Thoughts on SentinelOne and its recent Conference Call

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Thoughts on SentinelOne and its recent Conference Call

There is a lot of disagreement about SentinelOne, showing that smart people can really disagree peacefully. For example Gaucho Rico wrote:

I still won’t invest in S because I can’t have confidence in S’s ability to ever become cashflow positive.

While Poleeko recently wrote:

I still see a really fast growing company, well-positioned, no debt, with lots of cash, and that stands to benefit when the macro pressure subsides. A $4b market cap company with $1.2b in cash, and with 106% relatively blistering growth? Just 10 years ago there’s not a single one of us who would not have been salivating over a company this strong. Holding my 7% position.

I’ll start with Sentinel’s recent results for their 3rd quarter . Bolding and comments in parentheses are mine.

Total revenue was up 106% to $115 million from $56 million a year ago.

Annualized recurring revenue (ARR) was up 106% to $487 million from $237 million a year ago.

Total customer count grew about 55% to over 9,250 customers as of October 31, 2022.

Customers with ARR over $100,000 grew nearly 100% to 827 from 416 [99% actually].

DBNRR was 134%.

Adj gross margin was 71%, up 4 points from 67% the same quarter last year, [and up a remarkable 18 points from 53% in the first quarter of last year. That was just six quarters ago.].

Adj operating margin improved by 26 points to minus 43% from minus 69% a year ago

Cash and equivalents were $1.2 billion.

[To me, Saul, that was a wowzer quarter in the middle of a market meltdown. But let’s go on to what they said in the conference call, that you may not be aware of. What you read is from my notes and therefore may be shortened or paraphrased.]

Conference Call

We reported another quarter of triple-digit revenue and ARR growth combined with significant margin expansion, meaningfully ahead of our guidance. Once again, we achieved a Rule of 60, and we are raising our full year revenue and margin expectations.

I will focus on two key areas; one, details of our quarterly performance including customer growth and expansion, as well as the broader demand and macro dynamics; and two, the actions we are taking to enable our path to profitability and execute in today’s environment.

Financially, we have taken a more prudent approach to investments like moderating new headcount growth. And operationally, we are streamlining our teams to unlock higher productivity and performance.

We have expanded operating margin by over 25 points yoy for five consecutive quarters. We expect that to continue in Q4.

We added over 600 new customers in the quarter. Our customer base now exceeds 9,250. That’s well over 3,000 more businesses added in just the last 12 months. Our customers over $100,000 grew nearly 100%, reflecting continued traction with larger enterprises.

Building on our partnership with CISA, we also extended our success in the federal arena by securing three new agencies during the quarter.

Q3 was a record quarter for Singularity Cloud, which once again remained our fastest-growing solution in Q3. We are seeing strong adoption of cloud security among new and existing customers.

We believe we are still in the early innings of a very large expansion opportunity.

NRR is proving to be resilient regardless of macro conditions. Our customer retention remains extremely high. We expect NRR to continue to drive a healthy base of growth.

Our momentum with channel partners continues to shine, especially with our strategic partner ecosystem, including MSSPs and incidence response providers. Our partners and customers want automated solutions that reduce reliance on human intensive processes, while offering best-in-class protection. We don’t compete with our partners, but enable them. This makes SentinelOne the partner of choice for MSSPs across the globe. We are partnering with most of the leading MSSPs.

THE MACRO CLIMATE: Consistent with many other software companies and even our competitors, we are seeing higher cost consciousness and prudence around IT budgets. That’s leading to elongated sales cycles and limited budget availability. These factors are most pronounced in larger deals and they require higher level of evaluations and approvals.

And finally, foreign exchange presented an incremental headwind in EMEA. While we price in dollars, foreign exchange can impact the purchasing power of international organizations. Together, these factors contributed to a softer net new ARR than we had expected and decelerating growth. Still, we are growing at a very healthy pace with ARR growth over 100%.

We believe these macro factors are temporary and there is no change to the long-term opportunity for our leading next-generation security. Our pipeline once again grew to a new high, giving us confidence in the opportunity in front of us.

ON RAMPING SALES REPS: We believe we can elevate our execution further regardless of market conditions. We moved quickly to hire a lot of terrific talent over the past year. Nearly half of our sales reps are newer and still ramping. As these reps ramp up the maturity curve, this should deliver meaningful productivity gains and improve our execution further.

ON LARGE ACCOUNTS: And finally, a more tactical change**, placing a higher emphasis on the largest account opportunities in our pipeline.** We have made significant progress in the past few years winning Fortune 500 and Global 2000 accounts.

