The question of “why did Crowdstrike sell-off” doesn’t seem to be satisfied by the $10 million miss on forward revenue and ARR.
Forward Q4 revenue was expected to be $634M and the company guided $619M to $628M for a miss of about $10 million, if we take a midpoint of $624 million (about 1.5% miss). ARR was $2.34 billion compared to analyst expectations of $2.35 billion, for a $10 million miss (less than 1% miss).
Although this likely contributed, I believe the analyst we quoted in our Pre-ER write-up that was modeling for net new ARR of $224M to $230M-plus may be providing a missing link between analyst expectations for this key metric and actual results of $198 million. At the midpoint, this would be more of a miss of 14.6%.
Here is what was said in the Pre-ER write-up:
“An analyst note from Barclays’ Saket Kalia is modeling ARR net addition of $224 million “but thinks upside could be $230M-plus given strong pipeline commentary.” At $230M, it would represent 5% sequential growth and 35% YoY growth. This would be down from 15% sequential growth in the previous quarter and 45% YoY.”
The reason we flagged this is because the net new ARR at high point of $230M would still mark a strong deceleration to 5% sequential growth down from 15% sequential growth last quarter. This means this would have to be met or we would be nearing flat to negative sequential growth on net ARR.
With the actual of $198 million reported, this drops the net new ARR at negative sequential growth of negative (9%) down from $218 million last quarter. This marks a change compared to the comp of 13% in sequential growth from Q2 2022 to Q3 2022.
The market is nervous with cloud becoming the other shoe to drop as enterprise budgets will slow long after consumer slows due to annual billing cycles, annual budget reviews (i.e., likely to produce budget cuts) and due to higher switching costs (or in cloud’s case, slower to switch off than consumer or ad spending, for example).
In my opinion, this is why outsized pressure is being placed on sequential growth. The market does not care about YoY because it’s assuming enterprise spending wasn’t affected yet.
CrowdStrike Q3 Overview:
CrowdStrike beat both top line and bottom line for Q3. In fact, an area where CrowdStrike continues to stand out from its peers is the health of the bottom line and both Q3 actual and Q4 guide was no exception in this regard. For example, the free cash flow margin of 30% is exceptional.
The company reported revenue of $581 million for growth of 53% compared to revenue of $574 million expected for growth of 51%. This is a slight deceleration from 58% last quarter.
For Q4, the company guided for revenue of $619 million to $628 million compared to expectations of $634 million. At the midpoint of $623.5 million, this is a $10.5 million miss.
The GAAP EPS of ($0.24) compares to ($0.22) EPS from the year ago quarter and ($0.25) EPS last quarter.
Adjusted EPS for Q3 came in at $0.40 compared to $0.32 expected. This compares to $0.36 last quarter and $0.17 in the year ago quarter.
Adjusted EPS guide for Q4 also beat at $0.42 to $0.45 compared to $0.34 EPS expected.
GAAP gross margin was 72.7% which was in line with a range of 73% to 74% over the past five quarters. The adjusted gross margin this quarter was at 75% compared to 76%-77% over the past five quarters. Subscription gross margins were also in line.
GAAP operating margin of (9.70%) compares to (9%) last quarter and (10.5%) in the year ago quarter. This resulted in GAAP operating loss of ($56.4) million which is a tad higher than the $48 million losses last quarter and the $40 million losses in the year ago quarter.
The adjusted operating margin was a beat in Q3 and Q4. This was a bright spot in the report with adjusted OM of 15.4% compared to 13% estimated. This compares to 16% Adj OM last quarter and Adj OM of 13% last year. This was essentially flat and it’s important it did not contract.
The guide on adjusted operating income of $87.2M to $93.7M implies an adjusted operating margin of 14.5%.
The GAAP net margin of (9.4%) and adjusted net margin of 16.5% was in line with previous quarters. The guide for adjusted net margin is also in line at 16.6%.
CrowdStrike is very strong on cash flow margins and is one of the top ranking cloud stocks in this regard. This quarter the company reported a free cash flow margin of 30% for FCF of $174 million. The company is guiding for a FCF margin of 28% to 30% next quarter. The operating cash flow was $242.9 million for a margin of 41.8%. There is $2.47 billion in cash on the balance sheet.
The company paid $140 million in stock-based compensation for a margin of 23.7%.
Key Metrics:
As stated in the Intro, the key metrics are likely causing the sell-off.
RPO was up 44% year-over-year for $2.797 billion and was up 11.6% sequentially. However, management reminded analysts that ARR is the leading key metric for their business.
Ending ARR grew 54% year-over-year to $2.34 billion and grew 9.3% sequentially. Therefore, because ending ARR was strong, the net new ARR could be easily underestimated in terms of impact. The net new ARR at $198 million in fiscal Q3 compared to $218 million net new ARR in fiscal Q2 indicates a 9% sequential decline.
