February 2021 Portfolio Review

Total Return: +1.8% YTD (+0.4% vs S&P)

Man, was it just me or was that a quick month?

I guess that’s what happens when an already condensed February gets cut to just 26 days since the final two fall over a weekend. Earnings season can always seem like a blur, and this month saw six of my 10 holdings report in a span of 21 days. It will be eight in 28 days after Zoom (March 1) and Okta (March 3) report early next week. I’ll get a small breather before DocuSign (March 11) and CrowdStrike (March 16) close things out. That’s a lot of new info to digest in a relatively short amount of time, but I can’t really complain about any of the results posted thus far. Here’s hoping that trend continues…

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2021 Results:

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February Portfolio and Results:

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2021 Monthly Allocations:

Key:

• darker green: started during month

• lighter green: added during month

• yellow: trimmed during month

• blue: bought and sold during month

• red: position exits

• positions >10% in bold

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Past recaps:

December 2018

December 2019 (contains links to all 2019 monthly reports)

December 2020 (contains links to all 2020 monthly reports)

January 2021

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Stock Comments:

Basically, it’s the same 10 with a twist. There is a popular saying you should have strong opinions loosely held. I believe that concept applies perfectly to portfolio management. All six firms reporting this month did enough to stick around, but the new info led to some changes in conviction and subsequent allocation tweaks. I’m content with where I am for now. ZM, OKTA, DOCU and CRWD will have their moment in the sun shortly.

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CRWD – This month’s first headline was CrowdStrike acquiring log management and observability company Humio for $400M. The deal is expected to close sometime this quarter. According to the release, this acquisition will let CRWD better leverage its data to provide actionable insights “at a speed and scale that no other vendor can match.” Given the sheer volume of data CrowdStrike is analyzing as its platform scales, adding technology to better manage this information makes perfect sense.

In thinking about this purchase, two observations come to mind. One, I find it interesting the “purchase price will be paid predominantly in cash.” This follows last month’s raise of $750M in interest-only notes which are not convertible into shares. In both cases management chose cash over shares to fund growth even with the stock in the neighborhood of all-time highs. That is definitely not standard operating procedure for most firms. I can’t help but wonder if this means management believes the stock is either fairly or even <gasp> undervalued. Again, interesting.

My second observation is this acquisition plainly indicates the start of a pivot into more than just security. As CEO George Kurtz explains:

“…we have pushed into other areas like IT hygiene and SecOps and DevOps with containers. We’re not moving away from security, but we’re expanding our total addressable market into areas that people care about…So this really allows us to provide monitoring on just about anything.”

As others have asked, does this put CrowdStrike on a collision course with Datadog? Maybe not exactly, but it sure does have them drifting toward similar markets as they grow. Fortunately, any overlap is likely far enough away it shouldn’t affect the present thesis for either firm. Security and observability are huge markets expanding rapidly, so it is not surprising some of the sector’s most innovative firms are exploring the fit.

CrowdStrike made the news again this past week when Kurtz joined other executives testifying before a US Senate investigation into the recent SolarWinds data breach. Kurtz was present because a) SolarWinds used CrowdStrike as a remedy after the breach and b) CrowdStrike itself recently thwarted an attempt by Russian hackers to access its email system. During his testimony he pointed the finger at Microsoft’s complicated and “antiquated” architecture as the vulnerability. He also suggested Microsoft could eliminate the threat by addressing these issues. Kurtz sounded like someone with a lot of confidence in what he’s saying. I hope he was also speaking with the confidence of someone who knows his company will be reporting blowout earnings on March 16. Hey, I can dream, can’t I?

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DDOG – I must confess to some nervousness heading into Datadog’s February 11 earnings. Most of my agita – one of my Nana’s favorite words! – was based on the market’s reaction to each of DDOG’s last two reports. COVID-influenced dips in revenue growth led to a 12%+ Q2 haircut and 15%+ last quarter. In my Q3 recap, I noted DDOG did almost exactly what I anticipated but still got taken to the woodshed by disappointed investors. Fortunately, in both instances the market eventually realized the strength of the underlying business and bid up the shares. In fact, DDOG was once again challenging all-time highs entering this report.

After doing some back-of-the-napkin math, I couldn’t help but see signs of a similar “buy the rumor, sell the news” response this quarter. While sequential quarterly growth is rapidly reapproaching pre-pandemic levels and is the real gauge of how DDOG’s business is doing, the Q2 stumble set up some difficult year-over-year (YoY) comparisons through 1Q21. Coming off last quarter’s “disappointing” 61% revenue growth, my Q4 estimates were ~53% growth with likely low-40’s guides for both Q1 and FY21 in order to leave enough room for future beats and raises. In my opinion, something along those lines would have DDOG right on track in rebounding from its Q2 hiccup. However, I felt Mr. Market would expect more given the pre-earnings run up and would be just as disheartened as it was after Q2 and Q3.

