GTLB - GitLab: Despite Strong Q2 AI Impact Creates Uncertainty

2023-09-06 09:00:09 ET

Summary

• GitLab's future is uncertain due to the rapid development of generative AI and its impact on the DevSecOps sector.
• GitLab, along with Microsoft's GitHub and Atlassian, recognizes the potential of generative AI and hopes to improve their offerings with it.
• While GitLab's results initially appear promising, closer examination of the 6M results reveals higher net losses and increased operating expenses.

GitLab Thesis

The deciding factor for GitLab ( GTLB ) will probably be how the whole situation with generative AI and its interplay with the DevSecOps sector plays out. As we live in a fast-paced world, it will be almost impossible to say what this sector will look like in the next few years, as the pace at which the sector is developing is rapid.

And everyone who has read the book Superforecasting - The Art & Science of Forecasting knows about the accuracy of predictions about the future. So my plan for a company with an unpredictable future like GitLab is to take a close look at the present, and here I see that today's quarterly results are not as good as they first appear. Let me explain this in more detail in the next sections.

GTLB And Generative AI

Although I said that the future of this company is hard to predict, I want to start by talking about AI, as GitLab has shifted its focus to this topic. GitLab is a leader in the DevSecOps space, along with Microsoft's (MSFT) GitHub and Atlassian (TEAM), with GitHub being the most well-known product. And all three know that generative AI and ML will have a big impact on the industry. But they also hope to use the technology to improve their existing offerings.

Ideally, this allows for real-time monitoring as well as a utomatic detection of security issues and automatic code improvements . If this happens as hoped, it would most likely drastically improve the speed of development as well as the level of security. However, this also means that R&D costs will increase in the short term until a satisfactory result is achieved and the new product is proven.

But in such a new and fast-moving environment, anything can happen. The threat of new and better solutions is always present in anything related to AI.

Q2 2024 Results from GitLab

On September 5, 2023, GitLab released its second quarter results , and at first glance, they look promising. Year-over-year revenue increased 38% to $139.6 million, NRR is 124% and non-GAAP net income is positive at $0.01, which is a bullish development. The trend for clients with more than $100,000 in ARR is also very encouraging, with an increase of 37% yoy.

Also, they raised guidance for FY24, now expecting revenue between $555 million and $557 million, whereas last quarter they only guided to $542 million for the fiscal year. All positive signs, as well as the release of GitLab 16 with new AI-powered workflows and the $40 billion TAM, which I think could be even bigger.

GAAP gross profit margins improved 2% to 89% and net loss also narrowed by $8.9 million. But my point of criticism is in the next picture when we look at the 6 month results from January 31, 2023 to date.

Here we see that despite much higher revenues, the net loss for the 6 months this year is higher than last year. On the one hand, R&D expenses were $99,394 million compared to $71,350 million last year, which is a positive sign because they are investing in the future. On the other hand, operating expenses increased about 30%, from $273 million to $350 million, which is still below the revenue growth rate, but a slowdown in revenue growth could hit them hard. But in Q1 , the growth rate of operating expenses was already more than 40%, from $120 million to $171 million, so the Q2 result shows an improvement over Q1.

However, expenses should be watched as SBC expenses in particular increased by ~40% from $55 million to $78 million. The good non-GAAP net income per share numbers come from excluding the SBC expenses, which I believe are real expenses and should not be ignored. So I would say that the non-GAAP numbers should be ignored and the focus should be on the GAAP numbers, where positive net income per share is still in the future. Here the GAAP loss per share was $0.33 for the second quarter.

And on a GAAP net loss per share basis for the 6-month period, the result is (0.67) this year and (0.58) last year, which shows that the result on a per share basis is not as positive as first thought. Net loss for the first six months increased to $104,107 from $88,110 in the prior year. And all this while the number of shares outstanding increased from 147 million to 152 million, further diluting shareholders.

Takeaways From The Q2 Earnings Call

In the earnings call , GitLab's management made some interesting statements. Partnerships with AWS and Google Cloud will be strengthened. And plans with Google Cloud (GOOG) are to add GitLab to deliver the AI-powered workflows they have been working on. Whereas Amazon started supporting GitLab in their AWS code pipeline in Q2.

Another important point is that they are looking at how to convert free users into paying users. They have done this by setting a user limit for free tiers, whereby they have seen a good conversation rate. Unfortunately, most free users have only moved to the $5000 and below category, but it is a starting point.

However, this conversion, combined with price increases for premium tiers, should lead to some revenue growth in the future. Just as the dedicated launch is likely to have an impact in the future. Fortunately, they also closed a $30 million multi-year deal last quarter, which shows that there is demand from larger customers.

Conclusion

I think it will be important to see how SBC's growth rates play out over the next few quarters, and whether the spending will be primarily R&D or whether other expenses will rise sharply. In particular, the relationship between FCF and SBC will be interesting. Will SBC grow faster than FCF? Will the Google partnership continue to grow? How will the AI landscape evolve over the next year? So there are a lot of questions that will shape the future of this investment over the next few years.

This is not a simple investment where you can predict the next few years with a high degree of certainty. So I would say that the risk/reward ratio could be more favorable in some other investments. However, the second quarter was much better than the first, so there is an upward trend and perhaps GitLab will finish the fiscal year strong in the next 2 quarters.

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