The Strongest Cybersecurity Stocks In Q3

Posted on December 4, 2023June 30, 2026 by io-fund

This article was originally published on Forbes on Forbes Forbes on Nov 30, 2023,09:40pm EST

Cybersecurity stocks have performed well in 2023, rising about +26.5% YTD, with the security backdrop boosted by an increase in data breaches and ransomware. Quarterly spending has increased approximately +12.7% YoY to ~$37.6 billion through the first half of the year, although commentary from sector leaders Fortinet and Palo Alto raised some concerns about spend optimization, with billings forecasts from the two weaker than expected.

Despite beating on the top and bottom lines, Zscaler provided flat billings guidance while revenue growth is set to slow. CrowdStrike was GAAP profitable from operations for the first time ever as net new ARR reached a record, but billings and ARR growth both decelerated.

Cybersecurity Market Growth Slows in Q2

Zscaler and CrowdStrike reported their October quarters this week with both providing important commentary that the macro environment is tougher than usual. CrowdStrike’s management said that buyers still remain cautious since the “macroenvironment remains challenging with continued increased budget scrutiny.” Zscaler said that while the “global macro environment remains challenging, and customers continue to scrutinize large deals, … customer sentiment seems to be stabilizing.”

Looking back at the cybersecurity market through Q2 offers a bit of color on those broader trends impacting growth this year. The market registered a third straight quarterly deceleration in Q2, per Canalys estimates, as the global market recorded +11.6% YoY growth to $19.0 billion.

This marked a slight deceleration from the +12.5% growth in Q1 to $18.6 billion, and a sharper deceleration from the +15.8% growth rate seen in 2022, as the cybersecurity market topped $71 billion for the year.

Source: CANALYS

Growth in North America remained resilient at +12.6% YoY in Q2, the bellwether of the market considering it accounts for more than half of total spending. Latin America and EMEA growth remained in the double digits, though both decreased approximately 180 to 210 bp sequentially. APAC growth saw the largest slowdown, from +10.7% YoY in Q1 to +8.8% YoY in Q2.

Headwinds Remain in Play in Q3

Budget cuts, consolidation, and optimization are some of the trends at play in the cybersecurity market that are pulling 2023’s growth rates lower. Microsoft CEO Satya Nadella said in January during its fiscal Q2 earnings call that customers were “consolidating on our security stack, in order to reduce risk, complexity and cost.”

CrowdStrike CEO George Kurtz echoed Nadella’s view in the company’s Q1 earnings call in March that customers “want to reduce cost and headcount, reduce the number of point products and agents, reduce complexity and simplify operations.”

Venture capital funding deals and deal value also reflect this challenging environment persisting through Q3. According to Crunchbase, deal count declined just over (-15%) from Q2 to 153. Although deal value was marginally higher at $1.9 billion compared to ~$1.8 billion in Q2, it was about (-30%) lower YoY as large late-stage deals faded. VC funding has totaled just $6.4 billion YTD, on track to mark the lowest level of funding for cybersecurity startups since 2019, which totaled $8.8 billion.

Source: CRUNCHBASE

Despite such cost and complexity concerns, companies are still committed to protecting data and operations. It’s this point that will drive long-term growth of the industry in the face of these near-term headwinds: there will always be more data to protect.

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Fortinet: Q4 Guidance Soft, Billings to Decline YoY

Fortinet declined (-12.4%) following its Q3 earnings report for three key reasons: Q3 revenues marginally missed estimates, Q4 revenue guide was below consensus, and most importantly, Fortinet is projecting a YoY decline in net billings.

Fortinet reported revenues of $1.33 billion in Q3, which missed expectations by just $20 million. For Q4, Fortinet guided revenues $80 million lower at midpoint than the consensus estimate of $1.49 billion.

Q4 billings were projected to be between $1.56 to $1.70 billion, representing a YoY decline of ~(1%) to (9%). Management’s transition to SASE and security operations, and challenging network comps, are some of the factors behind the revenue slowdown with Fortinet seeing “modest” revenue growth for the next few quarters.

Source: I/O FUND

Fortinet’s billings slowdown and the lowered revenue forecast is a concern as 2023 would mark Fortinet’s slowest billings growth since its IPO in 2009. Growth is estimated at just +10.2% YoY at the $6.165 billion midpoint. It’s also a significant slowdown from the +34% and +35% billings growth seen in 2022 and 2021. Management said the growth slowdown in Q3 stemmed from “1 month shorter contract duration and importantly, lackluster appliance demand.”

