SentinelOne had an excellent earnings report. There are a few things to unpack, yet the 10,000-foot view is that the company has continually proven its capable of growth during a time of uncertainty for other cloud peers.

Key metrics accelerated including customers with ARR over $100,000 and dollar-based retention rate. The most notable positive surprise was the company’s dollar-based net retention rate of 137%. This is a record for the company and marks an acceleration from 131% last quarter and from 125% in the year ago quarter. 

You can reference our product overview on SentinelOne from a year ago here on Forbes and updated in January here on the premium site.

Financials:

SentinelOne reported revenue growth of 124% for $102.5 million compared to a consensus of 109% growth based on revenue of $95.7 million. The company raised Q3 guidance to 98% growth for $111 million compared to a consensus of 93% growth based on $108 million consensus. The full year guide was also raised to $416 million, up from $406.4 million previously. This represents growth of 103% for FY2023 ending in January, up from guidance of 98% growth for the full year.

The Attivo acquisition adds ARR of $35 million to the numbers stated above and SentinelOne is not breaking out the numbers any further now or in the future. Management stated the growth outlined above does not come from Attivo, rather came from growth in the organic business. They do feel identity will grow in the future but did not in the immediate quarter. 

Remaining performance obligations for SentinelOne, which includes deferred revenue and other non-cancelable contract revenue was $444.7 million with 84% recognized as revenue over the next 24 months.

The margins are where the rubber meets the road with SentinelOne. The GAAP gross margin of 65% is improving from the GAAP gross margin of 59% in the year ago quarter. The adjusted gross margin of 72% also shows significant improvement from the 62% adjusted gross margin a year ago. 

We’ve previously covered in detail how the company operating expenses in sales and marketing, R&D and also stock-based compensation contribute to a weak operating margin. This has resulted in an GAAP operating margin of (106%) and adjusted operating margin of (57%). This is an improvement from a GAAP operating margin of (147%) and an adjusted operating margin of (98%) in the year ago quarter. This is also an improvement from the previous quarter at (115%) GAAP operating margin.

This was a beat for Q2 as operating margin was previously guided to be (75%) to (73%). We noted this would make meeting the FY2023 guide a bit tough so it’s good to see this in line with the FY2023 guide on operating margin.

Notably, the company has doubled its spend in sales and marketing, research and development and G&A from the year ago quarter. Stock based compensation was 40% of revenue in Q1 at $31.6 million and is still roughly 40% of revenue in Q2 at $41 million in the current quarter. 

However, the management team has delivered on its promise to greatly improve its margins. At the onset of the year, it was stated the company would reach Non-GAAP operating margin in FY2023 of (60%) to (55%). The company is now stating: “we're improving our full year range to negative 58% to 55%, a one-point improvement at the midpoint from our prior range.”

Management is guiding for the same margins next quarter in Q3 which is 71% adjusted GM and (57%) OM.

The company has stated its goal is to become cash flow positive by 2025. The company’s free cash flow was ($66) million. If we assume the company spends $250 million in cash per year with $1.2 billion in cash, cash equivalents and short-term investments, there shouldn’t be a capital raise unless there are more unforeseen acquisitions. The Attivo acquisition cost $351.5 million in cash and 6.032 million shares of Class A stock for an aggregate value of $185.9 million and 379K assumed options to purchase shares of Class A stock.

The company’s adjusted net loss per share is ($0.20) compared to ($0.38) for the same period last year. It beat the analysts’ consensus estimates by $0.05. 

The company’s valuation is 17 forward P/S. Bottom line valuations don’t work well in cloud due to how few companies are profitable. With that said, SentinelOne’s valuation is in line with Crowdstrike and is between cybersecurity companies such as Cloudflare and Zscaler.

Key Metrics:

The company provided ARR of $438 million for growth of 122%. It was unclear if Attivo’s $35 million was included in the ARR provided. If it was, then organic ARR for the quarter was $403 million for growth of 103%. I’m assuming it’s the 103% as total customer count combined both organic and acquired. This marks a deceleration from 110% in the previous quarter. 

