This article was originally published on Forbes on Dec 10, 2020,11:25pm ESTForbes on Dec 10, 2020,11:25pm EST

In this analysis, we review the recent earnings reports from Zoom Video, Okta, Snowflake, Crowdstrike, ZScaler and Elastic.

Zoom Video Q3 Earnings

Zoom Video provided a nearly flawless earnings report for the first full quarter that followed initial work-from-home orders. The company reported lower-than-expected churn and market-leading growth on both an annual and quarterly basis. Notably, margins were thinner on both a YoY and QoQ basis due to free accounts. Regardless, it's hard to find fault with Zoom Video's current level of profitability in relation to other tech growth stocks (outlined below).

Strong forward guidance also provides a glimpse into Zoom's traction as the company expects revenue growth to continue at a similar rate year-over-year and also quarter-over-quarter. Revenue grew 367% in Q3 with customers that have more than 10 employees growing 485% year-over-year.

Quarterly revenue is at $777 million or a $3 billion run rate – or 500% growth from FY2019 revenue. Quarterly revenue beat the top-end of guidance at $690 million with the company reporting "lower-than-expected" churn. Customers generating more than $100,000 in trailing 12-months revenue grew 136% year-over-year for an increase of more than 300 customers compared to Q2.

The blend of Zoom Video having virality across consumers from its freemium model combined with enterprise is the company's strength strategically as the competitors do not have the virality component. In Q3, customers with more than 10 employees represented 62% of revenue with net dollar expansion rate of 130%. Globally, Zoom exhibits strong growth, as well, with revenue from APAC and EMEA growing 629% year-over-year.

Gross margins were a weakness in the report at 68.2% compared to 82.9% last year and 72.3% last quarter. The company is providing the service for free to many users including K-12 schools during the pandemic. From my perspective, the temporary margin hit in exchange for virality and establishing consumer behavior is a good trade-off.  

Adjusted operating margins improved year-over-year but were slightly down quarter-over-quarter at 37.4%. Adjusted EPS was $0.99 which exceeded guidance by $0.25. RPO totaled $1.6 billion, up 215%, from $517 million year-over-year which is a strong sign the growth will continue. The company ended Q3 with $1.9 billion in cash (nearly unheard of for a tech growth company at this stage).

Guidance for the next quarter is in the range of $806 million to $811 million with adjusted earnings of $0.77 to $0.79 EPS. Fiscal year guidance is for revenue of $2.57 billion to $2.58 billion, representing 314% year-over-year growth (currently company is in Fiscal Year Q3 2021 and the fiscal year ends next quarter). The adjusted operating income for FY2021 is forecast to be $865 million to $870 million for nearly 900% growth and equal to $2.85 to $2.87 EPS.

The Gartner report that Zoom Video references canbe found here. The bigger revelation is not that Zoom Video is listed as a leader but that Gartner forecasts only 25% of enterprise meetings will take place in-person compared to 60% today. The analyst firm also predicts that 74% of companies plan to shift to more remote work — (keyword here is more – not entirely shift)

Source: Gartner (2020)

The interesting piece about the chart above is that Zoom Video leads enterprise players Microsoft and Cisco but is also in a wide lead for consumer. The consumer traction may be Zoom's biggest tailwind as consumer behavior will be hard for a competitor to change.

The strengths that Gartner sees include zoom's user-centric design, service reliability and flexible consumption model. Zoom is also moving into verticals, such as healthcare and financial services, to add to its popularity in education.

The primary risk for Zoom Video is security. As I've stated a few times, it's common for an enterprise to not offer end-to-end encryption as the employer prefers to access the data on their employees. In response to the criticism, Zoom Video offers end-to-end encryption for accounts with more than 200 users.

In another Gartner report for Unified Communications-as-a-Service, Zoom appears for the first time due to the recent launch of Zoom Phone and receives a leadership position with its first mention in the UCaaS report. That's a significant entry. Zoom Video offers Zoom Phone at no additional charge and has secured a partnership with ServiceNow. The company is also partnered with Pinterest on hobbyist classes. Despite the Zoom Phone service being relatively new, it offers a 99.999% availability SLA target.

Source: Gartner (2020)

Visionary CEOs tend to better than competitors who lag because they have a vision for what the space will need next. We see many products rolling out of Zoom that challenge the way video conferencing is done today. As pointed out in the earnings call, Rakuten has partnered with Zoom for the broader UCaaS offering of Rooms and Phone. This is a leader in internet services with 1.4 billion members globally.

OnZoom is a product in beta that will help creators monetize fitness classes, concerts and music lessons. There is also an event discovery feature. Recently, Pinterest has announced a partnership to help creators on their platform reach a larger audience with Zoom.

Analysts on the recent earnings call seemed especially excited about Zoom's ability to sell into the Global 2K with international expansion being a large focus. From Rakuten's recent partnership, plus Lumen/Centurylink and Deutsche Telecom, these larger partnerships with tech providers are my favorite catalyst moving into next year. Essentially, they see Zoom as the best product available (and least threatening) to integrate for unified communications and voice. This is the best evidence that Zoom Video is not a fleeting pandemic stock as large telecommunications providers shift towards cloud.  

Zoom Rooms is a software-defined video conferencing system. Eric Yuan is likely tapping into his experience at Cisco as this will be one of the main competitors he takes on with this move to eradicate conference hardware.

The software-defined solution also extends to kiosks for virtual receptionists, will allow for voice control including an Alexa integration and advanced AWS console. The Smart Gallery will use AI to create a gallery-view of participants for hybrid workforces to where the viewpoint of the camera creates the best imaging possible and other whiteboard features are coming in 2021.

Okta

According to most standards, Okta's earnings report was solid and resulted in an uptick in the stock price. However, the growth has been flat for most of this year.

Revenue rose 42% to $217.4 million ahead of estimates for $202.7 million. Bookings (remaining performance obligations) are growing faster than revenue at 53% to $1.58 billion. Calculated billings were up 44% year-over-year. This was a re-acceleration of calculated billings from the previous quarters in FY2021 where the pandemic weighed on budgets.

The company is profitable on an adjusted basis with EPS of $0.04 and free cash flow of $41.6 million, up from $9 million a year ago. Highlights include a growing number of customers in the financial services sector and government.

The guidance was conservative at $221 million to $222 million, representing a growth rate of 32% to 33% year-over-year. The company is also guiding for an adjusted loss of $0.02 to $0.01 EPS. The fiscal year 2021 offered stronger guidance of 40% growth year-over-year for $822 million in revenue with adjusted EPS of $0.04 to $0.05.

According to the investors deck, the company has a combined addressable market of $55 billion across Workforce Identity and Customer Identity. The contribution margins at 70% for fiscal 2017 cohort analysis on page 14 was impressive. The net retention rate is 123% with adjusted gross margins of 78% and adjusted operating margins of 2.5% and free cash flow margins of 19%. The net retention rate saw a re-acceleration to its highest level in two years. Typical NRR is in the 119-121% range. Free cash flow margin was also its highest in two years.

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Total customer count was up 27% and annual contract value was up 34%. The current outlook for the company is 30-35% CAGR through FY 2024 and free cash flow margins in FY 2024 of 20-25%. The total number of $100,000 plus customers stands at 1780, an increase of 34%. The base of customers with annual contract value of greater than $500,000 grew 50%.