It turns out I was kinda sorta right…

The headline numbers of 56% Q4 growth with Q1 and FY21 guides of 43% and 38% respectively were within range of my estimates. At the same time, the low guides were slightly offset by the stronger than anticipated Q4 and concurrent announcements of two acquisitions bolstering Datadog’s product line. My first major takeaway is sequential growth continues to pick up steam and quickly challenge pre-COVID levels. So, while annual growth has drifted down the last six quarters…

• 88%, 85%, 87%, 68%, 61%, 56%

…quarter-over-quarter (QoQ) growth has picked back up after bottoming out…

• 15.2%, 18.5%, 15.5%, 6.7%, 10.5%, 14.8%.

A typical beat in Q1 would put these rates around 54% and 14%. More importantly, continued quarterly improvement should push YoY growth back into the low-to-mid 60’s through Q2/Q3. That would almost certainly keep the stock on an outperforming path. So, are there signs this could happen? I believe there are.

First of all, CEO Olivier Pomel and CFO David Obstler have done a tremendous job identifying the COVID hiccup and effectively communicating it to investors. They have also been excellent in illustrating why it should have a limited impact on future business. This includes Obstler very clearly detailing the hopefully temporary pressure on recent and upcoming YoY comps.

The reality is Datadog’s underlying business appears to be humming right along. This quarter set records for new clients and the annual recurring revenue they will bring. For context, customer adds fell from 1,000 in Q1 to 600 in Q2 but rebounded to 1,000 and now 1,100 the last two quarters. So, more customers committing to higher recurring dollars? Sounds like potential acceleration to me.

In addition, Pomel implied some clients forced to reduce earlier spending are starting to loosen up. He highlighted “a number of notable upsells in companies that were negatively impacted by the pandemic, including a seven-figure upsell with a travel technology company and six-figure upsells with two separate airlines as well as a physical event company.” So, existing customers feeling comfortable enough to resume spending they had previously shelved? Yes, please.

Best of all, Datadog continues to shine at meeting those customers’ needs. It now offers nine products after launching with just one four years ago. It has strong relationships with all the major cloud providers, including its first deals from the recently expanded Microsoft partnership. 72% of customers are using 2 or more products, up from 58% last year. 22% are now at 4 or more, up from just 10%. As in past quarters, ~75% of new clients came on board with two or more products, illustrating DDOG’s ability to immediately address multiple pain points for its users.

Going forward, the innovation shows little sign of slowing. Datadog recently released its first security-specific module to augment its core monitoring tools (there’s that possible CRWD/DDOG drift thing again). In addition, it announced two separate acquisitions in conjunction with earnings. The first was Sqreen to bolster DDOG’s security offerings, mostly in app management. Next was Timber Technologies to strengthen its observability platform and log management tools. The Timber Technologies acquisition has already closed with no impact on guidance. Sqreen is expected to close in Q2 and will “have an immaterial impact to both our revenue and operating income guidance in 2021.” That suggests to me both deals were small tuck-ins targeted mostly for the technology. Assuming the new tech fits – which I have no reason to doubt – these seem like smart moves. The software market is moving blazingly fast, so any action improving or expanding DDOG’s offerings can only be viewed as positive.

In summary, Datadog seems to be in a great spot. Operationally, it is obvious management does not plan to rest on its laurels. Performance-wise, key metrics are not only holding firm but lining up in a way that suggests accelerating growth even as the company continues to scale. As a shareholder, I’m not sure what else you could ask. I really like where Datadog is headed and fully anticipate it remaining a top holding the rest of the year.

[EPILOGUE: Being fully transparent, I went very much out of character with DDOG this month. I generally view playing earnings as a terrible strategy, but here I considered the odds of a Q2/Q3 repeat simply too strong to ignore. Consequently, I cut my allocation from 8% all the way to 1.1% by selling all my non-taxable shares during the pre-earnings rise at an average of $116.54. After very much liking the report, I plowed the entire amount right back in the very next day at a cost basis of $111.51. So, I basically netted ~4.5% more shares for free, which is not an insignificant number coming off an 8% position. In fact, I grabbed quite a bit more as February progressed to build the position even further.

Was the gamble worth it just to save a few bucks per share? Ultimately, I determined it made too much sense not to try. Fortunately, the Q2/Q3 pattern held. Even though the dip wasn’t as large as prior quarters, I ended up with extra shares in a company I like at no additional cost. To be clear, I do NOT consider this a new tool in my investing toolbelt. In fact, I strongly contemplated leaving it out of this recap before deciding I wanted it for accountability. I view this as a perfect storm event and want to make sure I can remind myself of that if it becomes a slippery slope instead. There can be a fine line between investing and trading. I prefer not to straddle it unnecessarily. But as hockey icon Wayne Gretzky once observed, “You miss 100% of the shots you don’t take.” I’m glad this one found the back of the net.]

