Sentinel...Not#1

Investment Analysis Clubs Saul’s Investing Discussions
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This is a really ̶m̶e̶d̶i̶o̶c̶r̶e̶ terrible earnings for them. Guiding for $137M and came in at 133M. This is disastrous given that their competitors crushed their estimates this quarter and raised their guidance.

Forward looking guidance is only $141M next quarter. FY2023 actually revised DOWN to 590-600 from guidance given just 3 months ago at end of q422 of 631-640.

The only thing preventing me from selling is that the algorithms pushed it down 30% faster than I could execute my orders. Hopeful for a bounce when retail buys the dip tomorrow maybe?

Glad I kept my cybersecurity play spread across $ZS and $CRWD.

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I agree. I intend to sell my S shares sometime tomorrow. Keeping ZS (11%) and CRWD (13%) as my security plays. And cut NET to 3% to keep an eye on it.

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I’m buying. Everyone trashed NET and SNOW after their earnings reports and they bounced back. I sold all my NET at around $45 and quickly regretted it. S, which was already among our cheapest stocks going into today, is now below seven times projected 2024 sales, even with the lower guidance. I think the big reason for such a massive drop is the “historical inaccuracies” noted in the press release and shareholder letter. Not a great look, I concede, but I’m betting it isn’t a harbinger of disaster. Maybe I’ll live to regret these words.

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Right Rob. One thing I noticed is that they are at 10,680 customers and only growing at 43.36 percent when Crwd had that many customers they were growing at around 82 percent. It looks like Crwd really is eating their lunch, they are FCF negative and not any earnings. All that and we haven’t even gone into recession. The only thing they can hope for is that someone buys them out.

Andy

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I get it, trust me. On Tuesday I did my first trades since last year. I tend to hold on if I believe the company, too long at times.
I think NET and SNOW have a place in my portfolio, hence why I trimmed NET today (I benefitted by the rebound), but I kept both.
The problem with S is a little different. They are small, a little too small. In software, size matters. I don’t see them having the R&D and Salesforce capacity to fight CRWD and Microsoft Defender.
At S current size, they should be crushing, but instead they are missing their guidance. I would love to be proved wrong. I haven’t read the details yet.

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I agree with @rodatl. At S’s scale, they should be crushing it revenue wise and taking market share. With all the cash they are burning, they need to stay in hypergrowth for the investment thesis to remain intact. Zscaler and CRWD are throwing out significant free cash flow and forecasting for higher revenue growth next quarter than S. Meanwhile S is forecast a non-gaap operating margin of negative 25-29% for FY2024.

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Here are my notes from the earnings call.

Sentinal One (S) Q1 FY24 Analyst Q/A
06/01/2023

Tomer Weingarten, CEO
David Bernhardt, CFO

OPENING REMARKS FROM CEO AND CFO
Essentially the earnings call was a train wreck. During his initial remarks, CEO Tomer Weingarten dealt with the two reasons that revenue fell short:

  1. Macro caused deal cycles to increase and deal sizes to decrease
  2. Major deals slipped to next quarter
    During Q/A, analysts were asking a lot of tough questions re: Why ARR and guidance were down so significantly from what was projected on their last quarterly earnings call on March 14, just 7 weeks ago. Questions that follow included, “explain to me why this will never happen again” and when did you first see this decline in the revenue?" The same questions were asked/phrased/worded by analysts several different ways and it did not seem they were believing the answers they were getting from Tomer Weingarten, CEO and David Bernhardt, CFO. (Me speaking here)
    2 more reasons revenue fell short per CEO:
    Lower consumption and usage.
    Inaccuracies in ARR calculations (yes the CFO used the word “inaccuracies” at least twice during the call)
    New methodologies based on usage and consumption will level out revenue in the future
    NRR is +125%
    Improved FCF by 43% y/y
    Expect macro conditions to worsen and assume lower pipeline, deal cycles to increase and deal sizes to decrease.
    GM 74 to 75% for this year

ANALYST Q/A
Q adjustment re: slowdown in usage.
A $27M one time adjustment (5%). Changed methodology of how to calculate ARR. It’s about data ingestion and data lake. Seeing customers right-sizing their spend. This will more carefully correlate ARR and revenue. Error in their CRM caused internal and external expectations re: what revenue would be.

Q Data ingestion
A Seeing this in two areas. With usage-based companies vs. user-based -Sentinal One removed the usage based revenue from their projections. This will remove the volatility from ARR, and this is the result.

