News of the Week (May 30 - June 2)

SoFi; Salesforce; SentinelOne; Lululemon; Zscaler; Meta Platforms; Amazon; Progyny; Match Group; Earnings Round-Up; Macro; Portfolio

Today’s Piece is Powered by our Friends at Long Term Mindset:

1. SoFi (SOFI) -- Student Loans

As part of the new debt ceiling agreement, the Federal Student Loan Moratorium will (finally) come to an end. As always, we don’t care about the politics of this decision, but care deeply about the potential impact it could have on SoFi’s business. And the potential impact is exciting. I brainstormed and collaborated with @DataDInvesting on Twitter. He’s a very smart guy, a hard worker and a great writer. We’d recommend that you check him out when you get the chance.

There are two pieces of good news stemming from this development: Demand recovery and more balance sheet flexibility. Starting with demand, SoFi’s largest business segment heading into the moratorium was student lending. It was also by far its most profitable business. During the moratorium, volumes have been running anywhere between 10% and 20% of 2019 levels while private loan payments continued. The company will not immediately ramp volumes back up to 2019 numbers considering how far the federal funds rate has risen (higher rates = less refi demand). Still, it’s expecting a meaningful ramp to expeditiously recoup the majority of that business. How?

We have to remember that college students are initially underwritten with virtually no credit history and at the very beginning of their credit building journeys. As federal loans season, these borrowers routinely build income streams and establish a track record making them less risky customers. This frees private loan vendors like SoFi to profitably offer more compelling rates to borrowers as the risk erodes. That does become more challenging in today’s rate environment vs. 2019, but the firm still sees a large chunk of existing federal loan volume as ripe for refinancing at lofty contribution margins.

During the moratorium, SoFi was still paid on its existing loans, but federal loan borrowers with high interest debt had no incentive to refinance with SoFi. Why would they pay a lower interest rate today when they can just pay nothing at all. Most wouldn’t and so SoFi’s volumes plummeted.

It maintained growth despite this (incredible actually) as it seamlessly pivoted to personal lending and financial services. This powered brisk compounding and operating leverage despite this vitally important student segment being on pause. That pause is now over and so the refinancing incentive is back. Why does this matter? Let’s explore.

Income Statement Impact:

In SoFi’s recent student loan lawsuit, it estimated the revenue impact from the pause to be around $350 million over the last 10 quarters. That equates to an annual revenue impact of $140 million or 9% of its 2022 revenue. This was very high profit business for the company with the contribution margin likely in the 60% range. Let’s assume 55% just to be safe for $77 million in annual contribution profits. This conservative estimate would have equated to a 43% boost to the company’s 2022 contribution profit had the moratorium not been in place.

Let’s calculate the impact with an alternative approach. Over the last few quarters of normal student refi demand, about 60% of SoFi’s total loan volume was from that segment. It was doing around $100 million in quarterly lending revenue at that time. Personal loans carry higher gross and net yields (see image below) than do student loans, so we’ll safely assume this 60% volume proportion equates to a 40% revenue proportion (based on the limited public historical data we have available on SoFi). This gets us to $160 million in 2022 revenue and $88 million in annual contribution profits.

Method 2 does not consider the rising rate environment in while method 1 does. It’s hard to see student loans jumping back to 60% of its lending activity in the current interest rate environment and with how large the personal segment has gotten. HOWEVER, method 1 ignores SoFi’s bank charter impact and its ability to now hold loans on the balance sheet in a more profitable manner and over a longer time period than it could before. So? It’s quite easy to see a scenario where method 2 even looks a bit conservative over time as it harvests more interest income, originates more volume, taps into more capital market buyers and enjoys near future rate cuts to act as a refi demand accelerant. There’s vast pent-up demand for refinancing created by the moratorium; that pent-up demand can now finally begin to unwind.

Along those lines, we’ve seen some estimates citing the incremental revenue impact being closer to $320 million with $176 million in contribution profit (or roughly double what we are assuming). This lofty estimate scrapes assumptions from 2019 when macro was far easier than it is now and when gain on sale margins were likely more appealing. Yes, it can hold loans for longer at higher net yields with the charter, but we still find $320 to be aggressive. For that reason paired with general uncertainty, we prefer taking a more conservative (ok, pessimistic) approach (margin of safety is a wonderful thing).

Regardless of what the exact incremental dollar amounts will be from this development, it is clear that the impact will be quite positive and material to SoFi. We’re excited to see the data flow in as payments start back up in the second half of the year and federal borrowers are pushed to seek more favorable rates (especially in today’s macro backdrop). Some could argue that borrowers will wait for rates to fall more before seeking a refinance. That will be true in the occasional instance, but two counter arguments there. First, the typical borrower is not paying attention to the fed funds rate and its projected near-term path. They just want a cheaper loan. Secondly, refi applications with SoFi are inexpensive and easy to complete. Borrowers can just refinance over and over again if the rate becomes even more compelling or they can elect a variable rate refi. Given that, there is no incentive to wait.  The time value of money tells us they’ll be driven to secure savings as soon as possible.

Cross-Selling:

As a company born to refinance student loans, SoFi’s brand association still presides heavily within that product vertical. Some consumers who were shopping for a loan in Q4 2019 simply don’t know how many products SoFi has added to its bundle over the past 3 years.

As these shoppers return to the market, a large chunk of them will do so through SoFi. These consumers entering the ecosystem for the first time in 3 years will be amazed at how much the financial offerings have expanded. Many who’ve had a positive SoFi experience (i.e. seeing their student loan payments drop like a rock) will surely be motivated to use and purchase additional SoFi products. This cross-selling revenue would incur virtually zero added customer acquisition cost and would feed its margin profile further.

Balance Sheet Impact:

As revenues and profits from the segment ramp, SoFi will have a few options on what to do with the newly originated loans on its balance sheet.