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DOCU – After January’s investor conference tour, DocuSign had a very quiet February. Hopefully, the silence is because management was too busy high fiving each other over the upcoming March 11 earnings report.

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NET – Cloudflare had some well-earned buzz coming into February 11 earnings. It has been on an innovation bender these last few months with a seemingly endless string of new products and updates. In fact, I can’t remember owning a company with as many irons in the fire as NET has right now. This report would be our first glimpse at just how much of the new swag was hitting the income statement.

I must admit I found much of that glimpse pretty ordinary…or at least ordinary compared to the trend of the last few quarters. Revenue growth of 50% was decent but also down slightly from 54% last quarter and 51% last year. Likewise, expenses ticked up for the first time in six quarters due mostly to increased Sales & Marketing spend. While that’s understandable given all the new wares NET is hawking, the additional expense led to a sharp decline in cash flows and slightly larger losses. All in all, I can’t say this was Cloudflare’s best showing.

Unlike last quarter when CEO Matthew Prince proudly trumpeted “sometimes you hit on all cylinders,” this quarter looked more like a consolidation of all the recent initiatives. I thought this most evident during the update on Teams, a formerly free product which became paid September 1. Last quarter Prince eagerly informed us the early conversion rate from free to paid was 75%. When asked this quarter, he gave a much more elusive “we’re-happy-with-the-progress” answer and no figures to back it up. He also explained many of the free extensions given to COVID-impacted clients upon the initial transition are still in effect. I take that to mean Teams isn’t quite as material yet as we (or management maybe?) might have hoped. While I don’t see this as a major issue, it does suggest it might take time for all the new offerings to gain traction.

Fortunately, there are signs that traction is building. First, customer growth accelerated to 32% YoY from 25% last quarter and 24% in 4Q19. The 10,215 new customers are roughly double the amount added in Q3. Prince also noted 50,000+ developers wrote and deployed their first project on the Workers platform during Q4. This is double the number just two quarters ago. Dollar-based retention hit a record 119% “driven primarily by customer adoption of our expanding product portfolio.” Finally, remaining performance obligation (RPO) grew 75%, meaning the contract pipeline appears strong. So, there does seem to be some coiled spring here.

As highlighted in prior recaps, there is much to like about Cloudflare’s recent streak of innovation. Prince and gang deserve a ton of credit for working hard to stay ahead of a rapidly evolving curve. On the call he emphasized, “going into 2021 look out we’re a lean, mean innovation machine, and we have no intention of slowing down.” The challenge, of course, is turning all the new trinkets into monetized adoption as we go. Prince has become one of my favorite executives, and I very much look forward to him backing up his bold words. Rest assured though, I’ll be keeping at least half an eye on how much of the hoopla actually becomes revenue and/or profits over the next couple of quarters. After all, that’s the real name of the game.

As for the stock, the market seemed to share my general sentiment. NET ran from $75 to almost $95 in the three weeks before earnings before giving all of it back and then some the remainder of the month. My take once the smoke cleared was wanting a bit more DDOG and a bit less NET, so I swapped ~1% worth of shares to help make that happen. Don’t get me wrong. Cloudflare still sits at #2 in my portfolio. I simply feel it played its way back a tick toward the names just behind it.

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OKTA – Another out of sight, out of mind month for Okta. As usual though, the stock ended the month with a price higher than it started. It seems to do that a lot. The spotlight returns to CEO Todd McKinnon and Co with March 3 earnings.

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PTON – Peloton reported February 4, and the story was much the same as last quarter. Red hot demand with continuing supply constraints. The headline numbers were plenty good:

• $1.06B in revenue (+128% YoY)

• 4.4M total members (+120% with a record 800,000 added this quarter)

• 40% total gross margin

• $198M in operating cash flow

• $116.9M in Adjusted EBITDA

A quick scan of subscription metrics was even better:

• 1.67M Connected Fitness subscriptions (+134% with a record number of new adds)

• 625,000 digital subscriptions (+425%. Management views these as a strong lead generator for Connected Fitness purchases and subscriptions.)

• 98.1M Connected Fitness workouts (+303%)

• An average of 21.1 monthly workouts per member, up from 12.6 last year

• A record 60.3% subscription gross margin

• A record 65.3% subscription contribution margin (targeting 70%+ long term)

Peloton continues to sell every piece of equipment it can produce while creating an ever-deeper relationship with its members. It is also seeing rapid adoption of non-bike classes like Boot Camps and Pilates with management noting 5X growth in the number of strength classes taken over the last year. As everyone knows, the one persistent chink in the armor is whether PTON’s inability to meet current demand ends up costing it customers and/or growth down the road.