Regardless of the ARR growth, the customer segment with ARR above $100K grew 117% to 755 total customers, up from 348 in Q2 of last year, and this is unlikely to have been affected by Attivo. Total customer count was 8,600 with 750 organic adds and 350 acquired from Attivo, up from 5,400 in Q2 of last year. According to the SEC Filing, no customer accounts for more than 4% of revenue and 33% of revenue is from outside the United States. 

“Our financials now incorporate the acquisition of Attivo, which performed in line with our expectations and is on track for our full year ARR target of $45 million or more. We do not intend to break out Attivo financials going forward as it becomes part of our broader platform offering as our identity suite.”

Note: Attivo’s current ARR is $35 million with a target of $45 million for the full year. 

Dollar-based net retention rate was 137%, up from 131% in the previous quarter and up from 125% in the year ago quarter. This is record DBNRR for the company. The company noted it fits the Rule of 60 and has plans to continue fitting the Rule of 40. SentinelOne’s Magic Number is above 1.3.

According to management, the fastest growing module is Singularity Cloud, followed by data retention and Ranger. The company mentions that even in cases where companies are using a competing security company on endpoint, they will use SentinelOne for cloud run time protection. 

When asked if SentinelOne has had success in replacing the endpoint provider by leveraging it’s best-of-breed cloud protection, the company responded it provides a back door yet the bigger opportunity is in protecting the cloud architectures. “But to be honest, I mean, when we look at how these cloud opportunities, especially with the cloud-native companies, they're probably 4x, 5x, sometimes 10x the size of the endpoint footprint and the endpoint opportunity.”

We covered from the Q4 earnings call that management expects cloud to be equal or greater than the endpoint opportunity. We also covered that “Cloud is a Growth Lever” in our full length premium report.  

The company has recently expanded its platform to include data ingestion on the backend that is now seamless with the user interface on the front end. When we discussed the differences between SentinelOne and competitors, we pointed toward the company’s data-forward approach. The company reiterated this in the recent earnings call, stating the platform runs petabytes of data everyday while “competitors can handle only a fraction” of this scale. The company also points towards data retention, which helps to reduce storage costs while maintaining critical information. 

Data retention is important because it drives down costs. Per management: “So our ability to process more data for customers, our ability to retain it for longer and really be a cost saver for customers. Obviously, in this macro environment, that's fixed volumes.”

From the Q4 call, we discussed that by going with a different EDR vendor, customers have to then figure out how they are going to retain data on the backend of a different platform, which can be costly. 

In addition to the data retention, the new platform product is the DataSet, or the ingestion of data from the backend that is now seamless with the front end.

Here is what the company stated about this new platform development:

“We completed the migration of our back-end DataSet, which was a meaningful undertaking that we completed in just over a year [..] It positions us extremely well in the future of XDR, a unified, scalable and efficient data back end, gives us a significant competitive advantage. And evident by our Q2 gross margin, it's already supporting our path towards our long-term gross margin targets.”

We’ve covered the Ranger product in the past, which is the product that helps to identify unsecured endpoints through a fingerprinting engine that runs an inventory of IP-enabled devices. Ranger and Ranger Pro detects and notifies IT teams of unsecured endpoints.

Overview of Earnings Call:

We’ve referenced how management teams in cloud are hesitant to pull forward the Q2 beats to an equal or greater full year fiscal guide. Rather than these management teams becoming bold macro economists who feel they can predict with certainty Q3 and Q4, they are instead playing it safe. 

SentinelOne beat Q2 by $6.8 million and guided for a Q3 beat of $3 million. The company carried this entirely through to the full year guide but did not go any further to raise Q4 at this time. This is marginally better its cloud peers who did not pull the Q2 beat forward, in some cases. 

Additionally, this is what management said about the current macro environment:

Demand is strong, and we remain extremely well positioned. At the same time, enterprises across all sectors of the economy are being impacted in different ways by evolving macro conditions. Like other software companies, we've seen some signs of cost consciousness and prudence around IT budgets. This has resulted in marginally longer sales cycle and more budgetary approvals.”

