Snowflake On The Path To $10B In Product Revenue
Summary
- Snowflake has a goal of producing $10 billion in product revenue by fiscal 2029 (calendar year 2028).
- Management believes the way for investors to track their path to $10B is to monitor million-dollar plus customers, which should be a significant portion of product revenue.
- The company is pioneering a new market which they call the Data Cloud, which has the potential of becoming the core infrastructure to the digital economy.
- Snowflake has a significant runway to grow into its valuation and be a market-beating investment over the next +5 years.
The first thing many investors notice when they look at Snowflake (NYSE: NYSE:SNOW) is that it is one of the most highly valued stocks in the market and that valuation makes some investors want to wait for better entry points.
Investors that choose to invest in Snowflake at current prices have to believe in the feasibility of the company's goal of producing $10 billion in product revenue by fiscal 2029 (calendar year 2028).
On June 10, Snowflake held their analyst day, in which they outlined their path to $10 billion in product revenue, complete with ways for investors to track their progress.
Among the reasons that I believe Snowflake can achieve that goal is because the company is in the process of creating a new market called the Data Cloud, which has the potential of becoming the core infrastructure to the digital economy and currently, Snowflake is the pioneer and leader of that emerging market, which is likely to be quite profitable in the future.
Source: Snowflake Investor presentation
Snowflake's current cloud data platform opportunity, as well as the emerging Data Cloud opportunity benefits from the following 3 trends:
- Workloads moving to the cloud
- Data volume growing
- Data driving decision making
Those three secular trends are the tailwinds that should drive Snowflake's results long term and are the reason to invest in Snowflake, even at current valuations.
What does Snowflake actually do?
Previous articles on Seeking Alpha have dived deeply into what Snowflake does. The best explanation of Snowflake for the non-techie is in the article written by Seeking Alpha contributor Jamie Louko under the section "Breaking Down Snowflake".
Snowflake is a cloud platform that is designed to provide data storage, processing, and analytic solutions for customers that are faster, easier to use, and far more flexible than traditional cloud offerings. Companies use Snowflake for things like data integration, business intelligence, advanced analytics, and security & governance.
Snowflake Customers
Source: Snowflake Investor presentation
Snowflake has adjusted their sales team to address their customers which is shown in the above chart. Snowflake uses an industry-oriented go-to-market strategy that specifically targets customers in different verticals like financial services, healthcare & life sciences, retail & CPG, advertising, media & entertainment, technology, public sector, education and manufacturing.
Snowflake's product has the ability to scale up or down to address all company sizes. One-million-dollar product revenue customers on Snowflake's platform can come from customers of all sizes. Unlike traditional enterprise software companies, Snowflake doesn't solely rely on a large employee count to drive customer spend.
Source: Snowflake Investor presentation
Two percent of one-million-dollar customers are corporate, which Snowflake defines as customers with 500 employees or less. Snowflake employs an inside sales team specifically focused on corporate customer acquisition.
At the time the presentation was made, only 25% of Snowflake's Fortune 500 customers were producing over one million in product revenue TTM and that number indicates there is still a significant runway ahead to gain more business with the largest enterprises in the world. Moving up market and gaining business from large enterprises is the primary way that Snowflake intends on getting to their $10 billion product revenue goal. Another benefit from gaining larger enterprises as customers is that it also helps Snowflake increase margins and achieve better operating leverage.
Source: Snowflake Investor presentation
The reason why Snowflake desires larger customers is that the company believes they can significantly grow the average spend in Fortune 500 accounts beyond the average 1 million TTM, however, one big headwind for Snowflake is that it can take significant time for the largest accounts to ramp up on the Snowflake platform.
Source: Snowflake Q2 FY22 Presentation
One thing people that are new to looking at Snowflake assume is that the company is a SaaS because aren't all cloud companies a SaaS? Apparently not, because Snowflake uses a consumption model and not a SaaS model, which means Snowflake only charges customers based on what they consume, and not by subscription.