Over two-thirds of our ARR comes from large enterprises and customers over $1 mil grew by more than 100% yoy in Q3. This is the right next step to drive further success with the largest enterprises.

We achieved a healthy mix of new customer additions and existing customer renewals and upsells. Our number of customers over $100,000 grew nearly 100% yoy to 827, much faster than the total customer count, and growth in customers with ARR over $1 million was even faster.

ON MSSP’S AND CUSTOMER COUNT. One reminder on customer count is that we count each MSSP as a single customer. Therefore, with some direct SMB customers facing budgetary pressures, much of that impact on us is offset by the strength and shift to our MSSP ecosystem. A lot of customers that we have added in the quarter can be uncounted as they are actually masked by one master MSSP service provider that basically onboards all of them.

ON MARGIN PROGRESS: Our gross margin in Q3 was 71.5%, up 5 points yoy. I CAN’T OVERSTATE THE PROGRESS WE HAVE MADE on gross margins, improving nearly 20 pointssince the beginning of last year… We have taken a major step forward as a company, operating above 71% gross margin and moving closer to the long-term gross margin target of 75% to 80% or higher.

Operating margin was up 26 points yoy to minus 43%.

We beat our EBIT margin guidance by 14 points. On a dollar basis, we also reduced our operating losses compared to the prior quarters of fiscal 2023. We are achieving scale, leveraging our channel and globalizing our talent pool. Our magic number was over 1.2x. These results signify our ability to maintain a balance between compelling topline growth and progress towards our profitability targets.

GUIDANCE: In Q4, we expect revenue of about $125 million, reflecting growth of 90% year- over-year. For the full year, we are raising our revenue outlook to $421 million, reflecting 105% growth. This is up over $4 million from our prior guidance.

To be clear, we expect Q4 NET NEW ARR TO BE UP AT LEAST 20% SEQUENTIALLY compared to the third quarter. And we believe this is a prudent view that reflects a continuation of the macro headwinds we experienced in Q3, yet we are in a position to deliver a seasonally strong end of the year.

We expect Q4 gross margin to be about 72% and we are increasing our full year gross margin guidance of 71% to 71.5%. This is up from prior fiscal 2023 guidance of 70.5% to 71% and up about 8 points year-over-year.

Finally, for operating margin. We expect Q4 operating margin of minus 39%, improving by 27 points yoy and implying a Rule of 50 for the quarter.

At the same time, we are improving our full year operating margin outlook to negative 50%. This new operating margin guidance is up 6 points at the midpoint from our prior range. It is also up 35 points compared to last year.

Our long-term margin targets remain intact and our goal is to reach operating breakeven for fiscal year 2025, which is basically calendar year 2024. We are making excellent progress.

We believe we will deliver at least 50% total ARR growth in fiscal year 2024. This is also based on our growing pipeline, strong win rates, high retention and expansion rates, and the enterprise need for security.

[In the Q&A a little further down, they emphasize that they consider this a floor, something that they can’t miss, and that they will be raising throughout the year.]

Expansion from our installed base of over 9,250 customers remains durable. We are securing hundreds of new customers every quarter.

We are increasing our focus on profitability and cash flow . We don’t intend to sacrifice growth, but we are moderating the pace of our investments and focusing on the most strategic areas.

When thinking about our path to profitability from here, consider our Q4 margin guidance. We are on track to exit fiscal year 2023 with two quarters of about 25 percentage points of yoy operating margin improvement. We expect another 25 points of operating margin improvement in fiscal year 2024 and our goal is to achieve profitability in fiscal year 2025 (calendar year 2024).

Q&A

While Microsoft’s Defender offering might be included and perceived as free. If you look at integration costs, management costs and then DDR services or any affiliated service that actually bumps up the price in a pretty significant manner. So if you look at the overall TCO, it stays relatively comparable with best-of-breed offerings. We we have seen more and more Microsoft displacements, customers rebounding from Microsoft’s offering. Some citing it as the most expensive solution they had to manage over the years.

The ARR tentative guidance for next year is really a floor . When I think about it, we believe it’s conservative. We are looking at it as something we can build from.

Our OpEx spend, a lot of it is highly elective and we will invest when it makes sense and we will pull back when it doesn’t. We basically cut down our losses by about half every year and I would anticipate that to continue into next year.

OUR LONG-TERM GOALS AND OUR PATH TO THAT IS UNCHANGED, no matter what the growth is.