The company was asked again in the call about macro and any impact it may have had on visibility around demand, and the CEO stated: “We still feel pretty good about demand. I think what you see reflected in our guidance is the level that we feel we need to be conservative and prudent. And all in all, again, things remain incredibly strong.”

The analysts on the call believe that part of SentinelOne’s success in the face of global budgetary slowdowns partly rests on the company’s channel partner strategy, which includes resellers and distributors, managed service providers (MSPs) and managed security service providers (MSSPs). 

Whether customers are direct or through the channel partner network, customers adopt the Complete product first and then upgrade across any combination of 15 modules. The modules upgrade is helping to drive a higher DBNRR as customers stay to spend more on the platform with the CEO stating 30% of revenue comes from the modules. They feel this is where the expansion opportunity remains.

When asked about the high net retention rate, management responded with the following:

“I think one of the very most exciting things about our business is the incredible demand that we're seeing from MSPs, MSSPs and – investments partners, many of which have become MDRs or managed detect and response providers themselves. And I think there's a couple of fascinating elements to this part of the business. One, it really lets us, in a very efficient way, cover a tremendous part of the market. Two, it absolutely fits amazingly well in today's macro environment where folks are looking to efficiently protect their networks, efficiently protect their data and their users and expand their security prowess without having to make a lot of capital investments. And managed services do exactly that. Third is incredible velocity in terms of deal cycles.”

Later, the CFO emphasized the channel partners by saying:

“As we've gone through an evolution of MDR and other more sophisticated security service providers, we're starting to see small, medium and large enterprises go with a managed service. And so, we've seen from an overall global trend perspective, I think the scrutiny around spend has lent itself to an upsell in that type of business.”

Another reason SentinelOne has performed well in the current macro backdrop is because it’s best-of-breed across many attack surfaces, including cloud and now identity with Attivo. The company also allows now data to be ingested for a stronger, singular platform and drives down costs with data retention.

Conclusion:

I agree that SentinelOne is best-of-breed and is combining modules to accelerate DBNRR – this is one of the best indicators we have in tech as to a product’s strength. It also helps to illustrate that growth is not at any cost as this typically includes a high churn rate and lower retention if S&M is bringing in lower quality leads. Since its IPO, SentinelOne has illustrated its competitive prowess, whether it’s through product development and R&D or an impressive acceleration in key metrics. For example, ARR accelerated in January of 2021 and continued to accelerate for many quarters. We are seeing this again with DBNRR.

SentinelOne’s stock price hinges on the company keeping its word to improve its margins. There are ample catalysts to sustain the company’s growth, primarily Singularity Cloud and data retention. Both emphasize SentinelOne’s strength in automation which now includes data ingestion on the backend. 

Investors will want to see a clearer path toward profitability next year as SentinelOne will need to assuage any concerns it’s a “growth at any cost” company. Additionally, acquisitions will need to remain limited until the company is free cash flow positive as the company has enough cash until 2025 barring any new acquisitions. Analyst consensus has SentinelOne with positive EPS in January 2025 in a predictable path; if SentinelOne can deliver on this then I believe it will be one of the better performing cybersecurity stocks on the market. 

There are a few reasons MongoDB saw a severe reaction its earnings report. The first is that the cash flow is much lower than it’s been in recent quarters. We wrote in May that this is the top thing to watch across cloud stocks and we positioned our portfolio for those that were FCF positive. 

Here is what I have for MongoDB’s FCF:

($22M): Q2FY22

($9M): Q3FY22

$16.9M: Q4FY22

8.4M: Q1FY23

($48.6M): Q2FY23*

In Q1, MongoDB was expected to report ($0.06) adjusted EPS and the company reported $0.20 EPS instead. This was a $0.30 beat. In Q2, MongoDB reported a beat of ($0.23) adjusted EPS versus ($0.28) adjusted EPS expected. However, Q3 and the full year guide missed on adjusted EPS consensus with Q3 at ($0.13) expected versus ($0.16) to ($0.19) EPS guided. For FY2023, consensus was at ($0.21) versus ($0.28) to ($0.35) EPS guided. I break down the reasons for the miss in the Financials section below.

