Crwd's FCF

Investment Analysis Clubs Saul’s Investing Discussions
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One of the reason’s I have continued to own crowdstrike is their operational leverage and ability to generate free cash flow is only matched by a few companies. CRWD has been running FCF margins in the 20-38% range which on the face of it are astoundingly good. However over the last 8 quarters stock based compensation (SBC) has been increasing as a percentage of revenue. In q3 2021 SBC/Rev Was 16.6% and has gone up every quarter to the most recent quarter at 22.5%. Ok, not great. Next I looked at (thanks @PaulBryant for this input) SBC as a percentage of free cash flow (FCF). Ideally what we want to see is that SBC makes up less and less of the total FCF. Instead what we see is that SBC has gone from 51.31% of FCF all the way up to 75.97% as shown in the last column below. A quick note, CRWD treats SBC as a direct dollar add to FCF. So if they give out 5 dollars of SBC then they add 5 dollars to FCF. Taken together, this means that CRWD is giving out more SBC as a percentage of their revenue and actual dollars of FCF are decreasing. Both of these metrics are heading in the wrong direction and have been for the last 8 quarters.


TTM Rev        TTM SBC             TTM FCF        %sbc/rev     %sbc/FCF
761.618        126.324             246.189        16.6%        51.31%
874.438        149.675             292.903        17.1%        51.10%
999.203        180.399             323.104        18.1%        55.83%
1137.922        218.973            364.326        19.2%        60.10%
1285.513        265.029            411.734        20.6%        64.37%
1451.594        309.952            441.674        21.4%        70.18%
1636.585        358.084            482.004        21.9%        74.29%
1834.048        413.347            544.122        22.5%        75.97%  *most recent quarter

I looked at this for DDOG and @paulbryant looked at it for snow. Both of them are have much better trends. If tables weren’t such a chore on this site then I would post them here.

Best,
Ethan

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One final post on this. Here is CRWD’s FCF margin on a TTM basis with SBC removed.

0.16
0.14
0.13
0.11
0.09
0.08
0.07 * most recent quarter

Reverse operational leverage

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There are a few things to consider here.

As stock prices stay depressed how do companies retain talent? (a) Give out more stock options which can increase SBC as a % of Rev or (b) Give out more in cash bonuses which will decrease FCF

In the last 12 months, more companies have started travel and in-person events. This will reduce FCF. During Covid their FCF was artificially higher.

CRWD has acquired Preempt and Humio. These may be impacting SBC as well.

Keep in mind these companies are still growing fast. They are not primed for FCF. So, we should not expect a uniform progression in FCF growth.

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A quick note, CRWD treats SBC as a direct dollar add to FCF. So if they give out 5 dollars of SBC then they add 5 dollars to FCF.

Ethan, I’m sorry but I don’t have a clue what that means. FCF is cash in the bank. It’s Operating Cash Flow less Capex, and plus or minus interest received or paid. It has nothing to do with SBC. If a company says they have $19.43 million in FCF it means they put $19,430,000 in the bank, and their level of Cash should be up by 19.43 million dollars. SBC just doesn’t figure in in any way.

SBC potentially dilutes us, the stockholders, but it doesn’t cost the company anything, NOT A PENNY. I don’t like excess SBC any more than you do, but NO COMPANY “treats SBC as a direct dollar add to FCF”. Putting those words “treats SBC as a direct dollar add to FCF” together simply doesn’t have any meaning. SBC is simply not a cash expense or add for the company.

Best,

Saul

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To exercise his options the employee buys the shares and pays cash.

Exercising Stock Options
Exercising a stock option means purchasing the issuer’s common stock at the price set by the option (grant price), regardless of the stock’s price at the time you exercise the option. See About Stock Options for more information.

https://www.fidelity.com/products/stockoptions/exercise.shtm…

Denny Schlesinger

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I think what Ethan is saying is, if instead of SBC they used cash for all compensation, the FCF would have been (roughly) stagnant for the last couple years – they have increased revenue quite a bit, but none of the added revenue is dropping to the bottom line.