A slowdown in product revenue growth is likely a driving factor behind the lowered revenue forecast for 2023. Product revenue is forecast to increase only +9% YoY to $1.935 billion – this is well below 2022’s +42% growth, 2021’s +37% growth, and its +23.7% average growth rate since 2009. CEO Ken Xie said that “the Secure Networking market is experiencing slower growth as product demand returns to normal levels following two years of elevated growth.” He added that “building and product revenue fell below our expectation” due to that slowdown in Secure Networking.

Palo Alto: Billings Weaker than Expected, Underlying Metrics Strong

Palo Alto shares fell (-5.4%) following its fiscal Q1 earnings report, but have since gained more than +14% to rise to new highs. The initial negative reaction stemmed from a lowered billings forecast as well as hints that revenue growth is slowing below 20%, but other underlying metrics remained strong.

Palo Alto reported +20% YoY revenue growth to $1.88 billion and +16% YoY billings growth to $2.02 billion, which came in below its prior outlook for $2.05 to $2.08 billion in the October quarter. This miss is amplifying concerns that revenue and billings growth is decelerating — revenue growth was at the lowest level since fiscal Q4 2020, while billings growth was at the lowest level in more than four years and marks a second quarter with growth below +20%.

Source: I/O FUND

For the full year, Palo Alto lowered its billing forecast to $10.7 to $10.8 billion, from a prior view of $10.9 to $11.0 billion. This correlates to YoY growth of +16% to +17%, roughly in line with the recent quarter’s +16% growth rate. Palo Alto cited volatility in contract duration, increased financing demand, and increased demand for deferred billings plans for the lowered forecast. CFO Dipak Golechha said that the company “saw the rising cost of money have an important and incremental impact on customer behavior in [fiscal] Q1.” Similar to Fortinet, Palo Alto saw minimal growth in product revenue, at just +3% YoY, with the majority of revenue growth driven by service revenue, +25% YoY.

Aside from that, Palo Alto had multiple underlying strengths in the report, especially with its next-gen offerings. Next-Gen Security ARR increased +53% YoY to $3.23 billion, and SASE ARR increased +60% YoY. Palo Alto saw very strong growth in multi-module customers, with +155% YoY growth in those adopting 5+ modules, and +59% YoY growth in those adopting 3+. XSIAM’s pipeline exceeded $1 billion, with more than $500 million of that pipeline added in Q1.

Zscaler: Billings Guide Unchanged, Revenue Growth May Slow

Zscaler maintained its billing guide for the full year, although revenue and EPS both came in ahead of expectations in its fiscal Q1. Large customer growth continued to slow, while fiscal Q2’s guide hinted at a possible deceleration in revenue growth.

Zscaler reported $497 million in revenue, +40% YoY, which handily beat expectations and the company’s guidance for +33% YoY growth to $473 million in revenue. While it did post +131% YoY growth in adjusted EPS to $0.67 and a surge in free cash flow, Zscaler remains unprofitable on a GAAP basis.

GAAP operating loss improved 33% YoY to ($46 million), while GAAP operating margin improved 10 percentage points to (9%). At its scale of more than $2 billion in annual revenue, it’s likely the market will want Zscaler to soon shift to operating profitability, which could be tough at the moment given that sales, marketing and R&D accounted for ~98.8% of gross profit in Q1. SBC also remained high at $129.1 million, or ~26% of revenue.

Billings growth remained strong, at +34% YoY to $456.6 million. However, Zscaler did not raise its full-year billings outlook as it tends to do, even if only by a few million; its outlook remained unchanged at +24% to +26% YoY growth, or $2.52 to $2.56 billion. That outlook suggests that billings growth will decelerate through the remainder of the fiscal year.

Fiscal Q2’s revenue guide also hinted at some early signs of revenue deceleration, with the $506 million guide pointing to YoY growth of approximately +30.5%. Fiscal 2024’s guide calls for +29.5% YoY growth at midpoint to $2.095 billion, again indicating that revenue growth in fiscal Q3 and Q4 is likely to slow to the mid to high-20% range.