Q On one hand you’re saying it’s a slippage of contracts from Q1. On the other hand, if this is just slippage, why are you adjusting costs and guidance. Is this more related to competition? Did you lose more deals.
A It’s not just deal slippage. They have had some execution hickups and they were not able to execute these deals in time for this quarter. In addition, taking a more cautious look into their pipeline and the 3rd factor has been the consumption dynamic. Taking consumption out of ARR does reduce their guidance.
Sentinal One has gunned for their competitors’ customers. As a result, competitors have gone to zero dollar deal size (cut their fees) to keep their larger customers.

Q Microsoft and how effective it is to buy.
A 4 customers were looking for pure play security vendors. Microsoft just doesn’t cut it re: cyber security. We’re targeting $100 Billion addressable market and a lot of it is still up for grabs. MSFT is a formidable vendor.

Q Data ingestion is a leading indicator for broader challenges to come later. How will you prevent this?
A 2 completely different things. They don’t churn customers. Customers don’t just leave Sentinel One. Consumption by it’s nature is just more volatile. User based is not even close to the volatility.

Q Quantify the usage based revenue please.
A It’s single digit % of ARR

Q Cloud security product. Last quarter was good. How’s this quarter.
A Great growth for them on the cloud side. Same % for ACV this quarter. All in all, it’s early in the process re: partnership with WIX. They’re expanding from an endpoint security company to a cloud security company.

Q $40M cost savings as a result of the 5% workforce downsizing.
A $40M based on their previous plan. It’s about $15M in savings or 5% savings and it’s all contemplated in terms of this guidance.
Targeted guidance is better thought of as a FY25 goal per CFO.

Q Bullish previously and the tone of this has changed significantly on this call.
A At the end of the quarter they noticed pronounced changes. With a few deal slips combined with the downsizing of consumption it’s a surprise to them and a surprise re: the magnitude. 10,700 customers were scrubbed by CFO, they noticed this in its entirety post quarter end.
Q What was the reason for missing guidance on March 17th. Reiterate why this won’t happen again.
A Previously over-stated ARR based on their previous methodology. It will never happen again because of the removal of consumption from their ARR calculation.

Q What is your strategic end game facing a difficult macro and conditions are worsening. How do you think about the different alternatives out there.
A Don’t see anyone else in the market making these increases in margin growth. This is not the economy to put the pedal to the metal. Can’t say it’s a lot of fun right now.
If we’re a profitable growth company in the future, there’s a lot of opportunity out there and they have an opportunity to take market share.

Q Is the NRR accounted for in the gross renewal rate?
A Still seeing revenue growth. Still seeing GRR growing. Seeing customers flatten out their revenue commitments. GRR is stable.

sjo

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so i see YoY has declined to 70% and will decline to 38% if they just meet their forecast next Q

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here is how crwd stacks up:

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crwd has de-accelerated on YoY basis continuously as well. QoQ it has grown at 8.7% vs 9.6% for S.

at 4.25b marketcap and 600m fy24 revenue this is trading at about 7x ev/s

crwd and zs are trading at about 12x ev/s or about 71% premium. buying S is a bet on macro conditions improving going forward. I had 5% into earnings but I did take good profit off table prior to earning. I have topped up my position back to 5% after this crash.

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I’ve seen this before. Lightspeed. Amplitude.

Recent IPOs with a short track record are inherently risky and difficult to predict. Position sizing and risk management are so important. Wild swings due to volatility in the hypergrowth investing style are certainly par for the course. But single day setbacks in one company that tanks earnings, though it may be the cost of doing business with this investing strategy, reinforces why I prefer to scale in over time as a company lays their earnings track record.

For me, it’s a riff on an old standard: If the company doesn’t perform, I’ll be glad I only had a little. If the company soars, I’ll only need a little (initial) allocation.

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I see this completely different, this has nothing to do with macro conditions. All of the other cybersecurity players did NOT show such difficulties. ZS, CRWD, PANW, MS - all of them beat their guidance while growing profitable and at much bigger size. This miss combined with the loss of a few high level executives to CRWD a few month ago doesn’t look good at all.

If anything, this is a bet on the ability of the management to turn this around. While competing against big, established companies with much deeper pockets and a lot more data to further enhance their offerings as AI/ML get’s even more important. I see this as a very risky investment even with the lower valuation…

Hannes

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I saw several comments mentioned that CRWD is eating market shares from SentinelOne. Actually, I think it’s Palo Alto Network and maybe some other new players that are taking away contracts from both CRWD and SentinelOne.

As Crowdstrike’s CEO said in their earning call, the endpoint security market is pretty fragmented, even Crowdstrike only has 17.8% market share.

Well, I feel good about that opportunity. And if you look at our current market leadership and just market-leading leadership at 17.8% for modern endpoint security, it’s still a very fragmented market, and we continue to take share from the legacy players that are in the market. Again, when you look at different geographies, obviously, we’ve got heavier penetration in North America, but there’s many geographies in the rest of the world that still have to be penetrated deeper, particularly in converting those legacy players. So, I feel really good about it.