Q1 was a “perfect 10” quarter. The company stood out as insulated to discretionary spending compared to its peer Snowflake who analysts questioned at length due to its rumored exposure to Coinbase and other heavyweight consumer-facing companies. Perhaps most importantly, in Q1, MongoDB posted adjusted profitability for the first time.

Another reason for the AH selloff is that in Q2, MongoDB and Snowflake switched seats. Analysts are now more concerned MongoDB has outsized exposure to macro conditions rather than Snowflake, as Q2 was a perfect quarter for Snowflake.

Current revenue growth would suggest there is robustness to MongoDB, yet this management team is mirroring more of Datadog’s approach, which is they are not raising full year guidance to match the Q2 revenue beat. If a company does this, it implies the other two quarters will be weaker than expected. MongoDB gave a solid raise to Q3, so that implies that Q4 will be weak despite being seasonally strong.

I also want to be a messenger and say that another reason we are seeing strong price activity is that analysts are concerned that enterprise spend will be the next shoe to drop. This concern was expressed across quite a few cloud companies’ earnings calls. The thinking is that enterprise spend will follow consumer spend, (eventually), yet is slower because budgets are cut more slowly and added back more slowly.

Any sign of weakness is being interpreted as this more serious concern. Whether it’s overblown or whether it’s being prudent is something every investor must decide for themselves as it requires a time machine to truly know when the macro environment will clear, and most importantly, the depth of the effects it will have on cloud.

Some cloud companies can show immediate effects and MongoDB, Snowflake, Confluent, etc, would be that group due to being the consumption model as usage can be increased/decreased fairly quickly whereas SaaS models would require subscription cycle to show these effects. This is not a company or developers electing to reduce usage on MongoDB, rather it’s a trickle down effect from lower usage within applications.

Here’s a quote as this was discussed many times:

“As we discussed last quarter, it's important to understand that the slower than historical consumption growth is a result of slower usage growth of our customers' underlying applications due to macro conditions.

Our customers spend on our platform is well aligned with the performance of their business. In the current environment, some businesses and consequently, their applications are growing more slowly.”

It’s important to note that slower usage from the underlying applications is distinguished from discretionary spending. However, for our purposes as investors, the result is similar, which is that even if MongoDB is a core product, it’s impacted by macro.

The company also stated that it’s a lower rate of workload expansion contributing to their cautious Q4 guide rather than a lower rate of new customers: “As you think about the business more holistically, new customers and new workloads are what really determine the long-term outcome and the long-term success […] As it relates to expansion of existing workloads, which is sort of the other piece of the equation, that's more relevant in the short term not as relevant in the long term. And so, that's where we've seen the slower growth that we've described. And so, we're continuing to take a long-term orientation”that's where we've seen the slower growth that we've described. And so, we're continuing to take a long-term orientation”

 

Financials:

 MongoDB reported revenue of $304 million, which beat consensus of $282 million by 7.6%. In terms of percentage, this was a larger beat than Q1 at 6.9%. The company is guiding for Q3 revenue of $301.5 million at the midpoint compared to $294.5 million consensus. The two quarters combined translate to $29 million in additional revenue. However, the company is only raising full year guidance by $16 to $18 million as the previous guidance was $1.8 billion for FY2023 and is now $1.196 to $1.206 billion. This would imply Q4 being lower than anticipated by $10 million at $320 million instead of consensus of $330 million.

It seems like this market is splitting hairs but it’s what the overall Q4 miss represents, which is, will cloud see extended lumpiness from the recession.

The adjusted operating margin fell from 6% in Q1 to (4%) in Q2 during a time when the market is especially bottom line sensitive. This is the lowest adjusted operating margin over the past five quarters.