Fortunately, the company is slowly but surely making progress in this area. Its new Taiwan factory is up and running, which has helped production. However, issues with shipping – particularly intake at US West Coast ports – are still creating “unacceptable” delivery delays. Peloton sacrificed margin this quarter to pay for additional air shipping and has committed at least another $100M over the next six months to do the same. Management anticipates outsized shipping costs “will largely abate” by June. Thinking long term, I have no issues with either of those decisions. Adding as many members as possible as quickly as possible is just smart business.

I think it is important to recognize delivery delays are faced by many companies right now and not just Peloton. If you don’t believe me, ask anyone who has tried to order something as simple as a set of dumbbells over the last year. Two comments really stood out to me in management’s understanding of its need to address this issue. First was CEO John Foley noting Peloton has increased its production capacity “by more than 6X in the last 12 months.” In fact, PTON is now making more bikes per month than in all of 2018. Next was the CFO stating, “We are extremely pleased that our current manufacturing capacity exceeds demand, a trend that will accelerate as we move through the back half of the year.” I find this encouraging for two reasons. One, it means current delays are due more to temporary shipping and delivery logistics than production issues. So, at least we know PTON believes it can get enough product out the door when delivery smooths out. Two, it suggests Peloton should have an easier time building inventory and meeting demand as it enters the treadmill and commercial markets.

And that’s where I still find PTON very interesting. While the current home workout craze shows no signs of slowing, the company is also making steady progress on new areas of growth. Most revolve around Peloton’s treadmill products. Tread was released in the UK on December 26 and is scheduled to make its Canadian, US and German debuts this year. Not surprisingly, this new offering has been a big hit. Management pegs the treadmill market as larger than bikes and is already seeing more demand than anticipated. In fact, that led to a decision to limit some early US deliveries and delay the general US launch to May 27. The Canadian launch still occurred this month. Basically, PTON is trying its best to ensure the Tread rollout doesn’t hit the same delivery snags as Bike. While this is mildly disappointing, I’d rather a delay due to crazy demand than a design or production flaw. On bumping back the release, Foley stated:

“[With] Tread, we're taking estimates up full stop based on what we've seen in the UK. And we felt like we had baked in a plan that had a strong forecast there. And based on what we've seen early, we've taken it up. And that's really informed the decision on moving out the U.S. launch general availability 60 days. As John noted, we're going to be rolling out some orders here in the U.S. but the general availability moving it out 60 days, because we think this is a rocket ship in terms of a product platform, and there's a lot of demand for it.”

In my opinion, this delay is not the end of the world since treadmill sales weren’t expected to be material to FY21 anyway. And let’s not forget that revenue is already forecasted to finish in the neighborhood of 125% YoY growth. Management has frequently said it expects the treadmill to be a major growth driver in FY22, which starts July 1. Early consumer reaction is strongly hinting management might be right. Could Tread create another crazy-profitable product S-curve for Peloton, much like iPod to iPhone to iPad did for Apple? I’ll admit cherry-picking the best example ever might be a stretch, but something similar is certainly not out of the realm of possibility.

Another potential area of growth is last month’s Precor acquisition. This purchase not only gives Peloton additional US-based production capacity by end of calendar 2021 but also fast tracks its path into commercial sales. Precor brings a sizable number of corporate, hotel, multi-family residence, and college campus customers. While Precor makes several items Peloton does not (ellipticals, stair climbers, weight racks, etc), it is not at all difficult to see many existing Precor bikes and treadmills becoming Pelotons at the first available refresh. Needless to say, that’s a lot of units. Management has promised more details on its commercial plans next quarter after the deal closes.

So, the multi-multi-million-dollar question is whether demand will hold while Peloton works through its delivery issues and initial forays into treadmills and the commercial market. At this point most customers seem willing to wait. In response to this specific question, Foley replied:

“We are not seeing a softening of demand. That is absolutely not what's happening here. We are seeing incredibly strong organic demand, even in the face of light marketing, as you know. The successes that we're seeing in getting ordered to delivery down and getting a backlog down are 100% based on incredible upgrades in our manufacturing capacity up over six times 6x increase in just the last 12 months in our capacity…we're now making more Bikes on a monthly basis than we did in all of fiscal 2018. So, it's a herculean effort based on our in-house manufacturing teams and our third-party partners. And so yes, I hope that answers your question, but it's absolutely not a softening of demand. That's now what we're seeing. We're seeing robust demand.”

He also stated:

“When the vaccine was announced in the fall, you saw a reaction to the stock, but we did not see any reaction to our sales or demand. We still have not seen any softening since that vaccine was announced and since the vaccine has been rolling out. So other than investors getting nervous, the consumers are still feeling like they want to work out at home.”

So, am I one of those nervous investors? Yeah, a little.