It’s a fragmented market if you just look at the numbers. And the ongoing conversion of legacy technologies into next-gen players like CrowdStrike will continue for the foreseeable future.

While CRWD and SentinelOne were only able to grow their ARR in the 40% range, Palo Alto Network’s next-gen security ARR grew 60% in this quarter to $2574 million. This is already very close to the $2.73 billion ARR CRWD currently has. I won’t be surprised at all if Palo Alto’s ARR exceeds CRWD’s in the next 2~4 quarters, with the current next new ARR growth momentum.

That being said, it’s hard to say that Palo Alto will be the eventual winner, either. This field just has too much competition. All of these next-gen players are still growing fairly fast as they replace the legacy providers. But I think the competitive environment will inevitably cause slow down on the growth of all of these companies.

Cheers,
Luffy

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Endpoint security is a 30+ year segment. Of course it’s fragmented and 17.8% is huge in this market. We are talking about Symantec, McAfee, TrendMicro old strongholds. The disruption in this market came in the shift from malware signatures (a scaling nightmare) to malware behavioral detection. Although Crowdstrike wasn’t the first in behavioral detection (I think Kaspersky was), it took it to next level for sure with the scale of cloud and much better ML models. In the beginning, it competed head to head with Carbon Black, but the VMware acquisition messed up its go to market and CRWD soared alone. Then came Microsoft giving steroids to Windows Defender. MS is the master of bundling, selling 10 products with 50% discount, when you only need 3. That’s the competition today: MS doing a good enough job (another MS specialty) for a much lower price, or CRWD to deploy the best endpoint protection available.
Did PANW break up its numbers by product? I find hard to believe that its performance is coming from Endpoint protection. See the Gartner Magic Quadrant from last October.

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@monkeydluffy It was discussed in another thread but PANW is basically reselling next gen products to own old installed based. Of course, there are also new clients but main bulk of this new gen products for PANW is selling to existing clients. I wouldn’t over-praise PANW as such as it’s basically a successful previous gen cybersec turn-around via acquisitions + good CEO. CRWD needs to basically onboard all the clients and PANW is using own old customer base which is much easier. Again, I don’t see PANW eating CRWD lunch although industry is competitive. If u have such a capable leader as Kurz who is also a founder + leadership position of CRWD in endpoint - I’m betting on CRWD’s continuous success in this business. Not saying PANW is bad investment - I think both should thrive. Not sure about S though.

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I just read the earnings transcript and I don’t understand what’s so terrible. The analysts said they were asking tough questions, but to me the answer was pretty straightforward. Perhaps SentinelOne should have been more assertive with their answers because to me the analysts were putting words into SentinelOne’s mouth. I will also allow that SentinelOne should have been clearer in explaining what they were doing. Maybe I’m missing something, and if I am please tell me, but here is how I translate the call.
SentinelOne: We were giving ourselves 100% credit for deals where our customers had some wiggle room to get out of part of the deal. Due to the more cautious outlook of these customers, they chose to exercise that wiggle room. Going forward, we are going to be more conservative in how we record sales, so we aren’t counting our chickens before they’re hatched. We are also looking backward to uncount some of those chickens we counted.
Analysts: You are saying you have uncounted those chickens and now everything is resolved, so why have you revised your outlook downward?
SentinelOne: Maybe we weren’t clear or maybe you read too much into our comments. We are being more conservative, and this applies to past sales and future sales.
Me: None of this sounds so terrible to me. I mean, maybe it’s bad enough to send the shares 10-15% lower, but not 37%.
Or maybe I am the one who misunderstood.

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I think it’s pretty straightforward. Every company is being conservative with their estimates in this environment, the problem is the epic slowdown. Last quarter they did 92% revenue growth, this quarter 70%, and next quarter they are guiding to 38%. Even with a solid beat next quarter, their growth rate got cut by more than half within 3 quarters. Add on to it they are a major cash burner and the market has responded as most would expect in my opinion.

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@philiproth , if you just look at all the growth metrics on their earning report, it’s already extremely terrible! The answers in the Q&A was not the primary cause of share price drop, but the disppointing results were. Their sequential growth now now even fell behind Crowdstrike, with a much lower ARR run rate. The sequential increase of 100k plus customers were only 12 in the entire quarter! This report was far below anyone’s expectation IMHO.

Luffy

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Growth is bad, no question, but they’re talking about margins and the path to profitablility. Didn’t BILL make a similar decision a few months ago? They were widely derided here at the time but since then the shares are up handsomely. S beat estimates and their own guidance for both EBIT and GPM, while raising their 2024 EBIT guide by 6.4%.

