June 2022 Portfolio Review

Total Return: -57.5% YTD (-36.9% vs S&P)

Sheesh. Even the market-beating months in 2022 are a grind…

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2022 Results:

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June Portfolio and Results:

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2022 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 report)

January 2022

February 2022

March 2022

April 2022

May 2022

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Stock Comments:

June saw the last of our earnings reports along with a fair bit of general news. Several firms hosted customer events as well, and I’m happy to say it doesn’t appear any have stopped innovating. That bodes well for the strong getting stronger as time goes on.

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BILL 0.00%↑ – In my opinion the most interesting Bill.com news didn’t come from the company itself but from business card competitor Brex. In a somewhat strange move, Brex's CEO announced the company would stop serving traditional small business customers to focus on its startup segment instead. This means Brex will be dropping “tens of thousands of traditional brick-and-mortar companies” which now have two months to migrate to another service. I can’t help but wonder how many of these abandoned customers might choose BILL as their next platform. I haven’t seen any direct comments from Bill.com on this development but would have to think it is aggressively trying to win as many of these companies as it can. Will Brex’s move make it easier for BILL to continue its recent trend of record new customer adds? Let’s hope so. If it does, BILL should be positioned extremely well the next few quarters.

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CRWD 0.00%↑ – Well, CrowdStrike gave us another CrowdStrike quarter. I wrote last month I hoped to see “60% growth [with] the usual strong profits/cash flows.” I’d say everything was on target. CRWD posted $488M in revenue for 61% YoY growth. Gross margin held at 77% with subscription gross margin at 79%. International business ticked up to 29% of the total growing at 71% YoY as CRWD expands its global presence. Net new annual recurring revenue (ARR) was seasonally light but still exceeded expectations and was large enough to grow total ARR 11% QoQ. Operating cash flow was a record $215M with free cash flow a record $157M. That in turn led to $83M in operating and $75M in net income, both records as well. Management felt comfortable enough to guide for 53% growth next quarter while raising the FY estimate to 52%. I’d anticipate something more 58-60% in Q2 and 55% on the year with the same record cash flow and profit trends. That’s an impressive combination of top line performance and bottom-line execution at this scale.

Eyeing supporting metrics, CrowdStrike added 1,600+ new customers for the fourth consecutive quarter bringing its total to 17,945 (+57% YoY). 59% of those customers now use 5 or more modules versus 57% last quarter and 50% last year. 35% are using 6+ (vs 34%/27%). With 70%+ now using 4+, management decided to retire that metric and initiate a 7+ category instead. The 7+ figure debuts at 19%, showing customers have no issue embedding several CRWD products into their operation. With 22 modules and a sturdy customer base, there appears to be plenty of room for continued upsells.

As usual, CEO George Kurtz ran a confident call. He called the current demand environment more robust than last year with no visible slowdown in “the willingness to buy security.” The CFO agreed stating, “Given the current geopolitical environment and growing regulatory requirements, such as GDPR, CISA reporting mandates and the forthcoming SEC cybersecurity disclosure requirements, we believe the essential nature of our offerings is increasing.”

Kurtz also touted CRWD’s cash flow as a tool for continuing investment “at a time when companies are forced to reduce their spending and hiring plans.” That included a record number of net new hires this quarter. With $2.15B in cash, management is very comfortable it can seize any opportunities that come its way including potential acquisitions. In that respect, CRWD is dealing from a clear position of strength.

Outside of earnings, CrowdStrike continues to win positive reviews. First, it was ranked #1 in the IDC Worldwide Corporate Endpoint Security Market Share report. IDC gives CrowdStrike “12.6% of the $10.3B corporate endpoint security market in 2021, demonstrating 67.9% year-over-year growth” edging out Microsoft for the top spot. Next, CrowdStrike’s Falcon platform was recognized as a winner in the Best Emerging Technology category at the SC Awards Europe 2022. The SC Awards Europe recognizes “products and services that continue to stand out from the crowd, exceeding customer expectations to help defeat imminent threats and cybersecurity attacks.” If nothing else, the third-party recognition shows CrowdStrike remains at the very front of a rapidly evolving cybersecurity market.

All in all, it’s hard not to like CrowdStrike’s current positioning. Even in a tightening environment, the general need for increased security appears intact. Kurtz believes CrowdStrike has “a winning formula that includes scale, growth, profitability, and free cash flow.” I’d tend to agree which is why CRWD remains a core holding.

