There are a few reasons MongoDB saw a severe reaction its earnings report. The first is that the cash flow is much lower than it’s been in recent quarters. We wrote in May that this is the top thing to watch across cloud stocks and we positioned our portfolio for those that were FCF positive.
Here is what I have for MongoDB’s FCF:
($22M): Q2FY22
($9M): Q3FY22
$16.9M: Q4FY22
8.4M: Q1FY23
($48.6M): Q2FY23*
In Q1, MongoDB was expected to report ($0.06) adjusted EPS and the company reported $0.20 EPS instead. This was a $0.30 beat. In Q2, MongoDB reported a beat of ($0.23) adjusted EPS versus ($0.28) adjusted EPS expected. However, Q3 and the full year guide missed on adjusted EPS consensus with Q3 at ($0.13) expected versus ($0.16) to ($0.19) EPS guided. For FY2023, consensus was at ($0.21) versus ($0.28) to ($0.35) EPS guided. I break down the reasons for the miss in the Financials section below.
Q1 was a “perfect 10” quarter. The company stood out as insulated to discretionary spending compared to its peer Snowflake who analysts questioned at length due to its rumored exposure to Coinbase and other heavyweight consumer-facing companies. Perhaps most importantly, in Q1, MongoDB posted adjusted profitability for the first time.
Another reason for the AH selloff is that in Q2, MongoDB and Snowflake switched seats. Analysts are now more concerned MongoDB has outsized exposure to macro conditions rather than Snowflake, as Q2 was a perfect quarter for Snowflake.
Current revenue growth would suggest there is robustness to MongoDB, yet this management team is mirroring more of Datadog’s approach, which is they are not raising full year guidance to match the Q2 revenue beat. If a company does this, it implies the other two quarters will be weaker than expected. MongoDB gave a solid raise to Q3, so that implies that Q4 will be weak despite being seasonally strong.
I also want to be a messenger and say that another reason we are seeing strong price activity is that analysts are concerned that enterprise spend will be the next shoe to drop. This concern was expressed across quite a few cloud companies’ earnings calls. The thinking is that enterprise spend will follow consumer spend, (eventually), yet is slower because budgets are cut more slowly and added back more slowly.
Any sign of weakness is being interpreted as this more serious concern. Whether it’s overblown or whether it’s being prudent is something every investor must decide for themselves as it requires a time machine to truly know when the macro environment will clear, and most importantly, the depth of the effects it will have on cloud.
Some cloud companies can show immediate effects and MongoDB, Snowflake, Confluent, etc, would be that group due to being the consumption model as usage can be increased/decreased fairly quickly whereas SaaS models would require subscription cycle to show these effects. This is not a company or developers electing to reduce usage on MongoDB, rather it’s a trickle down effect from lower usage within applications.
Here’s a quote as this was discussed many times:
“As we discussed last quarter, it's important to understand that the slower than historical consumption growth is a result of slower usage growth of our customers' underlying applications due to macro conditions.
Our customers spend on our platform is well aligned with the performance of their business. In the current environment, some businesses and consequently, their applications are growing more slowly.”
It’s important to note that slower usage from the underlying applications is distinguished from discretionary spending. However, for our purposes as investors, the result is similar, which is that even if MongoDB is a core product, it’s impacted by macro.
The company also stated that it’s a lower rate of workload expansion contributing to their cautious Q4 guide rather than a lower rate of new customers: “As you think about the business more holistically, new customers and new workloads are what really determine the long-term outcome and the long-term success […] As it relates to expansion of existing workloads, which is sort of the other piece of the equation, that's more relevant in the short term not as relevant in the long term. And so, that's where we've seen the slower growth that we've described. And so, we're continuing to take a long-term orientation”that's where we've seen the slower growth that we've described. And so, we're continuing to take a long-term orientation”
Financials:
MongoDB reported revenue of $304 million, which beat consensus of $282 million by 7.6%. In terms of percentage, this was a larger beat than Q1 at 6.9%. The company is guiding for Q3 revenue of $301.5 million at the midpoint compared to $294.5 million consensus. The two quarters combined translate to $29 million in additional revenue. However, the company is only raising full year guidance by $16 to $18 million as the previous guidance was $1.8 billion for FY2023 and is now $1.196 to $1.206 billion. This would imply Q4 being lower than anticipated by $10 million at $320 million instead of consensus of $330 million.