Hold the Balance Sheet Stable in Size and Make-up:

First, it can keep the balance sheet and student loan position at the same size and make-up that it is today. The recovering demand will free SoFi to recycle the existing student loans more expediently on its balance sheet and to replace them with newer, higher coupon student loans to harvest more interest and servicing income. For context, its student loan average coupon has risen by more than 10% over the last 12 months while default rates have improved. High credit quality and coupons rising faster than benchmark yields is a perfect combination… and it continues to boost its coupon faster than rates rise. This inherently makes newer originations more profitable and capital market demand stable. SoFi’s credit recipe is exactly what most capital market buyers seek and is how SoFi has found consistent demand across credit cycles.

All of this can happen while it leans on its banking charter to enjoy lower cost of funding and higher net yields associated with holding.

We were somewhat concerned about the demand for SoFi student loans originated with a fed funds rate at 0% and if these loans carried attractive enough net yields to motivate capital market demand. That concern ignored a key reality: Through this entire moratorium, SoFi has been consistently selling off student loans into capital markets (as private student loan payments continued). The loans it currently holds are predominately newer originations with a lower proportion of pre-pandemic volume. Pre-charter, it was selling at about the rate of origination but has since elected to hold a larger proportion of less seasoned loans with higher coupons. There is not some massive base of student credit sitting on its balance sheet from a 0% fed funds era -- and so unrealized losses on sales should be minuscule while new capital market demand should be stable.

Furthermore, its hedging program to remove downside rate risk means it really doesn’t need favorable capital market terms for these deals to make sense. Cash flows have already been “locked in.” It likely will get favorable terms as it has consistently found in the past for some of the loans. It may, however, have a tough time netting typical gain-on-sale margins with its remaining 2021 originations. Again, with the hedging program that’s completely fine.

Hold the Balance Sheet Stable in Size and Change the Make-up:

In SoFi’s mission of ROE optimization, it could also elect to replace a chunk of its $5 billion in student loans with a larger proportion of personal loans. These personal loans boast superior net interest margins when held vs. student loans (see chart above). Unlike the student product, SoFi can easily continue profitably tapping into 6% warehouse debt to fund personal credit thanks to the 13%+ coupon rate that it fetches (vs. 5%-10% for SoFi’s variable & fixed student products). This is possible, but we’d argue it would have already been doing this if it didn’t want to hold as many student loans via the stable capital market demand.

More Aggressively Grow the Balance Sheet:

Alternatively, it could also elect to grow the balance sheet and simply hold as much as it responsibly can. With its nearly $20 billion in funding capacity and $16 billion in loans, there is still room for the balance sheet to grow at today’s capital structure. This wiggle room exists while rapid deposit growth feeds it more cheap cost of capital to fuel originations. How big can the balance sheet responsibly get right now with SoFi’s current business? That answer is quite subjective, but its excess liquidity and conservative leverage ratios both clearly point to it not being near maximum today. While student loans are lower net yield than personal, they’re still profitable to hold, still very low delinquency and still bolster SoFi’s equity return ratios.

Reality Will Be a Combination:

What will SoFi do? In our view, it will likely be a combination of these paths. The balance sheet will inevitably continue to grow. At the same time, it would be silly not to accept robust gain on sale margins while recycling seasoned loans with higher coupons as rates remain elevated.

The effect will likely be gradual balance sheet growth, but still frequent capital market activity to ensure that growth is as optimal (safe & profitable). Capital market usage will also obviously rely on macro and residual demand. When loan re-purchase demand is weak (as it is now), SoFi will skew towards a holding bias. As demand recovers over time (like in 2020-2021), that bias will erode. In SoFi’s path to becoming a top ten banking institution over the next 5 years, the balance sheet will have to exponentially grow. As my colleague at @DataDInvesting points out, this expansion will require a near term inflection of GAAP net income to maintain conservative tier 1 capital ratios and flexibility. Fortunately, that’s coming. And in its path to realizing that top 10 goal while delivering attractive return metrics, it will need to grow responsibly. Balance.

2. Salesforce (CRM) -- Q1 2024 Earnings Review

a)  Results

• Beat revenue estimates by 1% & beat guidance by 1%.

• Beat Current Remaining Performance Obligation (cRPO) guidance by 0.8%.

• Missed $0.27 GAAP EPS estimates by $0.07 & missed $0.25 guidance by $0.05.

• Beat EBIT estimates by 8.6%.

• Beat $1.61 EPS estimates & its identical guide by $0.08.

FCF = Free Cash Flow

b) Full Year Guidance Updates

• Reiterated revenue guidance which barely missed estimates.

• Raised GAAP EBIT guide by 5.4%. Raised its GAAP EBIT margin assumption from 10.8% to 11.4%.

• Raised EBIT guide by 3.7% & beat EBIT estimates by 3.4% and raised its EBIT margin assumption from 27% to 28%.

• Raised OCF guide by 0.8% & missed OCF estimates by 0.9%.

  • Raised FCF growth guide by 100 bps to 16.5% Y/Y growth.

• Raised $2.60 GAAP EPS guide by $0.08 & beat GAAP EPS estimates by $0.07.

• Raised $7.13 EPS guide by $0.29 & beat EPS estimates by $0.25. $7.13 would represent lofty 36% Y/Y EPS growth.

Reiterated plans to reach a 30% non-GAAP EBIT margin by Q1 of next year.

Next quarter guidance was slightly ahead on revenue & comfortably ahead on profit.

c) Balance Sheet

• Share count fell 1% Y/Y via $2.1 billion in buybacks. Buybacks - stock comp = $1.36 billion for the quarter. This is its 3^rd straight quarter of share count shrinkage. Salesforce continues to expect to offset all dilution with buybacks and committed to stock comp falling below 9% of sales this year. It was 8.4% of sales this quarter.

• Nearly $14B in cash & equivalents.

• $9.4B in debt ($181M current).

d) Call & Release Highlights

Demand Context:

• Revenue rose 13% Y/Y on an FX neutral basis.

• The revenue beat was credited to its core business.

• Slack revenue rose 20% Y/Y; Tableau revenue rose 12% Y/Y; MuleSoft revenue rose 26% Y/Y.

• The Data Cloud is now its fastest growing cloud ever.