TexMex gave some good reasons that this might be so. Still isn’t what we want to see, but I do believe it is temporary and will get back on track eventually – but thank you to Ethan for pointing it out! It is definitely a trend to watch.

I don’t consider it a red flag, and I hesitate to even say it’s a yellow flag, but I certainly would prefer if they were just printing money and not having to spend all the revenue they’re adding (whether they spend cash or spend shareholder’s money via SBC).

CRWD remains a top 3 position for me.

Bear

If you isolate just Q2 of this year, this did improve a bit. Hopefully that’s the start of a good trend!

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Ack, I messed up my reply. Sorry if this gets posted twice.

FCF is cash in the bank

I like to shorthand think of FCF the same way but it is a short hand that isn’t quite correct.

In Crowdstrike 10-k they show us how they calculate FCF. Here it is copy and pasted from the 10-k

“GAAP net cash provided by operating activities
Purchases of property and equipment
Capitalized internal-use software and website development costs”

So then we go to the cash flow statement, line five under “adjustments to reconcile net loss to net cash provided by operating activities” is stock based compensation expense.

or if one does not want to wade through the 10-k, this article lays it out quite nicely.
https://www.fool.com/investing/2016/06/16/stock-based-compen…

Here is the relevant quote.

Stock-based compensation also complicates free cash flow, which is sometimes touted as an alternative to GAAP earnings. Free cash flow is a useful number, as it represents the amount of cash a company’s operations generate minus capital expenditures. But since stock-based compensation is non-cash, it gets added right back in. When the only source of free cash flow is stock-based compensation, that free cash flow fails to reflect the company’s true profitability.

-e

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if instead of SBC they used cash for all compensation, the FCF would have been (roughly) stagnant for the last couple years

But Bear, they did use SBC (which cost the company NOTHING!), which means they DO HAVE all that wonderful growing FCF. It’s there, real money, REAL MONEY in the bank!!!

They have increased revenue quite a bit, but none of the added revenue is dropping to the bottom line.

But Bear, that’s the whole point! It DID drop to the bottom line!!! FCF is the “bottom line”!!! It’s in the bank!!! In CASH!!! They can use it to pay dividends. They can use it to buy a building, or to pay the electric bill. They can use it to buy an acquisition. It’s real money.

Stock based compensation just allows employees to acquire new stock at below market prices. It dilutes us stockholders, but there is NO COST to the company… I repeat, there is NO COST to the company!!!

Saul

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But Bear, they did use SBC (which cost the company NOTHING!), which means they DO HAVE all that wonderful growing FCF. It’s there, real money, REAL MONEY in the bank!!!

I know. I kinda wish they’d pay 100% of their expenses with SBC!

But I’d still like expenses to steadily decrease as a percentage of revenue. Even if the expenses are free to the company.

Bear

PS - to be fair, I think they will decrease over time. Just hasn’t been steady lately.

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Ethan, your quotes are correct,

Free cash flow is a useful number, as it represents the amount of cash a company’s operations generate minus capital expenditures. But since stock-based compensation is non-cash, it gets added right back in.

But I think you missed a key point. It does get added back in, but that is only because it was taken out when capital expenditures were taken out (bolded above).

So you have cash from the companies operations minus capital expenditures (which includes Stock Based Compensation) and then you put the SBC back in because it is non cash.

Your math of taking it back out again is basically taking it out again after it was already taken out.

So it really doesn’t (and shouldn’t) have any effect on free cash flow (as Saul is saying).

Randy

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But I think you missed a key point. It does get added back in, but that is only because it was taken out when capital expenditures were taken out

Thanks Randy, that does make it clearer!

GAAP makes the accountants take SBC as an expense to the company, even though it’s not an expense to the company. But when they get to Free Cash Flow, which deals with actual cash rather than accounting make-believe, they have to add it back in, because the cash is still there and hasn’t actually been spent.

(Although I believe it is originally taken out as a salary expense, rather than a capital expenditure).

Thanks,

Saul

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Randy, I completely agree but what I am trying to show is that CRWD’s costs are increasing. I also agree with Saul that SBC is not an expense to the company.

