JFrog Ltd

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

JFrog Ltd. provides an end-to-end hybrid, universal DevOps platform that enables organizations to manage and deliver software updates continuously, including infrastructure, deployment tools, and security.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

JFrog provides a platform for software delivery in the DevOps market. The company’s platform helps organizations manage the entire software lifecycle - from development and security through to delivery and update. JFrog operates on a subscription basis, where customers pay recurring fees to access its services.

Revenue Distribution

JFrog’s revenue is primarily generated through its subscription model, which can be divided into Self-Managed and SaaS.

  • Self-Managed: This refers to revenue from licenses to run the software within a customers’ infrastructure. These licenses are often long-term and usually very sticky revenue.
  • SaaS: (Software as a Service) This is where the software is run on the provider’s platform, and customers subscribe to use it. They are generally shorter-term contracts than self-managed and are seen as more scalable and more easily accessible.

The trend has been that, overall, the revenue is increasingly shifting to be derived from cloud services rather than self managed licenses, which are declining year over year. However, both subscription areas are experiencing growth, with self-managed slightly slower and SaaS growing considerably faster.

The DevOps industry is experiencing a rapid transformation and adoption of modern software technologies and methodologies across the board. Companies need to release, update, and deploy software faster than ever before, while still ensuring reliability, quality and security. As such, modern continuous integration and continuous delivery (CI/CD) and DevSecOps tools are paramount, and the entire market is experiencing rapid growth. This trend has seen a major shift from traditional software development practices to more flexible and iterative approaches. New technologies such as AI are also becoming increasingly integrated in software development, requiring new security procedures and considerations. Cloud-based platforms are becoming extremely popular and are becoming the standard way of accessing and delivering software.

  • Shift to Cloud: The adoption of cloud-based software delivery solutions is increasing. This shift allows organizations to scale and reduce management overhead.
  • Increased Emphasis on Security: The need for integrated security tools within the software pipeline is becoming a necessity, due to both high-profile data breaches and increased legislation.
  • Automation and DevOps: Automation is required more and more to have development and releases be effective, without them, most large companies can not be effective in software deployment.

Margins

JFrog has strong gross margins, consistently above 70%. However, like many SaaS businesses, it has high selling, general, and administrative expenses and therefore struggles to have positive net margins, but it is trending in a positive direction. As revenue growth rate begins to settle, the expenses are expected to stay at a somewhat consistent rate which will increase net income over time.

Competitive Landscape

JFrog competes in an intense and increasingly crowded market. The major competitor categories are:

  • Traditional Software Companies Companies that have moved to DevOps practices as a result of the overall market push for it, such as Microsoft, Atlassian, and IBM.
  • Specialized DevOps Vendors: Companies who are singularly focused on providing specialized services around DevOps. This is a growing market that is extremely competitive. For a complete analysis of this competitive landscape, please refer to Appendix B. The specific competitors are: GitLab, Cloudbees, and Codefresh.

What Makes the Company Different

JFrog differentiates itself by presenting itself as a platform that incorporates the entire software lifecycle. Most competitors only focus on specific segments of this, such as version control, artifact management, CI/CD etc. This allows JFrog to position itself as an end-to-end solution, which gives significant value to companies that want a unified platform for all of their software development. They also offer services on premise (in-house) as well as on the cloud which they manage.

Financials in Depth

We have seen that the business is transitioning into more of a SaaS based company, which will have an affect on its financials.

Revenue Growth

JFrog has been experiencing high growth for the past few years, but growth is starting to slow. For the quarter ended September 30, 2023, Total revenue came in at $90.2 million, a 23% increase YoY (year-over-year), which was below prior quarter growth rate. It is extremely important to keep a watch on this metric. Revenue growth will be the key for the business’s profitability in the long run.

Income Statement

  • Gross margin is solid at around 78%, showcasing its ability to extract value from each dollar of revenue.
  • R&D expenses are very large, comprising over half of the operating expenses, which shows the investment they are making into their software platform.
  • Sales and marketing expenses are also very large, which is a sign of both the scalability of the business, but also that large resources are still being allocated to growth.

A key point to look at is the efficiency metrics of the company. Their gross profit margin is very high, over 70%, but they have extremely high operation expenses in R&D and marketing. This puts considerable pressure on the bottom line and makes it more volatile. However, with a high growth rate, the company is able to offset much of these expenses and still generate value.

Balance Sheet

The company has a strong balance sheet with:

  • a decent cash position of $526 million as of September 30, 2023.
  • low level of debt obligations of just $5 million at the end of September 30, 2023. These low liabilities and high cash balances present very little risk to the company’s viability, and the ability to expand and buy out other competitors and continue investing in their business.

Cash Flow

JFrog is generating relatively positive cash flows from operations. The cash flow from operating activities is trending upward, but the company also has significant expenditures into CAPEX (Capital Expenditures). Their free cash flow for the trailing twelve months (TTM) is about $48 million, which represents a FCF margin of 14%.

Moat Analysis

JFrog’s moat comes from the difficulty of competitors being able to compete in its market. This manifests itself in several ways:

  1. Customer lock-in: Once a company begins heavily using JFrog’s platform, it can be extremely difficult to switch to a competing platform, due to the cost and time of training new staff and migrating all the data and business operations over to another platform.
  2. Brand identity: JFrog has significant brand recognition in the DevOps community, particularly due to its strong presence in open-source projects.
  3. Economies of Scale: JFrog has a large user-base and therefore benefits from large economies of scale, the more users they have, the better they get. Although the company does have a very compelling value offering, the market is extremely competitive, and these factors do not give JFrog a clear path to a wide moat. As such, the rating is only a 2 out of 5.

Risks to the Moat

  1. Intense Competition: Intense competition from larger tech companies and other startups, along with the emergence of new technologies, can erode the moat.
  2. Rapid technological changes: As new technologies emerge quickly, the product portfolio needs to be continuously updated and that would require more R&D.
  3. Disruptive innovation: If a competitor comes up with a disruptive new offering, they may be able to outcompete.

Business Resilience

Given its relatively high margins, decent cash balances, and an increasingly stable and recurring source of SaaS revenue, the business seems poised for resilience, even if the market forces were to turn unfavorable.

Understandability

The company’s business model and product offering is reasonably simple to understand, making it neither too complex nor too basic. Although the overall financial statements are relatively clear, a good in-depth understand of software development and deployment is important to truly understand the business. Therefore, its understandability rating is a 3 out of 5.

Balance Sheet Health

The company’s balance sheet is quite strong, with a lot of liquidity and low debt obligations. They appear to be financially well managed. Therefore its balance sheet health rating is a 4 out of 5.

Conclusion

JFrog is a rapidly growing software development company operating in a high-growth market, and it seems well positioned to benefit from the market trends. The company has strong potential for growth and therefore could be an extremely compelling investment. The main concern is the company’s profitability issues and its relatively weak competitive moat. This presents a high risk for the company’s long term viability in the increasingly competitive DevOps market.

Recent Problems and Controversies

The only major controversy for JFrog has been related to their hiring practices, and how they compensated some of their senior level employees, where the company was accused of putting undue emphasis on stock based options. The company has addressed this in its latest earnings call, by emphasizing that they are looking to pay employees in other ways to address this issue.