February 2023 Portfolio Review

Total Return: +8.4% YTD (+5.0% vs S&P)

Winning!

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2023 Results:

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February Portfolio and Results:

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2023 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 (the one that got things started)

December 2019 (contains links to all 2019 monthly reports)

December 2020 (contains links to all 2020 monthly reports)

December 2021 (contains links to all 2021 monthly reports)

December 2022 (contains links to all 2022 monthly reports)

January 2023

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Stock Comments:

February kicked off yet another earnings season. Our portfolio saw some good and bad but fortunately no blatantly ugly. However, I did make a few allocation changes based on conviction levels exiting this round of reports. Below is the nitty gritty on how I saw it.

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BILL 0.00%↑ – I’d call Bill’s February 2 report less than stellar. While we’d already seen a string of decent quarters with softer outlooks this season, Bill’s outlook was arguably softer than most. Its passable $260M in revenue was paired with a disappointing $248M Q3 guide. It’s the first time ever Bill has guided for a sequential decline and a sign of some of the difficulty facing its customers. Adding insult to injury, management held the top of its FY23 guide flat at $1.07B. So, an uninspiring start.

At first glance, the supporting metrics look oddly strong. Bill posted a record 86.7% gross margin, record $28.9M in float revenue, and another 10,700 customers. Revenue per transaction ticked up to $7.31 (its smallest uptick in nine quarters but an uptick nonetheless). The $55.3M in operating cash flow and $49.8M in net income were records as well. So, where exactly is the hang up?

Well, after touting Bill’s relative macro resilience last quarter, the CEO quickly referenced the “challenging economy” this time around. The CFO agreed by acknowledging “customer spend levels for Bill and Divvy [deviated] from typical seasonal patterns in this challenging environment.” To analysts’ credit (yes, we can credit analysts), they followed up with appropriately challenging questions. Management gamely touted its opportunity and competitive advantage but was also forced to admit the remainder of the year will likely be a grind.

Simply put, the total payment volume (TPV) passing through Bill’s platform has contracted sharply in the tightening economy. Last quarter marked the first time ever core TPV per customer dropped from Q4 to Q1. This quarter marks the first contraction from Q1 to Q2. That suggests things are especially tough for Bill’s clients in what the CEO called this “wait-and-see” economy. Your guess is as good as mine when things might loosen back up.

Digging deeper, it appears much of the decline is being driven by customers recently added through Bill’s financial institution (FI) partners. Below is a quick TPV per customer breakdown for the last five quarters oldest to most recent.

• Direct Customers:  $462K -> $429K -> $452K -> $439K -> $441K

• FI Customers:  $208K -> $162K -> $155K -> $131K -> $119K

Where direct TPV seems to have stabilized, FI customer TPV has cratered. I assume most of these customers are smaller and more vulnerable to current macro. Unfortunately, this cohort makes up a large portion of Bill’s recent record customer adds. Extra unfortunately, this cohort will likely continue seeing pressure until things clear up. That’s a likely reason all those new customers have yet to produce a noticeable revenue bump.

If nothing else, Bill just became more complicated. It’s now clear the recent rapid customer growth is being fueled by a smaller and less stable brand of client. While that doesn’t change Bill’s overall value proposition, it’s certainly a headwind to potential top line growth until the broad economy loosens. That factor wasn’t quite as visible until this quarter and is something to watch closely going forward. I trimmed a small amount but am content to hold the rest for now.

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CRWD 0.00%↑ – Most CrowdStrike news this month involved management shuffling. The most significant was promoting Mike Sentonas from Chief Technical Officer to President. In this new role Sentonas “will be responsible for leading the company’s product and go-to-market functions including its sales, marketing, product and engineering, threat intelligence, corporate development and CTO teams.”

The last few weeks have seen Sentonas’ promotion, two new executives added from competitor SentinelOne, and the appointment of the former Chief Marketing Officer to the board. CEO George Kurtz is clearly restructuring CrowdStrike for its next phase of growth. I wouldn’t expect much short-term impact from these moves, but I’m guessing we’ll hear plenty about the long-term vision when CRWD reports March 7.

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DDOG 0.00%↑ – Datadog’s February 16 report wasn’t quite what I’d hoped. While DDOG held steady enough to post a decent Q4, uncertainty surrounding customer usage resulted in a dreadful FY23 guide. The initial 24.6% estimate is a steep drop from last year’s 49% guide and eventual 61% result. CEO Olivier Pomel admitted optimization will “end at some point but we don't know when exactly, so we're not building that into our guidance.” Ugh.