Since revenue is only recognized when consumption occurs and it takes time to get new large accounts up and running before significant consumption occurs, it really benefits Snowflake to help their clients to get up and running as fast as possible.
Source: Snowflake Investor presentation
The above graph is the average number of days that it takes a customer for seven-day annual run rate to exceed their contracted annual amount. This graph shows it took a customer 212 days or roughly 7 months to get up to a consumption rate that they were contracted for.
Snowflake needs to accelerate the time to value for their customers, in order to recognize revenue faster, which is why Snowflake prioritizes time to value initiatives. Snowflake has found that once a customer is up and running, their product revenue growth doesn't just stop at their original contracted amount but often goes way beyond.
Source: Snowflake Investor presentation
In addition, Snowflake's path to profitability requires Snowflake to move up market to larger companies. Snowflake CEO Frank Slootman mentioned during their analyst day that the company's success with Fortune 500 and other large enterprise accounts is considered an important component of being able to expand margins.
As Snowflake moves upmarket, they will sell even more enterprise and business critical premium editions which the company recognizes higher contribution margins on, which is what will drive gross margin improvement.
Source: Snowflake Investor presentation
Snowflake believes the way for investors to track their path to $10B is to monitor million-dollar plus customers, which should wind up being a significant portion of product revenue.
This is the reason Snowflake has an extreme focus on moving upmarket and strongly emphasizes the million-dollar plus number during earnings. If Snowflake executes, it has the ability to become the fastest enterprise software company to reach the $10B revenue milestone.
Source: Snowflake Investor presentation
The above is the goal for what the numbers should look like if Snowflake reaches its FY29 target of $10B in product revenues.
Source: Snowflake Investor presentation
CEO Frank Slootman identified Snowflake's priorities at Analyst Day, which are listed from left to right in the above graphic as:
- Invest for durable growth.
- Show continued product gross margin expansion by moving up market.
- Show meaningful free cash flow generation.
- Show operating leverage.
Whenever an investor looks at and analyzes Snowflake's earnings, they should be looking for signs that the company is hitting on all of those specific priorities.
Snowflake Q2 FY2022 Earnings
Source: Snowflake Q2 FY22 Presentation
Snowflake revenue was up 104% YoY to $272.2 million, beating analyst estimates $15.5 million. Product revenue was up 103% YoY to $254.6 million. Professional services and other revenue came in at $17.5 million.
Remaining performance obligations or RPO was $1.5 billion, up 122%, which is an indication of Snowflake's sales strength during the quarter. Of the $1.5 billion in RPO, the company expects approximately 56% to be recognized as revenue in the next 12 months, representing approximately $87 million increase QoQ.
RPO was driven by net new bookings primarily in the technology and financial services verticals.
Snowflake customers with greater than $1 million in TTM product revenue increased to 116, up from 104 last quarter. Like I stated previously, this is an extremely important number to track from quarter to quarter, in order to gauge Snowflake's progress toward $10B in product revenue.
Source: Snowflake Q2 FY22 Presentation
Snowflake's dollar-based net revenue retention rate reached 169%. As a general rule of thumb, dollar-based net retention rates in the 110% or more range indicate a best-in-class enterprise software company. Snowflake's retention rate at 169% is on a whole other level, though. It is the best retention rate of all the companies that I am aware of.
Source: Snowflake Q2 FY22 Presentation
Snowflake added 458 net new customers during the quarter, up from 397 in Q2 of last year. Snowflake's area of focus, which is the largest organizations or Fortune 500 companies, increased by 18 to total of 212 during the quarter.
As stated previously, Snowflake makes sales using a vertical industry-oriented go-to-market strategy. The financial services customer vertical, which represents the largest contribution to overall revenue. grew product revenue more than 100% year-on-year, The healthcare vertical grew product revenue nearly 200%. There was also continued strength from the technology vertical.
Source: Snowflake Q2 FY22 Presentation
Snowflake Q2 product gross margin was 73.6%, up 140 basis points from last quarter, which shows continued product gross margin expansion, which is one indication that the company is successfully moving up market. The company also attributes the improved gross margins to succeeding in gaining better cloud agreement pricing and developing better discipline over discounting.