• Revenue in the Americas was a notable weak spot as its large book of tech and financial service business remained hampered by Macro. Latin America, Brazil, Italy and Switzerland were notable geographic bright spots.

• 8 of its industry specific clouds grew ARR over 50%.

Margin Context:

• Sales & marketing as a % of revenue fell by a full 600 bps Y/Y.

• A restructuring charge hit GAAP EBIT by 860 bps.

On Restructuring & Cost Cutting:

Last quarter, Salesforce embarked on an operational overhaul of its business to identify excess resources and inefficiencies within operations. The margin expansion seen this quarter was credited to these actions. It continues to “scrutinize every dollar of investment and transform every corner of the company.” During the quarter, it removed complexity to accelerate and improve its go-to-market strategy.

Its restructuring will be 2-phased. Phase one is now largely complete while phase two will be implemented shortly once Bain has finished its consulting overview of the business. While R&D spend will remain a main focus, S&M and G&A cost buckets should provide meaningful leverage going forward.

Macro:

Demand for longer term, larger deals continues to be soft as added deal scrutiny and elongated sales cycles persist. That was most noticeable with smaller clients and is reflected in the forward guide via a 100 bps growth headwind from less professional service demand as. For this reason, cRPO was a bit lower than what some analysts had modeled but this was related to shorter term deals being signed amid poor macro. CrowdStrike, Okta and countless other software names told a similar story. This is why annual revenue guidance was not raised despite the strong performance.

“Our customers can contract for Professional Services in 2 ways, either on a time and materials basis, which is typically for smaller projects, or on a fixed fee basis. For purposes of cRPO, we only include projected business from fixed fee deals. One of the things that we are seeing right now is more customers are choosing to contract on a time and materials basis, which is not included in our cRPO.” -- CFO Amy Weaver

On AI:

With its tight OpenAI partnership, Salesforce debuted a slew of generative AI-infused product upgrades during the quarter. First is an upgrade to its Einstein offering called Einstein GPT. As a reminder, Einstein is Salesforce’s AI tool to augment the Salesforce CRM platform. It automates data sifting and insight gleaning to reveal valuable patterns to guide decisions. It also comes with language tools to translate and analyze text to uncover sentiment among other things. These tools existed before the generative AI wave, but now they’re getting an upgrade thanks to it. Einstein GPT allows Salesforce clients to plug into language models (including OpenAI’s) to make workflows more productive, intuitive, conversational and automated. It features a low code tool set to reduce the barrier for non-experts to build applications on top of. It also boasts expert-level tools to build more complex models and use cases.

If Einstein is peanut butter, its data cloud is jelly. To train models, companies rely on vast and organized databases which Salesforce provides. In CEO Marc Benioff’s words, it provides a “real time intelligent data lake to bring together all customer data in 1 place.” This aggregation translates to more frequent and direct feeding of data and insight to train models to enhance model efficacy.

While cool models and automation are both valuable and fun, trust and security is a prerequisite for motivating large clients to embrace generative AI. That’s where the salesforce trust layer comes into play. This layer effectively gates data and permissions to ensure proper access and authorizations. It automatically grounds company data to ensure open language learning models are not storing and using impermissible data. This ensures generative AI can be enjoyed without sacrificing authoritative posture and computer hygiene; more utility without more risk. The trust layer is also instrumental at solving for complex, dynamic global regulatory compliance like Europe’s GDPR.

More Salesforce Products being augmented with OpenAI’s and Anthropic’s (recent venture investment) language learning models:

• SlackGPT is leveraging the platform’s “treasure trove” of data to give every company and employee their own AI assistant. GPT models and Anthropic are now natively integrated into the tool.

• Tableau is its acquired data visualization platform to help build context-rich patterns and insights from a firm’s data. This allows firms to plug in spreadsheets and so much more to automate the intuitive, utility building organization of that information. TableauGPT morphs this process into a more conversational, lower code flow to lower the skill barrier for usage.

• It invested $250 million into a new AI venture fund to support startups.

• Within its own apps and developer ecosystem, generative AI is already boosting coder productivity by 20%-30% with Microsoft Copilot-type tools.

Customer Wins:

• Northwell Health added the Data Cloud to its Salesforce products to join the Health Cloud, Tableau and more.

• Landed Paramount, Lenovo, Vodafone, Discover, Alaska Air, Siemens, Spotify, NASA and the U.S. Department of Agriculture.

• MuleSoft (its integration layer for apps and data sources) is now #1 in integration market share per IDC for the first time.

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3. SentinelOne (S) -- Earnings Review

As a direct competitor to CrowdStrike in endpoint security, it’s interesting and relevant to compare these two companies to gauge how each is performing vs. one another. CrowdStrike seems to be pulling ahead of SentinelOne. Here’s a link to our CrowdStrike review published earlier in the week to compare.

a) Results

• Missed revenue estimates by 2.3% & missed guidance by 2.6%.

• Beat GPM estimates by 180 bps & beat guidance by 160 bps.

• Beat EBIT loss estimates by 9.4% & beat guidance by 9.6%.

• Met -$0.37 GAAP EPS estimates. Beat -$0.15 EPS estimates by $0.02.

ARR = Annual Recurring Revenue

b) Full Year Guidance Updates

• Lowered revenue guide by 6.4% & missed estimates by 6.7%.

• Raised EBIT guide _by 6.4% & beat estimates by 6.8%.

• ARR growth in the mid 30% range vs. previous estimates of 47%. This is being impacted by an ARR recognition accounting change (discussed below). That plus general demand weakness was the source of the large revision lower.

  • Note that CrowdStrike is expecting nearly identical ARR growth this year at far larger scale and with far better margins. I’m a biased CrowdStrike shareholder, but worth noting.

Importantly, this disappointment takes a more “prudent” forecasting approach and assumes further macro deterioration throughout the year. It assumes worsening pipeline conversion and worsening usage trends. This could turn out to be the kitchen sink quarter and needs to be for this investment to find its footing.