Source: I/O FUND

Growth in large customers of over $1M in ARR has slowed significantly by 21 points over the past year, from 55% growth down to 34%. Growth in $100K+ ARR customers has also slowed from 37% to 22%.

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CrowdStrike: Net New ARR Rises to Record, But Billings Decelerate

CrowdStrike beat on the top and bottom lines and guided fiscal Q4 marginally above consensus. The report in itself was fairly strong, as net new ARR rose to a record and CrowdStrike recorded its first-ever quarter with positive operating income. However, ARR growth and billings growth both decelerated, similar to peers who are also seeing decelerating billings. Management added that “buyers are still cautious” as the “macroenvironment remains challenging with continued increased budget scrutiny.”

Source: I/O FUND

Net new ARR rebounded to a record $223.1 million, +12.6% YoY, a strong recovery from Q1 and setting the stage for another possible record to close out FY24. With this rebound in net new ARR, CrowdStrike’s ARR topped $3 billion for the first time, reaching $3.15 billion in fiscal Q3. CrowdStrike emphasized that it is the “fastest and only pure play cybersecurity software vendor in history” to surpass the $3 billion ARR milestone.

However, ARR growth is still decelerating, as is billings growth. ARR growth in fiscal Q3 was +34.6% YoY, a slight deceleration from Q2’s +36.9% YoY growth rate and a sharper deceleration from the +55% YoY growth rate from fiscal Q3 last year. What’s important is that CrowdStrike soon shows ARR bottoming and stabilizing, instead of decelerating further into the +20% range or even the high teens.

Source: I/O FUND

Billings also decelerated, matching what we’ve seen so far with CrowdStrike’s peers. Billings were calculated to have fallen (-2%) QoQ and +9% YoY to $821.5M for Q3, a significant slowdown from the +13% QoQ and +22% YoY growth rate recorded in the prior quarter. You can read more about billings and ARR in our CrowdStrike’s Q3 earnings recaphere.

Source: I/O FUND

Pictured Above: I/O Fund calculations for CrowdStrike’s billings growth/decline

CrowdStrike also recorded its first quarter to generate operating income, albeit at a razor-thin 0.4% operating margin. However, this shift to a positive margin benefited the bottom-line, allowing net margin to expand ~225 bp QoQ to ~3.4%. This marked CrowdStrike’s third straight quarter of GAAP profitability, with sequential growth in each of the three quarters. We had previously mentioned that while CrowdStrike had begun to post GAAP profitability, it was preferable that the company be GAAP profitable from operations rather than interest income – now, the next task is for CrowdStrike to show further growth in operating income.

Conclusion

Aside from Fortinet, the remaining cybersecurity stocks covered here have all rallied to new highs following earnings, despite each report having some weaknesses. Cybersecurity stocks are investor favorites due to an ever-growing need for cybersecurity solutions among enterprises and high cash flow generation metrics – all of the four reported free cash flow margins higher than 30%. Billings growth remains an important metric to track, given the decelerations seen this quarter and hints at more deceleration ahead. Yet, these key metrics are providing clues as to which companies will be strongest moving into 2024.

Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.

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Marvell Q3 Earnings: The Market Wants More on AI

Posted on December 1, 2023June 30, 2026 by io-fund

Marvell’s report was primarily in line with a marginal miss for the Q4 guide. The market was expecting $1.46B on the guide and Marvell provided $1.42B at the midpoint. For Q4, the adjusted EPS of $0.46 guided by management also missed estimates of $0.49. However, the cash was strong at $503M in operating cash flow and $448.3M in free cash flow.

Although the data center beat expectations, Marvell is expected to face near-term weakness in its Carrier Infrastructure (5G) and Enterprise Networking end markets, which partially contributed to the miss in guidance vs. consensus for both revenue and Non-GAAP EPS. The 5G market is weak because the initial wave of 5G rollout is finishing and also demand is continuing to weaken as carriers are holding back on CapEx spend in tough macroeconomic conditions. For Enterprise Networking, weakness is due to both inventory management form OEM customers and weak demand. Furthermore, there isn’t that much visibility for the Enterprise Networking business.

Regarding the data center, last quarter, Marvell was forthright in saying they had a $200 million quarterly revenue run rate, or $800 million annualized. Per the Q2 transcript: “Based on our latest demand outlook for our electro-optics products, we now expect revenue from AI to exit this year at over a $200 million quarterly revenue run rate or $800 million annualized.” It naturally follows that investors want an update to this number the following quarter.