Okta's management pointed to three trends in driving business: Cloud and Hybrid IT, Digital Transformation and Zero Trust security. There is a partnership across Proofpoint, Netskope and CrowdStrike which is classified as a deep product integration for an enhanced product stack.

Okta was also recently introduced to the AWS marketplace and is the only identity vendor in the products for Control Tower, which allows for the management of more complicated AWS environments.

Notably, Okta was given a lower-ranking spot in the leader category of the 2020 Gartner Magic Quadrant for Identity and Access Management. One could argue too much attention is given to Gartner at times as Okta has been through a challenging and anomalous year. However, it should be noted that Okta was in a wide lead on the leader quadrant for 2019 and has been bumped down to equal standing with Microsoft and Ping Identity.

Snowflake

Snowflake grew 119% year-over-year to $159.6 million with remaining performance obligations of $927.9 million, or 240% year-over-year growth. Product revenue grew 115% year-over-year. The net revenue retention rate of 162% is impressive although other companies have exceeded this in their 6th year (Snowflake was founded in 2012 but was in stealth mode until 2014 when it began to work with customers).  

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Gross margins are between 58% to 63%, which it's normal for a cloud company to be lower than a SaaS company on margins. However, operating margins were negative (30%) with FCF margins of negative (23%). Probably the biggest issue that Snowflake faces are the sales and marketing costs. In the previous two quarters, they were near or exceeded total revenue and in this quarter they were about 90% of revenue at $134 million compared to the $159 million in revenue.

The issue here is the rapid growth is being paid for in sales and marketing dollars and could slow when the bottom line becomes prioritized. Growth marketing tactics like this can often skew the true growth rate of a company at the expense of the bottom line. When equilibrium is sought, the top line suffers (or the alternative is that profitability is a long way off). Oddly enough, the bleeding operating and FCF margins weren't mentioned by the analysts in the Q&A on the earnings call.

The bigger product announcements on the earnings call include Snowflake expanding from semi-structured to unstructured data (which will be helpful for machine learning), SnowPark which enables users to query in their language of choice (Java, Python, etc). The overarching goal is to consolidate workloads and meet the demand for data governance purposes.

The company issued forward guidance for FY 2021 of revenues between $538 million and $543 million for YoY growth of 113% to 115%. Margin will be decent for adjusted gross at 68% compared to negative (40%) operating margin and negative (18%) adjusted FCF margin.

Snowflake is a strong company. In my opinion, the valuation is a major risk and continues to be considering the high sales and marketing costs that are causing an imbalance between the top line and bottom-line growth. Net retention rate of 169% is impressive although is a consumption model and cannot be compared to SaaS.

CrowdStrike

CrowdStrike beat consensus estimates on both the top and bottom lines and raised Q4 guidance. Revenue grew 86% YoY, representing an 8% beat above Wall Street estimates. Subscription revenue increased 87% YoY while annual recurring revenue advanced 81% compared to a year ago. The company also achieved its most impressive quarter ever in terms of profitability, earning $0.08 per share on the bottom line. This was CrowdStrike's third consecutive quarter of positive EPS and its highest total yet. Free-cash-flow margin increased to 33% and gross margin improved to 76%.

Here is how CrowdStrike's FCF margin compared last quarter:

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In the quarter, CrowdStrike added 1,186 net new subscription customers, representing growth of 85% YoY. CrowdStrike also continues to drive new module adoption in existing customers, as 44% of the company's subscription customers have adopted five or more modules versus 39% in the previous quarter. Management guided for $248M in revenue for Q4 (+63% YoY), representing a 7% raise above expectations.  

This was an impressive quarter for CrowdStrike both in terms of increased usage of existing customers and the addition of new customers. As previously mentioned, CrowdStrike continues to excel in its ability to drive new module adoption with 61% of the company's customers adopting 4 or more modules versus 52% in the same period a year ago. 

In the quarter, CrowdStrike announced the addition of three new modules to the Falcon Platform, covering cloud security posture, dark web threats, and incident response investigations. The Falcon Platform now encompasses 16 modules in total. 

CEO George Kurtz highlighted new module adoption as a key to the company's growth strategy in its Q3 Earnings Call: "I'm pleased to announce that in Q3 we reached a new milestone with 22% of our subscription customers having adopted six or more modules. Driving adoption of our expanding module lineup is a keystone to our growth strategy as it increases the strategic value we provide to customers, which also translates to higher retention rates." 

This quarter indicates CrowdStrike is successfully executing on this growth strategy.     

The second key to CrowdStrike's growth hinges on its ability to add new customers, a metric that increased 85% YoY in Q3. One key customer win in the quarter was signing Target, which displaced Symantec and deployed Falcon completely across its footprint in less than 10 days. 

CEO George Kurtz discussed the marquee win in its earnings call: "a win with Target that highlights how our single agent cloud-native architecture, intuitive console, and rapid re-bootless deployment capabilities continue to be significant differentiators for us. Target Corporation was looking to rapidly move away from Symantec and transition to a single agent cloud solution that could be deployed in days, not months or years." 

Zscaler

ZScaler announced Fiscal Q1 2021 results that easily cleared analysts' expectations. Revenue growth accelerated to 52% YoY, which represents the company's third consecutive quarter of growth acceleration.

Adjusted billings growth increased 64% YoY, far surpassing the consensus expectation calling for 39% growth. This beat was driven in part by a record quarter of seven-figure deals. The company's net retention rate of 122% advanced from 120% last quarter and 119% the quarter before. Non-GAAP EPS of $0.14 was 8 cents better than expectations while the company also announced an impressive 30% FCF margin. Non-GAAP operating margin of 14% far exceeds the consensus of 2.9%.

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The acceleration in growth coupled with the record quarter of operating profits and free cash flows makes this one of the best quarters ZScaler has announced.

CEO Jay Chaudry discussed the three main factors that allowed his company to outperform this quarter: "One, building on our growing traction with large enterprises. We closed a record number of seven-figure ACV deals… two, our optimized go-to-market engine is driving significant velocity… Last year, we doubled down on our investment in our sales organization. These efforts are also bearing fruit in two big ways. One, our newly hired sales reps are contributing at a faster pace. And two, our sales productivity is higher than a year ago, despite a high percentage of ramping sales reps… Three, the power of our Zero Trust Exchange platform is resonating with CxOs."

Looking ahead, ZScaler believes that the strong business momentum they have exhibited in the last several quarters will continue. Management raised guidance over 5% for FQ2, now expecting $147M of revenue at the midpoint (+45% YoY). Management attributed the strong FQ1 in part to stronger than expected deal activity and expects these trends to continue into the next quarter. 

In its FQ1 Earnings Call, CEO Jay Chaudry touted the company's position amongst a growing opportunity: "I believe in the current challenging environment and in the post-COVID economy, Zscaler will be the go-to-platform for vendor consolidation, cost-saving, increased user productivity, and better cyber protection.."

Elastic

Elastic announced strong FQ2 earnings on 12/2. Total revenue increased 43% YoY, representing an 11% beat above consensus. Total billings grew 42% YoY while SaaS revenue increased 81% versus the same period a year ago. The company's losses also improved significantly, with non-GAAP EPS of -$0.03 coming in 17 cents better than expected. Non-GAAP operating loss improved to -$1.9 million, representing a -1% operating margin versus -10% projected. Gross margins also came in better than expected with 77% versus a consensus of 75%. FCF margin was -13% for the quarter. 