Next quarter guidance was weak across the board while it reiterated plans to reach breakeven EBIT by calendar 2024.

c) Balance Sheet

• Stock compensation rose from 40.3% of sales to 41.6% of sales Y/Y (and vs. 36.6% Q/Q). This is borderline egregious and needs to fall a lot more quickly than it’s falling.

• There are no liquidity concerns here despite the lack of cash flow. It has $700 million in cash & equivalents with another $400 million in long term investments. It can burn cash at this rate for several years and be fine and its margins also continue to improve to diminish the burn rate.

• Share count rose 6.9% Y/Y. Too high.

d) Call & Release Highlights

Demand Silver Linings:

• 88.9% 2-yr revenue CAGR vs. 105% Q/Q & 116% 2 Qs ago.

• Win rates remain “stable” with “no pricing pressures.” Over and over again it was asked about competition and was adamant that the competitive environment is stable.

• Gross retention remained “stable.”

• Net revenue retention is still at a lofty 125%+.

• Emerging modules represented 33% of its bookings as its cloud offering grew by triple digits Y/Y.

• It added a new Fortune 10 client and now has 5 of them. Impressive.

• 917 customers w/$100K+ in ARR vs. 905 Q/Q & 591 Y/Y.

Margin Context:

• R&D rose 20% Y/Y; S&M rose 64% Y/Y; G&A rose 48% Y/Y. Ideally for a growth company like this, R&D would be a heftier expense bucket with the other two being smaller.

• Scale and data usage efficiency drove the gross margin expansion.

• It talked up how its margins are expanding faster than the competition. That’s easy to do when your Y/Y FCF margin comp is -70% vs. 20%+ for these companies it’s comparing itself to.

ARR Recognition, Poor Macro and Execution:

SentinelOne changed its ARR calculation methodology during the quarter. For whatever reason, it was lumping usage and consumption-based revenue into the RECURRING revenue figure. Whoever made that decision should be immediately fired. It has now stripped that piece out of the number. During this review, it uncovered “historical recording inaccuracies” within ARR calculation that it has now fixed. Not good, Mr. CFO. All in all, these factors reduced ARR by $27 million or 5% of its total book of business. There was no impact to revenue or bookings from this change, but it did impact net revenue retention (NRR).

While Palo Alto, Fortinet and CrowdStrike all cited tough yet stable macro conditions, SentinelOne discussed these headwinds worsening significantly during the quarter. This is despite its somewhat bullish comments during the period at investor conferences. Budget scrutiny worsened, sales cycle elongated, lower usage from existing customers continued, deals shrank, pipeline conversion deteriorated and these factors (plus the accounting change) led to it revising its full year growth outlook down to 41% Y/Y. It’s also dealing with aforementioned softness in data usage trends as clients streamline their storage requirements to cut costs by “filtering out a lot of the data they don’t feel is as useful.” We heard something very similar from Snowflake within its usage-based model. The team also blamed disappointment on deal slippage (especially with larger deals), but if that were the main reason, the annual guide would not have been as severely affected.

Finally, leadership talked about poor execution on its inability to close a few large deals during the quarter. Loved the honesty here.

Cost Cutting:

It’s Meta’s year of efficiency… it’s Amazon’s year of efficiency… it’s SentinelOne’s year of efficiency… it’s everyone’s year of efficiency. Amid the soft selling and demand environment, SentinelOne is looking to trim its cost base. That action will include firing 5% of its staff and cutting variable costs wherever it can. It is fully committed to continued rapid operating leverage regardless of macro (good considering how far margins have to do). These moves will shave $40 million from its total costs. That $40 million in added net income would have made the company FCF positive this quarter (with a massive stock comp add back).

Purple AI:

SentinelOne launched its own generative AI product called Purple AI. This is very similar to CrowdStrike’s newly announced Charlotte AI. The product infuses new layers of automation and inference into security analyst workflows to free them to cover larger portions of security data and enterprise environments. Per CEO Tomer Weingarten, it upgrades security analysts to “superhuman levels” by giving them the capacity to protect more workloads. Beginner analysts can now interact with SentinelOne’s complex infrastructure with conversation to rapidly secure answers to pressing threat inquiries. Purple AI steers these analysts to the right results and the right corrective action. The tool is built on SentinelOne’s singular security data lake to ensure all relevant info is available to be leveraged across all attack surfaces. Again… very similar to Charlotte AI.

Cloud:

SentinelOne and Wiz completed their integration for the new cloud partnership. Now when SentinelOne finds a cloud threat, it queries relevant insight from Wiz about the make-up of that asset and any vulnerabilities/misconfigurations to expedite remediation. This gives analysts a more visual and overarching view of cloud posture and computer hygiene.

4. Lululemon Athletica (LULU) -- Q1 2023 Earnings Review

a) Demand

Lululemon beat revenue estimates by 4.2% & beat guidance by 4.7%.

More Demand Context:

• Foreign exchange (FX) hit revenue growth by 280 basis points (bps).

• 3-year comps were very easy due to the pandemic. This propped up its 3-yr CAGR for the quarter.

• International revenue rose 60% Y/Y (China reopening is helping a lot with 79% Y/Y growth). North American revenue rose 17% Y/Y.

• Women’s grew 22% Y/Y, men’s rose 17% Y/Y and accessories expanded 67% Y/Y.

  • Its most mature women’s bottoms category enjoyed 22% Y/Y growth.

• E-commerce = 41.7% of total sales vs. 44.7% Y/Y. More traffic helped; lower conversion rates hurt.

• Other revenue (outlets, wholesale, licensing, re-commerce, pop up shops and Lululemon Studio) generated $207.8 million in revenue vs $160.6 million Y/Y.

b) Profitability

• Beat $1.99 GAAP EPS estimates by $0.29 & beat its guide by $0.32.

• Beat GAAP EBIT estimates by 12.4%.

• Beat GAAP Gross margin (GPM) estimates by 50 bps.

NI = Net Income; OCF = operating cash flow

More Margin Context:

• GPM ex-Mirror impairment last quarter was 57.4%.

• Like for demand, 3-year margin comps were very easy.

• Generated $45.5 million in operating cash flow vs. -$243.3 million in the Y/Y period.

