Software Stack Investing

Following a disappointing Q1 earnings report highlighted by challenges in the go-to-market effort, Cloudflare demonstrated renewed momentum in Q2. The sales reorganization is progressing well. Large enterprises expanded spend, adding to multi-product subscriptions across several categories. In parallel, profitability measures continue to improve with growing operating margin and cash flow.

After delivering favorable results in Q1, Confluent continued on largely the same trajectory in Q2. Sequential growth rates even imply stabilization around 30% annually, after almost 2 years of deceleration from Covid highs. This growth is being led by rapid adoption of Confluent Cloud, with the licensed Confluent Platform offering for on-premise deployments demonstrating surprising resiliency as well. This is an audio summary of the original blog post. For more details go to softwarestackinvesting.com.

Headwinds from workload optimization may have peaked in Q2. After nearly a year of negative drag on revenue growth for the hyperscalers, it appears that cloud infrastructure customers are shifting their focus away from workload optimization and back towards the deployment of new ones. At least that is what Amazon’s CEO told us in the opening statement of their earnings release. While the hyperscalers delivered revenue growth rates that decelerated from the prior year, they are now showing an uptick sequentially from Q1.

AI has crashed onto the investing stage in 2023, driving significant stock price gains for several companies. Some, like Nvidia and Microsoft have already projected a direct revenue benefit as part of recent earnings reports. Others have indicated they expect AI to drive demand tailwinds going forward as part of management commentary.

After guiding for a sequential 4% drop in revenue for Q1, MongoDB delivered a strong beat. More importantly, their preliminary estimate for Q2 revenue would achieve a reacceleration of annual growth if they outperform at the same level as Q1. The revenue projection for Q2 even leapfrogged past the analyst consensus for Q3. While the market expected some conservatism, this level of outperformance caught investors by surprise, with the stock surging 28% the next day.

Snowflake’s consumption business continues to feel pressure as large enterprise customers look for ways to optimize usage. While it seemed that management had a handle on forecasting the impact of this effect when they lowered guidance back in Q4, they still underestimated the trend. With the Q1 report, they once again brought down the full year revenue target. This is a summary of the more detailed post at Software Stack Investing.

Datadog stock surged 45% over the month of May, following their earnings report on May 4th. The results aligned with the common theme of "better than expected", shared with several other software companies reporting results recently. This outperformance appears to have set a baseline across the software sector, with upward momentum building as more companies report results. A new tailwind has been excitement around the potential for AI to drive an incremental demand cycle for software and security infrastructure.

Following their Q1 earnings report on May 3rd, Confluent stock jumped by 16%. Since then, CFLT has continued appreciating, recently passing their previous high for 2023. While the report itself was pretty good (but not outstanding), the market appears to be anticipating more growth to come. Perceived AI tailwinds are likely at play. In order to capitalize on the potential advantages from advanced insights and new proprietary AI models, enterprises need access to all their data in one place. It should be filtered, consistent and recent. As the leading independent provider of data streaming, and soon stream processing capabilities, Confluent is well positioned to address this demand.

After setting an optimistic target for full year 2023 revenue growth in early February, Cloudflare management was forced to reset guidance lower after sales cycles unexpectedly elongated in March. While this can be attributed to exogenous effects like banking turmoil and macro conditions, investors are left guessing whether the Q1 results were a one-time speed bump or a precursor to further deceleration in growth.

Coming out of 2022, the catchphrase of the Q4 earnings reports from the hyperscalers was "customer workload optimization". This referred to the process by enterprise customers of scrubbing their cloud infrastructure bills for savings. This exercise introduced a headwind to revenue growth, offsetting the positive impact of new customer cloud migration projects and digital transformation efforts. This effect drove deceleration in Q4 revenue growth rates for AWS, Microsoft Azure and GCP.

