SentinelOne, Inc. (NYSE:S) Q3 2023 Earnings Call Transcript

SentinelOne, Inc. (NYSE:S) Q3 2023 Earnings Call Transcript December 6, 2022

Operator: Good afternoon. And thank you for attending today’s SentinelOne Earnings Conference Call. My name is Jason, and I will be the moderator for today’s call. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. I would now like to past conference over to our host, Doug Clark.

Doug Clark: Good afternoon, everyone. And welcome to SentinelOne’s earnings call for the third quarter of fiscal year 2023 ended October 31st. With us today are Tomer Weingarten, CEO; and Dave Bernhardt, our CFO. Our press release and shareholder letter were issued earlier today and are posted on our website. This call is being broadcast live via webcast. And following the call, an audio replay will be available on the Investor Relations section of our website. I would like to remind you that during today’s call, we will be making forward-looking statements regarding future events and financial performance, including our guidance for the fourth fiscal quarter and full fiscal year 2023, as well as certain long-term financial targets.

We caution you that such statements reflect our best judgment based on factors currently known to us and that actual events or results could differ materially. Please refer to the documents that we file from time-to-time with the SEC, in particular, our annual report on Form 10-K and our quarterly reports on Form 10-Q, including our filings for Q2. These documents contain and identify important risk factors and other information that may cause our actual results to differ materially from those contained in our forward-looking statements. Any forward-looking statements made during this call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information.

Except as required by law, we assume no obligation to update these forward-looking statements publicly or to update the reasons the actual results could differ materially from those anticipated in the forward-looking statements even if new information becomes available in the future. During this call, unless otherwise stated, we will discuss non-GAAP financial measures. These non-GAAP financial measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the GAAP and non-GAAP results is provided in today’s press release and in our shareholder letter. And with that, let me turn the call over to Tomer Weingarten, CEO of SentinelOne.

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Tomer Weingarten: Good afternoon, everyone. And thank you for joining our fiscal third quarter earnings call. 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, we were raising our full year revenue and margin expectations. While the impact of macro challenges has become more pronounced, cybersecurity remains mission-critical. Most importantly, our autonomous technology is best-in-class. Our platform is purpose-built for leading efficacy, cost efficiency, scalability and ease of use. We remain well positioned to help enterprises stay protected and realize a superior return on their cybersecurity spend.

On today’s call, 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. Let’s first turn the discussion to our quarterly performance. We once again delivered triple-digit revenue and ARR growth fueled by the adoption of our Singularity XDR platform across endpoint, cloud and identity. We are taking market share and we achieved a Rule of 60 again in the third quarter.

We have consistently combined rapid growth with meaningful margin improvement, showcasing strong unit economics and scalability of our business model. We have expanded operating margin by over 25 percentage points year-over-year for five consecutive quarters. We expect that to continue in Q4. Let me highlight some of the key strengths of our business from the quarter. Around the world, we are protecting more enterprises than ever before. 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 with ARR over $100,000 grew nearly 100%, reflecting continued traction with larger enterprises. For example, an iconic media brand chose SentinelOne for our superior performance across endpoint, cloud and data retention.

In another example, a global consumer brand consolidated on SentinelOne’s cloud-native platform, reflecting several legacy and next-gen competitors. We continue to secure wins across a significant majority of competitive situations based on our platform performance and technical capabilities. Building on our partnership with CISA, we also extended our success in the federal arena by securing three new agencies during the quarter. Our land and expand strategy is working. With existing customers, our net retention rate remained extremely strong at 134%. This is driven by footprint expansion and rapid adoption of our adjacent solutions by our 9,000 plus customers. 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, reinforcing the ease of deployment and superior protection from our cloud workload security solution. A leading software company selected Singularity Cloud, despite having deployed a competitive next-gen EDR solution on their endpoints. Separately, a large existing customer expanded coverage for the third quarter in a row. The continuation of these trends over the past few quarters highlights increasing demand for our cloud workload protection. Given the breadth of our platform and expanding customer base, 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. Many small- and medium-sized businesses are increasingly turning to managed security service providers. It helps them address cyber talent shortages, gain cost efficiencies and offset potential economic challenges. We have designed our platform to support multi-tenancy, fully customizable role-based access control and a full set of open and documented APIs. These product-driven differentiators fuel ease of deployment, scale management and unprecedented integration capability.