It seems like this market is splitting hairs but it’s what the overall Q4 miss represents, which is, will cloud see extended lumpiness from the recession.
The adjusted operating margin fell from 6% in Q1 to (4%) in Q2 during a time when the market is especially bottom line sensitive. This is the lowest adjusted operating margin over the past five quarters.
The company stated the increased opex is due to an increase in sales and marketing and R&D. Translation: tech companies spend for growth, it’s part of their DNA. Tech companies spend on growth if they think it will help them expand market share at critical point of adoption. The current market doesn’t like this but previous market conditions have not cared. (Tech companies have not changed and how they operate, the market has). This puts extreme pressure on a company — do you stop spending and risk growth and losing market share OR do you ignore the market and continue spending. It’s not good for MongoDB’s stock right now but spending to increase market share is almost always the right answer.
The GAAP operating loss also increased in the recent quarter. It came at ($114.8M) compared to an operating loss of ($72.5M) in the same quarter last year and ($75.9M) in the Q1 FY23. The operating margin was -38% in the recent quarter compared to -36% in Q2 FY22 and -27% in Q1 FY23.
Net income also saw a deceleration and the current market conditions do not take kindly to this. MongoDB adjusted net loss was ($15.6M) down from adjusted net loss of ($7.7M) in the year ago quarter. MongoDB had demonstrated a path to profitability recently and this has now been reversed.
The cash from this quarter (noted in the intro) was impacted by the conference MongoDB World, yet we aren’t getting much from management in terms of a turnaround on the bottom line as the year continues. For our purposes, MongoDB is no longer a positive FCF company and this is a marked change in the fundamental story. We felt very strongly that our cloud positions must be free cash flow positive this year.
The guide is adjusted operating loss in Q3 to be ($10M) to ($8M). The FY2023 guide is for adjusted operating loss to be ($13M) to ($8M). At the midpoint this is ($10.5M) which implies a weaker bottom line the rest of the year at ($9M) for Q3 and ($4M) for Q4.
The company’s stock-based compensation is high. In the recent quarter, it was $96.56 million (32% of revenue) and in the Q1 FY23, it was $83.57M (29% of revenue), which is one of the key metrics investors are tracking in the recent quarters.
Key Metrics including Atlas
Atlas decelerated from 82% growth last quarter to 73% growth this quarter. This was the larger decel we’ve seen in the previous four quarters, which have been range bound between 82% to 85% growth. Atlas customer growth was at 29% compared to 33% last quarter. However, the contrast is clearer when compared to the year ago quarter at 44% Atlas customer growth.
Management expects this trend for lower Atlas growth (compared to the previous four quarters) to continue.
“First, we expect the Atlas consumption trends we experienced in Q2 to continue for the remainder of the year. Second, in the second half of last year, as we called out at the time, we had exceptionally strong Atlas consumption growth leading to difficult Atlas year-over-year compares to the back half of the year. And third, we expect a sequential decline in Enterprise Advance in Q3 as the renewal base is sequentially lower. Looking into Q4, we expect a seasonal uptick in revenue from EA. But recall, we faced a very difficult year-over-year comparison given strong EA new business activity we saw last year.”
Customers over $100,000 were up 27%, this is down from 30% growth last quarter. Overall customers grew 27.5%, down from 31% growth last quarter. The net ARR expansion rate was “over 120%” which is the same information provided in previous quarters.
Comments on the Call:
The call centered around a few things. The first is how macro headwinds affect MongoDB’s business where management described puts and takes. There are actually tailwinds, according to management, as the migration away from legacy databases is now more prioritized:
“On your first question, I just want to remind everyone, we're not seeing any change in deal sizes or sales cycle times. I think your point about as customers face this macro headwind, is there an opportunity for them to essentially drive more efficiency in their business? And we're definitely seeing customers starting to do that. We're definitely seeing customers look at their legacy platforms and recognize how expensive and brittle those platforms are and are more motivated to move on to more modern platforms like MongoDB.We're definitely seeing customers look at their legacy platforms and recognize how expensive and brittle those platforms are and are more motivated to move on to more modern platforms like MongoDB.