What I am trying to look at is what is CRWD’s FCF if we take out the SBC effect to give us a picture of how CRWD is doing without SBC. Yes, GAAP counts SBC as an expense, so on the cash flow statement the company adds the SBC back in to cancel out that expense. From a true cash flow that is of course the right way to deal with it. Just to take an extreme example. If crwd paid no salary to any of its employees and paid them only SBC…but someone wanted to see how the business was performing to compare it to other companies that paid only salary…then you would subtract the SBC from FCF, just like what I am doing. That is the analysis I’m doing here and what it shows is that CRWD is in that theoretical example that crowdstrike’s FCF outside of the money it saves from SBC is going down.

As Bear said, “But I’d still like expenses to steadily decrease as a percentage of revenue. Even if the expenses are free to the company.”

Talking about how to account for SBC is like talking about politics or religion at the dinner table. I’m not trying to have that conversation. I’m simply trying to correct for SBC to see how FCF outside of SBC is doing.

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As Bear said, “But I’d still like expenses to steadily decrease as a percentage of revenue. Even if the expenses are free to the company.”

A possible solution is to track that very relationship from both a GAAP and non-GAAP standpoint. Here’s CRWD:


Op Ex % Revenues					Non-GAAP Op Ex % Revenues					
	Q1	Q2	Q3	Q4	YR			Q1	Q2	Q3	Q4	
2018				145.5%	164.8%		2018					
2019	129.0%	121.3%	129.9%	105.3%	119.9%		2019	125.5%	117.4%	110.2%	101.6%	111.9%
2020	96.4%	117.6%	100.9%	91.9%	100.9%		2020	92.8%	91.7%	85.3%	77.9%	85.9%
2021	86.3%	87.7%	83.9%	80.8%	84.3%		2021	74.7%	70.8%	67.6%	64.3%	68.8%
2022	84.4%	87.3%	83.8%	79.3%	83.4%		2022	67.0%	65.9%	62.9%	58.2%	63.0%
2023	78.9%	82.8%			0.0%		2023	59.7%	60.1%			0.0%

Clearly GAAP is choppier, which I believe reflects a lot of the dynamic being discussed here. I guess I fall into the camp a company’s combination of growth, gross margin, cash flow margin, and profit margin plays a much larger role in my personal calculus than SBC. If a firm has a crappy combination in those areas, I couldn’t care less that they were being prudent in not diluting shareholders.

SBC is just another tool each of us can use to judge a business. How much weight it should carry is up to the individual (as we are clearly seeing). For younger investors, I’d view this as an educational thread as to how to consider this topic rather than some sort of either/or dilemma.

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Allow me a little bit of a comment here at the risk of wading into a dogfight. I feel we don’t often enough look at the cash flow statement, focusing disproportionally on the P&L…FCF is a non-gaap number generally calculated from the CF statement that is useful for valuing companies.

It is not universally calculated the same way. And it is not cash in the bank - for that you need to go and look at the cash flow statement right at the bottom, where it shows what happened to your cash and cash equivalent balances for the year. It specifically excludes all the cash flows the company gets or pays for financing activities (say you borrow money and get cash in return - excluded, issue shares and get cash in return - excluded, pay cash for an acquisition - generally excluded). SBC is absent from all of this as it is a non-cash expense (the cash flow statement excludes all non-cash items), same as depreciation, amortisation and other accruals like accruals for taxes (the CF statement only includes the actual cash taxes paid in a period) for example.

CRWD has this to say in their latest release about FCF: “Free cash flow is a non-GAAP financial measure that we define as net cash provided by operating activities less purchases of property and equipment and capitalized internal-use software and website development costs. We monitor free cash flow as one measure of our overall business performance, which enables us to analyze our future performance without the effects of non-cash items and allow us to better understand the cash needs of our business. While we believe that free cash flow is useful in evaluating our business, free cash flow is a non-GAAP financial measure that has limitations as an analytical tool, and free cash flow should not be considered as an alternative to, or substitute for, net cash provided by operating activities in accordance with GAAP. The utility of free cash flow as a measure of our liquidity is further limited as it does not represent the total increase or decrease in our cash balance for any given period. In addition, other companies, including companies in our industry, may calculate free cash flow differently or not at all, which reduces the usefulness of free cash flow as a tool for comparison.”

