/news/home/20180320005434/en/Sca…) so, lets say they continued acquiring customers at this pace (±70 per year), they would have been around 350 customers when they got acquired. Let’s allow for, say 100 shared customers, that would put the “bump” in customers in Q1 2021 at around 250. It could be a bit more, or less, of course.

Assuming all of these back of the matchbox calcs are ok, then the organic adds for S in Q1 FY2022 would be around 550 (800-250). And in Q1 of Fy2023 is was 750.

A new record.

Revenue growth

Turning to revenue now and doing the same: adjusting for Scalyr as if it didn’t happen to try to get to “organic” revenue growth. I stripped out Scalyr completely from the last 5 q’s. They gave us two data points (in Q2 Q&A): the acquired ARR from Scalyr in Q1 was $9m and in Q2 that had grown to $10m. And they told us that since acquisition to end July (their Q2 - so for Q1 and Q2) the revenue included in their results from Scalyr was $5m. I therefore pulled the ARR forward at the same clip of +$1m per quarter. Since acq date was 6 Feb, I assumed 1/4 of the ARR in each period as Scalyr reveneue - allocating the ARR ratably to revenue. By my calcs the Q1 and Q2 revenue together is $4.8m, so a close a dammit to the $5m they gave us. Excluding Scalyr then for all of the past 5 q’s using this methodology, the adjusted revenue numbers look like this:


**Reva$m	Q1	Q2	Q3	Q4**
2020			12.1	15.3
2021	17.9	20.7	24.6	29.9
2022	35.1	43.3	53.3	62.6
2023	75.1			

**QoQ	Q1	Q2	Q3	Q4**
2020				26.4%
2021	17.0%	15.6%	18.8%	21.5%
2022	17.2%	23.5%	23.0%	17.6%
2023	**19.9%**			

YoY	Q1	Q2	Q3	Q4
2020				
2021			103%	95%
2022	96%	109%	116%	109%
2022	**114%**

Looked at in this way, their latest Q1 was their best qoq performance in the last 3 yrs, and revenue growth pretty awesome for a q1. It also shows that Q1 has been relatively seasonally weak historically.

That should put any concerns about organic revenue growth to bed. It looks to me like underlying organic trends and momentum are strong, with both Scalyr and now Attivo adding some further juice.

FCF

Moving to the next “orange flag”. If one digs a bit into cash flow, it is quite obvious what caused the seemingly big FCF decline, which as far as I’m concerned, makes it a non-issue.

Basically it stems mainly from them accruing (and not paying) a big and increasing chunk of payroll-related expenses from Q1 on until Q4 last year (“Accrued Payroll Benefits” under current liabilities in the b/s), thereby boosting FCF relative to operating profits in each of the 4 Q’s of last year, with the biggest boost, of $21.7m happening in Q4. They then actually paid these already incurred expenses, and then some, in Q1 of this year, leading to a big decrease in FCF - a $21.5m negative impact:


**Acr$m	Q1	Q2	Q3	Q4**
2021				20.1
2022	21.4	26.6	39.5	61.2
2023	39.7

The delta between these amounts impacts FCF (because you actually paid or did not pay the expense which you have accrued), as follows:


**imp$m	Q1	Q2	Q3	Q4**
2022	1.3	5.2	12.9	**21.7**
2023	**-21.5**

That leads me to conclude the the huge FCF “improvement” of last year as well as the huge FCF “retracement” this last Q was artificial relative to operating margins. It was simply a timing effect of when they actually paid payroll benefits which they accrued throughout the year.

I can live with this: they accrued for payroll benefits earned throughout the year, but did not pay it until after the financial year-end. Nothing to see here.

Margins

Despite operating margin of -73% in Q1, a guide for Q2 of -74% and an indication of 1-2% of the Attivo pricetag (so $6m-$12m additional costs) to be spent on integration, they are maintaining their full-year operating margin guide at -57.5% (mid-point), which implies a fairly bullish view on Q3 and 4 margin progression. So the operating margin improvement trajectory is firmly in tact as Q1 is seasonally the quarter in which they typically slip back from their Q4 operating margins due to it being a seasonally weak quarter.