The company stated the increased opex is due to an increase in sales and marketing and R&D. Translation: tech companies spend for growth, it’s part of their DNA. Tech companies spend on growth if they think it will help them expand market share at critical point of adoption. The current market doesn’t like this but previous market conditions have not cared. (Tech companies have not changed and how they operate, the market has). This puts extreme pressure on a company — do you stop spending and risk growth and losing market share OR do you ignore the market and continue spending. It’s not good for MongoDB’s stock right now but spending to increase market share is almost always the right answer.

The GAAP operating loss also increased in the recent quarter. It came at ($114.8M) compared to an operating loss of ($72.5M) in the same quarter last year and ($75.9M) in the Q1 FY23. The operating margin was -38% in the recent quarter compared to -36% in Q2 FY22 and -27% in Q1 FY23.

Net income also saw a deceleration and the current market conditions do not take kindly to this.  MongoDB adjusted net loss was ($15.6M) down from adjusted net loss of ($7.7M) in the year ago quarter. MongoDB had demonstrated a path to profitability recently and this has now been reversed.

The cash from this quarter (noted in the intro) was impacted by the conference MongoDB World, yet we aren’t getting much from management in terms of a turnaround on the bottom line as the year continues. For our purposes, MongoDB is no longer a positive FCF company and this is a marked change in the fundamental story. We felt very strongly that our cloud positions must be free cash flow positive this year.

The guide is adjusted operating loss in Q3 to be ($10M) to ($8M). The FY2023 guide is for adjusted operating loss to be ($13M) to ($8M). At the midpoint this is ($10.5M) which implies a weaker bottom line the rest of the year at ($9M) for Q3 and ($4M) for Q4. 

The company’s stock-based compensation is high. In the recent quarter, it was $96.56 million (32% of revenue) and in the Q1 FY23, it was $83.57M (29% of revenue), which is one of the key metrics investors are tracking in the recent quarters.

 

Key Metrics including Atlas

Atlas decelerated from 82% growth last quarter to 73% growth this quarter. This was the larger decel we’ve seen in the previous four quarters, which have been range bound between 82% to 85% growth. Atlas customer growth was at 29% compared to 33% last quarter. However, the contrast is clearer when compared to the year ago quarter at 44% Atlas customer growth.

Management expects this trend for lower Atlas growth (compared to the previous four quarters) to continue.

“First, we expect the Atlas consumption trends we experienced in Q2 to continue for the remainder of the year. Second, in the second half of last year, as we called out at the time, we had exceptionally strong Atlas consumption growth leading to difficult Atlas year-over-year compares to the back half of the year. And third, we expect a sequential decline in Enterprise Advance in Q3 as the renewal base is sequentially lower. Looking into Q4, we expect a seasonal uptick in revenue from EA. But recall, we faced a very difficult year-over-year comparison given strong EA new business activity we saw last year.”

Customers over $100,000 were up 27%, this is down from 30% growth last quarter. Overall customers grew 27.5%, down from 31% growth last quarter. The net ARR expansion rate was “over 120%” which is the same information provided in previous quarters.

 

Comments on the Call:

The call centered around a few things. The first is how macro headwinds affect MongoDB’s business where management described puts and takes. There are actually tailwinds, according to management, as the migration away from legacy databases is now more prioritized:

“On your first question, I just want to remind everyone, we're not seeing any change in deal sizes or sales cycle times. I think your point about as customers face this macro headwind, is there an opportunity for them to essentially drive more efficiency in their business? And we're definitely seeing customers starting to do that. We're definitely seeing customers look at their legacy platforms and recognize how expensive and brittle those platforms are and are more motivated to move on to more modern platforms like MongoDB.We're definitely seeing customers look at their legacy platforms and recognize how expensive and brittle those platforms are and are more motivated to move on to more modern platforms like MongoDB.