Free cash flow aims to calculate the cash flow that a company would have generated if it wasn’t actually financed the way it is, and didn’t receive things like proceeds from share issues that it actually may have received, didn’t receive or repay any loans, or pay cash to buy companies, which it likewise may have done. CRWD’s FCF does not include the $38.7m cash that they received last Q from investing activities, for example. FCF also excludes some actual, real cash outflows from investing - generally reducing cashflow only by the capex part of investing activities (and in CRWD’s case also by the cash they spent on developing software for internal use). CRWD deducted $74m of its $79m cash used in investing activities last quarter, and $35m of the $41m in the quarter before to arrive at FCF.

For CRWD - go and have a look at what they adjust their P&L for on p11 of their latest 10-Q to get to operating CF: https://ir.crowdstrike.com/static-files/49137c3e-100d-4ad7-8… - it’s a list of 16 non-cash things, one of which is SBC. Their big kicker is that deferred revenue of course gets added to operating loss as it’s cash actually received. So FCF includes all “operating” cash flows and aims to exclude all “non-operating” cash flows.

As another example have a look at ZI (which has debt and pays interest) - they specifically show unlevered FCF - i.e. with leverage aka debt taken out. CRWD does not specify that because they have no debt. ZI defines FCF thus: “We define Unlevered Free Cash Flow as net cash provided from operating activities less (i) purchases of property and equipment and other assets, plus (ii) cash interest expense, (iii) cash payments related to restructuring and transaction-related expenses, and (iv) cash payments related to integration costs and acquisition-related compensation. Unlevered Free Cash Flow does not represent residual cash flow available for discretionary expenditures since, among other things, we have mandatory debt service requirements.”

So if FCF isn’t the actual cash flow of our companies, what’s the point? It’s a “what if” calc which is very useful in comparing companies with each other. What if SNOW didn’t have $5bn of cash on it’s balance sheet, and what if ZI didn’t owe tons? If we tried to strip out how the company is financed and other funnies/non-operating items in cash flow and try to normalise/standardise the cash flow number - what would cash flow have been? That’s the utility of that number. Deciding what is operating cash flows vs non-operating cash flows is at least a bit of a judgment call. FCF is used in DCF valuations so that you can value a company independently of it’s actual capital structure (adding or deducting the actual cash or debts of company as a last step of the valuation.)

So what?

I think that asking the question: “what if” a company actually paid its employees with cash in stead of with SBC is as valid a question as asking “what if” a company didn’t actually have any cash or debts on balance sheet, didn’t receive any dividends, didn’t actually pay all of the taxes it owed and didn’t actually pay the cash it did for the acquisitions it has made. The SBC “what if” question is interesting as paying with SBC / not is at least a bit of a financing decision - should we pay our employees or should we ask our shareholders to pay them directly? Ethan and Bear’s analysis raised an orange flag for CRWD and a screaming red flag for ZS and showed the superiority of DDOG and SNOW on this measure. It’s not useful in isolation but its another piece of the puzzle, nothing more, and quite a useful one imo.

-WSM

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CRWD’s FCF does not include the $38.7m cash that they received last Q from investing activities, for example.

->should read:

CRWD’s FCF does not include the $43.3m cash that they received last Q from financing activities, for example.

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"So if FCF isn’t the actual cash flow of our companies, what’s the point? It’s a “what if” calc which is very useful in comparing companies with each other. "

I would disagree with the characterization that FCF is a “what if”. It IS the universally accepted metric for cash in the bank. To make sure a company’s debt load is taken into account, it’s better to look at levered FCF.

“It specifically excludes all the cash flows the company gets or pays for financing activities (say you borrow money and get cash in return - excluded, issue shares and get cash in return - excluded, pay cash for an acquisition - generally excluded).”

As it should. None of these are a measure of a company’s ability to generate cash, but rather capital allocation decisions by management (same as you’re free to spend the cash that hits your bank account).