Following disappointing results from the hyperscalers, Confluent was one of the first independent software infrastructure providers to report Q4 earnings on January 30th. Further complicating the picture, they preceded that report with an announcement of an 8% staff reduction on January 26th. That filing included top-level Q4 results. This flurry of news overshadowed two key points from the reports that subsequently became clear. For the full report, go to SoftwareStackInvesting.

With MongoDB's Q4 earnings report following most peers in the software infrastructure space, investors were bracing for decelerating revenue growth and a conservative guide for the upcoming year. MongoDB delivered just that. While Q4 notched a nice beat on revenue with growth of 36% annually, the preliminary guide for FY2024 came in at just 16% growth, almost 10% below analyst estimates.

Leading up to Snowflake's Q4 FY2023 earnings report, investors felt insulated from the risk of a low revenue guide for the full year. This concern had been abated in the Q3 report, as management blunted a reduced Q4 revenue guide with a preliminary estimate that FY2024 would deliver product revenue growth of 47%. During the Q3 earnings call, this had the immediate effect of propping up the lagging after-hours stock price.

After enjoying several years of hypergrowth, Datadog's revenue outlook for this year reflects a substantial slowdown. The challenge for investors is to discern whether annual growth in the mid-20% range is the new norm for Datadog or reflective of headwinds from the broader pullback in IT spend. For the complete review, check out the blog: https://softwarestackinvesting.com/datadog-ddog-q4-2022-earnings-review/

Cloudflare's Q4 FY2022 earnings report was much anticipated by the market. Like other software infrastructure companies with their fiscal Q4 aligned to the calendar year, investors received their first firm view of guidance for not just the current quarter, but also the full year of 2023. Given trends that I discussed in a prior post, results from the hyperscalers pointed to further deceleration in cloud utilization as a consequence of workload "optimization" by customers. As the hyperscalers generally only project results a quarter forward, investors lack a clear signal as to when optimization headwinds might abate. A few software companies reported in the interim, providing some support for a view that software infrastructure demand might level out over the full year.

Over the last two weeks, we received earnings results from the three hyperscalers - AWS, Google Cloud Platform and Microsoft Azure. Additionally, several software companies reported, providing another view of trends in software infrastructure and developer tooling. If that wasn't enough, various economic reports and a Fed meeting were mixed in. I won't cover the macro developments, beyond commenting on how they influenced market performance during the period and exacerbated the market's reaction.

ServiceNow has evolved over the last ten years from a specialized ITSM provider to a full-featured low code platform with ready-made solutions for a number of common enterprise business functions. If you were to believe the often hyperbolic CEO, ServiceNow will become the only software platform needed by enterprises to address digital transformation. While their product expansion has been impressive, I think their scope will land somewhere in between.

Okta has undergone a lot of change over the last two years. In 2020, the company was considered the leading independent provider of IAM (Identity and Access Management) services, enjoying great brand recognition and rapid growth. They had achieved strong penetration in the workforce identity space and were tracking to extend their reach into customer identity. Okta had labelled their product category as the Identity Cloud and attributed an estimated TAM of $55B (which they have further increased to $80B). They were well positioned to consolidate this new market segment around solutions to manage identity for both enterprise organizations and application developers.

Confluent stock recently bounced off its 52 week low, yet still trades under the closing price from 2022. This is in spite of posting strong results in their Q3 report in early November, which drove an 11% after-hours pop. More broadly, Confluent is part of a basket of companies that provide enterprises with software infrastructure and services to power their digital experiences. Entering 2023, we see pressure on this basket, associated with concerns around the durability of growth. This effect, along with lingering headwinds from the path of interest rates and macro volatility, has ratcheted down expectations for the software infrastructure basket.

At their Analyst Day in September, the leadership team set an ambitious growth target for $2B in revenue by FY2025. As we are halfway through Elastic's FY2023, this represents roughly a 2x increase in revenue within 2.5 years. When the leadership team presented the model for this target, they projected a revenue CAGR of 36% to reach it. That would represent an acceleration from the current growth rate in the low 30% range.