Increased price per credit related to higher price addition consumption and higher-than-expected compute as a percent of revenue from improved storage compression mentioned last quarter drove the outperformance. We have confidence in our ability to show leverage over time, but we view this significant quarter-over-quarter increase as one-time in nature.
Source: CFO Michael Scarpelli - Snowflake Q2 FY22 Earnings Call
Source: Snowflake Q2 FY22 Presentation
Snowflake recorded $125.3 million in Q2FY22 non-GAAP S&M expenses, which is 46% of revenues down from 65% of revenues from Q2FY21.
Snowflake recorded $65.8 million in Q2FY22 non-GAAP R&D expenses, which is 19% of revenues down from 24% of revenues from Q2FY21.
Snowflake recorded $29.8 million in Q2FY22 non-GAAP G&A expenses, which is 13% of revenues down from 18% of revenues from Q2FY21.
Snowflake showed operating leverage in their operating expenses on a quarterly year-over-year basis.
Source: Snowflake Q2 FY22 Presentation
Snowflake's Q2FY22 non-GAAP Operating loss was 21.9 million with an operating margin of negative 8%. This compares to a non-GAAP operating loss of $58.3 million with an operating margin of negative 44%.
Snowflake Q2FY22 operating numbers benefited from revenue out-performance.
Adjusted free cash flow margin was 1%, which CFO Michael Scarpelli attributes to the number being "positively impacted by strong linearity in bookings and operating margin outperformance". He also mentioned that moving forward, the company should remain adjusted free cash flow positive.
Source: Snowflake Q2 FY22 Presentation
GAAP loss per share was $0.64 compared to the $0.70 loss in last year's quarter. The number beat analyst expectations by $0.02.
Balance Sheet
Snowflake ended Q2FY22 with $4.1B in cash, cash equivalents and short-term investments.
Snowflake ended Q2FY22 with $875.7M in current liabilities and no long-term debt.
Roku had a quick ratio of 4.99. A company with a quick ratio of 1.0 and above can easily pay current liabilities.
Guidance
Source: Snowflake Q2 FY22 Presentation
Snowflake projects Q3FY22, product revenues between $280 million and $285 million, representing YoY growth between 89% and 92% with negative 7% operating margin
For the full year FY22, Snowflake projects product revenue of $1.06 billion to $1.07 billion, representing 91% to 93% growth with 73% product gross margins, negative 9% operating margin and 7% adjusted free cash flow margin.
This guidance indicates that Snowflake's blistering triple-digit growth is starting to come to an end. Many short-term investors had already been on edge because of a recent report by Cleveland Research that talked about Snowflake's signings growth slowing amid increased competition from the hyperscalers like Google.
While growth with Snowflake might indeed be slowing, the company will still be growing at a relatively brisk pace. However, investors can expect moving forward that there might be increased volatility in Snowflake's stock as fears of slowing growth will likely get stoked by people uncomfortable with Snowflake's valuation.
Data Cloud
One of the key ideas that Snowflake is counting on to achieve its goal of reaching $10 billion in product revenue by fiscal 2029 is the concept of a "Data Cloud". What is the Data Cloud?
Snowflake CEO Frank Slootman appears to define the Data Cloud as the sum of all data networking relationships that are active at any point in time.
The Data Cloud is a way to not only allow organizations to unify and connect to a single copy of all of their own data but to also connect to an ecosystem of thousands of other businesses and organizations to consume shared data and data services.
The Data Cloud is the sum of all data networking relationships that are active at any point in time. We track these data relationships through what we call edges. We added over 450 customers in the quarter and continue to expand the number of customers with stable edges. At the end of the quarter, 16% of our customers had stabilized edges in place with external Snowflake accounts compared to 15% last quarter.