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BILL had plenty of customer growth (though the FI customers were admittedly weaker than core) and never had to state down.

S has now screwed up ARR projections three times since making its acquisition. It significantly missed the “hi-$50’s” call a few quarter ago despite being 30 days into a 90 day quarter. It than missed the initial FY ARR guide for the current year. Now, it’s admitted it apparently doesn’t know how to calculate ARR.

The bottom line is this was a bad report with a pessimistic outlook no matter how you slice it. Yes, they are now talking margins and the path to profitability. The question becomes just how much you want to trust management’s word on that given its recent track record.

Caveat emptor.

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Saul, it would be great if you can share your thoughts on sentinel one’s report. You had high allocation and conviction on this one.

FYI…I added last night but today’s price action has convinced me to move on. In addition to board’s general consensus, market action is telling me this is bad apple.

I will reconsider this if share price can atleast go back above $16 (this would be market action negating current judgement, which is how net/snow acted)

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Let me chime in here and add my voice to stocknovice’s, as S was my second-biggest allocation stock just 1 day ago at 15% and I’ve been following them for a while.

The thesis was based on 1) them taking market share from their competitors 2) them hitting their revenue guidance and thereby growing exceptionally fast and 3) expected cf positivity by year-end.

All three of those were blasted apart in their call yesterday and then some.

  1. They grew revenue 5.8% qoq at $133m. CRWD grew 8.7% qoq at $693m - five times the size and growing much faster!! S is NOT winning. Their revenue growth has come to a screeching halt. They are growing at a qoq annualised rate of 25% atm. This is their qoq growth over the last several quarters. It takes a special type of analysis to get that to look good:
QoQ Q1 Q2 Q3 Q4
2020 26.4%
2021 17.0% 15.6% 18.8% 21.5%
2022 24.7% 22.8% 22.3% 17.1%
2023 19.4% 30.9% 12.5% 9.4%
2024 5.8%

Last quarter I also looked at ARR and noted that this looked hunky-dory and growing faster than CRWD. And that ARR strength pointed to good things ahead. Because ARR is forward-looking!! And here comes the really big problem. And supposedly RECURRING!!! Excuse me but this is important and if people don’t get this then they need to pay attention. ARR is recurring revenue at the end of the period you are reporting on. So you could theoretically have almost zero incremental revenue in a quarter if you signed up all of your new business on the last day of the quarter, and that new business will show in your ARR (and to state the obvious - point to a good quarter ahead).

And they misrepresented ARR for the last several quarters. They included NON-recurring usage-based revenue in that number. So ARR was actually lower than what they thought and what they told us.

And this caught the management team by surprise! They couldn’t understand why their revenue was falling short in this quarter relative to their guide, given their great ARR numbers. Then, when the CFO delved into the ARR of all of their customers - only then - did they realise that their ARR was too high and included usage-based NON-recurring revenue. And because it was too high and it is a forward-looking number, the penny dropped for them and they had to restate ARR lower. Imagine the oh dear moment there. And once they realised that, they had to also face the music and lower their guidance for the remainder of the year.

So even though the ARR snafu is not directly visible in the P&L, the fact that they overstated that number led me and others to project the ARR forward and come up with relatively rosy future revenue numbers. Not only me, but also them! They - the CFO - did that and therefore gave too rosy a guide before realising his mistake.

  1. They missed their revenue guide for the quarter. Big no-no. Revenue was $133.4m vs a $137m guide. The FY guide was $631m-640m and they lowered that to $590-$600m - but can we trust them to hit that now? Point 2 of the thesis in tatters.

  2. They stated that they would get fcf positive end of this year. They did not give an update in the prepared remarks, but one of the analysts dragged it out of the CFO, who grudgingly admitted that this will not happen until 2025.

That’s on top of what can only be described as incompetence in reporting ARR. As CFO you either deliberately misstate your numbers or you do it because you did not get it right despite your best efforts. I don’t think there was anything deliberate here, so that means the CFO and team made such a rookie mistake by simply fumbling the ball. That’s not good enough for a listed company CFO imho and for an important number such as ARR. That’s forgivable in amateur sport, not professional…

The call was an absolute shambles. Their answers were not convincing, the tone was almost shell-shocked and the analysts were (understandably) acid. Just listen to how the CEO ended the call - that says it all.

It was a terrible call.

I feel lucky to have hedged my position somewhat going into earnings and to have gotten out at above $14 today. I sold everything. The numbers tell a story of rapid deceleration and of losing against competitors. In addition I have lost faith in the company and management.

-wsm.

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