COMMENT FROM AN ANALYST - I appreciate the color you gave for Q4 and ARR for at least 20% sequential growth. Others in the broader market are calling for no seasonal budget flush, no Christmas this year, even sequential declines in Q4.

[Saul here again: This is an inspiring read and very positive and confident. Very much like Snowflake as I see it. It’s only my 5th highest position so I’m not being silly about it, but like Poleeko I see no reason to lose confidence in it.]

Saul

Please feel free to disagree with me about Sentinel. It helps all of us get a fuller understanding.

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Phenomenally thorough recap, Saul. I think it’s safe to say SentinelOne’s verbiage is more positive than Crowdstrike’s was, but also I can’t forget that SentinelOne did have one miss. In the Q2 call they said: We expect net new ARR in Q3 to be in the high $50 million range so I was expecting 55+ and they delivered 49. Sure, it’s a tough environment…but that means they shouldn’t have said high 50’s 90 days prior! If they can’t do what they say they’re gonna do, why should we expect them to be able to next year? Or in F25 (when they say they’ll be FCF positive).

Also, I am sympathetic to Gaucho’s point about their losses. While the FCF margin (aka percentage) has improved by leaps and bounds, the raw dollar FCF losses for the last 8 quarters are:

Q421: -$25.6m
Q122: -$32.6m
Q222: -$44.7m
Q322: -$20.7m
Q422: -$7.1m (18.5m improvement YoY)
Q123: -$55.7m ($23.1m worse YoY)
Q223: -$66.9m ($22.2m worse YoY)
Q323: -$64.7m ($44.0m worse YoY)

Like @GauchoRico, I’ve lost patience with this, and have reduced my SentinelOne position to less than 2%. I’m trying to find silver linings, but even though they should trounce their 50% floor for growth next year, I’m not sure 60% or 70% revenue growth is enough for me – and frankly I’m not sure I believe they’ll be able to get to cash flow break even when they say they will.

Hope you or someone can correct me if I’m wrong here, but I’m not seeing much to be happy about.

Bear

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I should probably explain this. I expect a lot from companies like this (or Monday or Gitlab etc) where the revenue base isn’t even close to that of a Datadog or Crowdstrike or Zscaler or even Cloudflare. The latter are all at run rates of $1b+ and in some cases close to or more than $2b. A company like SentinelOne with just $362m in TTM revenue, not to mention deep FCF losses, just needs to grow super fast. If it slows from well over 100% this year to 60% or 70% next year, what is it gonna do the year after?

Another thought on this: SentinelOne added $49m of net new ARR this quarter and plans to add at least 20% more than that next quarter, we’ll call that $59m. But neither of these numbers is impressive based on the trajectory of net new ARR in the last 8 quarters:

Q421: $28m
Q122: $30m
Q222: $37m
Q322: $39m
Q422: $55m
Q123: $47m
Q223: $65m (organic…$100m total)
Q323: $49m
and then 59m in Q4?

Even with a decent beat on that 59m, it won’t be huge growth vs 55m in Q4 last year. Seems like they’ve kind of stagnated the last 4 or 5 quarters.

Meanwhile Crowdstrike is adding roughly $200m each quarter.

I don’t know. There’s just lot of uncertainty with SentinelOne, in my opinion. They have a lot left to prove, and I just don’t know how it’s gonna go.

If the FED gives us a bump this afternoon, I might sell the rest.

Bear

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While I certainly agree with this, my main counterargument would be that much of this uncertainty is already ‘price in’, so to speak. I believe the market is accounting for this added uncertainty and risk and has priced the stock accordingly. With its current market cap of just over $4B, SentinelOne trades at an EV/S below 10. I am not talking about a forward EV/S either, this is based off its TTM revenue. This type of valuation would have been unfathomable a year ago, especially for a company growing this quickly. When compared to the rest of my portfolio, SentinelOne trades at a steep discount. Aside from Crowdstrike, every other business is valued at an EV/S north of 15.

So while yes, the business is decelerating (although what software company isn’t right now), and is a far ways off from profitability, it is valued as such. While things can always go lower, it does feel as if the market has tossed this company to the curb for its lack of cash flow in this challenging macro environment.

However, when you run a concentrated portfolio like many do here, I understand you only want to own the best. And to quote Buffett, “it’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” But I would argue their performance has not been all too different recently than the likes of most their software peers, apart from the fact that they are burning through cash.

I can understand if this additional risk and uncertainty keeps SentinelOne from entering one’s portfolio but I view the risk/reward as favorable at current prices. I wouldn’t be surprised to see the stock price double just based primarily off multiple expansion if they can execute. I will admit, that is a big if. Time will tell!