Guidance

Full-year organic revenue guidance was raised from 80% to mid 80% - so call it a 5%pt organic guide increase, say from $370m to $380 for the full year. On top of this they expect around $30m contribution from Attivo, of which about $8m will be in Q1 raising from $370 to $407 at the high end.

They guided for Q2 revenue of $96m total revenue - or 107% growth, but which includes $8m from Attivo, so organic revenue of $88, which is good for about 92% yoy.

In summary

I don’t know of any SaaS company (or elsewhere for that matter - perhaps someone can weigh in if they know of one? Would be a good challenge for anyone on the fence :-), which combines the following:

  1. has some scale: run-rate revenue > $300m pa
  2. gross margins above 65% with an improving trend and guide
  3. guiding for organic next Q revenue growth above 90% (and total revenue growth above 100%.)
  4. guiding for full-year revenue growth of ±100%
  5. NRR above 130%
  6. operating margins improved by >30%pts yoy
  7. guiding for operating margins improving a further ±30%pts in the coming year
  8. In a market with big tailwinds and which is expected to see limited pullback of spend in the expected coming economic recession

And not to get into a debate on whether it’s warranted or not, but just to point out: S is trading at a revenue multiple of slightly less than CRWD, NET, ZS. So if multiples remain roughly where they are (I.e. the big re-rating is behind us), will outperform these names due to the superior revenue growth.

ZSCALER reported disappointing earnings in my book, and I exited. Seems that others did the same, for different reasons. Here is my main reason:

Billings decelerated a lot.

And not only for one quarter; this is not a one quarter billings blip. This is the second quarter of decelerating billings growth. Last quarter this was the main orange flag I saw in an otherwise very solid set of numbers - and I did not sell, but this quarter the trend got worse - and I did:


**Bill	Q1	Q2	Q3	Q4**
2019	65	115	85	126
2020	88	135	131	195
2021	145	232	225	332
2022	248	368	346

**YoY	Q1	Q2	Q3	Q4**
2019	35%	17%	54%	55%
2020	64%	72%	72%	70%
2021	71%	58%	54%

So while the last 3 quarters of revenue growth has tracked above 60%, billings growth has now been in the 50-s for two consecutive quarters.

And my expectation, based on what they’ve done in the last 3 years (a 48% qoq billings increase) is that billings growth will again hit mid/low fifties yoy next quarter.

Because billings drive revenue (I pointed out in this post that billings almost perfectly predict revenue coming down the line: https://discussion.fool.com/zscaler8217s-remarkable-predictabili…), it is inevitable that revenue growth will drop below 60% in the next couple of quarters, imho.

So by my calcs, at least, Zscaler is in for a fairly rapid revenue deceleration in the quarters ahead. Hence, I’m out.

I took a position in MONGODB on the back of their continuing success with their cloud-based Atlas offering, accelerating revenue growth, the superiority of their solution and the tailwind of cloud-migration of apps.

Mekong summarised the thesis and Q1 results for MDB nicely here: https://discussion.fool.com/mongodb-mdb-q123-results-35122038.as…

Lastly, for more detail about what the other companies in my portfolio were up to, I recommend Stocknovice’s write-up, here: https://discussion.fool.com/stocknovice39s-june-portfolio-review…

FINISHING UP

It feels to me like we may have bottomed for our stocks this past month. But hey, what do I know, right? I thought the same three months ago.

  • WSM

Previous reviews:

May 2022: https://discussion.fool.com/wsm8217s-portfolio-30-may-2022-35121…
Apr 2022: https://discussion.fool.com/wsm39s-portfolio-review-april-2022-3…
Mar 2022: https://discussion.fool.com/wsm8217s-portfolio-review-end-march-…
Jan 2022:https://discussion.fool.com/wsm8217s-portfolio-31-jan-2022-35041…

Dec 2021 full-year: https://discussion.fool.com/wsm8217s-year-end-portfolio-dec-2022…
Dec 2020 full-year: https://discussion.fool.com/Message.asp?mid=34710356

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Hi wsm007, I wanted to thank you for the illuminating and well documented summary for SentinelOne. I was both quite impressed and very appreciative. Nice job, and a big thanks.
Saul

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That leads me to conclude the the huge FCF “improvement” of last year as well as the huge FCF “retracement” this last Q was artificial relative to operating margins. It was simply a timing effect of when they actually paid payroll benefits which they accrued throughout the year.