• Q4 is a seasonally strong cash flow period and was helped further by inventory shedding.

• Net income was hit by 69% Y/Y growth in cash taxes. Still it earned $2.28 per share vs. $1.48 Y/Y for 54% Y/Y growth.

• Gross margin was helped by lower air freight but hit by higher Y/Y inventory provisions and a 50 bps FX headwind.

• CapEx rose 22.8% Y/Y to $136.9 million to support store openings and upgrades along with distribution center investments.

c) Full year Guidance

• Raised revenue guide by 1.3% & beat estimate by 1.2%. This represents 16.5% Y/Y growth vs. its long-term target of 15% Y/Y growth.

• Raised $11.61 GAAP EPS guide by $0.23 & beat estimate by $0.24.

• Now sees 190 bps of gross margin expansion for the year vs. 150 bps previously.

• It sees 40 bps of EBIT margin leverage for the year vs. 30 bps previously via less freight expense, markdown normalization and offset by ramping investments to grow the brand amid strong demand.

Next quarter guidance was roughly in line across the board.

The company remains on track to deliver on its Power of Three *2 Growth Plan calling for 15% revenue compounding and modest operating leverage.

“We are pleased with our momentum for Q2 and the rest of the year as reflected in our outlook.” -- CFO Meghan Frank

d) Balance Sheet

• $950 million in cash & equivalents.

• $393 million in undrawn credit capacity.

• 127.6M shares diluted vs. 128.5M Y/Y.

• Inventory rose 24% Y/Y and 9.2% Q/Q. It’s comfortable with its inventory position and expects growth here to be in line with revenue for 2023. Inventory turn rate should fully normalize back to pre-pandemic levels as supply chains finish recovering.

• $646 million left in buyback capacity following $98 million in repurchases this quarter.

e) Call & Release Highlights

Performance Context:

The outperforming results were powered by a sharp re-acceleration in China revenues as that country opens up. Favorable air freight costs helped as well. Its margins continue to outperform thanks to the strong loyalty associated with its brand. While its sector continues aggressive markdowns to liquidate inventory, Lululemon is not following suit. Its markdown rate is 40 bps BETTER than pre-pandemic periods and was flat Y/Y.

Importantly, the month of April was even stronger than its March performance while several other retailers cited deteriorating performance from March to April. Guest metrics for both new and existing customers remained robust (over 20% growth for both segments) across all geographies throughout the quarter and into Q2.

Community-Based Model and Events:

The Essentials Membership tier continued its torrid pace of growth. Leadership will not update the member count quarterly but did say the free tier continues to rapidly expand. These members engage more with the brand and spend more too. Its paid membership program as part of its new Lululemon Studio App launched this week at $12.99 per month. It requires no hardware. We’ll see how it does.

Lululemon brought back community-based events to pre-pandemic levels this quarter. Its 3 Essentials events were “hugely oversubscribed".” It also ran a promising new promotion in California. This consisted of a 2-day pop-up shop allowing customers to trade in knock-off leggings for Lulu leggings. 50% of the trade-ins were from brand new customers which fulfilled its core campaign goal of new customer acquisition. 50% of the attendees were also younger than 30. Lines started building 6 hours before the stores opened each day. What a brand.

Global Expansion:

Lulu’s plan to 4x its international business within the long-term growth model is fully on schedule. Spain – where it launched last fall – is off to a “great start.” It just opened its first store in Israel with plans to enter Thailand this quarter. In China, it is now ramping marketing spend and has added its apparel to Tmall, JD.com and others.

Shoes:

Launched its updated Blissfeel running shoe and its first trail running shoe. Not much detail was added here.

f) My Take

Excellent quarter. This company is expensive for a reason and carries the kind of clout reserved for the most iconic brands on the planet. This is a ubiquitous brand in the making. Share gains continue, product expansion is working and international business is booming. It did not blame poor results on macro headwinds like its competition, but instead overcame those headwinds in its execution. What a team, what a brand, what a company.

5. Zscaler (ZS) -- FY Q3 2023 Earnings Review

While CrowdStrike and SentinelOne are the endpoint disruptors, Zscaler presides as a disruptor in the complementary product category of network security. It competes with Cloudflare. Palo Alto and Fortinet (which both compete in endpoint and network). Please note that during the quarter Zscaler revised its in-period estimates higher. The beats and guidance raises this quarter were therefore modest but estimates and guidance had already been raised to reflect that pre-announcement.

a) Results

• Beat revenue estimate by 1.7% & beat updated guide by 0.4%.

• Beat EBIT estimate by 6.1% & beat updated guide by 3.1%.

• Beat $0.42 EPS estimate by $0.06 & beat guide by $0.09.

• Met GAAP EPS estimate; Beat FCF estimate by 11.8%.

NRR = Net Revenue Retention = Revenue growth from existing cohort of clients Y/Y.

b) Guidance

• Roughly reiterated updated revenue guide & beat estimates by 0.8%.

• Raised billings by 0.2%.

• Raised EBIT guide by 1% & beat EBIT estimates by 2.5%.

• Raised $1.53 EPS guide by $0.10 & beat estimates by $0.07.

Next quarter guide was slightly ahead across the board.

The guidance balances “optimism with macro uncertainty” per CEO/Co-Founder Jay Chaudhry. The guide assumes sales cycle elongation worsens and deal closing rates fall sequentially. We love conservative assumptions baked into estimates. Make any potential surprise be to the upside.

c) Balance Sheet

• Stock comp = 26.6% of sales vs. 28.8% last quarter and 39% of revenue Y/Y. Great progress with more needed.

• Stock compensation represented 150% of FCF vs. 255% Y/Y.

• Nearly $2 billion in cash & equivalents.

• $1.14 billion in convertible senior notes.

d) Call & Release Highlights

Overcoming a Tough Environment:

The theme of this earnings season for cybersecurity seems to be go-to-market execution. Some companies are taking the necessary steps to close deals in a timely manner and hold C-suite hands throughout all layers of approvals… and some companies aren’t. Zscaler’s success was powered by strong go-to-market execution. It’s taking a very hands-on approach to educating CFOs on immediate time to value and hefty return on investments. This “high-touch engagement” was credited for its strong results.

