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