Subscription revenue totaled 93% of Elastic's total revenue in the quarter, with 45% of total revenue coming from outside the US. Management views this geographical distribution as a strength in the company's business model. Elastic's net retention rate ticked down several points from last quarter but still remained modestly above 130%. Elastic now has a total of 12,900 subscription customers with 650 of those (5%) having annual contract values exceeding $100K. 

At the start of its fiscal year, Elastic's management discussed how COVID-19 would likely create headwinds to calculated billings for a couple of quarters and that they would then see gradual improvement beyond that. 

In its FQ2 Earnings Call, management confirmed that the first half of fiscal 2021 played out as expected. The company has observed longer sales cycles and many customers are looking to conserve cash as spending patterns have not recovered to pre-COVID levels. Management updates its outlook for the second half of the year, noting that they expect the trends they observed in the last two quarters to continue in the next two: "given the global situation with the pandemic, our current assumption is that the mixed demand environment that we experienced in the first half will continue for the rest of the fiscal year. Previously we were expecting the environment to gradually improve during the second half." Still, Elastic's strong execution in the first half of its fiscal year gave management the confidence to increase its guidance for the next quarter. Management raised guidance 4% for FQ3, now expecting $146M of revenue (+29%). However, the company expects EPS to decline to -$0.15 on a -7% operating margin for FQ3.     

Elastic's management ultimately expects the demand environment to return to pre-COVID levels in fiscal 2022, which would align with the summer of 2021. While the company is certainly facing some headwinds due to the pandemic, the digital transformation has provided tailwinds that have allowed growth to remain strong. Management expects these tailwinds to continue beyond the rest of their fiscal year: "the tailwinds of cloud and our solutions adoption position us well for the rest of this fiscal year and beyond."

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

I had the privilege of joining Tim Beyers and Brian Feroldi on The Motley Fool podcast earlier this month.  In the hour-long interview, we cover topics such as big tech, my research process, tech valuations, and we also cover a number of individual stocks including Twilio, Bandwidth, Zoom, Facebook, and Palantir.

The discussion starts off with big tech and why I believe Google Cloud Platform has missed an opportunity to catch up to Microsoft Azure and Amazon Web Services on cloud IaaS. With that said, all three players are aggressively pursuing edge computing and how to combine the compute and storage from hypescalers with the low latency and speed offered by 5G connectivity. This is primarily being accomplished through partnerships between the hyperscalers and telecoms which are best described as “frenemies.”

Later in the interview, we dive into my research process and how I go about finding the top tech stocks.  One example of a trend that I think the market is misunderstanding is telehealth. The market is pricing the opportunity as a covid tailwind rather than pricing and evaluating the opportunity for early innings – especially as AI will merge with telehealth in the near future.

We also chat about what’s on everyone’s mind – which is whether tech valuations are in a bubble right now. I give some guidelines on what I consider to be attractive valuations versus unattractive valuations in the tech space and I break this down by annual revenue growth rates. 

Towards the end of the interview, they ask what is the one stock I’d buy right now and the one stock I’d sell right now. My answers include a lesser-known stock in the OTT advertising space that I am bullish on.

You can access my full interview with the Motley Fool podcast below

Access the interview here:

Interview timestamps:

0:00 – Introduction

4:40 – Discussion on Big Tech

7:40 – Does Google (GOOGL) need Google Cloud Platform to work out for the company to do well?

13:40 – Opinion on Fastly (FSLY)

19:20 – What is your process on researching stocks?

22:40 – Is it time to start talking about Salesforce (CRM) as a big tech company?

23:00 – Discussion about Twilio (TWLO)

28:00 – Thoughts on Bandwidth (BAND)

30:00 – How much potential does Twilio (TWLO) have?

35:00 – Is tech in a bubble right now?

37:00 – Guidelines on valuations for tech stocks

38:45 – What do you consider high growth, medium growth, and low growth?

39:30 – Discussion about Zoom (ZM) and its long-term outlook post-COVID

42:30 – What does product-market fit mean?

45:45 – 1 stock to buy and 1 stock to sell

49:50 – Top public stock pick in telehealth

50:55 – What private tech investors do you like to follow?

52:20 – Current state of hybrid cloud versus multi-cloud and the future of hybrid cloud

53:20 – Discussion about Datadog (DDOG) and the partnership with Microsoft Azure

56:40 – Thoughts on Palantir (PLTR)

In the 3rd part of my Q3 earnings analysis, I review reports from Zoom Video, Okta, Snowflake, Crowdstrike, ZScaler and Elastic.

Zoom Video

Zoom Video provided a nearly flawless earnings report for the first full quarter that followed initial work-from-home orders. The blend of Zoom Video having virality across consumers from its freemium model combined with enterprise is the company’s strength strategically as the competitors do not have the virality component. In Q3, customers with more than 10 employees represented 62% of revenue with net dollar expansion rate of 130%. Globally, Zoom exhibits strong growth, as well, with revenue from APAC and EMEA growing 629% year-over-year.

However, gross margins were a weakness in the report at 68.2% compared to 82.9% last year and 72.3% last quarter. The company is providing the service for free to many users including K-12 schools during the pandemic. From my perspective, the temporary margin hit in exchange for virality and establishing consumer behavior is a good trade-off.

Okta

According to most standards, Okta’s earnings report was solid and resulted in an uptick in the stock price. However, the growth has been flat for most of this year.

Revenue rose 42% to $217.4 million ahead of estimates for $202.7 million. Bookings (remaining performance obligations) are growing faster than revenue at 53% to $1.58 billion. Calculated billings were up 44% year-over-year. This was a re-acceleration of calculated billings from the previous quarters in FY2021 where the pandemic weighed on budgets.

The company is profitable on an adjusted basis with EPS of $0.04 and free cash flow of $41.6 million, up from $9 million a year ago. Highlights include a growing number of customers in the financial services sector and government.

Snowflake

Snowflake grew 119% year-over-year to $159.6 million with remaining performance obligations of $927.9 million, or 240% year-over-year growth. Product revenue grew 115% year-over-year. The net revenue retention rate of 162% is impressive although other companies have exceeded this in their 6th year (Snowflake was founded in 2012 but was in stealth mode until 2014 when it began to work with customers).

Gross margins are between 58% to 63%, which it’s normal for a cloud company to be lower than a SaaS company on margins. However, operating margins were negative (30%) with FCF margins of negative (23%). Probably the biggest issue that Snowflake faces are the sales and marketing costs. In the previous two quarters, they were near or exceeded total revenue and in this quarter they were about 90% of revenue at $134 million compared to the $159 million in revenue.

CrowdStrike

CrowdStrike beat consensus estimates on both the top and bottom lines and raised Q4 guidance. Revenue grew 86% YoY, representing an 8% beat above Wall Street estimates. Subscription revenue increased 87% YoY while annual recurring revenue advanced 81% compared to a year ago. The company also achieved its most impressive quarter ever in terms of profitability, earning $0.08 per share on the bottom line. This was CrowdStrike’s third consecutive quarter of positive EPS and its highest total yet. Free-cash-flow margin increased to 33% and gross margin improved to 76%.