Frankly, to help customers in that journey, that was a motivation for us to release the Relational Migrator product because this is not a new trend to help customers just reduce the cost of moving off relational to MongoDB. And I think you're going to see more and more customers take a hard look at their legacy infrastructure and think about modernizing potentially sooner than later.”that was a motivation for us to release the Relational Migrator product because this is not a new trend to help customers just reduce the cost of moving off relational to MongoDB. And I think you're going to see more and more customers take a hard look at their legacy infrastructure and think about modernizing potentially sooner than later.”
There was quite a bit of conversation around “digital native” companies. There are many large enterprises that are digitally native (Amazon, for example) and so I took the mid-market digital natives to mean startups, especially e-commerce, which are seeing slower usage and strapped for funding right now. It can also mean any other consumer-facing applications that are stagnant/not growing but e-commerce comes to mind.
“Moving on to the mid-market channel. For context, the customers in this channel tend to be traditional medium-sized businesses. This channel included — tend not to be traditional medium-sized businesses. This channel includes a disproportionate share of digital native, fast-growth companies that have built their businesses on MongoDB […] Our expectation that the mid-market slowdown we saw in Europe in Q1 would become global in Q2. This is what we experienced, but the slowdown was more significant than we had expected, specifically the digit layer subset of the mid-market experienced slower growth in their applications as a result of macroeconomic conditions, and therefore, their underlying consumption growth of MongoDB slowed as well.”
Of course, the softer operating income was drilled into and this is what was stated:
“Jason Ader:
Guys, in thinking about the lower op income guide, are you basically saying that the mix of new customers versus existing customers is different than what you expected a quarter or two ago and basically new customers are more expensive to transact with? Is that the right way to think about the lower op income for the year guidance?
Michael Gordon:
No, that's not how I think about it. I think about it as being — we are continuing to see good customer wins and strong receptivity in the market that underscores or translates into strong customer unit economics. And so, we are continuing to invest in building out sales. And as you think about what the implication is in terms of rolling through some of the slower cohort expansion of existing Atlas customers that we're seeing. And when you run the math through, that winds up having a slight impact to our full year op income guide.
So I wouldn't take it as any kind of judgment or try to do any math unless some sort of incremental value of workloads or slicing and dicing it that way, just simply us, saying, us looking at the market, having a long-term orientation, continuing to see strong new wins, no increases in customer churn, continuing to have the value proposition resonate and being sort of at the top of the customer priority list.”
Translation: Management was consistent in saying the operating expenses are increasing to help attract more new customers, an area of strength for them (note: although recent quarter did show a deceleration in new customers). Where MongoDB has been impacted is in “cohort expansion” or workload expansion.
Conclusion:
The economy is tough right now and it’s being echoed across many management teams. As much as we want to believe there are companies that are immune (Snowflake this quarter, MongoDB last quarter), it seems macro headwinds are catching up to nearly every industry. What the market is most concerned about is whether enterprise budgets will follow in the footsteps of consumer spending, with enterprise budgets typically being slower to cut and slower to add back in.
There’s nothing inherently wrong with MongoDB’s report except the company can’t grow as rapidly as it can during perfect market conditions. In addition, the company wants to spend to grow new customer accounts while the expansion opportunity presents itself. There’s nothing inherently wrong with that, it’s simply the market conditions aren’t favoring free cash flow negative companies right now which puts immense pressure on management teams to decide between growth or profits.
MongoDB has leverage and they have cash of $1.8 billion. There shouldn’t be any reason in the foreseeable future the company has to dilute shareholders to raise cash. That’s the most logical reason to care about negative cash flow but the market is sensitive and emotions are running high. Valuation, of course, is also key as the top cloud companies in terms of valuation are all free cash flow positive which means MongoDB cannot be in the top 5 on valuation until it returns to FCF positive.
Coupled with the decreasing margins, MongoDB is not being able to provide anything on the horizon to look forward to as a few cloud companies have asserted to do so would be to become an economist. Right now, Q3 and Q4 are expected to mirror Q2.
If you join the webinar today, Knox is going to speak about a long overdue bounce that we still hope is coming and will provide us the opportunity re-arrange positions. I don’t see us holding MDB at this high of allocation and I also don’t see us closing it – it’ll be something in-between.