That was compounded by what I thought were mixed secondary metrics. The highlights:

• Continued strength in customers using 2+, 4+, and 6+ modules. Customers keep adding modules. Now all they need to do is start using them more.

• DDOG added another 1,000 new customers marking ten consecutive quarters at 1,000+. At least it’s continuing to feed the front end of the customer funnel at a reasonable rate.

The mid-lights:

• A 22nd consecutive quarter of 130%+ net retention rate, though that streak isn’t likely to last much longer. In fact, the CFO stated management is already assuming a drop below 130 in its projections. We’ll have to see where it settles.

• Profit and cash flow margins were down from last year but still strong. With gross margin holding firm at 80.6%, future growth looks a bigger concern than bottom line leverage right now.

• Remaining Performance Obligation is seeing pressure as well. It’s down from years past, but did post an uptick from Q3 and past the $1B milestone. Regardless, the portion expected to convert to FY23 revenue wasn’t large enough to bolster the 24.6% guide.

The lowlights:

• 360 new $100K customers in the second half is down from 440 in FY21. It’s possible that number is being dinged by customers who have temporarily dipped below $100K but will return later. Regardless, a trend worth watching.

My biggest disappointment was management’s accompanying comments. Despite the prepared remarks’ usual “no change in long-term trends,” this was as uninspiring a Q&A as I’ve ever heard from this team. That’s understandable though given the uninspiring quarter. My main takeaway is this optimization rough patch will be here awhile. I’ve always viewed DDOG’s outperformance in relation to competitors as one of its key advantages. That advantage appears to have shrunk considerably heading into 2023. Something to ponder.

I’d previously labelled DDOG’s November report its most lackluster to date. Unfortunately, this quarter now wears that crown. The good news is the underlying metrics appear strong enough to grind through this. The bad news is it’s clear that grind will take longer than expected. Plan accordingly. I did by cutting our position considerably until management gains more visibility.

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ENPH 0.00%↑ – Enphase began February with a successful demonstration of its new bidirectional electric vehicle charger. What’s unique about this product is it directly connects the vehicle to any home or grid already using an Enphase solar-energy system. This “[empowers] homeowners to make, use, save, and sell their own power [and] will be a game changer for homeowners who want maximum control over their energy usage.” Enphase expects to bring this charger to market in 2024.

It followed that announcement with what I thought was another steady Eddie quarter. Even better, I thought management’s comments and record gross margin estimate suggest a healthy underlying business. Expenses are clean, margins are improving, and Enphase continues to spit out cash flow and profits at scale. Hypergrowth continues in Europe (+21% QoQ; 130%+ YoY) with recent expansions in both the Netherlands and Germany. In addition, ENPH just recorded the debut sales for its flagship IQ8 microinverter on the continent. The CEO highlighted strength in Latin America, Australia, and Brazil as well, but those markets remain in the early stages.

Management enters the new year comfortable it has the production capacity and supply chain stability to meet growing demand. After manufacturing 4.8M microinverters in Q4, Enphase enters 2023 with 6M in capacity and plans to reach 10M+ by year end. All things considered this was about as confident an update as one could expect in this environment. Enphase followed earnings by extending its relationship with US distributor Lumio, launching its battery products in Austria, and expanding deployments in Maryland and Pennsylvania.

Putting it all together, I’m satisfied with where ENPH stands. While seasonal US softness pressured the Q1 guide, the CEO twice implied a bounce back as the year progressed. This management team has done an excellent job maintaining growth while improving leverage, efficiency, and production capacity along with way. All signs point to Enphase being well-positioned for another quality year. I’ve taken advantage of what I believe was a sector-related pullback to bump this position.

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NET 0.00%↑ – Cloudflare went a little contrarian with its February 9 report. While everyone else issued decent Q4’s with underwhelming full-year guides, NET decided to give an underwhelming Q4 and decent FY guide a try. Its $274.7M in revenue was a record-low beat of just $200K and 0.2%. However, FY23’s initial 37.6% growth guide was firmly above analyst consensus and almost certainly the major catalyst for its post-earnings jump. With a Q1 guide of 37.2%, management has not only set a stable floor but left enough wiggle room for re-acceleration at some point during the year. There certainly aren’t many companies making that claim right now.

