The word “record” was emphasized in the opening remarks as CrowdStrike put up a record quarter in many regards: record net new ARR of $223 million, record non-GAAP subscription gross margin, record GAAP and non-GAAP operating profitability, and record free cash flow.
What is weighing on CrowdStrike after hours is the deceleration in billings. CrowdStrike prefers to focus on ARR and Net New ARR, yet the market is keeping an eye on billings, especially this earnings season, considering we’ve seen mixed results on billings from cybersecurity peers. We detail this for you below.
The other blemish, if you will, was when the CFO stated: “our dollar based net retention rate was slightly below our benchmark in Q3.” This means DBNRR was below 120. Looking back, the July 2022 quarter was at 120%. However, I believe this is the first time that DBNRR was below 120.
Beyond this, the company had a solid report. It was the first quarter the company was profitable from operations (as you’ll recall, CrowdStrike was profitable from interest income in the past). Net new ARR also accelerated nicely from (-10%) last quarter to +13% this quarter. This helps to set the stage for more growth in the future.
Key Takeaways:
CrowdStrike delivered a 1.1% revenue beat and 10.8% EPS beat relative to consensus estimates, and guided fiscal Q4 marginally above consensus; however, the quarter was relatively strong, as net new ARR rose to a record at $223 million. ARR growth decelerated slightly to 35%, but topped the $3 billion mark for the first time. CrowdStrike re-emphasized its goal to reach $10 billion in ARR over the next five to seven years. The company also stated “we are maintaining our net new ARR assumptions which call for in-line to modestly up net new ARR for the full year and double-digit year-over- year net new ARR growth in the second half.” This implies net new ARR will be strong again next quarter.
Revenue growth remained strong at +35%, but billings growth looked to decelerate to the high-single-digit range YoY, compared to prior growth rates above +20%. A key item in the report was that Q3 marked CrowdStrike’s first quarter with positive operating income. CrowdStrike now has to prove that it can continue to expand operating margin further into positive territory.
Financials:
Revenue and EPS:
- Revenue of $786 million beat consensus estimates by $8.6M. This represented growth of +35% YoY
- Subscription revenue was $733.5 million, up +34% YoY.
- ARR increased +35% YoY to $3.15 billion, marking the first time that ARR has surpassed $3 billion.
- Net new ARR reached a record at $223.1 million, and was +12.6% higher compared to $198.1 million in the year-ago quarter.
- Adjusted EPS of $0.82 beat estimates by $0.08, or 10.8%. This represented YoY growth of +105%.
- GAAP EPS of $0.11 compares to a GAAP loss of ($0.24) in the year-ago quarter.
Margins:
- Gross margin of 75.2% increased ~240 bp YoY ~20 bp QoQ.
- Subscription gross margin of 78.2% increased ~270 bp YoY and ~40 bp QoQ.
- Operating margin of 0.4%, compared to an operating margin of (9.7%) in the year-ago quarter and (2.1%) in fiscal Q2.
- Net margin of 3.4% expanded ~225 bp QoQ, and marked the third straight quarter with a positive net margin.
Cash & Debt:
- Cash and short-term investments of $3.17 billion.
- Total debt was $742.1 million.
- Operating cash flow reached a record at $273.5 million, representing an increase of +12.6% YoY from $242.9 million. Operating cash flow margin was 34.8%.
- Free cash flow reached a record at $239 million, an increase of +37.3% YoY from $174.1 million. Free cash flow margin was 30.4%.
Noteworthy:
Net new ARR growth and a first quarter with positive operating income were the two major positives from Q3’s report. Net new ARR rebounded to a record $223.1 million after falling to $174.2 million in fiscal Q1, a strong recovery and setting the stage for another possible record to close out FY24.
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 mentioned in the pre-ER write-up that while CrowdStrike had begun to post GAAP profitability, it was preferable that the company be GAAP profitable from operations – now, the next task is for CrowdStrike to show further growth in operating income. You can read our last earnings report write-up following Q2 earnings here.
Another interesting snippet was an increase in the number of customers deploying 7+ modules. Whereas customers deploying 5+ remained the same QoQ at 63%, the amount deploying 7+ increased from 24% last quarter to 26% this quarter. Those deploying 6+ modules also increased by 1 percentage point to 42%. CrowdStrike has done an excellent job of upselling existing customers to higher amounts of deployed modules, so this 2 percentage point increase was a healthy figure to see.
Billings:
However, there was one glaring negative from the report – billings growth has decelerated to the single digit range. Billings was 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.