Rex

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I have reread the Q3 ER notes and cannot find if Sentinel One reports a breakout of MSSP revenue vs direct customer sales. I want to see what the growth is between these two sales channels. Sentinel brags about their big enterprise sales and customer additions. But where is the bulk of new revenue growth? MSSPs are Manage Service Providers who will provide network services to smaller enterprises and sell add on capabilities such as Sentinel endpoint Singularity with XDR. This could have a big impact on ARR as MSSP revenue is billed quarterly and does not reflect new MSSP customers. And it could have a big impact on gross margins as the MSSP gets a piece of the pie.

Some Q3 comments
We don’t compete with our partners, but enable them. This makes SentinelOne the partner of choice for MSSPs across the globe. We are partnering with most of the leading MSSP. Our MSSP exposure continues to drive meaningful and resilient growth as SMB shift to more flexible security models.

Over two-thirds of our ARR comes from large enterprises and customers with ARR over $1 million grew by more than 100% year-over-year in Q3.

And Fatima, to answer your second question in regards to free cash flow, what – I think you are seeing two dynamics. You are seeing, one, where customers just aren’t prepaying for multiyears, which was more prevalent in the past and then you are also seeing the shift to MSSP, where they tend to be paying quarterly versus larger upfront deals. That dynamic we expect to continue for a while.

-zane

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I’m one of those who didn’t like the quarter. Here’s what I wrote:

S - This season’s earnings theme has definitely been:

  1. a pressured top line
  2. a softish guide
  3. a deep dive to see how underlying trends are holding up.

Why would we expect SentinelOne to be any different?

I entered anticipating ~$117.25M in revenue with a $127M Q4 guide. We received $115.3M and $125M. Close, but the 3.9% beat was SentinelOne’s smallest as a public company (another recurring theme).

So, how ‘bout the underlying trends I was looking for?

  • An emphatic meet and hopeful beat of the “high-$50’s” projection for net new ARR [annual recurring revenue]. Ugh. Just $49M “as enterprises adjusted to macroeconomic conditions by tightening budgets.” Not a great way to start this recap. Using $56-$59M as a proxy, that’s somewhere between a 12.5% and 17% miss. That’s extremely disappointing for a projection given 30 days into a 90-day quarter just three months ago. Combined with CrowdStrike’s ARR gaffe, I have to wonder what the heck is going on with visibility in endpoint security. Is it really drying up that quickly? Management anticipates 20%+ sequential growth in new ARR next quarter (while admitting that’s roughly half the usual Q4 rate). In addition, the CFO pre-guided to 50%+ total ARR growth next year. I find myself underwhelmed with both figures. Not only does it suggest a huge organic slowdown in a key metric, but I’m not even sure how much to trust it given the current environment and this quarter’s obvious miss.
  • A solid beat of management’s 71% gross margin guide. Last quarter’s 72.2% cleared 70% two quarters earlier than expected. I’d like it to stay there. This came in at 71.5%, so not bad.
  • Continued shrinking of expenses as a percentage of revenue. Probably the best trend of the quarter. Non-GAAP expenses came in at 114% of revenue vs 129% last Q and 136% last year. Management’s comments suggest it’s very aware of staying on top of expenses.
  • Though Q2’s record 1,150 new customers was padded by the Attivo acquisition, management touted record organic adds as well. I’m looking for similar comments this quarter with $100K+ customer growth ideally remaining north of 100%. Frankly, I didn’t like the “over 600” new customer number at all considering this now includes both SentinelOne and Attivo. For context, Q2’s first combined number was 1,150 while the prior two quarters were 750 and 700 for SentinelOne alone. $100K customers didn’t wow either with 72 new customers combined (+99% YoY) vs 164 last quarter (combined) and 68 last year (S alone). This was S’s first quarter ever with single-digit sequential growth in $100K customers at 9.5% vs 28% last quarter (inflated by Attivo) and 19.5% last year (S alone). Management suggests some of these issues are just business pushed to Q4, but it’s hard to see how that push dynamic isn’t going to continue a while.
  • Net retention to hold most if not all last quarter’s jump from 131% to 137%. This finished at 134%, which is plenty good in this environment.
  • Cash flow margins closer to last year’s -30% operating and -37% free cash than last quarter’s -61% and -65%. Operating cash flow margin was -52% (-$60M) and free cash -56% (-$65M). So, a fail here. On one hand, S has plenty of cash on the books to cover the burn. On the other, that’s not much in the way of cash flow efficiency to offset the slowdowns in ARR and customer growth.
  • At least mild improvement over Q2’s -57% operating and -55% net income margins. I’m also hopeful the current -55% FY23 operating margin guide gets bumped after staying flat last quarter. Good here. This quarter improved to -43% operating and -39% net with the FY23 guide moved to -50%. Though the improvement was driven more by controlling expenses than revenue outperformance, management deserves credit for keeping this on track. It also floated profitability at some point in FY25 (two years from now)
  • Continued confidence from management the Attivo integration is going smoothly. Some specifics on business wins from all the recent partnerships wouldn’t hurt either. We didn’t get much here since most comments and questions rightfully revolved around the ARR weakness, cash flows, and tightening customer budgets. While management sounded appropriately prudent, I didn’t exit the call feeling much underlying confidence.