In the quarter, CrowdStrike added 1,186 net new subscription customers, representing growth of 85% YoY. CrowdStrike also continues to drive new module adoption in existing customers, as 44% of the company’s subscription customers have adopted five or more modules versus 39% in the previous quarter.

Zscaler

ZScaler announced Fiscal Q1 2021 results that easily cleared analysts’ expectations. Revenue growth accelerated to 52% YoY, which represents the company’s third consecutive quarter of growth acceleration.

Adjusted billings growth increased 64% YoY, far surpassing the consensus expectation calling for 39% growth. This beat was driven in part by a record quarter of seven-figure deals. The company’s net retention rate of 122% advanced from 120% last quarter and 119% the quarter before. Non-GAAP EPS of $0.14 was 8 cents better than expectations while the company also announced an impressive 30% FCF margin. Non-GAAP operating margin of 14% far exceeds the consensus of 2.9%.

Elastic

Elastic announced strong FQ2 earnings on 12/2. Total revenue increased 43% YoY, representing an 11% beat above consensus. Total billings grew 42% YoY while SaaS revenue increased 81% versus the same period a year ago. The company’s losses also improved significantly, with non-GAAP EPS of -$0.03 coming in 17 cents better than expected. Non-GAAP operating loss improved to -$1.9 million, representing a -1% operating margin versus -10% projected. Gross margins also came in better than expected with 77% versus a consensus of 75%. FCF margin was -13% for the quarter.

Subscription revenue totaled 93% of Elastic’s total revenue in the quarter, with 45% of total revenue coming from outside the US. Management views this geographical distribution as a strength in the company’s business model. Elastic’s net retention rate ticked down several points from last quarter but still remained modestly above 130%. Elastic now has a total of 12,900 subscription customers with 650 of those (5%) having annual contract values exceeding $100K.

Read the Full Article at Forbes

This article was originally published on Forbes on Dec 3, 2020,11:03pm EST

Google Cloud certainly has the technical chops and engineering talent to compete with Microsoft Azure and Amazon’s AWS when it comes to cloud infrastructure, edge computing – and especially inferencing/training for machine learning models. However, Google may lack focus due to Search and YouTube being the main revenue drivers. This is seen from the company’s inability to ignite revenue growth in the cloud segment during a year when digital transformation has been accelerated by up to six years due to work-from-home orders.

In this analysis, we discuss why Google (Alphabet) may have missed a critical window this year for the infrastructure piece. We also analyze how Microsoft directed all of its efforts to successfully close the wide lead by AWS. Lastly, we look at how all three companies will bring the battle to the edge in an effort to maintain market share in this secular and fiercely competitive category.

Cloud IaaS Overview:

The three leading hyperscalers in the United States have diverse origins. Amazon found itself serendipitously holding server space year-round that it could rent out and was first to market by a wide lead. Amazon continues to release customization tools and cloud services for developers at a fast clip and this past week was no exception.  

Microsoft’s roots in enterprise created a direct path to upsell on-premise and become the leader in hybrid. The majority of the Fortune 500 is on Azure as they want seamless security and APIs regardless of the environment.

Google is one of the largest cloud customers in the world due to its search engine and mass-scale consumer apps, and therefore, is often first to create cloud services and architectures internally that later lead to widespread adoption, such as Kubernetes. Machine learning is another piece where Google was one of the first to require ML inference for mass-scale models.

Despite all three having very talented teams of engineers and various areas of strength, we see AWS maintain its lead and Microsoft Azure firmly hold the second-place spot. Keep in mind that Azure launched one year after Google Cloud yet has 3X the market share and is growing at a higher percentage.

CANALYS

Google Cloud grew two percentage points from 5% to 7% since 2018 while Azure grew four percentage points from 15% to 19% in the same period. In the past year, Google Cloud saw a 1% gain compared to Azure’s 2% gain, according to Canalys.

Azure is under Intelligent Cloud but the company does break down the growth rate which was 48%. Although Google Cloud Is not specifically broken down, the Google Cloud segment grew 45% year-over-year compared to Microsoft Azure up 48% year-over-year.

Amazon Web Services is growing at 29%, which is substantial considering the law of large numbers. In the past two quarters, Google Cloud reported 43% year-over-year growth and 52% in the quarter before that. Microsoft has seen a slightly less deceleration from 51% and this is down from the 80%-range almost two years ago.

The key thing here is that when Microsoft held the percentage of market share that GCP currently holds, Azure was growing in the 80-90% range. This is the range we should be seeing from Google Cloud if the company expects to catch up to Azure.

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In 2020, the term “digital transformation” has become a buzzword with cloud companies seeing up to six years of acceleration. Nvidia is a bellwether for this with triple-digit growth in the data center segment in both Q2 and Q3. Despite this catalyst, Google has lagged the category in Q2 and Q3 in terms of both growth and percentage share of market. If there were any year that Google Cloud could pull ahead, it should have been this year.

Alphabet has emphasized that GCP is a priority and the company will be “aggressively investing” in the necessary capex. However, the window of opportunity was wide open this year and aggressive investments would ideally have been allocated during the years of 2017-2018 to stave off Azure’s high-growth years with 80-90%.

Google is Capable but Lacks Focus

There is no argument that Alphabet is an innovator within cloud and a leader in its own right. Across public, private and hybrid cloud, containers are used by 84% of companies and 78% of those are managed on Kubernetes – which has risen in popularity along with cloud-native apps, microservices architectures and an increase in APIs. Kubernetes was first created by Google engineers as the company ran everything in containers internally and this was powered by an internal platform called Borg which generated up to 2 billion container deployments a week. This led to automated orchestration rather than manual and also forced a new architecture away from monolithic as server-side changes were required.

Kubernetes also helps with scaling as it allows for scaling of the container that needs more resources instead of the entire application. Microservices dates back to Unix, while Kubernetes, the automation piece around containers, is what Google engineers invented before releasing it to the Cloud Native Foundation for widespread adoption.

Just as Google was one of the first to need automated orchestration for containerization of cloud-native apps, the company was also one of the first to require low-power machine learning workloads. The compute intensive workloads were running on Nvidia’s GPUs for both training and inferencing until Google made their own processing unit called Tensorflow (TPUs) to perform the workload at a lower cost and higher performance.

Performance between TPUs and GPUs is often debated depending on the current release (A100 versus fourth-generation TPUs is the current battle). However, the TPU does have an undisputed better performance per watt for power-constrained applications. Notably, some of this comes with the territory of being an ASIC, which is designed to do one specific application very well whereas GPUs can be programmed as a more general-purpose accelerator. In this case, the benchmarks where TPUs compete are object detection, image classification, natural language processing and machine translation – all areas where Google’s product portfolio of Search, YouTube, AI assistants, and Google Maps, for example, excels.

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Notably, TPUs are used internally at Google to help drive down the costs and capex of its own AI and ML portfolio and they are also available to users of Google’s AI cloud services. For example, eBay adopted TPUs to build a machine learning solution that could recognize millions of product images.

Unless Google releases an internal technology as open-source, it won’t be adopted by the competitors. This is where Nvidia’s agnosticism becomes a positive as it’s universally used by Amazon, Microsoft, Google —- and Alibaba, Baidu, Tencent, IBM and Oracle. Meanwhile, TPUs create vendor lock in which most companies want to avoid in order to get the best capabilities across multiple cloud operators (i.e. multi-cloud). eBay is the exception here as the company needs Google-level object detection and image classification.