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DDOG 0.00%↑ – Datadog provided several updates this month. One of the most interesting was a detailed investor presentation at the Jeffries 2022 Software Conference (webcast or transcript). The TL;DR version is management remains confident in its business even in light of current macro conditions. One of the main takeaways was comfort in DDOG’s contractual business as a reasonable floor should customers look to tighten their usage spending over upcoming quarters. The key quote is below.

Moderator:

That's great. The elephant in the room right now is the economy. And everyone is asking, we heard from Workday, some pushouts; Snowflake, little capacity, capacity utilization was down. When you think about last night Salesforce said, we're not seeing it, which I don't think most people believe Benioff would show any weakness. But what's your sense of what's going on in the environment? And how -- assuming things got worse on the macro side, what is the insulation to your model that gives you a little more protection from the headwinds that are coming in?

CFO David Obstler:

Great question and something we think about a lot. We said on our earnings call that in our first quarter, we didn't see any impact from the economy or from Russia, Ukraine that we -- our first quarter was very similar to our previous first quarters in terms of net retention and adoption and the growth of the business.

Of course, we're looking -- we're not naive. Back in the second quarter of -- at the beginning of 2020, at the beginning of COVID, we did see some flattening of the business. The business continued to grow very substantially, but clients began to look at their spend and do some rationalization.

And that could happen again, that clients, in periods of time where there is some economic pushback, will look at their cost structure. We take some comfort in the fact that we are only low single digits cost of their cloud expense. And there are tremendous trends towards digital migration. In fact, there may be things in a tighter labor economy and with cost management where you want to go to more of a managed solution than do-it-yourself. So there are a number of things that we look at, but we haven't really seen any effect yet. In addition, we have a very long-term trend here in cloud migration and DevOps.

In terms of what protections do we have in our model because I know that's top of mind, the whole world of consumption-based pricing, which was very appealing on the upside, but causes some concern is something on the mind of many investors.

And I think I want to emphasize, we have a different model. 75% to 80% of our business is in take-or-pay subscriptions. And what that provides is a very strong underpinning, meaning most of our business is committed contractually. So we only have -- we have less than 10%, in fact, around 5%, of what you would call pure consumption month-to-month. The rest of it is on-demand pricing associated with the part that's not the 75% or 80% related to subscriptions. So whereas our organic growth can vary, there's a very strong underpinning in our business model in cases where there might be a little bit less consumption.

In addition, we've seen such factors as our product growth, our expansion of SKUs and things like that be strong factors in clients continue to adopt more and more of the solution even if they're in a cost management mode.

The entire presentation is worth the read/listen if you have the time. While no company can claim immunity from the broader economy, Datadog is at least expressing confidence in its baseline importance to customers. In my opinion, they’ve earned more than enough trust to take them at their word.

Later this month DDOG issued two new product releases. First was Observability Pipeline. This product “enables more precise cost control, reduces technology lock-in and improves compliance and standardization of data quality to support organizations in scaling their observability practices.” This sounds like a natural complement for Datadog’s existing offerings and another way to further embed itself with current customers.

Next was the general release of Audit Trail for improved compliance and governance. Audit Trail monitors changes within Datadog’s platform to mitigate “risk of significant data breaches, unauthorized user access and unintended configuration changes.” This upgrade should be particularly useful for customers required to run ongoing audits under FedRAMP, GDPR, HIPAA or other regulatory rules. This looks like a nifty little add on that should help a significant subset of users.

In broader news Datadog was named a Leader for application performance monitoring and observability by Gartner research:

It was DDOG’s second consecutive year in the Leader category, and its “position as the vendor with the highest level of ability to execute is a reflection of meeting customer needs and solving existing pain points.” This is not surprising given Datadog’s recent business performance, but it’s always nice to receive independent recognition as to why this is such a strong company.

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MDB 0.00%↑ – MongoDB, a software firm with a wide array of database management and analytics tools, makes a return to our portfolio after a solid quarter. Total revenue of $285M led to a fourth straight quarter of accelerated growth at 57% YoY. Subscriptions accelerated to 57% as well and now account for 96% of total revenue. Gross margin came in at a record 75%. Expenses as a percentage of revenue improved to 68.9% vs 73.9% last year. However, the main selling point here is the continued success of Mongo’s cloud-based Atlas database product.