I like what I see but would sure like PTON to get through this rough patch. Apparently, so would the market since the shares are down sharply YTD. Management guides for $1.1B in revenue and 110% growth next quarter, which I would anticipate being closer to 120%+. Any improvement in delivery times would push this number even higher. PTON also guides for 2.275M Connected Fitness subscriptions, which would be +109% year over year. Adjusted EBITDA will be considerably lower next quarter due to the increased shipping costs, but management strongly believes this is more than a fair tradeoff to deliver as many bikes as possible. I see no reason to doubt them. The full year revenue guide was raised to “$4.075B or more” (+123%). I’d take the over for sure. The flip side is management left its prior full year Adjusted EBITDA guide of “$300M or more” unchanged to give itself wiggle room to streamline production and shipping.

Shortly after earnings, Peloton used its recent clout to raise some super cheap capital through convertible notes. What was initially announced as a $600M offering ended up raising $1B upon closing a few days later. The notes, which are due in 2026, pay zero percent interest but may be converted into 4.18 shares per $1,000 principal. That initially valued the placement at $239.23 per share, which is a roughly 65% premium to the price at time of closing. The shares are capped at a 150% premium of $362.48. According to Foley, this is the “best 5 year convertible terms in history of the convert market!” (His exclamation mark, not mine.) So, it seems big money has some interest here. Given PTON already had $2.1B on the books while being both profitable and cash flow positive, management obviously has something significant up its sleeve. I’ll guess we’ll just have to wait and see.

As mentioned previously, Peloton is the only company I own whose main business is selling widgets. It sure is frustrating it can’t simply scale like a software company to meet this demand, but that unfortunately comes with the turf. And it’s hard to complain too loudly when that turf includes triple-digit growth with no real end in sight for just about every metric that matters. Peloton has a chance to not only dominate fitness but possibly turn itself into a lifestyle ecosystem. It all boils down to whether it can distribute its equipment fast enough to take advantage of the opportunity. While I’m content holding a smaller position, I did trim some to add to ROKU and ZS after they posted what I thought were stronger quarters.

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ROKU – When reentering Roku in December, I noted it was almost entirely based on the company’s quicker than expected turnaround from a COVID-induced hit to platform revenue and gross profit. February 11 earnings would help clarify whether that rebound was a one-time head fake or the start of a more positive trend. I’m happy to say it looks like the latter. Below are the key metrics I’ve been watching with Q4 results tacked on (oldest to most recent):

• Platform Revenue Growth:  72%, 73%, 46%, 78%, 81%

• Platform Gross Margins:  63%, 56%, 57%, 61%, 64%

• Platform Gross Profit Growth: 49%, 39%, 26%, 73%, 85%

• Total Gross Profit Growth: 44%, 40%, 29%, 81%, 89%

Nice! As you can see, the metrics that matter – to me at least – all strongly accelerated into the end of the year. Even better, much of the supporting info suggests the outperformance should extend at least a couple more quarters. Roku finished 2020 with 51.2 million accounts streaming a total of 58.7 billion hours of programming on the year. To lend some perspective, “Roku’s U.S. active account base is now more than twice the number of the U.S. video subscribers of the biggest cable company.” So, I guess we know where at least some of those cord cutters have ended up.

As viewership grows, Roku appears to be getting better and better at monetizing it. Average revenue per user has climbed steadily to $28.76 over the past 12 months. This represents not just advertising dollars but also an increasing number of subscriptions to third-party channels driven directly through Roku’s platform. It’s a virtuous cycle that should keep on spinning as long as Roku keeps adding eyeballs.

Luckily, adding eyeballs is something at which Roku is becoming quite good. Roku owned the top-selling smart TV operating system in North America during 2020, powering 38% of new units sold in the US and 31% in Canada. Third-party media firm Conviva reported Roku’s platform “was the most popular streaming platform with a 41% share of streams, which is nearly equivalent to the next three platforms combined.” International expansion continues to gain traction with a three-pronged approach similar to North America:  grow accounts, increase engagement and then monetize. Management highlighted gains in Brazil, Mexico, the UK and Ireland. Although much of the international effort is still in the “grow accounts” stage, management hinted there was enough progress to give specific breakdowns in the not-too-distant future. That would be a significant milestone in my opinion.

Roku’s increasing audience is generating additional interest from advertisers looking to move from traditional to streaming TV. For example, while retailers spent 7% less on traditional TV ads in Q4, spending for retail ads on Roku’s platform more than doubled. In addition, the six largest ad agencies more than doubled their Roku spend in Q4 while also making significantly larger 2021 commitments. When management points out these six agencies control “the vast majority of TV ad spending,” you can’t help but take notice.