In a similar vein of Google being early to the company’s internal requirements, BigQuery is also a superior data warehouse system that competes with Snowflake (I cover Snowflake with an in-depth analysis here). BigQuery has a serverless feature that makes it easier to begin using the data warehouse as the serverless feature removes the need for manual scaling and performance tuning. Dremel is the query engine for BigQuery.

BigQuery has a strong following with nearly twice the number of companies as Snowflake and is growing around 40%. Due to AWS being a first mover and having a large cloud IaaS market share, Redshift has the biggest market presence but growth is nearly flat at 6.5%.

Point being, Google has important areas of strength and first-hand experience – whether it’s in data analytics, machine learning/inference or cloud-native applications at scale. Google’s search engine and other applications are often the first globally to challenge current architectures and inferencing capabilities.

However, as we see in the contrast between Google and Microsoft in the most recent earnings calls, Google has a hard time prioritizing cloud over the bigger revenue drivers. Meanwhile, Microsoft has a no holds barred approach with one, singular focus: Azure.

Q3 Earnings Calls

The most recent earnings calls from both Microsoft and Google could not have carried more contrast. Google focused primarily on search and YouTube while adding towards the last half of the call that GCP is where the majority of their investments and new hires were directed. Notably, one analyst wondered if the capex investments would eat at margins and produce enough returns. 

Microsoft, on the other hand, held an hour-long call that was nearly all-Azure including what the company is doing right now to capture more market share, a laundry list of large enterprises coming on board and strategic partnerships to strengthen its second place standing. The company’s beginning, middle and end was Azure and cloud services.

Here is a preview of how the two opened:

Thanks for joining us today. This quarter, our performance was consistent with the broader online environment. It's also testament to the investment we've made to improve search and deliver a highly relevant experience that people turn to for help in moments big and small. We saw an improvement in advertiser spend across all geographies, and most of verticals, with the world accelerating its transition to online and digital services. In Q3, we also saw strength in Google Cloud, Play and YouTube subscriptions.

This is the third quarter we are reporting earnings during the COVID-19 pandemic. Access to information has never been more important. This year, including this quarter showed how valuable Google's founding Product Search has been to people. And importantly, our products and investments are making a real difference as businesses work [indiscernible] and get back on their feet. Whether it's finding the latest information on COVID-19 cases in their area, which local businesses are open, or what online courses will help them prepare for new jobs, people continue to turn to Google search.

You can now find useful information about offerings like no contact delivery or curbside pickup for 2 million businesses on search and maps. And we have used Google's Duplex AI Technology to make calls to businesses and confirm things like temporary closures. This has enabled us to make 3 million updates to business information globally.

We know that people's expectations for instant perfect search results are high. That's why we continue to invest deeply in AI and other technologies to ensure the most helpful search experience possible. Two weeks ago, we announced a number of search improvements, including our biggest advancement in our spelling systems in over a decade. A new approach to identifying key moments and videos, and one of people's favorites hum to search which will identify a song noticed based on the humming. -Sundar Pichai, Q3 2020 Earnings CallSundar Pichai, Q3 2020 Earnings Call

Compare this to the tone for Microsoft’s earnings call …

We’re off to a strong start in fiscal 2021, driven by the continued strength of our commercial cloud, which surpassed $15 billion in revenue, up 31% year-over-year. The next decade of economic performance for every business will be defined by the speed of their digital transformation. We’re innovating across the full modern tech stack to help customers in every industry improve time to value, increase agility, and reduce costs.

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Now, I’ll highlight examples of our momentum and impact starting with Azure. We’re building Azure as the world’s computer with more data center regions than any other provider, now 66, including new regions in Austria, Brazil, Greece, and Taiwan. We’re expanding our hybrid capabilities so that organizations can seamlessly build, manage, and deploy their applications anywhere. With Arc, customers can extend Azure management and deploy Azure data services on-premise, at the edge, or in multi-cloud environments.

With Azure SQL Edge, we’re bringing SQL data engine to IoT devices for the first time. And with Azure Space, we’re partnering with SpaceX and SES to bring Azure compute to anywhere on the planet.

Leading companies in every industry are taking advantage of this distributed computing fabric to address their biggest challenges. In energy, both BP and Shell rely on our cloud to meet sustainability goals. In consumer goods, PepsiCo will migrate its mission critical SAP workloads to Azure. And with Azure for Operators, we’re expanding our partnership with companies like AT&T and Telstra, bringing the power of the cloud and the edge to their networks. Just last week, Verizon chose Azure to offer private 5G mobile edge computing to their business customers.  -Satya Nadella, Fiscal Q1 2021 Earnings (Calendar Year Q3 2020)Fiscal Q1 2021 Earnings (Calendar Year Q3 2020)

The calls continue in a similar manner with Microsoft making it clear they have their entire weight behind cloud while Google must continue to cater to its largest revenue drivers – search and consumer. The main takeaway we get from the call is that Google is investing in GCP rather than a takeaway of market dominance or growth. Here are a few examples:

As we’ve told you on these calls, given the progress we’re making, and the opportunity for Google Cloud in this growing global market, we continue to invest aggressively to build our go-to-market capabilities, execute against our product roadmap, and extend the global footprint of our infrastructure … And another: An obvious example is Cloud. We do intend to maintain a high level of investment, given the opportunity we see. That includes the ongoing increases in our go-to-market organization, our engineering organization, as well as the investments to support the necessary capex. So, hopefully, that gives you a bit more color there. And, also here … And the point that both Sundar and I have underscored is that we are investing aggressively in Cloud, given the opportunity that we see. And, frankly, the fact that we were later relative to peers, we're encouraged, very encouraged, by the pace of customer wins and the very strong revenue growth in both GCP and Workspace. We do intend to maintain a high level of investment to best position ourselves. And I kind of went through some of those items, the go-to-market team, the engineering team, and capex. And so we describe this as a multi-year path because we do believe we're still early in this journey.

The question remains if aggressively investing will have the same impact after the digital transformation has been accelerated by up to six years. Nobody could have predicted covid and the work-from-orders but we see from the growth rates on large revenue bases that AWS and Azure were better positioned to answer the demand.

Edge Computing: No rest for the weary

The race for cloud IaaS dominance is only beginning and the hyperscalers are not resting on their laurels as they compete for the edge. Major strategic partnerships are being struck with telecom companies to break open new uses cases for decentralized applications and increased connectivity. Google mentioned Nokia in their earnings call while Microsoft mentioned AT&T, Verizon and Telstra. Amazon also has partnerships with Verizon and Vodafone. (For brevity sake, you can assume every telecom company is either partnered or will be partnering with multiple hyperscalers for edge computing).

Here is a breakdown of the buildout and how these strategic partnerships plan to profit from 5G. The result will be new use cases, such as remote surgery, autonomous vehicles, AR/VR and a significant number of internet of things devices that aren’t feasible with 4G and/or with the current centralized cloud IaaS servers.

AWS Wavelength:

Amazon’s edge computing technologies are being rapidly built-out. For example, Wavelength is being embedded in Vodafone’s 5G networks throughout Europe in 2021 after being in beta for two years. This will provide ultra-low latency for application developers enabled by 5G. On Vodafone’s end, they have developed multi-access edge computing (MEC) to fit both 4G and 5G networks to process data and applications at the edge. This lowers processing time from about 50-200 milliseconds to 10 milliseconds. Amazon is also expanding its Local Zones to offer low-latency in metro areas from L.A. to about a dozen cities in 2021.