Despite there being 20% growth this quarter in the data center and an impressive 35% expected next quarter for the data center, the CEO declined to raise the exit rate for AI other than to say: “well north of $200 million.” When pressed further, management declined to update the exit rate. This may seem like semantics, but it’s important because this is Marvell’s bull case. The rest of the segments weigh considerably on the company due to cyclicality.

Looking further into Q1, management seemed to imply the other segments could drag on the company’s outlook. They didn’t guide Q1, of course, but the response to a question in terms of whether the other segments will drag too much on revenue growth was answered with what appeared to be low confidence.

Financials

Marvell reported revenue of $1.419B, down 8% YoY and up 6% QoQ, slightly above consensus. Revenue next quarter is expected to be $1.420B, which is below consensus of $1.46B.

Non-GAAP EPS was $0.41, slightly above consensus of $0.40. GAAP EPS of ($0.19) missed guidance of ($0.07) EPS. Of this $269.8M is for the amortization of acquired intangible assets from the Inphi and Innovium acquisitions. There is another $158.5M paid in stock-based compensation.

Adjusted EPS for next quarter is expected to be $0.46 which is below consensus of $0.49.

The gross margin has been improving quite a bit. The adjusted gross margin was 60.6% and the guide for next quarter is 63.5% to 64.5%. The GAAP gross margin was considerably lower at 38.9% this quarter.

The adjusted operating margin was in line at 29.8% and the adjusted net margin was 25% for profits of $354 million.

Cash and cash equivalents was $726M, increasing by $202M from the Jul quarter. Operating Cash Flow was $503M up from last year of $411M. The gross debt-to-EBITDA ratio was 2.21 times and net debt-to-EBITDA ratio was 1.83 times. In other words, debt of $4.19 billion didn’t improve this quarter.

Revenue Segments:

Data Center:

Data Center Revenue of $555.8M (down 11% YoY, up 21% QoQ)

The strength in Data Center revenue was driven by stronger than expected AI revenue. A positive within the Data Center end market was cloud revenue returning to YoY growth. Cloud revenue grew >30% with contributions from AI and cloud infrastructure with AI revenue growing substantially faster than cloud infrastructure revenue. Marvell’s product portfolio of PAM4 optical products, Teralynx, Ethernet switches, and Data Center Interconnect products contributed to the QoQ growth for Data Center revenue. You can read our previous write-up on Marvell here.

However, the strength in cloud revenue was offset by enterprise on-premise data center revenue declining QoQ, which was expected by management. Similar to Q2, data center revenue for the storage market remains weak.

Enterprise Networking:

Enterprise Networking revenue of $271.1M (down 28% YoY, down 17% QoQ). Enterprise Networking revenue weakness was due to weak demand in this end market, which is in-line with management expectations.

Carrier Infrastructure:

Carrier Infrastructure (5G) revenue of $316.5M (up 17% YoY, up 15% QoQ. 5G revenue strength was driven by the wireless part of its 5G end market

Consumer:

Consumer revenue of $168.7M (down 5%, up 1% QoQ)

Automotive:

Automotive/Industrial revenue of $106.5M (up 26% YoY, down 3% QoQ)

Earnings Call:

AI Revenue:

The comments on AI revenue were positive in the opening remarks yet the CEO sounded less confident during the Q&A. Personally, I found it to be confusing and analysts did, as well.

To start, the opening remarks were encouraging but it later changed, for example: “In our data center end market, revenue for the third quarter was $556 million, well above our guidance, driven by stronger than forecasted AI revenue,” and also, “In cloud, revenue from both AI and standard cloud infrastructure grew sequentially with AI growing significantly faster.”

At this point, given this commentary, the expectation was for a higher exit rate than the $200M provided last quarter. Yet, when pressed in the Q&A, management had a different tone.

Q:: I'm kind of hearing mixed signals on the custom silicon opportunity. And I just wanted you guys to clarify on that. I guess, first of all, are you guys above or below $200 million expectation you guys had for the year? […] You guys talked about that $200 million for this year -Christopher Rollins

A: Yeah, exactly. So yeah, so we're tracking, I'd say, close to the $200 million, okay, for this year. And then what we had said at the Investor Day and kind of the long-term was this $800 million, and that was between, sometime between FY 2025 and 2026, that was what the — if you looked at the slide from a couple of years back.