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 MSSP. Our MSSP exposure continues to drive meaningful and resilient growth as SMB shift to more flexible security models. Let’s turn the discussion to the demand environment and the trends we are seeing in our market. 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. Customers are more focused on the most critical and immediate security needs while taking a spend later approach for other areas.

And finally, foreign exchange presented an incremental headwind in EMEA. While re-pricing 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 in decelerating growth. Still, we are growing at a very healthy pace with ARR growth over 100%. There are clear signs that demand and our competitive positioning remains strong. While we are not experiencing the cancellations, we are seeing elongated deal cycles and budget adjustments. We continue to successfully close these deals. For instance, several large units that pushed beyond Q3 have already closed in Q4 with some closings to-date after the quarter ended. That was several million dollars of secured deals that simply didn’t close in time.

Also, pricing remains healthy and our technical win rates remain extremely strong. 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. We are also encouraged by extremely strong customer retention and the expansion from our installed base. With net retention north of 130%. And newer solutions like cloud and identity are opening even more opportunities with some of the largest enterprises in the world. Shifting gears to the second key topic, the steps we are taking to increase productivity and to enable our path to profitability. We are streamlining our teams, elevating executive leaders and ramping our 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. We are putting more focus on performance management across all functions as we seek scale and efficiency company-wide. This is a routine part of growing in optimizing the business. Our employee retention remains better than industry average as a result of our dynamic and inclusive culture that is highly valued by all Sentinels. Next, to further accelerate our new customer growth and shortened sales cycles we have combined sales and solution engineering under one organization to improve velocity of execution and customer engagement in every region.

And finally, a more tactical change, replacing 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 with ARR over $1 million grew by more than 100% year-over-year in Q3. This is the right next step to drive further success with the largest enterprises. It’s clear there’s a slowdown going on and no one can fully predict the extent of the impact. Based on what we are seeing and the steps we are taking to adjust to evolving conditions, we are well positioned to deliver seasonally strong growth in Q4. Our growing pipeline demonstrates that customer intent is there and enterprises need security.

We are gaining share across multiple large market segments, endpoint cloud and identity. We remain confident in our long-term growth potential and are in the early innings of a large and expanding addressable market. We are pairing that growth with a commitment to profitability. We are increasing our focus on cost management and productivity, and calibrating our investments with the pace of growth. Our investments are largely elected, which allow us to be flexible. Over the last two quarters, we have adapted to evolving market conditions, taking a more prudent approach to investments. As a result, we have delivered significant margin upside for two consecutive quarters with over 25 percentage points of improvement in Q3. As we saw the early signs of macroeconomic challenges, we started to adjust investments accordingly, such as moderating the pace of hiring.

Going forward, our focus as a team is to ensure that our time and to profitability does not deviate across different economic or growth scenarios. Our third quarter results and raised full year margin expectations demonstrate our ability to balance compelling topline growth with consistent margin improvement. We will continue to calibrate investments to support high growth and reach profitability in FY 2025. Taking a step back, over the past few years, we have built a truly disruptive and technically superior security platform. We have challenged the status quo of legacy and next-gen security vendor and the like in the pursuit of enterprise trust, collaboration and protection and we are succeeding. Our Singularity platform truly stands out from all other solutions in the market.

Customers overwhelmingly choose our technology whenever they evaluate or use it. In addition to best-of-breed security, customers can optimize their total cost of ownership by consolidating on our Singularity platform. We designed Singularity to be a cost effective solution with leading performance. This value proposition is compelling, especially in a higher cost-conscious environment. We are the only company with leading results in all three macro evaluations across endpoint, identity and managed services, which demonstrates platform superiority of our product and services. Cybersecurity is mission-critical and remains a must buy for all enterprises. We are committed to innovation, listening to our customers and empowering businesses with the best security resources.