In order to support its retail business, AWS built out 200 points of presence where serverless processing like Lambda can run. The network latency map will be enhanced by telco partnerships who have about 150 PoPs per telco.

Microsoft Azure with Edge Zones:

Azure has the largest global footprint across the cloud providers. Where AWS has been the long-standing developer preference, Microsoft is the C-suite/enterprise preferred company across the Fortune 500. Microsoft’s goal will be to move compute closer to end users and to offer Azure-hosted compute and storage as a single virtual network with security and routing.

Microsoft excelled at hybrid as a strategy for taking market share (which I also detailed as the investment thesis for my position in Microsoft after the company missed Q3 2018 earnings and prior to winning the JEDI contract). Azure Edge Zones extends the current hybrid network platform to allow distributed applications to work across on-premise, edge data centers both public and private, Azure IaaS both public and private. This allows the same security and APIs to work seamlessly across these hybrid environments. The overarching performance will attempt to combine the range of compute and storage capabilities of Azure with the speeds/low-latency of the edge.

Google Cloud with Global Mobile Edge Cloud (GMEC):

Google is also partnering with telecom companies such as AT&T to deploy Google hardware inside AT&T’s network edge to run AI/ML models and other software for 5G solutions. Similar to AWS and Azure, the goal is to open up new use cases for industries, such as retail, manufacturing and transportation.

Anthos for Telecom is a Kubernetes-orchestrated infrastructure that can be deployed anywhere including an AWS cluster. In this way, the strategy for Google continues to amplify its strengths which is containerized network functions to merge edge and core infrastructure. This helps with decentralized applications and could potentially compete with “network slices” to where AT&T could potentially use local breakouts to offer a cloud service tier in a few years from now.

Conclusion:

We’ve seen Google build some of the best products for developers in terms of automating microservices and container-orchestration with Kubernetes and also ASIC chips (TPUs) that compete with the likes of Nvidia. I’m not betting against Google’s talented engineers by any means, rather I’m simply observing that the infrastructure piece is leaning towards more of a duopoly at this time. Cloud is expensive on a capex level, so if Google doesn’t find its footing, the margins driven by ads could take a hit in the near-term.

Who will lead software and AI applications is impossible to predict (and when) as the main competitors will be hundreds (if not thousands) of startups. With that said, I personally own Amwell because Google is a backer and I think health care is an example of a vertical where Google’s experience with data can deliver a serious competitive edge. To be clear, Alphabet may have an advantage with AI/ML software whereas this analysis is about the infrastructure. Perhaps there will be a catalyst in the future for Google Cloud to take more share but the strategy is not evident at this time.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

In our latest Forbes report, we discuss why Google (Alphabet) may have missed a critical window this year for the infrastructure piece. We also analyze how Microsoft directed all of its efforts to successfully close the wide lead by AWS. Lastly, we look at how all three companies will bring the battle to the edge in an effort to maintain market share in this secular and fiercely competitive category.

Google Cloud grew two percentage points from 5% to 7% since 2018 while Azure grew four percentage points from 15% to 19% in the same period. In the past year, Google Cloud saw a 1% gain compared to Azure’s 2% gain, according to Canalys.

Azure is under Intelligent Cloud but the company does break down the growth rate which was 48%. Although Google Cloud Is not specifically broken down, the Google Cloud segment grew 45% year-over-year compared to Microsoft Azure up 48% year-over-year.

Amazon Web Services is growing at 29%, which is substantial considering the law of large numbers. In the past two quarters, Google Cloud reported 43% year-over-year growth and 52% in the quarter before that. Microsoft has seen a slightly less deceleration from 51% and this is down from the 80%-range almost two years ago.

The key thing here is that when Microsoft held the percentage of market share that GCP currently holds, Azure was growing in the 80-90% range. This is the range we should be seeing from Google Cloud if the company expects to catch up to Azure.

In 2020, the term “digital transformation” has become a buzzword with cloud companies seeing up to six years of acceleration. Nvidia is a bellwether for this with triple-digit growth in the data center segment in both Q2 and Q3. Despite this catalyst, Google has lagged the category in Q2 and Q3 in terms of both growth and percentage share of market. If there were any year that Google Cloud could pull ahead, it should have been this year.

Alphabet has emphasized that GCP is a priority and the company will be “aggressively investing” in the necessary capex. However, the window of opportunity was wide open this year and aggressive investments would ideally have been allocated during the years of 2017-2018 to stave off Azure’s high-growth years with 80-90%.

This analysis is about the infrastructure, not software. Perhaps there will be a catalyst in the future for Google Cloud to take more share but the strategy is not evident at this time.

Read the full article on Forbes

This article was originally published on Forbes on Nov 12, 2020,09:01pm ESTForbes on Nov 12, 2020,09:01pm EST

Roku

Roku reported Q3 earnings on November 5th. The 73% year-over-year revenue growth the company announced was 23% above consensus expectations. Gross profit rose 81% YoY while gross margin rose 216 basis points in total to 47.6%. 

Roku added 2.9M active accounts in the quarter (+43% YoY). Total streaming hours increased by 0.2 billion hours over the last quarter to 14.8B (+54% YoY), while ARPU grew 20% YoY to $27.

Roku was a beneficiary of the rebound in ad spend, as the company saw Q3 monetized video ad impressions grow 90% YoY vs. 50% YoY growth last quarter. Roku is anticipating that Q4 revenue growth will likely be in the mid-40% range, similar to the growth rate seen in the last few holiday seasons. Per the earnings call, the company is being cautious about holiday spending with this forecasted guidance. 

ROKU shares briefly hit all-time highs immediately following the announcement of these results.

Brands like DraftKings are shifting budgets especially as TV sports have been canceled and delayed. Roku also pointed towards CPG brands as a large driver for ad revenue in the current quarter.

We have got brands like DraftKings, for example, who is a big sports spender, had to shift budgets out of TV as sports were canceled and delayed. Has moved a significant portion of their budget into OTT.

In the earnings call, management felt confident the migration from linear TV would be a long-lasting trend after COVID.

We are not going back to the way it was to be clear. I mean, I think, COVID did — COVID triggered a lasting durable change in how CMOs and marketers are thinking about their TV ad spend. In Q3, we saw a 17% drop in linear viewing, Roku was up 54%, 92% of Roku cord-cutters are very satisfied with their decision to cut the cord and aren't planning to go back.

So I really think this is a one-way transfer function. We don’t go back to the older spending patterns, because the audience isn’t there, marketers need to follow the audience into OTT. And they stay, they stay because of the enhanced capabilities.

Roku also tackled the question of Wal-Mart and Comcast partnering. The CEO reiterated that Roku is the #1 TV operating system and software operating system in the United States and now Canada with a world-class team of software engineers. He also emphasized that Walmart is a large partner with Roku and has carried many Roku OEMs: 

In terms of Walmart, I will just say a few words. I mean, Walmart is a big retailer, a very strong partner of Roku’s. We have a great relationship with them. They sell millions of Roku players a year. They sell millions of Roku TVs for various Roku OEMs, including TCL, Hisense, RCA, Philips, JVC.