MDB’s long-term thesis has always been about transitioning from on-premise database tools to helping customers in the cloud, particularly developers. In that respect, MDB has made considerable headway. Atlas revenue grew 82% YoY this quarter and now accounts for 60% of its business versus 58% last quarter and 51% last year. The CEO commented, “Atlas continues to be a key growth engine as new and existing customers run more and more of their mission-critical workloads on Atlas.” He noted Mongo’s software has been downloaded more this year than the first 11 years of the company combined. He also implied Atlas could one day be 80-90% of the overall business, so plenty of room to run. MDB added a steady 2,200 Atlas customers bringing the total to 33,700 (+33% YoY). Customers spending $100K+ was down slightly though another 72 joined the ranks for 1,379 overall (+31% YoY).

The operational benefit of Atlas’s success is continued progress on cash flows and profits. After bouncing around with slightly negative cash flow for several quarters, MDB posted solidly positive figures the last two. I wouldn’t be surprised if that dipped a bit in Q2 as Mongo resumes travel and hosts its first live customer conference in three years, but that would barely dent the $1.8B in cash on the books.

In a bigger surprise, this was Mongo’s first ever profitable quarter with $17M in operating income and $5M in net income after guiding for a slight loss. The Q2 guide is for another slight loss but should finish noticeably better than past Q2’s regardless of the final figure. The FY profit guide was raised to breakeven, which I’d have to think will end positive on the year. While that’s not as sexy as some of our other firms, it’s what MDB shareholders have been patiently waiting for.

Despite the positive quarter and market reaction, it’s important to note management tightened its forward estimates. The CEO noted “deal cycles were in line with normal patterns,” but early macro effects on usage have management assuming a $4-5M revenue headwind for Q2 and $30-35M for the full year. That led to just an $11M raise of the $1.2B FY guide. Management was clear it considers these headwinds temporary given the underlying growth of the application and digital markets. Here’s the CFO’s view.

Analyst:

Michael, just to put my positive hat on here, you’re absorbing a $30 million, $35 million revenue hit in fiscal 2023, but you raised your full year revenue guidance by $11 million. So that tells me that X the macro impact you’re actually raising by $41 million to $46 million, which is substantially above the Q1 beat and substantially above the full your guidance raise last April quarter.

CFO Michael Gordon

And so again, I think it mostly just speaks to the size of the market, the success that we’re having. I always worry about words like inflection or some of these other things, but we’re seeing real traction in account. And I think about the breadth of use cases, the types of workloads, the mission criticality that were being selected for whether it’s a de-novo application or a migration of an existing application speaks to the traction and success that we’re having in the market. And then overlay that with a lot of just good execution in market and it all adds up to a very positive picture.

Well, hold on a minute. While I appreciate the sentiment, there’s no way I can give credit for a phantom $40-$46M raise or a “very positive” picture. I will, however, praise management’s transparency in proactively addressing the current landscape. I also like its confidence Atlas is building a floor for growth as things stabilize. In fact, MDB’s early-June customer event saw the release of several features expanding Atlas use cases. For those interested in an excellent and more detailed recap of the tech behind these enhancements, you can find it here.

In the bigger picture, this is exactly the type of Atlas traction long-time MongoDB shareholders have been seeking. That’s enough for me to dip my toe back in with a starter position.

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NET 0.00%↑ – Cloudflare’s June highlight was Cloudflare One Week detailing its Zero Trust Platform. NET says expanded features now make it the only cloud-native Zero Trust solution with a global network scale. This includes “sophisticated email security protection, data loss prevention tools, cloud access security broker (CASB), and private network discovery. Now, any organization can use Cloudflare One for a comprehensive and deeply-integrated Zero Trust security and networking solution to protect and accelerate the performance of devices, applications, and entire networks to keep workforces secure and productive.” Posts detailing more of the tech behind these features can be found on the company blog.

One announcement I found particularly interesting was the introduction of Cloudforce One, an internal team to track and disrupt online threats. This effort will be led by Blake Darche, the former co-founder and head of Threat Intelligence for NET acquisition Area 1. With prior stints at CrowdStrike and the National Security Agency, Darche is well versed in the cyberthreat landscape. Cloudforce One will not only work on improving security for NET’s existing offerings but also be available to provide live briefings and/or current threat research to interested customers. Cybersecurity matters if you’re going to be online. Cloudforce One puts that security front and center for Cloudflare customers. I like it.