It’s really good we’re monitoring SBC and I’m not a big fan either. But, it’s a non-cash expense (as Saul said it costs the company nothing) and we can’t create a metric by deducting it from actual cash. Imo, the simpler option is to look at GAAP (for most of the companies discussed here, SBC is the major difference between GAAP and non-GAAP).

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I fully concur that Free Cash Flow is THE key metric for companies in their growth phase. And I also agree that SBC is not a cash expense. Currently SBC has two effects on the income statement:

(1) It is treated as an expense, reducing net income. This doesn’t seem like the correct treatment, so following non-GAAP net income is better for our purposes.

(2) It dilutes the number of shares outstanding, which may not seem like a big deal, but it is a serious drag on stock performance. Companies that engage in SBC in a big way must be tracked by their “per share” results. Why? Well, as shareholders, it is only our share of the pie that matters; this is why we don’t track net income, but net income per share. Net income, gross income, free cash flow, etc. act as an aggregate measures of business performance, while the “per share” numbers measure the performance of OUR SLICE of the business.

If a company routinely dilutes the shares outstanding by 5% per year, over time that is a 5% drag on our annualized returns. For companies with amazing returns, we can live with that. But I sure wish that drag just wasn’t there, because 5% makes a HUGE difference in lifetime results.

Tiptree, Fool One guide and Market Pass home Fool

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(2) It dilutes the number of shares outstanding, which may not seem like a big deal, but it is a serious drag on stock performance.

This is a very common misconception because it only looks at half the picture. The missing part is that if instead of paying with shares you paid with cash your FCF would be lower.

What most people don’t realize because they don’t know “real” accounting is that expensing SBC is a terrible perversion of accounting principles because it commingles the accounts of the company with the accounts of the shareholders. SBC should only be a footnote to the financial statements.

The one thing to watch for is the occasional abuse of stock options. Maybe expensing SBC is an attempt to highlight the possible abuse.

If a company routinely dilutes the shares outstanding by 5% per year, over time that is a 5% drag on our annualized returns.

This is what I call ‘stock option abuse’ but it is no different than paying management absurd amounts of money.

Denny Schlesinger

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Many great points about the metrics of their FCF in this thread.

I recently sold my holdings in CRWD after their last Q2 report, but not for specifically their FCF metrics. Rather I’m more concerned with much higher up and how they talk(brag?) about their Non-GAAP “Adjusted” earnings.

Condensed Quote from their report:

“We believe that non-GAAP financial information, provides (1) CONSISTANCY and comparability with past financial performance and facilitates period-to-period comparisons of operations, as these measures eliminate the effects of certain variables (2) unrelated to our overall operating performance”

Coming at this from 2 fronts, because they are making 2 claims here.

  1. Consistency - It’s not consistent, each quarter their SBC gets higher and higher, by a lot

  2. Salary Costs Unrelated - Claiming employee salaries are unrelated to operating performance (of a SAAS company) is just a flat out lie, in fact it is the exact opposite of their claim.

Why do they do this with all of these claims and repeatedly bragging about their non GAAP adjusted metrics (while providing flat out lies attempting to reconcile those adjustments) . Companies like DDOG and TWLO do not do this, at all. It’s a very unsettling feeling.

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Hi Tiptree,

I think that you are missing the point here:

“If a company routinely dilutes the shares outstanding by 5% per year, over time that is a 5% drag on our annualized returns. For companies with amazing returns, we can live with that. But I sure wish that drag just wasn’t there, because 5% makes a HUGE difference in lifetime results.”

  1. The company needs to compensate quality employees somehow. If it’s not done with SBC then it would need to be some other way. The alternatives are generally more costly from the company’s point of view.

  2. The use of SBC helps align employee interests and motivation with the company. Employee owners are motivated to further the company’s success.

There’s no waving a magic wand and making SBC disappear. There are reason’s for the various accounting mechanisms that exist. When looking at SBC I think that it’s important to look at the effect of fully diluted share counts in addition to outstanding share counts.

Macroman77 aka Mark

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