This was admittedly a tough recap to write. While smaller beats with softer guides have been the norm recently, SentinelOne also holds the distinction of the least stable cash flows and profits in our portfolio. That by nature puts more pressure on revenue growth and its underlying drivers to keep everything in check. Unfortunately, I’d label S’s biggest drivers as net new ARR and customer growth which both disappointed.

In my opinion, management now has two gaffes under its belt in the last three quarters. First was some clumsiness articulating the first S/Attivo guide. Now we have a large whiff on an S/Attivo net new ARR guide set just 90 days ago. Putting it all together, I find myself uncomfortable sticking around to see if Q4 bounces back enough to deliver a decent set of FY24 guides. Therefore, I decided to sell our ~7% allocation and take some time to reassess. My instinct says I’m unlikely to miss a catalyst that sends S soaring in the short term. That being said, I hope everyone who owns it sees a run that makes me eat my words. SentinelOne goes back to the watch list for now.

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The more I contemplate this, seems it’s more egregious than I realized. Their revenue guide for Q3 was $111m. Even the $49m of net new ARR they delivered led to a beat on revenue. So the high 50’s net new ARR the CFO gave as an expectation was not in accord with the revenue guide they were giving on the same day! The net new ARR guide was wildly aggressive. He was in effect guiding to a revenue beat! A bigger beat than what actually happened.

Worse, he’s doing it again! He said, To be clear, we expect Q4 net new ARR to increase by at least 20% sequentially compared to the third quarter. So again they could beat on their $125m revenue guide, and it would still be possible for them to miss this net new ARR expectation.

Being this aggressive is just plain unwise. But they don’t seem to realize they’re doing it! They said many times on the call this quarter how conservative they’re being. But last quarter when the CFO gave the net new ARR expectation he said, This incorporates the macro factors I just mentioned, which we believe is prudent in this environment. And then then the big miss.

So does SentinelOne’s management just not know how to be conservative? My guess? I think they are having trouble adjusting to just how much the environment has changed, perhaps especially for endpoint. Crowdstrike said on their Q3 call that they expect their net new ARR to be flat in calendar 2023. Flat! SentinelOne thinks theirs will be up 50%. That’s supposed to be conservative?? I am really not so sure they have any idea what net new ARR will be. It sounds like they’re basing it on trends from the past, and I’m not sure those will hold.

Perhaps I’m wrong. Maybe they can take share from Crowdstrike and others. If they meet their expectations, I think SentinelOne’s stock will do great…but can anyone tell me why we should believe they can and will do what they expect?

Bear

PS Rex made a very good point that a lot of this is priced in. He’s right. The stock is cheap. Historically, that hasn’t turned out well for us. Maybe this one will be the exception…but I’m not sure I want to grit my teeth and hope for the best.

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Bear, here is what I thought.

First of all, beat on revenue but miss on net new ARR guide is totally possible for any company.

In S case, when S CFO said “We expect net new ARR in Q3 to be in the high $50 million range. This incorporates the macro factors I just mentioned, which we believe is prudent in this environment.”, they did believe we would close those deals before end of Q3 therefore to achieve high 50m target, obviously they didn’t manage to close probably ~10m deals by Q3 (due to elongated sales cycle, again this happened to CRWD, NET, etc as well) but CFO commented in Q3 CC: “several large units that pushed beyond Q3 have already closed in Q4 with some closings at days after the quarter ended. That was several million dollars of secured deals that simply didn’t close in time.”. Look, I agree here that the CFO was still not “prudent” enough when they provided Q3 net new ARR guide. However the net new ARR from the end of Q3 quarter was NOT supposed to contribute much to the revenue top line, which the management knew therefore it is not a surprise at all to have both