Another which caught my attention was a head-to-head comparison of Cloudflare’s Zero Trust offering with portfolio mate ZScaler. There’s clear bias here, but it’s also apparent Cloudflare fully intends to compete in this space. For now, I have no reason to think both can’t succeed. I also know ZScaler has a sizable lead in security certifications, particularly in the government sector. I’ll be paying close attention the next few quarters to see just how much either firm is encroaching on the other’s turf.

Lastly, Cloudflare received an external accolade by winning Microsoft’s Security Software Innovator of the Year Award. Drawing from Microsoft’s integrated security partners, this award demonstrates “excellence across security, compliance, identity, management, and privacy during the last 12 moths.” Being deeply integrated with both Microsoft 365 and Azure, this is nice recognition of NET’s ever-expanding security portfolio.

Like most months, I exit believing Cloudflare is our most innovative company. However, I’ll be holding CEO Matthew Prince firmly accountable to his promises of improved cash flows and additional government security certifications in the second half. I see both as important factors in Cloudflare maintaining the growth we’ve come to expect.

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S 0.00%↑ – SentinelOne (S1) reported what turned out to be a complicated quarter June 1. It was the first report incorporating the Attivo acquisition, so there was naturally more to sort through. Unfortunately, after all the sorting I had just as many questions as answers.

First and foremost, the headline fell short of my expectations. Even with management’s limited guiding history, I was looking for $79-$80M in revenue and an $87-88M Q2 guide excluding any Attivo contribution. The combined number was just $78.3M in revenue with a total guide of $96M. I honestly anticipated more for both.

The shortfall was even more confusing considering some of the supporting numbers and comments. Gross margin hit a record 68.4%, a strong showing versus 65.7% last quarter and 53.4% last year. As a result, the FY gross margin guide was bumped to 69-70%. A record 750 new customers were added, bringing the total to 7,450 (+55% YoY). Net retention rate hit a record 131%. International business now represents 33% of the total and grew 129% YoY. In addition, S1 landed its largest US federal government deal to date and exits the quarter “with our largest ever pipeline.”

That all seems great. So, where’s the hang up? Well, a few things rubbed me the wrong way. First, expenses jumped considerably this quarter. That meant cash flow and loss margins took a sharp step back from prior quarters (though admittedly not terrible versus last year). Next, management kept its previous -55% FY operating margin guide, suggesting a longer slog toward profits. Lastly, I thought management was subpar handling its first call combined with Attivo. Every company I’ve ever owned is asked by analysts about organic versus combined numbers after an acquisition. In this case, S1 sounded almost unprepared. Rather than a clear breakdown of the two businesses in their first joint quarter, messaging was suspiciously vague with the comment management did not plan to break out the two going forward. Most notable was clumsiness by the CFO on exactly how the two companies contributed to the updated FY guide. He was specifically asked twice, and neither answer was particularly strong. He did target “low-to-mid 90’s” Q2 organic growth with “mid-80’s” for the FY, which are decent enough rates. However, it shouldn’t have been this difficult. Frankly, it felt like management couldn’t engineer a guide that looked strong off its initial Attivo numbers while still leaving room for beats going forward. It also smelled like a group that might not have as much visibility as thought on exactly how the combined company will track the next few quarters. Maybe those aren’t red flags, but they at least a shade of yellow that wasn’t there before. I must admit to not feeling great about it.

Is SentinelOne still making inroads toward being a successful company? I’d say yes. But it has also slammed headfirst into integrating a large acquisition in an environment where current and potential customers are watching every cent. That makes each new dollar tougher to win. It also means recent progress on improved cash burn and narrowing losses likely slows for a while. Since that loss and cash flow progress was a big part of my original reason for entering S1, I exit the quarter with less conviction. I’ve cut this allocation accordingly until we gain more clarity.

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SNOW 0.00%↑ – Snowflake rejoins our portfolio with a small position. As I wrote at the end of May, I found the quarter more adequate than good overall. However, I do believe in the inevitability of data and the quality of this management team. That belief was backed by several pieces of news coming from the recent Snowflake Summit conference. First, SNOW announced support for the Python programming language, increased its ability to manage streaming data, and unveiled enhanced tools for programming in the cloud.