We build — we help them build on branded, which is their house brand, Roku TVs, smart TVs, and that’s a business that’s been growing extremely well for them. So, it’s a great partnership and it’s a long-standing partnership, and we have put a lot of work into making sure that it stays strong.

Square

Square announced blowout Q3 results with huge beats on both the top and bottom lines. Non-GAAP EPS of $0.34 beat consensus expectations by $0.18. The company saw revenue grow 140% YoY to $3.03B, beating the consensus estimate by $950M or 46%. 

Gross payment volume of $31.7B was 6% above expectations. In total, Square saw gross profit rise 59% YoY, while Cash App gross profit soared 212% YoY. 

In the quarter, the number of average daily transacting Cash App customers nearly doubled from the same period last year. Square did not provide guidance for Q4, but noted in its shareholder letter that the trends they observed in Q3 remained strong through October.

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Square’s Seller Ecosystem revenue grew 5% YoY as regions began to reopen. More impressive was the growth of Square’s Cash App Ecosystem, which saw an increase of 23% in daily active users and 574% YoY growth in revenue. 

Bitcoin revenue for Square grew 11x last year’s total, but even excluding Bitcoin transactions, Square grew Cash App revenue 174% YoY this quarter. This is an acceleration from the 140% Cash App growth (excluding bitcoin revenue) Square recorded last quarter, and 98% growth previous to that. 

Square is focused on expanding Cash App’s utility beyond peer-to-peer payments, CEO Jack Dorsey remarked in the company’s shareholder letter: “We remain focused on increasing daily utility for our Cash App customers to products beyond peer-to-peer payments, which helps drive higher engagement and monetization.” 

Square’s investments into increasing Cash App engagement continue to pay off as the company’s Cash App Ecosystem displayed an acceleration in growth across the board this quarter. 

BETH.TECHNOLOGY

Jack Dorsey noted that Square is positioned to benefit in both segments moving forward:

“We continue to believe that our Seller and Cash App ecosystems are well-positioned to benefit from the acceleration of secular shifts, such as omnichannel commerce, contactless payments, and digital wallets for consumers.” 

The company did not give Q4 guidance due to uncertainties yet did discuss what they have seen so far through Q4. Square's Seller Ecosystem saw a modest acceleration from Q3 in October:

“Seller GPV was up 8% year over year, which improved modestly compared to year-over-year results in the third quarter.” 

Cash App has seen a modest decrease in transaction volume in October, which management attributes to the end of government stimulus programs and unemployment benefits:

“Gross profit growth in October moderated compared to the third quarter, driven by a decrease in transaction volume per active customer. We believe this was partly a result of the end of government stimulus programs and unemployment benefits at the end of July, as stored funds in Cash App have decreased since July.”.

The Trade Desk

The Trade Desk announced Q3 results that easily cleared analysts’ expectations. Revenue grew 32% YoY, beating consensus estimates by 19%. Non-GAAP EPS of $1.27 was a big beat on the consensus bottom-line expectation of $0.45. The company noted that it saw Connected TV grow over 100%, Mobile video spend grow 70% and Audio spend grow 70%. 

Management issued an upbeat outlook for Q4, expecting $289M in revenue at the midpoint vs. expectations of $255.1M. At the midpoint of this estimate, The Trade Desk is expecting roughly 34% YoY revenue growth in Q4. TTD shares traded over $700 for the first time immediately following the announcement of these results. 

Most impressive from TTD’s report was exceeding 100% YoY growth in their Connected TV segment. CEO Jeff Green remarked in the company’s press release that COVID has accelerated advertising innovation across the board:

"So far in 2020, we've seen several years of advertising disruption and innovation compressed into a few months. As a result, advertisers have become more deliberate and data-driven with every advertising dollar." 

In the Q3 earnings call, Green talked more about how companies are adapting data-driven measurement strategies for justifying marketing budgets:

“We recently surveyed more than 200 top advertisers, around 85% of them said they are under new pressure from CFOs to justify marketing spend and to measure against business goals.” 

Despite The Trade Desk’s beat, the company did not report the numbers that Snap or Pinterest did (32% growth versus 50-60% growth). TTD’s stock is trading at a valuation that has been historically very hard to sustain in ad-tech.

Rarely, does ad-tech trade over 20 forward price-to-sales even during high-growth periods. Not only is The Trade Desk well exceeding the mean but is trading roughly 200% higher than peers even though Roku, Pinterest and Snap had a better current quarter and are forecasting stronger forward guidance. 

The Trade Desk stock trading 2x more expensive than ad-tech peers that reported much higher revenue growth. – YCHARTS

TTD’s forward PE Ratios (not pictured) is also outsized at 168 compared to Facebook’s 30 forward PE Ratio. Facebook’s PE Ratio has never exceeded 119 even during its high-growth quarters of 100%+ growth and/or with low EPS (law of large numbers). 

Facebook’s current P/S has also never exceeded 20 even during its high-growth quarters. 

This is despite The Trade Desk facing headwinds with Apple’s changes to IDFA. Apple extended the iOS update from September to an undetermined time “early next year.”

On September 3rd, Apple delays IDFA changes until early next year – @BETH_KINDIG

Although the risks are hard to quantify right now, most advertising experts are in agreement this will affect the entire mobile ad industry on iOS. Facebook has stated they would shut down Audience Network as most ad exchanges need some kind of identifier for targeting and attribution. Here is a great write-up from mobile analyst Eric Seufert on how this could affect ad prices. 

The Trade Desk has stated only 10% of its inventory uses the IDFA but has made no clarifications on how it will run mobile attribution and measurement without an identifier, whether that’s Apple’s or their own. There are efforts from a collective federation of ad companies to use encrypted emails, although there is no guarantee would Apple would allow this on iOS and Safari even if the ad industry agrees to pursue this method. ATS requires users to authenticate which is another unproven factor in the work flow.

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Overall, the risk is an unknown and we will get real answers it looks like “early next year.” For The Trade Desk, it’s a risk investors need to be aware of.  Notably, publisher segments can help augment targeting but this will come from the supply-side.

Datadog announced strong Q3 results and an upside outlook that cleared analyst expectations. The company grew revenue 61% YoY to $155M, representing a 7% beat above consensus estimates.  

The company grew customer count by 38% in the quarter versus consensus expectations of 32% and added 92 new customers with over $100K ARR (+52% YoY), slightly above the consensus estimate of 90. 

Datadog

In Q3, Datadog recorded its 13th consecutive quarter with a dollar-based net retention rate exceeding 130%. Operating margin improved to 9% in the quarter versus expectations of 0.6%, while gross margin improved 3% to 79%.  

Q4 guidance was issued for $163M in revenue at the midpoint (+43% YoY) which was 5% above the consensus outlook. Datadog shares initially sold off as much as 14% on these results, but the stock pared its losses to close trade on Wednesday. The stock rebounded Thursday and is now up over 11% off Wednesday’s lows.  

In its Q3 earnings call, Datadog’s CEO Olivier Pomel commented on the recovery in usage trends the company observed after a weak Q2. “Throughout the quarter, usage growth of existing customers was robust which was a return to more normalized levels after slower usage expansion in Q2…the pace of usage growth in Q3 was broadly in line with pre-COVID historical levels.”  