  • Revenue beat (they beat ~4% in Q3, it was low for S but not quite similar to Q1’s beat. While we see many companies had much smaller beat in Q3, such as SNOW, NET, CRWD hence smaller revenue beat might be acceptable here due to rapid weakened macro)
    AND
  • Net new ARR miss (yes S missed their guidance and so did CRWD)

In summary, revenue guidance is much much more reliable than net new ARR (from a sales point of view) for the following reasons:

  1. If a deal is closed in the beginning of the quarter, then pretty much the net new ARR would add into that Q’s revenue immediately, say incremental revenue would be net new ARR/4
  2. If a deal is closed in the last few days of the quarter, the incremental revenue from these deals is negligible but it would contribute 100% to the net new ARR
  3. Hence Net new ARR is heavily impacted by deal close timing!
  4. IMO, as long as a company keeps a good track record in beating their REVENUE guide, I would say the management did a good job and the beat trend is likely to continue in the next several quarters.
  5. S now has 5 quarters reported since IPO and I would say they did a great job in revenue beat. Let’s compare the last 4 quarters’ revenue beat for a few companies:
     Q4     Q1      Q2     Q3       Beat Q3/Q2
S    7.6%   4.4%    6.8%   3.9%     57% 
CRWD 4.6%   4.8%    3.6%   0.9%     25%
NET  4.6%   3.0%    3.1%   1.2%     39%
SNOW 2.5%   1.2%    5.1%   2.8%     55%

All companies are facing elongated sales cycle (probably except GTLB), and if we agree that SNOW delivered one of the best Q3 ER among our companies - their Q3 beat was actually 55% of Q2 beat but still not bad compare to NET and CRWD, but S’s Q3 beat is actually BETTER than SNOW at 57% of Q2 beat!

Next, there are a few questions we need to ask ourselves in order to make a decision on whether we shall add/trim S position:

  1. Shall we continue to trust S’s guidance on Q4 and FY2024?
    My take: Yes, cause S’s management at least did a better job than their software peers in delivering a decent revenue beat even in Q3’s tough macro environment. Short term wise, Net new ARR is hard to predict due to timing but as long as S is closing the deals in the beginning of next Q (deal slip), they may deliver a nice net new ARR surprise in Q4 (I would say management became more prudent in providing Q4 and FY2024 net new ARR guidance after Q3’s miss) and long term wise, the ARR growth will trend closely with revenue. IMO, 20% QoQ net new ARR in Q4 is not aggressive at all, especially after a much lower Q3 number (remember that few million ARR was supposed to be part of Q3’s now add into Q4). I would tend to believe they would deliver 30%+ net new ARR in Q4 (remember that they delivered 40% QoQ net new ARR growth in last year Q4 against a strong last year Q3 (where they delivered 5% QoQ growth instead of 25% QoQ drop in this year Q3). And next year 50%+ net new ARR growth would be the absolute floor IMO and I am not surprised they would provide high 50s% revenue growth guide in Q4 ER.

  2. Will S continue to improve margins?
    My take: Yes, Q4 Non-GAAP operating margin guided at -39%. Remember they guided Q3 at -57% but delivered -43%, with the same beat, I believe S’s Q4 OM would be close to -20%. And Q4 is also their seasonally strongest FCF quarter, they may beat their -11% FCF margin last year to close to breakeven.

  3. What we are gonna do now?
    My take: I agree with what Ruben said, when S is to deliver a inline result (without any positive surprise), S should see one of the strongest rebounds among our companies when sentiment reverses in 2023 (if that happens) due to super super cheap valuation - even including all the diluted shares, their current TTM EV/S is only 7.9, which is way too low. Assume everything is the same, S might have the highest upside in my portfolio in 2023 fueled by margin expansion. (we don’t need to expect S to get the same valuation as DDOG/NET, but assume a fair valuation at 14-15 would give us 80%+ return on valuation ONLY)

Finally, I agree that there are concerns and uncertainties like some board member mentioned but at the current price, I think I have superior margin of safety to hold S as one of my top positions to outperform the market in 2023.

Zoro

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One more thought here. If we are to challenge whether S could deliver 50%+ ARR (or revenue growth) in next FY, why not we start challenge SNOW as well?

Let’s look at the trend one by one (To make a fair comparison, I took out Attivo’s revenue 9.3m in Q2 and 9.8m in Q3 to get organic picture as from Q2 FY24 onwards it would be all organic):

Revenue YoY     Q4     Q1      Q2     Q3      Q4e (same beat as in Q3)   Next FY Guide
S (inorganic)   119%   109%    124%   106%    98%                        
S (organic)     119%   109%    104%   88%     81%                        50%+
SNOW            101%   85%     83%    67%     54%                        47%+

What can you find from here?