While its selling practices were very successful, its product suite utility also deserves some credit. Legacy, firewall-reliant network vendors are “impeding progress and operational growth.” Zscaler’s zero trust exchange eliminates this operational glut by creating more intuitive and simplistic (from a user experience (UX) point of view) workflows while driving down costs and delivering superior efficacy. This is why 80% of the largest banks and insurers in the world use it, why Zscaler’s NPS sits over 70 and why its gross revenue retention remains in the high 90% range.

Zscaler’s macro commentary mirrored CrowdStrike, Palo Alto and Fortinet. Sales cycle elongation, budget scrutiny and some deal shrinkage all continue to hold the company back. Still, these macro pressures did not worsen for it during the quarter like SentinelOne claimed they did.

• 55.9% 3-yr revenue CAGR vs. 56.4% Q/Q and 56% 2 quarters ago.

• It now has 2,432 customers with ARR over $100,000 vs. 1,891 Y/Y.

• It calls 40% of the Fortune 500 its clients.

Competition -- Chaudhry took a bit of a shot as his competition like security CEOs so often love to do:

“Given our large opportunity and our success, it is not surprising to see vendors claiming to have the same capabilities we do. They built their products using something known as service function chaining, in order to reduce their time to market. The reality is service chaining for in-line traffic inspection using micro services results in poor performance. They are effectively trying to scale lower performance. Our unique architecture… enables us to deliver comprehensive security at high performance and scale.” -- CEO/Co-Founder Jay Chaurhry

Wins:

The combination of Zscaler securing the highest FedRamp authorization paired with an executive order mandating Zero Trust usage within federal agencies continues to be a tailwind. It landed another Cabinet-Level agency citing superior cost and value during the quarter.

Beyond public sector momentum, Zscaler upsold additional products with a large global Financial Institution. It helped the client reduce its time to new branch openings by 50% and to eliminate its usage of legacy firewalls. It signed a new Fortune 100 member thanks to the 300% ROI this client expects to enjoy. Finally, it signed a Global 30 Healthcare Insurer and replaced a legacy vendor that couldn’t scale to more than 5% of its employees. Zscaler easily serves 100% of them.

Aside from customer specific wins, Zscaler’s bundled sales of ZIA, ZPA and ZDX (defined below) was also a notable standout powering its growth while its new marketing campaign with CrowdStrike is driving material new pipeline activity.

• ZIA = Zscaler Internet Access to protect client internet connections. This is a middleman between user and network ensuring proper authorizations and access.

• ZPA = Zscaler Private Access to protect “remote access to internal applications and resources.” It is an upgrade and extension of legacy Virtual Private Networks (VPNs) by “connecting directly to the required resources without exposing them to the public” – per Zscaler investor materials.

• ZDX = Zscaler Digital Experience and is the newest tool of the 3. This is built to ensure high quality and always on performance of cloud apps. It sifts through networks to identity sources holding back performance to be remediated.

Syam Nair:

Zscaler named Syam Nair as its new CTO and EVP of R&D. Nair was most recently Salesforce’s Head of Product Engineering and Tech for a wide range of its products and spent 6 years there climbing the ladder. Before Salesforce, he was Head of Product for an Azure tool at Microsoft. His resume is rock solid.

Nair will handle new product development and launches like Zscaler’s AI-powered ZDX upgrade from this past quarter. That product offers intelligent recommendations to accelerate cloud vulnerability troubleshooting and to speed time to remediation from “weeks to minutes.”

AI:

AI was refreshingly not that large of a piece of this call. Leadership did discuss how its Zero Trust access controls ensure data and applications are used by the right person at the right time. Its data loss protection tools prevent impermissible ingesting by models like ChatGPT and Bard. Like Salesforce talked about, trust and security are prerequisites for clients embracing generative AI. This is the way to build that trust and establish that security.

6. Meta Platforms (META) -- Quest 3

Next week, Apple is expected to debut its first extended reality (XR) headset to rival the Quest lineup. This will cost about $3,000 based on rumors. Well… this week Zuckerberg and Meta announced the 3^rd iteration of its Quest headset in Quest 3. Coincidence? I think not.

The new headset will cost about $500 and the hardware will be about half as clunky and cumbersome as the predecessor. That slimming down won’t sacrifice performance thanks to Qualcomm’s Snapdragon chip which doubles Quest’s GPUs. Resolution improvements are expected to amount to 30% vs. the old device as the added GPU capacity will significantly sharpen display and graphics. To help with graphics and the realistic feel further, Quest 3 adds 3 new sensors each with 4 individual cameras as well as “TruTouch” technology within its controllers to emulate feel.

Other new perks include natural depth perception and hand tracking for the base model to better immerse users into the experiences. Speaking of those experiences, Quest 3 will come with 500+ games including rumors that Roblox will be added to the device as well. That would be big. As part of the news, Quest 2 price will fall from $400 to $300. Supposedly, the Quest 3 sales will boast more compelling unit economics vs. Quest 2 to ideally curb losses for the segment. For now, however, profits will be powered by Family of Apps and the firm remains in product market mode here. There will need to be many more iterations before this can hopefully become ubiquitous.

While this device seems to be a lot more compelling vs. what Apple has planned, this is not a zero-sum game. There will be no “winner-take-all” in VR or even in VR hardware. Apple deciding to invest heavily into the category and compete is a vote of confidence in the real use cases and viability of this technology. Will Apple likely win some share? Absolutely. Will it also likely grow the market via its entrance into it to make those share losses irrelevant? Absolutely.

From The Verge

7. Amazon (AMZN) -- Telecom, AWS & Profits

a) Telecom

Amazon is rumored to be entering the mobile phone service market to compete with telecom giants like Verizon. Rumors surfaced that it will offer this as the low cost option and may even consider offering it at cost for Prime Subscribers. Amazon denied these rumors for now. Amazon’s business leans on customer retention and loyalty to power continued growth. Lumping in as many value-added services as possible into its subscription bundle is the way to accomplish that. This would certainly be a value-add service.