This spending shift has also allowed Roku to significantly leverage last year’s acquisition of DataXu, an ad-buying platform since rebranded as OneView. Ads purchased through OneView more than doubled in 2020 while spending on ads delivered directly through Roku’s platform more than quadrupled. A major benefit of OneView is letting advertisers use Roku’s first-party data to help target ads across dozens of apps and linear television all at the same time. OneView also permits clients to combine their own data with Roku’s to optimize purchases on any platform, which is a nifty little trick when you think about it. Bassil El-Khatib, CEO of Frndly TV noted:

“For every dollar we spent on Roku versus a large social media platform in July 2020, we had a 65% better return on investment with Roku as their promotional capabilities attract the right customers in the right mindset to build long-lasting relationships.”

Of course, you need to have content for all those ads. Along those lines, Roku added more than 50 channels to its lineup during Q4. Management also provided more detail on its acquisition of distribution rights to the content from defunct media company Quibi. CEO Anthony Wood labelled it an affordable content buy for The Roku Channel, which is growing twice as fast as the platform overall. He stated, “more viewers bring in more advertisers, more advertising dollars brings in…better content and then that cycle continues.” I personally wouldn’t be too keen on a hard pivot into content production at this stage given the associated high costs, but Wood twice suggested the focus was more on licensing or acquiring existing content than producing new content. He assures “we’re disciplined about making sure the content we onboard into The Roku Channel fits in the [ad-supported on demand] business model.” That’s good enough for me…for now.

As an investment, Roku has always had a lot of moving parts. This in turn has always made it a little tougher to wrap my head around. However, one thing is now abundantly clear: Roku is no longer just your grandfather’s cable box maker. It has now evolved into a powerful, must-have streaming and advertising platform for almost every major channel. Not surprisingly, this has contributed to a rapidly improving bottom line. Adjusted EBITDA over the last 4 quarters has gone from -$16M to -$3M to $56M to $114M. While profitability has previously been hit or miss, recent developments suggest Roku may have turned the corner. Management stated ad impressions were up 100%+ in Q4 and have now returned to pre-COVID growth levels. This is much sooner than anticipated and has led to a top end EBITDA guide of $34M in Roku’s traditionally weaker Q1. I view this as a semi-big deal. Roku’s first FY19 EBITDA guide was for breakeven before finishing at $36M. FY20’s initial guide was breakeven again – which the market hated at the time – before knocking EBITDA out of the park. I realize most of the 2020 beat is due to the unforeseen surge of COVID viewers, but this initial FY21 guide seems to indicate platform leverage is starting to kick in at scale.

Management expects similar outperformance during the first half of FY21 before hitting tougher comps in Q3 and Q4. The challenge, of course, is to keep adding viewers, content and advertisers as quickly as possible. In the short term, Roku has guided for top end Q1 growth of 54% in total revenue and 71% in total gross profit. The CFO’s estimate of platform as “roughly three quarters of total revenue” would put platform growth at 59%. So, even a moderate beat would once again have platform revenue over 60% and platform gross margin potentially challenging 80%. That not only has me wanting to keep Roku around for a while but led to swapping out some PTON to bump it up a notch. Now I just have to hope everyone doesn’t decide to flock back to cable.

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TWLO – Well, hello there Twilio! Though it rarely gets as much attention as some of my other holdings, February earnings once again proved TWLO is a damn fine company.

The surface performance included 65% revenue growth and an 11th straight quarter of positive earnings. However, to keep things kosher – l'chaim! – we must acknowledge one-time revenues from the Segment acquisition ($23M) and political spend ($22.7M). The good news is even after backing these out, TWLO’s recent business looks very strong (oldest to most recent quarter):

• YoY Revenue Growth (unadjusted): 46%, 52%, 65%

• YoY Revenue Growth (adjusted): 46%, 52%, 52% (at a $2B+ organic run rate)

• QoQ Revenue Growth (unadjusted): 9.9%, 11.8%, 22.4%

• QoQ Revenue Growth (adjusted): 9.9%, 11.8%, 12.1%

• YoY Gross Profit Growth: 37%, 42%, 62%

• Expansion Rate: 132%, 137%, 139%

What makes it even more interesting is customer trends suggest TWLO can keep up the momentum. Overall customer growth accelerated from 21% to 24% (including some Segment adds). Global 2000 transactions increased 76% during 2020 with the number of 7-figure deals up 93%. The number of users on the Flex customer engagement platform quadrupled. Twilio now boasts over 221K customers and more than 10M developer accounts. Even better, the accelerating expansion rate implies this rapidly increasing customer base is spending an increasing amount of money on Twilio’s products.

I believe cross selling into this customer base is where the Segment acquisition can be a real winner. The combined company lets Twilio change its messaging from customer communication to end-to-end customer engagement. Fortune 1000 client Camping World was used as an example. Camping World currently owns three different brands with three different websites and three different customer databases. Twilio/Segment can now help Camping World collect, analyze and gain insight from its scattered data in a more consistent way. Adding Segment’s capabilities lets Twilio move from the simple facilitation of mechanical communication to directly influencing the entire customer conversation. That will be powerfully sticky if TWLO can pull it off.