By end of the current FY, S is likely to grow 81% organically and they are currently guiding a super low 50%+ in next FY;
While coming out of Q4, SNOW is growing 54% but they guided 47% for next FY’s growth!

I would say there are plenty of room left for S to either easily achieve “50%+ ARR/revenue next FY growth” (which is priced in or IMO overdone already) or increase their full year guide in Q4 ER. But for SNOW, there is no deceleration room left at all! They are truly priced for perfection and they HAVE TO barely decelerate in next FY to beat that 47% full year target. Anything miss or lower down full year guidance in Q4 ER would be a disaster for SNOW.

Look, I agree SNOW is one the best companies here but from the financials point of view, I see they have higher risk than S - they HAVE TO beat that full year target and it is HARD, but IMO S could easily beat their guidance and their share price is really on the floor right now.

Finally, I like SNOW and did rebuild a position recently but I did see the risk as well.

Zoro

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Thanks for the thoughts, Zoro. I guess I understand why you’d want to forgive their miss this quarter. So, what would cause you to lose confidence? If they miss again on Q4 net new ARR, what would your plan be? Would you sell? Would you still expect they can hit their net new ARR goal for next year?

Thanks,
Bear

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Hi Bear,

It’s not I wanted to forgive their “net new ARR” miss, many of our companies actually had the similar miss in Q3, such as CRWD, NET, SNOW, etc - they all had a much smaller beat. And like I mentioned in the post, from revenue point of view, S’s Q3 beat/Q2 beat was actually better than above companies. Hence this is not a S specific thing and therefore I will NOT discriminate them.

Like I said, I will keep more focus on revenue beat instead of net new ARR beat due to timing. Having said that, I did expect them to easily beat Q4 and next year guidance even on net new ARR guidance.

I will keep monitoring all these metrics closely to adjust my positions. So far I will believe S has a great R/R in 2023, under-performers in 2022 doesn’t necessarily mean they would continue to underperform in 2023 - I know cheap is cheap for a reason but that doesn’t seem to apply to S as they are still a very high quality name.

The big picture for cybersecurity especially endpoint security in 2023 is still very bright (see this:
https://twitter.com/alphaseeker84/status/1604694768667267072?s=46&t=LeStkVFDnWqrjzlL92_Uew) and S outperformed CRWD in Q3 ER, to me that sounds like a great indicator to pick S as a top candidate in 2023.

BR
Zoro

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“Bear, here is what I thought (…)”

@ZoroSGInvesting, I thought that was an excellent post. You made some very important and relevant points.

I just wanted to share some additional thoughts about the math and behavior of ARR and net new ARR in particular. This is an excerpt of a discussion I had with @Bear off-board, but thought some others might find it useful as well:

One question I asked myself that was motivated by @Bear’s post is this: Is their 20% QoQ net new ARR guide for Q4 consistent with their revenue guide or not?

To make it easier to follow the numbers, have a look at below table:

S_table
S_table808×1340 112 KB

Now, by guiding for 20% QoQ net new ARR growth they effectively guide for $546M in total ARR. So ARR/4 would be 136.5. Historically, actual revenue has then been in-between 90% and 95% of the actual ARR/4 figure. Using the net new ARR guide we get ARR/4 of $123M -$130M. They guided revenue to be at $125M at the midpoint, right in-between.

So, bottom-line, they guided revenue through ARR calculations to be in-between 123 and 130M and they guided revenue directly to be at 125M at the midpoint. Makes sense to me and pretty consistent.

What might be surprising to some is that if revenue changes by just a few percent, then net new ARR will change by tens of percent and vice versa:

you could do this calculation the other way round which shows you that QoQ net new ARR growth is an extremely lumpy metric, which is why I am always careful interpreting too much into changes, or guides in this metric:

they guided for 125M in revenue. Since actual revenue is historically in-between 90 and 95% of total actual ARR/4, you can get an equivalent ARR/4 guide in a range of 131.6 to 138.9. This translates to a total ARR guide of 526.3M to 555.6M. Now comes the interesting part: this translates to a net new ARR guide of 38.9M to 68.2M OR a guided net new ARR growth range of -20% to +40%; a huge range of possible outcomes which are all consistent with their revenue growth guide.

By the way, this is nothing unique to Sentinel, but rather a consequence of the math that applies to every company that quotes and guides ARR.