Next, it expanded services for developers to build, monetize, and deploy applications in Snowflake’s data cloud. The new features will let developers list applications in the Snowflake Marketplace where consumers can “securely install and run those applications, directly in their Snowflake instances, reducing the need for data to be moved.” This should increase the stickiness of SNOW’s platform for both partners and customers.

Last, it launched a Unistore feature letting users to work “with transactional and analytical data together in a single platform.” This is meant to “streamline and simplify” use cases in which developers need to gain insights from these traditionally siloed data sets. While I don’t necessarily understand all the tech behind these enhancements, I do understand SNOW’s goal of expanding use cases and data sharing opportunities for its customers. This would then increase the amount of compute done directly on Snowflake’s platform, which is where the real money is made. These announcements all seem like strong moves in that direction.

In conjunction with Summit, management conducted a detailed investor session (slides here). While macro concerns might make the short-to-medium term choppier than shareholders might like, management expressed enough confidence in the long term to raise FY29 targets for gross margin (75% to 78%), operating margin (10% to 20%), and free cash flow (15% to 25%). With shares recently dipping back below SNOW’s $120 IPO price, I find things interesting enough to grab some and follow along for a while. If that price is good enough for Warren Buffett, I can’t see why it shouldn’t be good enough for me.

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ZS 0.00%↑ – ZScaler began June with the release of its annual ransomware report. Not surprisingly, attacks are up considerably in the past year which is why cybersecurity companies are getting so much attention in the first place. The month ended with several product announcements at Zscalers’s annual Zenith Live customer event (slides here).

First, it expanded its relationship with Amazon Web Service (AWS) to make it easier for customers to onramp to the cloud using Zero Trust security measures. The new features “deliver customers a unified solution to consolidate and simplify cloud security operations” directly through AWS.

Next, ZS announced new AI/ML capabilities for user protection and workload monitoring in its Zero Trust platform. These capabilities will better leverage ZScaler’s enormous data set to help customers identify threats and coordinate responses in real time.

Lastly, ZS released enhancements to better secure cloud workloads. Its new Posture Control solution will help developers and security teams assess and remediate risks in cloud-native applications earlier in the development lifecycle.

While I can’t say ZScaler innovates as rapidly as a Cloudflare or Datadog, it does seem to steadily and consistently strengthen its core offerings. Here’s hoping that translates to another set of strong numbers and supporting comments when ZS releases its initial FY23 guide next quarter. However, I’ve continued to trim this position due to the billings softness and potential competition I commented on last quarter.

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My current watch list…

…is down to monday.com (MNDY 0.00%↑), The Trade Desk (TTD 0.00%↑), and ZoomInfo (ZI 0.00%↑) after MDB and SNOW enter our portfolio. I can’t see any earning a spot though until at least another quarter or two of reports. I’ve bought everything I’m comfortable owning for now.

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And there you have it.

As stated at the outset, the 2022 grind continues. June started with the highest inflation since 1981 and the market’s biggest weekly decline since January. The S&P followed by finally joining the other indices in official bear market territory June 13. It did so in spectacular fashion too with 495 of its 500 companies negative that day. With the skids sufficiently greased, the S&P finished with its worst first half in 52 years. Accordingly, market sentiment is…uhhh…not great.

I don’t mean to be doom and gloom but do think it’s important we face up to the historic reality of this decline. There really is nowhere to hide and hasn’t been for a while, so most of us should probably cut ourselves some slack as this drags on. Heck, by mid-June even 20-year US treasuries had seen a bigger drawdown from their all-time high than the Nasdaq’s 30%+ drop. Stop and think about that for a second. Aren’t bonds supposed to be safer than stocks during routs, especially tech stocks? Apparently not in 2022. That’s a humbling thought whether you’ve been through this before or not.

The one saving grace is history says these are often some of the best times to buy for those capable of gutting it out. There are certainly companies at prices today that will look like bargains in the future. The problem, of course, is no one knows exactly when that future will arrive. But it will. At some point. Because the future always does. And as usual, it will likely be the best businesses which lead the way on the other side of the grind.

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

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* A special thank you to everyone who joined the Strictly Business subscription tier this month. I greatly appreciate the support. The next subscriber-only post will be mid-July’s portfolio update. I also anticipate several pre-earnings expectations posts in late July once formal report dates are released. BILL, DDOG, and NET will likely be in the first wave. In the meantime, feel free to reach out with any questions or comments.

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