That claim was boosted by Cloudflare’s $33.7M in free cash flow and $16.8M in operating income. It is clear management heard the market’s message that cash flows and profits matter. The market usually likes when companies listen.

I thought NET’s other execution metrics were mostly marginal. Net retention has drifted from 127% to 126% to 124% to 122% the last three reports. Even with management reaffirming its 130%+ long-term target, this is something to watch. Likewise, customer growth has seen recent pressure. The 6,806 total customers added in Q4 is down from 7,706 last year while the 134 new $100K customers trails 159 from last quarter and 156 last year. Both these areas bear watching as well.

The silver lining is a generally positive outlook from management on its road to $5B revenue in five years. NET’s recent FedRAMP approval and contract protecting the .gov domain name should help. So should recent price raises. My main takeaway after hearing management is Cloudflare’s direction remains intact, which itself is an accomplishment in this market.

In the end, the guide and outlook won the day. Management deserves a ton of credit for bolstering that guide with drastically increased cash flow and profits in the second half. The improved efficiency eased some concerns and appears to imply a stable 2023. I’d let this allocation run to 10%+ into earnings but thought the after-hours pop was overdone. I trimmed about 40% of our shares between $64-$67 before letting it settle where it is now. I bought a tick back below $60 and might look to add more as we go. I find I’m more comfortable with a medium-sized NET position than large one for now.

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SNOW 0.00%↑ – Snowflake issued a few updates this month. First it acquired LeapYear, a “differential privacy platform…to help our customers leverage previously off-limits data.” LeapYear’s features should increase the number of data-sensitive use cases managed on Snowflake.

Next, it moved Snowpark-optimized warehouses to general availability for customers on any major cloud provider. These warehouses have “16x the memory and 10x the local cache compared with standard warehouses.” In techspeak for dummies (i.e. my best paraphrase effort from the blog post) this will make it easier and more efficient for users to run memory-intensive use cases. The most notable example to me was machine learning workloads, which I’m guessing will grow exponentially in coming years.

Lastly, Snowflake launched a dedicated data cloud to help telecom customers “monetize data and maximize operational efficiency.” Some of SNOW’s largest telecommunications customers are already using this service including AT&T, OneWeb, and M1. This is yet another industry vertical where Snowflake is handling enough traffic to create an industry specific cloud. That bodes well for increased volumes in the future.

CEO Frank Slootman constantly beats the drum of making it easier to migrate and run workloads on Snowflake. My oh-so-hot take is everything the company did this month was a move in that direction. We’ll learn more via March 1’s earnings report.

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TMDX 0.00%↑ – TransMedics kicked off the month by hiring Nick Corcoran as Senior VP of Supply Chain and Operations. It ended the month by filling us in on all the cool opportunities Nick will be working on during 2023.

That update came in the form of February 22 earnings. I anticipated this report capping a very successful year and am glad to say that’s exactly what happened. More importantly, the story remains intact with a strong outlook for 2023. TransMedics’s $31.4M (+225% YoY) in revenue blew away its implied guide of ~$23M. That put this year’s final tallies at $93.5M and 209% YoY growth. More and more clinics are adopting TMDX’s end-to-end product. Case volumes increased for all three organ types during Q4 with heart and liver rising for the fourth consecutive quarter. Management is pleased with both the pace of adoption and its ability to increase utilization rates as it scales.

The challenge, of course, is increasing production capacity and staffing to alleviate pent up demand. Management continues to be very proactive in this area including the Corcoran hire. It has already increased clean room capacity and is awaiting FDA approval to ramp. It also continues to streamline its air and ground transportation network. The CEO stated numerous times he expects pressures to subside and potentially bring “significant efficiencies to increase the numbers” during the second half. My guess is the rate of any future FY growth raises will be directly proportional to the pace of these improvements. C’mon, Nick, DO YOUR THING!

As for those FY growth rates, I must admit the “methodical and conservative” initial FY23 guide for $145M and 55% growth was a tick lower than I’d hoped even after giving credit for 57% organic by backing out Q3’s one-time $1.4M revenue adjustment. Despite meeting demand as quickly as it can, TMDX still has supply chain and logistics variables to work through. Too much demand might be a great problem, but it’s a problem nonetheless. Management would need to raise the guide an average of $10M per quarter during FY23 to reach 100% growth. Since that’s the exact amount of this year’s quarterly raises, it doable. I’d just prefer less doubt going into it.