And what we had said, I think I think two quarters back or it was a quarter back that, that number would be bigger overtime now because of the AI piece of it, even though some of the stuff had shifted around that wasn't an AI. And I think that's still largely on track in that timeframe. We never gave an exact kind of — it's going to happen in XYZ quarter.

But in that FY 2024, 2025 to FY 2025, 2026 timeframe it should be able to get towards above that number we gave before which is the $800 million.

So I don't think there's any mixed signals. I don't think there's any update, which I think we're – I think there's some enthusiasm around, but nothing's changed from a quarter ago. In fact, I think the thing that's positive is that the chips are looking really good to go to production for next year, and that was always a risk.” -CEO, Matthew Murphy

My translation: To be frank, I do think the CEO gave mixed signals as the opening remarks stated “significantly above our forecast,” yet later, the CEO stated: “nothing's changed from a quarter ago.” It seems management is mixing words by saying “above our forecast” to reference a forecast from many quarters or even years ago instead of the forecast in Q2.

It's quite obvious this year the market is keen on AI revenue, and mixing words when describing the AI revenue was odd, at best, and careless, at worst.

Fiscal Q1:

The rebound we outlined in our pre-earnings report is crucial for a win-win scenario to where the rebound ideally aligns with AI driving more data center revenue. Therefore, although being two quarters out, Q1 is important because it’s the quarter the rebound is expected to be most evident with 13.2% revenue growth and 60% EPS growth expected.

The question on the call about fiscal Q1 did not exude confidence:

“And then also for fiscal Q1, do you still think that revenue can grow? I know you said that networking is down and carriers down. But data center would be up. Do you think that total revenue can be up? Thanks.” -Tim Acuri, UBS

“On Q1, while we don't guide specifically, I understand what you're looking for. I think the way to think about it is that, and I guess I gave the information. Carrier is down after a really great run in that's going to stay weak. The telco environment and CapEx spending is very constrained out there and the end customers seem to be having some trouble. We talked about enterprise being down.

And then on consumer, which actually did a little bit better than we thought it would have this year. The last time buy program that we had has been largely going to conclude now in the fourth quarter, and so we see a stepping down there. So if you kind of add all that up, that's about half our revenue that's going to come down in Q1.

And then the real question is the data center strength and how does that continue? And it's too early to call, but just the way to think about it is it's a lot to offset at this juncture when you have that much of your of your revenue coming down.” -CEO, Matt Murphy

Later, it was asked if carrier would bottom in Q4 but the CEO indicated it could be Q1 or further out. Carrier is the second largest segment and so this may be where the lack of confidence in Q1 is coming from.

Q: “Thank you for that Matt. One last one on carrier. Is Q4 going to be the bottom? Or do you think there could be some more yet to drop? And then I think you have some additional content coming at one of your customers at the end of the year. Is that going to be a meaningful lift for the segment? Thanks.” -Christopher Rolland

A: “Yes. So there's – as I think I said in my remarks, there's going to be continued softness into Q1 in carrier, okay? It's going to take, who knows how many quarters. And it really depends, I think, there'll be some inventory and then you've got to also look at kind of where the CapEx ends up during next year and where carriers are actually going to spend globally on their deployments.” -Matt Murphy

Conclusion:

Marvell has a strong AI story that is obfuscated by its other segments. The lack of confidence for fiscal Q1 due to the other segments, plus management declining to update the AI exit rate is why the price action reversed. I agree with the market; I think the report needed to be stronger in terms of management communicating more clearly on the AI story since this is the bull case. The tone is that this is a waiting game, and it’s not possible for management to help investors time when the many pieces will come together. Lastly, the opening remarks were confusing — although it doesn’t change Marvell’s potential, it did create some disappointment that there was not “significantly more revenue” from AI – rather, come to find out, the guide was unchanged. Or, if there is significantly more revenue, than Marvell is not willing to be as forthright as management was last quarter, and is leaving investors guessing.

There were some positives such as the cash flow and margin improvement. However, without more AI revenue to report in terms of an exit rate, these improvements won’t be enough to end the year as a 2023 outlier.

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