Today’s market requires a relentless focus on optimizing and efficient execution, as evidenced by our improving margin profile and strong magic number. We believe the opportunity in front of us across endpoint, cloud and identity security is larger than ever before. We are taking market share every quarter and we can do even better. We are sharpening our focus on cost discipline and driving productivity throughout our organization. I want to thank all Sentinels for delivering leading technology and strong growth even in today’s macroeconomic environment. I also want to thank our customers for their trust in SentinelOne as their security partner. Before concluding, I’d like to recognize Nick Warner for his excellent leadership and dedication to SentinelOne.

After more than five years of building the business, Nick has made a decision to transition from President of Security to an advisory role. I am pleased that Nick will continue to support SentinelOne and our customers and look forward to continuing to work together with him. With that, I will turn the call over to Dave Bernhardt, our Chief Financial Officer.

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Dave Bernhardt: Tomer, thank you. I will discuss our quarterly financial highlights and provide additional context around our guidance for Q4 and fiscal year 2023. As a reminder, all margins discussed are non-GAAP unless otherwise stated. We once again delivered high growth combined with meaningful margin expansion, showcasing the efficiency of our business model and strong unit economics. We are raising our full year revenue and margin expectations again. In the third quarter, we achieved year-over-year revenue and ARR growth of 106% and ARR grew to $487 million. We had a net new ARR of $49 million in the quarter, driven by a combination of new and existing customers. Compared to our expectations, the lower net new ARR was largely due to macroeconomic conditions impacting the timing and size of new enterprise deals.

In general, these are not lost opportunities. In many cases, we have either closed the deals in our fourth quarter or secured technical wins and are awaiting deal closure. We saw similar dynamics across geographies with international markets facing incremental FX related pressure. Nonetheless, we are still delivering significant growth. We achieved a healthy mix of new customer additions and existing customer renewals and upsells. Our customers with ARR over $100,000 grew nearly 100% year-over-year to 827, much faster than the total customer count and growth from customers with ARR over $1 million for even faster. 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 is offset by the strength and shift to our MSSP ecosystem.

Our ARR per customer increased sequentially, reflecting the strength of our business among large enterprises and the adoption of more of the Singularity XDR platform in spite of recessionary concerns. There were no outsized large deals in Q3. Our net retention rate remained north of 130%, driven by strong subscription expansion and cross-sell of adjacent solutions. Growth from our installed base has proven to be quite durable and should continue to fuel a solid base of growth regardless of broader conditions. Turning to our cost and margins. Our gross margin in Q3 was 71.5%, an increase of 5 percentage points year-over-year. I can’t overstate the progress we have made on gross margins, improving nearly 20 percentage points since the beginning of last year.

We are benefiting from our land and expand strategy and platform unit economics where we collect data once and enable more and more capabilities. We are seeing continued benefits from economies of scale, data processing efficiencies now including a data set back end and module cross-sell. Looking at the rest of our P&L, we delivered substantial operating margin improvement expanding 26 percentage points year-over-year to negative 43%. As market conditions evolve throughout the quarter, we became more selective with our investments. As a result, we outperformed our EBIT margin guidance by14 percentage 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. Moving to our 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 $420 million to $421 million, reflecting 105% growth. This is up over $4 million at the midpoint versus our prior guidance. While we don’t specifically guide for ARR being a subscription business, our year-over-year revenue and total ARR growth tracked closely. We expect that relationship to hold in Q4. To be clear, we expect Q4 net new ARR to increase by at least 20% sequentially compared to the third quarter.

We believe this is a prudent view and 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. Fundamentally, there is no market demand for the Singularity platform. Our pipeline reached a record high as we exited Q3. At the same time, we want to be mindful of enterprises prioritizing cash preservation. Cybersecurity remains a top IT priority and our AI-based autonomous Singularity platform is optimally positioned to deliver superior enterprise value. Turning to the outlook for margins. 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. We are benefiting from platform data efficiencies inherent in our business model and our platform approach.