The market has the jitters right now so the sequential decline is important to pay attention to especially because management said to expect further weakness in the upcoming Q4 quarter. Here is what the CFO said:
“Even though we entered Q3 with a record pipeline, we are expecting the elongated sales cycles due to macro concerns to continue, and we are not expecting to see the typical Q4 budget flush given the increased scrutiny on budgets. While we do not provide net new ARR guidance given the current macro uncertainty, we believe it is prudent to assume that Q4 net new ARR will be below Q3 by up to 10%.”
If I understand the CFO correctly, then this implies a net new ARR of $178.3 million for Q4 (10% lower than the current quarter at $198.1M) compared to net new ARR of $216 million in the year ago quarter. This is important because it’ll mark not only a sequential decline but a year-over-year decline in net new ARR. The market had already sold off for what I presume was a sequential decline in Crowdstrike’s leading key metric, and management then stated the decline would be steeper for Q4 on the call. Once the comment above was made, we were certainly not going to see a reversal in the stock price from the earnings call.
Customer count was strong at 44% growth. The mix of domestic versus international was slightly lower than usual for North America at 69% with EMEA being slightly higher at 15%.
Deferred revenue grew 56.4% year-over-year and backlog grew 19%.
Additional Commentary:
CrowdStrike was transparent about the importance of ARR even in the face of net new ARR being lower than expected. Here is what was said by the CFO:
“And then finally, just to comment on ARR. You pointed out that's how we run our business. ARR, though, is really an X-ray into the contracts themselves. And as we view that as the most important — or most transparent metric into the outlook for our business, that's the one where we're focused on. So, hopefully, that gives some more clarity on how we think about cRPO and ARR.”
Later on, an analyst did zero-in on the (9%) decline.
“Andrew Nowinski
Great. Thank you for taking the question this afternoon. So total ARR of $2.3 billion, growing 54% is still absolutely amazing, I was – and it's at scale. But I was wondering, were you surprised that the net new logos that you added were down 9% this quarter?
Burt Podbere
Thanks, Andy. So when we think of the net new logos, it really corresponds to what we talked about in terms of what we saw in that SMB space. The SMB space is the one that drives the velocity of our net new logos. And as we talked about, we saw an 11% increase in our sales cycle in the SMB space. And that actually equated into $15 million in terms of deals in that space that could push out. And so when you think about 15 million in that space and what it means in terms of logos, where you can do the math, it's a pretty big number.
So that's how we think about net new logos corresponding to what we saw in net new ARR from the SMB space. So from that perspective, we weren't surprised at the end of the day when we saw that what happened with respect to the increased sales cycles and the amount of money that got pushed out in the SMB space.
My note: Just to be clear, when they say “push out” they are referring to a delayed sales cycle for an impact of $15 million.
The CFO did reiterate the 10% further sequential decline in net new ARR between Q3 and Q4 when he said:
“When we do talk about net new ARR, I did talk about in the prepared remarks about how we think about up to 10% headwinds going into Q4 from Q3, and that's just to coincide with some of the headwind activity that we saw accelerated at the end of this quarter. So that's how we think about that.”
Conclusion:
Given the tough macro, our goal is to fully understand why the market may favor some stocks and deeply discount others after an earnings report. The market is getting nervous on cloud. We talked about this with Microsoft and also saw this following Datadog’s report.
As a reminder, here is a brief overview of Microsoft’s report:
“Microsoft is guiding down for next quarter with analyst expectations for the December quarter at $56.04 billion compared to management guidance on the call for revenue of $52.75 billion, at the midpoint. This represents 2% growth. […] That’s a 11% deceleration over the next few months. Some of this may be coming from Azure as the company is expected Azure to decline 5% next quarter for its current growth rate. This will be 37% growth on a constant currency basis, down from 42% this quarter.”
Here is a snippet from our Datadog ER write-up:
“RPO decelerated and is a concern. The deceleration we noted in our last earnings report and our pre-earnings write-up where we noted the deceleration went from 85% to 51%. This quarter, the deceleration steepened to 31% year-over-year growth for $941 million. RPO is still up on a sequential basis with $858M in RPO in Q1, $881M in RPO in Q2 and $941M in RPO this quarter. If it were to decline on a QoQ basis, the stock would be deeply penalized, so we will monitor this as we go along.”
What we saw today from CrowdStrike sounded very familiar, in my opinion. The market is nervous about cloud and is swiftly discounting these stocks on slowing revenue plus any additional signs revenue may slow in the future. We will need to see more information to draw any conclusions, most especially we will need SentinelOne’s report coming next week.
Most recent coverage on product:
Forum: Crowdstrike’s Pre-Earnings Report
https://io-fund.com/premium/crowdstrike-cybersecurity-is-techs-leading-sector
https://io-fund.com/premium/cybersecurity-stock-faceoff-crowdstrike-vs-zscaler-vs-cloudflare
https://io-fund.com/cloud-software/cybersecurity-continues-to-lead-cloud-stocks