Predictably, management is not only proud of 2020 but openly excited about 2021. As CEO Jeff Lawson explained it, the Segment acquisition adjusts Twilio’s mission “to [improving] every interaction that businesses have with their customers.” And one thing we know for sure is an ever-increasing number of those interactions happen digitally. Lawson called it the “API economy,” and I think that’s a great description. The beauty is Twilio’s quickly becoming a one-stop shop for clients to navigate that economy in whatever way they choose. In that regard, I share management’s excitement.

Shortly after earnings, Twilio announced a $1.54B secondary offering. I have no idea how the money will be used, but management has shown it knows what it is doing when given some cash. The SendGrid acquisition has proven to be a good move. And while it is still early, the potential synergies with Segment are easy to see. Despite the dilution, I’m totally fine with Lawson refilling the coffers in case another opportunity presents itself.

I wrote in December Twilio had lined itself up for a very interesting 2021. All it needed to do was execute. So far, so good in my oh-so-humble opinion. I see no reason not to let this one run for a while, and I even added a smidge post-earnings with some of the dwindling cash I had left.

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ZM – This month’s news was the release of the "Everywhere Workforce" for Zoom Rooms. Everywhere Workforce enhancements will help employees “safely re-enter the workplace and better enable a hybrid workforce.” The release lists the following new features:

1. Pair a Zoom Room with your mobile device: Pair your iOS or Android mobile client to a Zoom Room, easily join meetings on the Zoom Rooms directly from your client and your mobile client is automatically placed in companion mode during the meeting.

2. View real-time people count data: With supported cameras, you can see how many people are in a room in real time on the Zoom Dashboard and on the Scheduling Display to ensure social distancing mandates are met and meeting spaces aren’t overcrowded.

3. Monitor a room’s environment and air quality: Neat Bar, a Zoom Rooms Appliance, includes an advanced set of capabilities called Neat Sense, which lets you monitor your meeting rooms for things like air quality, humidity, CO₂, and volatile organic compounds to keep occupants safe and healthy.

4. Virtual receptionist/kiosk mode: Provide a contactless entry experience for your building guests with our new virtual receptionist/kiosk mode. Just customize the “Start Meeting” button on a Zoom Rooms for Touch device in your lobby to connect visitors with a receptionist and safely greet them.

5. Control shared desktop from Zoom Rooms for Touch: Zoom Rooms for Touch users can control, right from the Zoom Rooms for Touch device, the desktop of the person currently sharing their laptop screen, streamlining collaboration.

6. Save whiteboard to chat: People can now send a Zoom Rooms for Touch whiteboard to Zoom Chat or email. This helps streamline content sharing outside the meeting room, greatly improving cohesiveness in the new hybrid workforce.

It has become abundantly clear businesses will reopen in stages post-COVID. Limiting physical contact and distancing where possible will clearly be part of that process. These features will go a long way in allowing users to customize interactions, and I could easily see the receptionist/kiosk mode getting heavy adoption in workspaces with waiting rooms and customer-facing lobbies. Zoom has always prided itself on being customer centric. Everywhere Workforce should be a very useful tool in helping customers reopen their business in a safe yet efficient fashion.

While the February news was nice, it pales in comparison to what’s on deck in March. A 2020 stock market darling, Zoom’s 2021 has been mostly on pause as the market awaits an end of year update and initial info on the company’s next act. CEO Eric Yuan gets to make his next pitch when ZM reports March 1. No pressure, Eric. It is only Zoom’s reputation as a hypergrowth stock on the line. The floor is yours. We are all ears.

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ZS – ZScaler, a new position in January, saw two significant pieces of news this month. First, the company was prioritized by the US government for FedRAMP certification at the High Impact Level. This certification clears vendors to “protect the government’s most sensitive unclassified data in cloud environments.” In 2019 ZScaler’s Internet Access product became the first cloud-based secure web gateway solution to earn FedRAMP certification. This new designation expands ZS’s availability within the government vertical as the world moves toward Zero Trust security. Given the recent government attention paid to cybersecurity, this only bodes well for the future.

Second was February 25 earnings, which I am glad to say looked very strong. ZS posted its usual profitable quarter with many key metrics accelerating for the fourth consecutive quarter. This was headlined by revenue of $157M and 55% growth. Billings growth checked in at 71%, deferred revenue at 60% and remaining performance obligations (RPO) at 68%, suggesting ZS’s recent sales improvements should continue generating accelerated growth. Management implied the same, increasing the FY21 top end revenue guide from $612M (+42%) to $638M (+48%). Billings and operating income also received strong raises. Even moderate beats would return ZScaler to low-to-mid 50’s growth for the year after declining to just 42% in FY20.