This playbook was written by Amazon and is now being followed by other marketplace/super-app type companies like Uber. Offering this would be the luxury of its unmatched scale. It can afford to operate at razor thin margins because of the vast market share it has built. That allows small profits to more meaningfully accumulate than for smaller alternatives. It makes chasing these small profits a viable approach for Amazon while it’s not for others. Last month, news broke that Dish was also considering selling mobile plans through Amazon’s marketplace. We’ll have to wait and see how real all of this news is.

b) AWS and AI

Amazon debuted the AWS security lake this week to allow clients to aggregate all relevant security data across all AWS workloads. Not only does this provide a new product to sell, but it also makes Amazon a better partner for XDR partners like CrowdStrike eager to devour as much public cloud data as possible for its own threat graph. And along those lines, as discussed in our CrowdStrike earnings review, the two are now collaborating to build new AI apps laced with CrowdStrike technology.

c) Profits

• Amazon is leveraging AWS and its training/inference models to automate the location of damaged goods within fulfillment centers. It’s easy to see this saving workers a lot of time.

• Amazon delayed its path to carbon neutrality to 2040. The extended timeline will help it space out costs to achieve that goal. Good decision.

• It’s raising its grocery delivery fee (within Amazon Fresh Service) next week. Just a few basis points of margin expansion within its massive book of business could be meaningful for profit growth. This will modestly contribute to that expansion. As an aside, this is one of the things that drew us to the investment. The number of levers it can pull to immediately bolster profits is wildly appealing. Its pricing power should mean future hikes elsewhere are met with minimal churn like its Prime Subscription price hike was a few months ago.

8. Progyny (PGNY) -- Job Market

The job market remains impressively resilient. The jobs number outperformed and unemployment remains at cycle lows. Progyny’s guidance for 2023 assumes flat organic headcount growth within its existing client base. It saw hiring from all industries besides tech as offsetting the layoffs from clients like Amazon and Meta. If these job numbers continue to be robust as mega cap tech layoffs slow, that assumption should prove to be conservative which could lead to modest upside. This company does not need incremental tailwinds as it’s thriving without them… but we’ll take all the tailwinds we can get. Recent short reports on the company cited a weak labor market as a reason for bearishness. Not only is this weakness baked into its guidance, but the weakness may be less pronounced than some assumed.

9. Match Group (MTCH) -- Artificial Love & Insider Buying

a)  Artificial Loving

Last quarter, Match leadership discussed a new app being developed for a summer debut. That app was announced this week. It’s called Archer and is set to serve the gay male community. No matter where you look, younger generations are identifying as LGBTQ+ at a higher clip than predecessors. The stigma associated with being gay is fading away and so naturally more feel comfortable to be open about it. That is the reality in 2023. Per a recent Ipsos study, 18% of GenZ identifies as LGBTQ+ vs. just 4% of baby boomers.

Knowing this stigma is fading, Match concocted the app to be more open, social and less secretive than the core competitor in Grindr. It focuses more on self-expression (must show your face in a picture unlike on other gay apps) and allows users to scroll through profiles in any way they want to. It’s set to function as a dating app, but also an exclusive social community to hopefully motivate user retention once they’ve found their special someone. It aims to incorporate a lot of the personalization that has made Hinge so successful.

In keeping with the times, AI will be a core part of this new app. Safety algorithms will prevent unwanted content from being shared and viewed while matching algorithms help to pair folks more efficiently. This will not be immediately needle moving but could turn into a material revenue contributor over time.

b) Insider Buying

Following bullish comments on May revenue trends at Tinder, new CEO Bernard Kim bought $1 million in stock. He did so previously when taking over the company, but that is a typical symbolic gesture common with new CEOs -- this is slightly more meaningful. According to the internet, his net worth is under $20 million which would make this a mammoth purchase. We were unable to confirm this with higher quality sources.

10. Earnings Round-Up

a) Veeva Systems FY Q1 2024 Earnings

This Quarter:

• Beat revenue estimates by 1.7% and beat its guide by 2.2%. This represents 9% Y/Y growth. Subscription revenue rose 8% Y/Y and services revenue rose 11% Y/Y.

• Beat EBIT estimates by 10% and beat its guide by 10.6%.

• Beat $0.80 EPS estimates & its same guide by $0.11.

• Beat $0.41 GAAP EPS estimates by $0.40.

• Beat OCF estimates by 4.8%.

• Billings rose 15% Y/Y to reach $2.615 billion.

Annual Guide Update:

• Raised revenue guidance by 0.4% and beat identical estimates by 0.4%.

• Raised EBIT guidance by 1.3% and beat estimates by 1.1%.

• Raised $4.33 EPS guidance by $0.26 and beat estimates by $0.27.

• Raised OCF guide from $810 million to $840 million. This is 0.7% ahead of consensus.

• Slightly raised billings guidance.

It also reiterated its next year guidance calling for $2.8+ billion in revenue and $1+ billion in EBIT.

Balance Sheet:

• $3.6 billion in cash and equivalents.

• Stock comp was 17.2% of sales vs. 13.3% of sales Y/Y.

• Stock comp was 18% of total operating cash flow.

Final Note:

A change in customer contracting practices is resulting in a vast evolution of revenue and profit seasonality. This took effect in February and hit revenue by $51 million this quarter while hitting EBIT by the same dollar amount. This is the reason for Y/Y profit declines.

b) MongoDB

This Quarter:

• Beat revenue estimates by 6.1% and beat its guidance by 6.4%. Revenue rose 29% Y/Y.

• More than tripled $12 million EBIT estimates and its guidance with a result of $43.7 million. Strong.

• Roughly tripled $0.19 EPS estimates and its guidance with a result of $0.56. Strong again.

• Beat gross margin estimates by a robust 160 bps.

• More than doubled $20 million FCF estimates with a result of $53.7 million.

Annual Guide Update:

• Raised annual revenue guidance by 2.5% and beat estimates by 1.5%.

• Raised annual EBIT guidance by 53.6% and beat estimates by 48%.