Frankly, to help customers in that journey, that was a motivation for us to release the Relational Migrator product because this is not a new trend to help customers just reduce the cost of moving off relational to MongoDB. And I think you're going to see more and more customers take a hard look at their legacy infrastructure and think about modernizing potentially sooner than later.”that was a motivation for us to release the Relational Migrator product because this is not a new trend to help customers just reduce the cost of moving off relational to MongoDB. And I think you're going to see more and more customers take a hard look at their legacy infrastructure and think about modernizing potentially sooner than later.”

There was quite a bit of conversation around “digital native” companies. There are many large enterprises that are digitally native (Amazon, for example) and so I took the mid-market digital natives to mean startups, especially e-commerce, which are seeing slower usage and strapped for funding right now. It can also mean any other consumer-facing applications that are stagnant/not growing but e-commerce comes to mind.

“Moving on to the mid-market channel. For context, the customers in this channel tend to be traditional medium-sized businesses. This channel included — tend not to be traditional medium-sized businesses. This channel includes a disproportionate share of digital native, fast-growth companies that have built their businesses on MongoDB […] Our expectation that the mid-market slowdown we saw in Europe in Q1 would become global in Q2. This is what we experienced, but the slowdown was more significant than we had expected, specifically the digit layer subset of the mid-market experienced slower growth in their applications as a result of macroeconomic conditions, and therefore, their underlying consumption growth of MongoDB slowed as well.”

Of course, the softer operating income was drilled into and this is what was stated: 

“Jason Ader:
Guys, in thinking about the lower op income guide, are you basically saying that the mix of new customers versus existing customers is different than what you expected a quarter or two ago and basically new customers are more expensive to transact with? Is that the right way to think about the lower op income for the year guidance?

Michael Gordon:
No, that's not how I think about it. I think about it as being — we are continuing to see good customer wins and strong receptivity in the market that underscores or translates into strong customer unit economics. And so, we are continuing to invest in building out sales. And as you think about what the implication is in terms of rolling through some of the slower cohort expansion of existing Atlas customers that we're seeing. And when you run the math through, that winds up having a slight impact to our full year op income guide. 

So I wouldn't take it as any kind of judgment or try to do any math unless some sort of incremental value of workloads or slicing and dicing it that way, just simply us, saying, us looking at the market, having a long-term orientation, continuing to see strong new wins, no increases in customer churn, continuing to have the value proposition resonate and being sort of at the top of the customer priority list.”

Translation: Management was consistent in saying the operating expenses are increasing to help attract more new customers, an area of strength for them (note: although recent quarter did show a deceleration in new customers). Where MongoDB has been impacted is in “cohort expansion” or workload expansion.

 

Conclusion:

The economy is tough right now and it’s being echoed across many management teams. As much as we want to believe there are companies that are immune (Snowflake this quarter, MongoDB last quarter), it seems macro headwinds are catching up to nearly every industry. What the market is most concerned about is whether enterprise budgets will follow in the footsteps of consumer spending, with enterprise budgets typically being slower to cut and slower to add back in.  

There’s nothing inherently wrong with MongoDB’s report except the company can’t grow as rapidly as it can during perfect market conditions. In addition, the company wants to spend to grow new customer accounts while the expansion opportunity presents itself. There’s nothing inherently wrong with that, it’s simply the market conditions aren’t favoring free cash flow negative companies right now which puts immense pressure on management teams to decide between growth or profits.

MongoDB has leverage and they have cash of $1.8 billion. There shouldn’t be any reason in the foreseeable future the company has to dilute shareholders to raise cash. That’s the most logical reason to care about negative cash flow but the market is sensitive and emotions are running high. Valuation, of course, is also key as the top cloud companies in terms of valuation are all free cash flow positive which means MongoDB cannot be in the top 5 on valuation until it returns to FCF positive.

Coupled with the decreasing margins, MongoDB is not being able to provide anything on the horizon to look forward to as a few cloud companies have asserted to do so would be to become an economist. Right now, Q3 and Q4 are expected to mirror Q2.

If you join the webinar today, Knox is going to speak about a long overdue bounce that we still hope is coming and will provide us the opportunity re-arrange positions. I don’t see us holding MDB at this high of allocation and I also don’t see us closing it – it’ll be something in-between.