Source: CEO Frank Slootman - Snowflake Q2 FY22 earnings call
Slootman went on to highlight that the total number of the "stable edges" grew more than 20% QoQ, which was stimulated by Snowflake's Data Marketplace growing their listings 32% QoQ.
The reason why I am highlighting this concept of the Data Cloud is because, increasingly, Snowflake is seeing competition from the likes of Google BigQuery (NASDAQ: GOOGL) and Amazon's Redshift (NASDAQ: AMZN). There might be a perception among some people that Snowflake doesn't have much of a moat and that competitors can easily copy what they are doing and take market share from Snowflake.
Well, a concept like the Data Cloud has powerful network effects, meaning that the more companies that join Snowflake's Data Cloud and share data, the more Snowflake's Data Cloud will become valuable to each company that joins the data sharing, which makes it increasingly harder for those customers to leave as they become more reliant on the data sharing.
That is why it is important to see high growth numbers from such concepts as Snowflake's Data Cloud and Data Marketplace. Those numbers could be considered a proxy for how rapidly Snowflake is building up a network effect moat.
Snowflake and The Trade Desk
Like I have mentioned previously in this article, Snowflake uses an industry-oriented go-to-market strategy and one of the industry verticals that Snowflake decided to get into is advertising.
The first bit of news that Snowflake announced recently is support for Unified ID 2.0, this past July. Unified ID 2.0 is an open source, industry-governed identity solution that was first developed by The Trade Desk (NASDAQ: TTD). Unified ID 2.0 members will now have the capability of utilizing the secure data sharing technology in the Snowflake Data Marketplace. and this will be a great example of the "Data Cloud" in action.
The Trade Desk CEO Jeff Green commented on Snowflake supporting Unified ID 2.0 on its latest earnings call:
I think Snowflake adopting UID2 is one of the biggest headlines that has happened for UID to date and not enough has been said about it. I don't think most people understand why this is so big.
Source: CEO Jeff Green - The Trade Desk Q2 2021 earnings call
Many in the advertising industry are looking at Unified ID 2.0 as a solution to Apple changing its rules on “identifier for advertisers” (IDFA) and Google possibly eliminating third-party cookies from Chrome in the future.
Very soon after Snowflake's Unified ID 2.0 announcement, Snowflake announced that The Trade Desk has joined the Snowflake Data Exchange as a data partner to make log-level bidding events available to its customers in real-time. This will have the effect of giving The Trade Desk customers improved data analytics, reduced time to insights, improved ad campaign results, and higher ROI for marketing investments.
Investors should pay attention to the initiatives Snowflake is making in different verticals like advertising because they have the potential to become very big. Right now, there is not much talk about what Snowflake is doing in advertising but The Trade Desk joining the Data Exchange and Snowflake supporting Unified ID 2.0 could pay very huge dividends down the road.
Valuation
Source: Yahoo Finance
The above is based on 25 Wall Street analysts offering 12-month price targets for Snowflake in the last 3 months. The average price target is $316.31 with a high forecast of $515.00 and a low forecast of $245.00. The average price target represents a 5.9% increase from the last price of $297.71.
Snowflake is among the most highly valued stocks in the market and with the company looking at growth tapering off a bit in quarters ahead, Snowflake is susceptible to downdrafts in price, especially if the market turns away from highly valued unprofitable growth stocks.
Conclusion
While revenue growth might indeed be slowing for Snowflake and could cause volatility in the short term, Snowflake is making strong progress towards its long-term goal of reaching $10B in product revenues by FY2029.
Snowflake added 25 new Fortune 500 customers during the quarter to reach a total of 212 logos, bringing Fortune 500 penetration to 42%. Snowflake customers with greater than $1 million in TTM product revenue increased to 116, up from 104 last quarter and still has a solid runway to grow large accounts. Snowflake has best-in-class net retention rates. Snowflake is also making progress in becoming profitable and recently became adjusted free cash flow positive.
Snowflake is a buy for long-term investors. While there might be volatility over the short term, this company has a significant runway to grow into its valuation and be a market-beating investment over the next +5 years.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of SNOW either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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