So I think we should just be careful not to interpret too much into net new ARR growth and as @Bear rightfully pointed out to me, guiding for 20%+ QoQ net new ARR growth for next quarter seems somewhat silly for two reasons. First, given the large range of possible outcomes for net new ARR growth when guiding for $125M in revenue and second, given that they just missed their last net new ARR guide.

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Hi slow and fast, nice write up and reasoning.

However, you have Sentinel down for $136.49 million in Q4 ARR.

However they had $121.85 million in Q3. If they hit their 20% qoq increase over Q3 that they are guiding to, well 121.85 up 20% comes out to $146 million, not $136 million. And I think I remember them saying “up at least 20%”.

Now in Q3, they had $121.85 ARR, which was up just 11% and just $13 million from Q2, and Sentinel is saying that in Q4 ARR will be up AT LEAST 20% and $25 million.

And, finally, with Crowdstrike saying:

“we believe it is prudent to assume that Q4 net new ARR will be below Q3 by up to 10%”.

And Sentinel saying that their net new ARR will be considerably up from what they had in Q3, I suspect that Sentinel was just trying to make the difference clear, and to point out that they weren’t having the same problems.

Best,

Saul

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Hey Saul, from my understanding, Slow & Fast has it correct based off the comment made on the earnings call. Here is the exact quote (bolding mine):

> To be clear, we expect Q4 net new ARR to increase by at least 20% sequentially compared to the third quarter.

The way I calculate this is looking only at the net new ARR rather than the total ARR number. Essentially, SentinelOne is telling us they will increase their net new ARR 20% QoQ - meaning a 20% increase from the $49M that was added in Q3. In other words, they expect to hit $58.6M in net new ARR next quarter, which would result in a total ARR figure of $546M, or a 12% increase QoQ, as Slow & Fast stated.

Net New ARR
2020 $9.0 $12.4
2021 $8.1 $12.4 $15.4 $28.2
2022 $30.5 $36.8 $39.0 $55.1
2023 $46.7 $99.6 $48.8 $58.6

It is all a bit confusing when they start talking about sequential increases on net new ARR versus total ARR but this is how I understood it. I would love to see a 20% QoQ increase of total ARR but that feels unrealistic in this environment. Let me know if I have this wrong.

Rex

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That’s correct, Rex.

The way I look it this, they might very well beat the $58.6m of net new ARR in Q4. But I don’t know how we can have confidence they’ll be able to do, on average, almost $70m in each of the next 4 quarters. That’s what (to my understanding) they’re guiding for when they say net new ARR will be up 50% next year.

Honestly, I didn’t want to badmouth the CFO too much, but I really do think he’s too much of a cheerleader for the company. In his defense, he’s seen them grow amazingly. He probably wants to believe that can continue no matter what. But maybe last quarter proved that there are some impediments building.

Anyway, there’s no way they can know what net new ARR will be next year. At least, I don’t see how they could.

Bear

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Boy no kidding! You may indeed be correct, but it sure is difficult to be sure without asking the CFO.

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Bear, management never said net new ARR would be up 50% next year. They mentioned total ARR would be up 50%:

"“While growth is slowing because of macro conditions in the near term, we remain confident in our ability to deliver high levels of growth next year and beyond. We expect to continue to win market share and outgrow the competition. Based on a prudent view of the current economic environment and expectations of further macro deceleration, we believe, we will deliver at least 50% total ARR growth in fiscal year '24. This is also based on our growing pipeline, strong win rate, high retention and expansion rates, and the enterprise’s need for security.”’

This compares with Crowdstrike’s guide implying ARR growth of low to mid 30s next year.

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Yeah, that’s what I meant. Sorry if I wasn’t clear. To Saul’s point, this is confusing!

But if they hit their $58.6m in Q4 they will have about $546m total ARR at the end of this fiscal year. So to grow 50% they’d need to get to about $820m next year. That’s an average of almost $70m for each of the 4 quarters next year, like I said.

But yeah, I had said in a past post that that compared to Crowdstrike being flat. But that means adding the same amount of net new ARR as this year, which for SentinelOne would be about $54m per quarter on average (organically). So thanks for the correction.

I still think doing almost 70m each quarter next year might not be easy, as it seems they’ve kind of stalled in the ~50m+ range (Thoughts on SentinelOne and its recent Conference Call - #3 by PaulWBryant). It’s certainly possible, but it depends on the endpoint market. We’re seeing some not great signs, and that was probably part of why they missed last quarter and “only” guided for $58.6m in Q4. Hope it gets better next year. Guess we’ll see what happens.

Bear

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