All in all, this was a great quarter in a watershed year for TransMedics. Its technology is seeing rapid adoption and quickly becoming a new standard of care for organ transplants. Likewise, management appears to have a firm grasp on where its opportunities lie and how to get there. CEO Waleed Hassanein “strongly” believes TMDX is creating an infrastructure that can grow from 7% of US liver, heart, and lung transplants during 2022 to “the lion’s share” in the future. Since this would be a win-win-win for doctors, insurers, and most importantly patients, I’m “strongly” rooting for them to pull it off.

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TTD 0.00%↑ – Coming into its February 15 report, I viewed The Trade Desk as one of the more straightforward firms we own. Luckily, we received a straightforward quarter. Both the $491M in Q4 revenue and $360M Q1 guide were reasonable. The $249M in adjusted EBITDA and 49.9% EBITDA margin were both records. Cash flows and profits remain strong as well with 34.8% operating cash and 33.1% net income margins to end the year. So, TTD’s executional prowess keeps humming along.

The highlight for me was a continued gain in market share. For the second consecutive quarter, TTD grew faster than both its main competitors and the ad market as a whole. Said CEO Jeff Green: “Specifically in the last 6 months of 2022, The Trade Desk started to separate from much of the digital advertising market in terms of relative outperformance. In the third quarter, we reported 31% growth while our competitors were either in retreat or posting single-digit growth. That same trend continued into the fourth quarter as we grew 24% and most of our large competitors were posting between negative 9% and negative 2% growth. I don't think we've ever had the level of industry outperformance in our 6 years or so as a public company as we did in 2022. And it means that we can be very confident that we're gaining share and that our platform continues to gain traction with advertisers.” The move of consumers to connected TV and content providers to ad-supported tiers are both contributing to this traction.

Ever the salesman, Green proclaimed “I also believe that 2023 will be the year that everything in TV changes…From an industry perspective, we have a lot of tailwinds. The shift from linear TV to CTV continues to accelerate, and I predict that at some point in the near future, we will reach a precipitous tipping point. It won't be a long gradual shift to CTV. It will be an acceleration and then a full long shift. One of the things I am preparing for as a CEO is making sure that we have the resources and scale in place to help our clients through that shift.” More relevant to me was his observation TTD has seen ad spending “become unpaused and unlocked” entering the new year. The CFO confirmed this sentiment by noting mild January acceleration from the pullback observed in November and December. It is encouraging to hear management is glimpsing light at the end of this tunnel.

In conjunction with this release, TTD announced a $700M buyback program to offset future stock-based compensation. I usually prefer our firms use excess cash to invest in growth, but it’s not as if TTD hasn’t innovated with its new Galileo offering and continued adoption of Unified ID 2.0. With Green’s future compensation heavily tied to the stock, I trust management to do the right thing.

In the end, I’d call this a steady quarter. Despite the pressured ad environment, The Trade Desk is gaining market share and maintaining growth as the ad dollars that are being spent shift from traditional campaigns to programmatic and targeted ads. That’s right in TTD’s wheelhouse and should be a considerable tailwind when ad spending returns. I can certainly see why Mr. Market liked the report. I did as well and have bumped the position.

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ZS 0.00%↑ – Zscaler’s February news was the acquisition of Canonic Security to further expand its Zero Trust protection capabilities. Canonic’s specialty is preventing supply chain attacks through browser extensions and third-party applications. This tuck-in will strengthen ZS’s existing cloud and SaaS security offerings, which sounds fine by me.

We’ll hear a lot more when Zscaler reports March 2.

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My current watch list…

…in rough order includes Aehr Systems (AEHR), SentinelOne (S), monday.com (MNDY) and MongoDB (MDB), and Gitlab (GTLB).

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And there you have it.

I’d call February a productive month. In fact, it’s the first month I led the market both month- and year-to-date since October, 2021 (yes, 2022 was that painful). That seems like a lifetime ago, but it’s not. Investing is an ongoing game requiring a long-term mindset. Any MTD and YTD results are just guideposts for double checking your process along the way. It all boils down to whether you find and own companies with a chance to get the job done. I head into March content with the group we’ve selected. Now it’s time to get back to work…

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