• Raised annual EPS guidance of $1.03 by $0.46 and beat estimates by $0.45.

Next quarter guidance was similarly excellent across the board.

Balance Sheet:

• $1.9 billion in cash & equivalents (including restricted).

• Stock comp was 28.2% of sales vs. 29.3% Y/Y. Ideally, progress here would be more brisk. Share count rose 3.6% Y/Y which needs to fall below 2% eventually. Sooner would be better than later.

• $1.14 billion in senior convertible notes.

Final Notes:

Aside from the excellent results, MongoDB’s positioning as a data management platform within AI is quite compelling. Again, models need vast quantities of relevant data to season them and make them useful. MongoDB (and others) have a way of uncovering that most relevant data and providing scalable access to it. Generative AI did not power the bulk of its outperformance this quarter but will be a tailwind for it going forward. Other sources of notable outperformance vs. competition included outperforming usage trends while others like Snowflake cited recent weakness.

“I think people tend to overestimate the impact of a trend like AI in the short term. And so I will clearly say it wasn't AI that drove the acquisition of workloads.” -- CEO Dev Ittycheria

• Extended a partnership with Alibaba through 2027 to “integrate MongoDB and Alibaba Cloud.”

• MongoDB delivered 2x performance for Temenos Banking Cloud providing evidence that MongoDB is poised to “support the largest global banks with superior price and performance.

• Build a new data querying (fetching) API to organize data sets for Generative AI applications.

c) Okta

This Quarter:

• Beat revenue estimates by 1.4% and beat its guidance by 1.6%. Revenue rose 25% Y/Y with subscription revenue rising 26% Y/Y.

  • International revenue rose 23% Y/Y.

• Nearly doubled $19.5 million EBIT estimates and its $19 million guide with a result of $37 million.

• Beat $0.12 EPS estimates and its same guide by $0.10.

• Nearly doubled $63.2 million FCF estimates with a result of $124 million.

• Current RPO was 1% ahead of guidance.

• Beat -$0.96 GAAP net loss estimates by $0.22.

Updated Annual Guide:

• Raised revenue guidance by 0.8% and beat estimates by 0.5%.

• Raised EBIT guidance by 17.8% and beat estimates by 16.6%.

• Raised $0.77 EPS guidance by $0.14 and beat estimates by $0.13.

• Raised FCF margin guidance from 10% to 12%.

Next quarter guidance was similarly strong across the board. The 1 soft spot was guidance of $1.715 billion in current RPO. That was a bit light compared to consensus. Okta is dealing with added budget scrutiny like everyone else which is leading to shorter contracts being signed which  weighs on billings.

“While macro pressures are increasing, we are well positioned to advance our leadership position by delivering valuable innovation and profitable growth to our shareholders.” -- Co-Founder/CEO Todd McKinnon

Balance Sheet:

• $2.37 billion in cash and equivalents.

• $1.83 billion in senior convertible notes vs. $2.2 billion Q/Q as it repurchased $366 million of that balance during the quarter.

• Stock comp was 32% of sales vs. 41.2% Y/Y. Share count rose 13% Y/Y largely via the AuthO purchase.

Final Notes:

• 117% net revenue retention vs. 120% Q/Q and 123% Y/Y.

• Crossed 18,000 customers vs. 17,600 Q/Q and 15,800 Y/Y for 10% Y/Y growth.

• 4,080 customers with ARR over $100,000 vs 3,930 Q/Q and 3,305 Y/Y for 23.4% Y/Y growth.

• Gross margin was 78.9% vs. 78.9% Q/Q and 76.1% Y/Y.

• EBIT margin was 7.1% vs. 9% Q/Q and -9.9% Y/Y.

Final Portfolio headlines:

• Shopify is fully rolling out Shop Cash (loyalty and rewards program for the Shop App) this week in the U.S. To promote the release, it will partner with merchants like Mr. Beast to give away Shop Cash rewards.

• Uber and Party City are partnering on deliveries.

• Morgan Stanley upgraded The Trade Desk for the same reasons we’ve been talking about for 3 years. It’s poised to dominate within secular growth trends of CTV and retail media.

• Meta Platforms will require in office work for 3 days a week starting this fall. Love this decision.

• PayPal issued about $650 million in Yen denominated debt this week carrying interest rates of 1.23% or less. Interesting. It will also host a “Management Meeting” next week. Perhaps this will be when it names a new CEO.

11. Macro

Consumer & Employment Data:

• Conference Board Consumer Confidence for May was 102.3 vs. 99 expected and 103.7 last month.

• ADP Non-farm Employment Change for May was 278,000 vs. 170,000 expected and 291,000 last month.

  • Mammoth beat which (paired with non-farm payroll) could give the Fed slightly more permission to delay rate cuts further. A pause we think is inevitable at this point.

• Initial Jobless Claims were 232,000 which roughly met estimates of 235,000 and compares to 230,000 last report.

• Non-farm Payroll for May was 339,000 vs. 180,000 expected and 294,000 last month.

• Labor force participation for May was 62.6% vs. 62.5% expected.

• Unemployment rate was 3.7% vs. 3.5% expected and 3.4% last month.

• JOLTs Job Openings for April came in at 10.1 million vs. 9.78 million expected and 9.75 million last month.

Output Data:

• Chicago Purchasing Managers Index (PMI) for May was 40.4 vs. 47 expected and 48.6 last month.

• Manufacturing PMI for May was 48.4 vs. 48.5 expected and 50.2 last month.

• Institute of Supply Management Manufacturing (ISM) Employment for May was 51.4 vs. 48.5 expected and 50.2 last month.

• ISM Manufacturing PMI for May was 46.9 vs. 47 expected and 47.1 last month.

Inflation Data:

• Average Hourly Earnings rose 0.3% M/M vs. 0.4% expected and 0.4% last month.

  • Cooler wage inflation paired with robust jobs data is a good combo for a soft landing thesis.

12. Portfolio

I trimmed 8% of my TTD position this week due to aggressive multiple expansion. Taking some profits felt prudent.