On the product front, ZScaler continues to innovate. It was the only firm earning Leader status in the recent Garner Magic Quadrant for Secure Web Gateways. Finishing best out of 12 vendors in “Completeness of Vision” and “Ability to Execute,” this marked ZScaler’s 10th straight year in the Leader category. This quarter also saw the company launch ZScaler Cloud Protection (ZCP). ZCP expands the product line from protecting users to protecting workloads, which positions ZS for usage earlier in its clients’ production process. ZScaler added over 100 product enhancements in its last major cloud upgrade, making its overall platform both wider and deeper.

As shareholders would hope, the expanding product line is helping increase sales. ZScaler hit milestones of 5,000 total customers and 500 clients in the Global 2000. It is seeing larger wins in the enterprise segment with more customers bundling multiple products right from the start. In addition, the recent success is coming across the board and not just one-time wins. When asked about the business mix, CEO Jay Chaudhry answered:

“[There’s] no onetime kind of special deals that artificially increased our billings numbers. It was properly distributed various pillars and across all Geos.”

The CFO reinforced this by noting new Q2 business was split roughly 50/50 between brand new clients and upsells to existing customers. Those upsells have been buoyed by a net retention rate that has accelerated for four straight quarters as well, coming in at a record 127% vs 122% last quarter and 116% last year. ZScaler is targeting this 50/50 split going forward, which in my opinion reflects a very healthy business.

All in all, this was a confident quarter and confident call. Cybersecurity is a huge deal right now with corporate leaders and governments around the world focused on ensuring their most sensitive information is safe and secure. Says Chaudhry:

“The #1 question ends up being, if people get compromised, how do make sure that the lateral movement doesn't happen? The answer is simple. Don't connect people to your network, don't build a moat with firewalls and VPNs, do Zero Trust implementation, where you connect users to applications, not the network.”

If ZScaler can really make it that simple, the stock should have a long and fruitful runway. ZS is expensive, but rightfully so. I bumped this position a couple times pre-earnings, then added a bit more under $200 when the stock pulled back from an initial 11% earnings pop. As we get into 2021, it seems like a lot of my companies have at least started dabbling in security. ZScaler sits right smack in the middle of it, which isn’t a bad place to be when you consider all the attention the sector is getting. I was very pleased with the quarter and would not be surprised if this allocation crept up a bit as we go.

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My current watch list…

…in rough order is ETSY (Etsy), LSPD (Lightspeed), UPST (Upstart), NARI (Inari), FVRR (Fiverr) and SNOW (Snowflake). Etsy in particular is getting a second look after crushing both its quarter and guide. Lightspeed’s business intrigues me but likely doesn’t really take off until things open back up. Upstart’s AI-based loan approvals could be truly disruptive, especially now that it is getting its first exposure to the auto loan industry. All are interesting if one of my current holdings falters.  

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And there you have it.

High highs and low lows. I’m guessing that sums up February for a lot of growth portfolios. My highs included a new all-time portfolio high on February 5. That surpassed my previous December 22 mark and began a satisfying streak of six consecutive new highs peaking at 20.0% YTD on February 12. So, a 14.4% portfolio rise in just 10 trading days. Very nice!

The lows began with a slight downdraft the following week before a 6.6% drop February 22. That was followed by an almost 11% plunge in the first 90 minutes February 23 before finishing down just 2% on the day. That means I came close to experiencing a full-fledged personal bear market in a span of…8 market hours? What the heck?!? Sadly, the mini rebound was short-lived since it was followed by another 5.9% slide two days later. So, a 17.5% pullback dropping me from +20.0% YTD to -1.0% YTD in just 9 trading days. Uhh…not so nice.

The late plummet left me resigned to finishing a month trailing the S&P on the year for the first time since October 2018. As luck would have it, a furious +3.0% portfolio rally and -0.3% S&P drop on February’s final day let me squeak back into the lead YTD. I know it’s small consolation, but I should take whatever I can get when things are trending down amirite?

Investing psychology stinks, and it’s even tougher if judged by stock price instead of company execution. This week’s price action was a gloomy reminder, even with the perspective of both the market and my portfolio simply retreating from all-time highs. Honestly, it is the same dynamic I experienced last November, September, August, March and…well, you catch my drift. Anyone who has been around a while knows experiencing a few of these drawdowns makes them easier to stomach as you go. Over the past 12 months this market has condensed years’ worth of lessons into months...months into weeks...weeks into days...and as we saw on Tuesday even days into hours. That being said, I do not consider "this time" very different at all. It's just faster. Fortunately, most of the tried-and-true investing strategies still work for those who can handle the speed and volatility. I would consider finding and owning what you believe to be quality companies one of the strategies that works. Therefore, despite February’s finish I fully expect most or hopefully all my companies to see much higher prices as the year goes on.

Thanks for reading, and I hope everyone has a great March.

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