I can live with this: they accrued for payroll benefits earned throughout the year, but did not pay it until after the financial year-end. Nothing to see here.

Hi WSM,
thank you for great articulation of S customer and revenue growth relative to acquisitions.

However, I am not sure why you look at just one piece of FCF and trying to say “nothing to see here”.
For the year (not quarter) ending Jan 31, 2022, their operating cash flow was -$95.6M… add another capex of $3.6M and you had almost $100M of cash burn. For a revenue of $205M for the year that was real cash burn. If one likes to be a little more careful, one needs to add the fact that they added $66M ($115M at Jan 22 vs $49M at Jan 21) of deferred revenue for the year… which is really “borrowing cash from future revenue”… so actual operation burned $165M for revenue of $204M…

Yes, they have ~$1.6B in cash and equivalents, so there is no fear of running out of cash… and yes, as an investor, I much prefer that they burn cash to gain market share… however, I would not classify this as “nothing to see” situation… it is an early stage company that will have to show that they can grow at a high rate without burning sizable cash… until then it is a smaller position for me.

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However, I am not sure why you look at just one piece of FCF and trying to say “nothing to see here”.

I guess I should have been clearer. They are definitely burning cash, and a lot of it. And yes, I’m focusing on just one part of FCF and there are clearly other drivers too. But I’m focusing on that one piece - the accrual for payroll benefits - because I believe that one piece distorts the FCF picture over the last 5 quarters the most.

So what I was trying to say is that the trend in FCF over the last 5 quarters is misleading/irrelevant, and that the thing to watch is therefore operating margins.

The apparent improvement in FCF margins in the last year and the apparent sudden deterioration this quarter is simply due to timing of cash flows, not an underlying business trend. This is what FCF looks like at face value:


**FCF %	Q1	Q2	Q3	Q4**
2021		-70.0%	-80.5%	-85.6%
2022	-87.4%	-97.6%	-37.0%	-10.7%
2023	-69.9%

So one could look at that and say: wow what an unbelievable improvement in FCF margins over the course of F2022 and a terrible backslide (of almost 60%pts!!! gasp!) in Q1 of 2023. Something bad must be going on under the hood.

But that’s not the case. If the timing impact of the accrual is reversed out, then FCF% would have looked like this:


**aFCF%	Q1	Q2	Q3	Q4**
2022	-90.9%	-109.0%	-60.0%	-43.8%
2023	-42.4%

And that trend is in line with what’s been going on in operating margin land:


**Op %	Q1	Q2	Q3	Q4**
2022	-127%	-98%	-69%	-66%
2023	-73%

So I’m not arguing that they’re not burning (a lot) of cash. They are. All I’m saying is that the operating margin trend is the one to watch, and if you strip out the timing effect of their payroll accrual/payments, then the FCF% improvement trajectory is also apparent and matches the operating margin trajectory - both of which have been improving over the last several quarters. And given how quickly the margins are improving, I’m happy to have it as a solid position.

Hope that’s clearer.

-WSM

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Basically it stems mainly from them accruing (and not paying) a big and increasing chunk of payroll-related expenses from Q1 on until Q4 last year

Is it NOT odd to accrue these sorts of expenses rather than pay them at least quarterly? Investors don’t need extra math challenges in FCF calcs. The backing out of charges every “however many quarters” is nonsense.

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thanks WSM… agreed this is improving picture… but with large burn rate, I am keeping a small position.

BTW - agree with your concern ZS billings deceleration and optimism on MDB.
ZS has potential upside of government but as always, government takes time and we want to see it in numbers…

I was a bit surprised on MDB’s enterprise revenue strength… then when I look around, I find that Oracle, IBM and even Pure Storage has seen strength this year in enterprise… I guess back to office has enabled some catch up spending with on-prem infrastructure… hopefully MDB will see a couple of more quarters of dual strength (cloud and on-prem)… it is my largest position (followed by CRWD and DDOG)… and ofcourse many years of cloud (Atlas) strength

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