Pictured Above: I/O Fund calculations for CrowdStrike’s Billings growth/decline
This deceleration matches what peers are reporting:
- Fortinet guided for billings to decline (-1%) to (-9%) in its upcoming quarter after reporting just +5.7% YoY growth.
- Palo Alto lowered its full-year billings forecast while it reported a slowdown to +16% growth compared to +27% in its year-ago quarter.
- Zscaler reported +34% YoY billings growth on Monday, but maintained its full year guidance calling for +24% to +26% YoY growth, suggesting that a deceleration is set for the next few quarters.
Earnings Call:
Billings:
Given Billings is where the potential weakness resides, there was a question from an analyst regarding the decline. Since this was the most important question on the call in regards to the price action, I’m quoting it below.
Q: “And then quarter was phenomenal. But I do see some weakness across the board of cyber companies with billings. In your case it was down about 2%. I also see some weakness in deferred revenues. How do I reconcile what I see with billings with deferred, with the underlying drivers that are very strong and your strong execution? Why is why are we seeing weakness not just with you, maybe with the entire space, but why are we seeing weakness with billings across the board? Thanks.”
A: CFO: I'm going to start with billings. Yeah. You're correct. For us specifically, we don't manage the business to billings. And we feel ARR gives you the absolute best proxy to revenue. And we felt that that's the right metric. As you know, since we went public to give you more transparency into the health of our business. And that's the metric that really guides you on health.
[…] We think that billings has certain things that just are not as relevant as a metric like ARR, you're comparing a balance sheet item to a P&L item and for us, the P&L is going to dictate the health of the business. So for us billings obviously is going to be impacted by duration and there are many things that go into that. And remember also that when you think about on a year-on-year basis, we're still up on billings. And I think that's the one thing that you want to take away. For us, when we think about how we want to continue to be transparent, ARR really gives you that notion of where we're going and how we're doing. And I think that that's the focus and it has been, by the way, since we've been public. Even as a private company, that's the one that we manage the business to, that's how we look at how to give out quotas to our reps, et cetera, et cetera. So for us that's not going to change. And, I hope that answers that question.”
Translation: CrowdStrike’s CFO did not really answer the question, such as perhaps seasonality contributed or some deferred revenue will be realized in Q4 that would have been realized in Q3 (these are hypothetical answers). Instead, the CFO answered that analysts should focus on ARR instead of Billings, but the problem is that ARR is not a GAAP metric and this is why Billings remains important for an apples-to-apples comparison with peers. This is something to monitor, yet given net new ARR accelerated, the market may conclude these two cancel each other out.
Macro Environment Weak:
The other takeaway was CrowdStrike’s discussions that the current environment is tough. CrowdStrike may be less susceptible, yet management made it quite clear they are facing challenges. Here is what the CEO said when asked if October was strong (given other cybersecurity peers have stated it was a weak month for them):
“Yeah, we certainly had a strong October. I think as I said in my prepared remarks, the macroenvironment is still is still challenging. And we make no mistake about that. Deals take longer, a lot more scrutiny a lot of sign-offs, and there's a lot more work that goes into these larger enterprise deals. Getting deals done, even like Falcon Flex, which are more enterprise-like in their nature, takes time. So, we had a great October, but in general, buyers are still cautious. And I think the fact that we're able to provide a real platform play that allows them to consolidate in other technologies and ultimately save money accrues values to us, but it certainly takes a lot of time and effort to get the deal over the goal line, but team did a great job, and October was strong for us.”
Management also stated they are not counting on a Q4 budget flush in their guide, which translates to a weaker environment: “As George outlined, strong demand for the Falcon platform is driving our pipeline to new heights. However, the macroenvironment remains challenging with continued increased budget scrutiny, and as a result, we are not expecting to see the typical Q4 budget flush.”
You can read our previous write-up on CrowdStrike’s product including AI-driven automation.
Conclusion:
As redundant as it may sound, we will rely on technicals to manage this position. We tend to rely heavily on fundamentals during pullbacks/selloffs or when the risk/reward is favorable for another leg up in the market. However, we use technicals for risk management when the market appears overextended. There were some weak areas in the report that were canceled out by a few metrics that really matter in terms of a strong foundation, such as operating profitability and accelerating/return to growth in net new ARR. We continue to see CrowdStrike as a strong choice within cybersecurity and this earnings report does not change our view.
You can read the current technical setup here in terms of what we want to see in terms of price levels.current technical setup here in terms of what we want to see in terms of price levels.
Equity Analyst Damien Robbins contributed to this analysis
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