After a period of cloud spend conservation among Datadog’s enterprise customers in Q2, the company added a record amount of ARR in the quarter. The company managed to do so profitably, as operating income, cash flow and FCF all came in above expectations. 

Notably, Datadog’s CAC payback period decreased to ~12 months from ~18 months sequentially despite adding over 400 more customers in Q3 versus Q2.  

The ~12 month payback period recorded in Q3 is more in line with pre-COVID levels, as last quarter is looking more like an outlier given the aforementioned headwinds the company faced in Q2.

Datadog’s platform has proven to be easily adaptable and sticky for enterprise customers migrating to the cloud, as evidenced by the increasing number of existing customers using more Datadog products. CEO Olivier Pomel remarked on this in the company’s earnings call when he said: “our platform strategy continues to resonate and win in the market. As of the end of Q3, 71% of customers are using two or more products, which is up from 50% last year. Approximately 20% of customers are using four or more products which is up from only 7% a year ago.”  

CEO Olivier Pomel also commented on the partnerships Datadog announced in Q3 with Microsoft Azure and Google Cloud Platform, noting that the flow of revenue from these partnerships will not be immediate: “there's not going to be an immediate impact, but we see that as being potentially meaningful contribution in the mid to long-term.” 

The partnerships with Microsoft Azure and Google Cloud Platform that Datadog announced in the quarter, along with the existing alliance with Amazon Web Services, validates the company’s leadership in cloud-native-observability and establishes its collaborative relationship with the world’s top public hyperscalers. Over the long term, Datadog expects that these partnerships will become meaningful sources of revenue growth.  

Looking ahead to Q4, Datadog is confident the rebound in usage trends the company observed in Q3 will continue.  CFO, David Obstler alluded to this expectation in the conference call: “Throughout the quarter, we saw usage growth that was more in line with pre-pandemic historical levels. The trend was broad-based and sustained throughout the quarter. This provides us with confidence that what we experienced in Q2 was a transitory optimization effort that were related to the challenging macro environment.”  

With the normalization of customer usage trends and secular tailwinds related to digital transformation and cloud migration, management continues to believe that Datadog is very well positioned to capture a “large and growing long-term market opportunity.” 

JFrog

JFrog announced earnings for Q3 in its first quarter as a public company. The company grew revenue 40% YoY, beating consensus expectations by 3%. JFrog also announced Non-GAAP EPS of $0.05, beating expectations by 5 cents. 

Gross margins came in at an impressive 83% while FCF margin improved to 25% in Q3. For Q4, JFrog expects $41.4M in revenue at the midpoint vs. consensus of $40.52M. The stock has initially sold off up to 10% on the results, as the 40% revenue growth represents a deceleration from the 46% growth recorded last quarter. Even after today's sell-off, FROG still trades at approximately 30x 2021 revenue, which remains among the highest valuations in the software industry.

Here is what the Analysts ratings for the recent string of IPOs and where JFrog ranks:

 Here is what the Analysts ratings for the recent string of IPOs and where JFrog ranks – BETH.TECHNOLOGY

When factoring in how fast some software names are growing, we see that JFrog still remains relatively expensive. With the deceleration, it’s likely we see an adjustment to JFrog’s valuation over the next quarter.

Growth Adjusted EV/2021 Revenue – BETH.TECHNOLOGY

We will be covering earnings again next week so consider giving us a follow.

Disclosure: Beth Kindig owns shares of Roku and Datadog, may purchase shares of Square in the near future and and she has owned shares of The Trade Desk and may again in the future. The information contained herein is not financial advice.

In the second part of my Q3 2020 tech earnings review series, I covered Roku, Square, The Trade Desk, Datadog and JFrog.

Roku

Roku reported Q3 earnings on November 5th. The 73% year-over-year revenue growth the company announced was 23% above consensus expectations. Gross profit rose 81% YoY while gross margin rose 216 basis points in total to 47.6%.

Roku added 2.9M active accounts in the quarter (+43% YoY). Total streaming hours increased by 0.2 billion hours over the last quarter to 14.8B (+54% YoY), while ARPU grew 20% YoY to $27.

Roku was a beneficiary of the rebound in ad spend, as the company saw Q3 monetized video ad impressions grow 90% YoY vs. 50% YoY growth last quarter. Roku is anticipating that Q4 revenue growth will likely be in the mid-40% range, similar to the growth rate seen in the last few holiday seasons. Per the earnings call, the company is being cautious about holiday spending with this forecasted guidance.

Square

Square announced blowout Q3 results with huge beats on both the top and bottom lines. Non-GAAP EPS of $0.34 beat consensus expectations by $0.18. The company saw revenue grow 140% YoY to $3.03B, beating the consensus estimate by $950M or 46%.

Gross payment volume of $31.7B was 6% above expectations. In total, Square saw gross profit rise 59% YoY, while Cash App gross profit soared 212% YoY.

In the quarter, the number of average daily transacting Cash App customers nearly doubled from the same period last year. Square did not provide guidance for Q4, but noted in its shareholder letter that the trends they observed in Q3 remained strong through October.

Square’s Seller Ecosystem revenue grew 5% YoY as regions began to reopen. More impressive was the growth of Square’s Cash App Ecosystem, which saw an increase of 23% in daily active users and 574% YoY growth in revenue.

The Trade Desk

The Trade Desk announced Q3 results that easily cleared analysts’ expectations. Revenue grew 32% YoY, beating consensus estimates by 19%. Non-GAAP EPS of $1.27 was a big beat on the consensus bottom-line expectation of $0.45. The company noted that it saw Connected TV grow over 100%, Mobile video spend grow 70% and Audio spend grow 70%.

Management issued an upbeat outlook for Q4, expecting $289M in revenue at the midpoint vs. expectations of $255.1M. At the midpoint of this estimate, The Trade Desk is expecting roughly 34% YoY revenue growth in Q4. TTD shares traded over $700 for the first time immediately following the announcement of these results.

Datadog

In Q3, Datadog recorded its 13th consecutive quarter with a dollar-based net retention rate exceeding 130%. Operating margin improved to 9% in the quarter versus expectations of 0.6%, while gross margin improved 3% to 79%.

Q4 guidance was issued for $163M in revenue at the midpoint (+43% YoY) which was 5% above the consensus outlook. Datadog shares initially sold off as much as 14% on these results, but the stock pared its losses to close trade on Wednesday. The stock rebounded Thursday and is now up over 11% off Wednesday’s lows.

In its Q3 earnings call, Datadog’s CEO Olivier Pomel commented on the recovery in usage trends the company observed after a weak Q2. “Throughout the quarter, usage growth of existing customers was robust which was a return to more normalized levels after slower usage expansion in Q2…the pace of usage growth in Q3 was broadly in line with pre-COVID historical levels.”

JFrog

JFrog announced earnings for Q3 in its first quarter as a public company. The company grew revenue 40% YoY, beating consensus expectations by 3%. JFrog also announced Non-GAAP EPS of $0.05, beating expectations by 5 cents.

Gross margins came in at an impressive 83% while FCF margin improved to 25% in Q3. For Q4, JFrog expects $41.4M in revenue at the midpoint vs. consensus of $40.52M. The stock has initially sold off up to 10% on the results, as the 40% revenue growth represents a deceleration from the 46% growth recorded last quarter. Even after today’s sell-off, FROG still trades at approximately 30x 2021 revenue, which remains among the highest valuations in the software industry.

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