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 negative 39%, up 27 points year-over-year and implying a Rule of 50 for the quarter. At the same time, we are improving our full year margin outlook to negative 51% to negative 50%. Our updated operating margin guidance is a 6 percentage point improvement at the midpoint from our prior range. It is also an improvement of 35 percentage 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 primarily calendar year 2024.

We are making excellent progress. Thinking longer term, let me shed some light on our growth drivers and our path to profitability. Over the past several quarters, we demonstrated the ability to remain dynamic and deliver significant margin outperformance even as growth moderates. We are confident in our timeline to profitability across different economic scenarios. While growth is slowing because of macro conditions in the near-term, we remain confident in our ability to deliver high levels of growth next year and beyond. We expect to continue to win market share and outgrow the competition. Based on a prudent view of the current economic environment and expectations of further macro deceleration, 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. From a bottoms-up perspective, expansion from our installed base of over 9,250 customers remains durable. On top of that base of growth, we are securing hundreds of new customers every quarter. We see tremendous potential in endpoint, cloud and identity, and expect to continue to take market share and expand with our existing customers, and our strategic channel partners like MSSPs give us a unique exposure to fast-growing portions of the market. As we crossed $0.5 billion in ARR, a milestone for any company, our focus is on continued growth and profitability. Indeed, we are looking carefully at our cost and parts of the business that can be more operationally efficient.

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. We are increasing performance accountability and aligning several teams to improve velocity and execution. We have a very strong balance sheet with $1.2 billion in cash, cash equivalents and investments with no debt. That’s substantial. It provides longevity, flexibility and ample runway to achieve positive cash flow generation. 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 at the year-over-year operating margin improvement.

Continuing this progress forward, we expect another 25 points of operating margin improvement in fiscal year 2024 and our goal is to achieve profitability in fiscal year 2025. We are laser-focused on execution to stay ahead of evolving economic conditions. Our strategy is to dynamically invest in our technology and business, while enhancing our path to profitability. In summary, Q3 was another strong quarter despite the near-term turbulence. The demand for cybersecurity remains intact. We expect the secular headwind supporting our business to continue and we believe we have the best technology to protect the modern enterprise. Thank you all for attending our earnings call. We are now ready for questions. Operator, can you please open up the line.

Thank you.

Q&A Session

Operator: Our first question is from Saket Kalia with Barclays. Your line is now open.

Saket Kalia: Okay. Hey. Good afternoon, guys. Thanks for taking my questions here. Tomer, maybe just for you, a lot of helpful commentary around the macro, and clearly, it’s hitting everyone. So probably not much of a surprise either. But I was wondering if you could just talk a little bit about the competitive landscape a bit, and in particular, Microsoft. I am wondering if you see them more in customer evaluations and how you think customers are viewing a Microsoft Defender option versus a specialist tool like Singularity or like other next-gen solutions out there, any thoughts?

Tomer Weingarten: Yes. I think that, by and large, the competitive dynamics stays relatively the same as we have seen in the past few quarters, past couple of years. All in all, folks look at best-of-breed security pretty much in the same token as they have had. It’s also worth mentioning that while Microsoft offering as it pertains to the software piece 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. The second dynamic I want to highlight is that we have seen more and more Microsoft displacements, customers rebounding from Microsoft offering.

Some citing it as eventually an eventual cost terms, the most expensive solution they had to manage over the years. So we feel the competitive environment versus Microsoft is relatively sustained. We haven’t seen any major shift, and again, if at all, we are seeing more displacement. And we feel that better be security, even in an environment where people focus on cost will still prevail in a lot of the cases.

Saket Kalia: Got it. Got it. That’s really helpful. I was going to direct this next question to Nick. I am not sure if he’s on the call, but my congrats to him on his next phase. So, Tomer, maybe I will make the follow-up for you as well. A lot of good stuff to talk about there with the MSSP channel. Could you just — can you just talk about to what extent are they selling some of your newer emerging products and what kind of revenue opportunity could that be?

Tomer Weingarten: Of course and we wish Nick all the best. He’s not on the call. MSSP for us, again, it’s a highly strategic go-to-market motion. We haven’t even started to unlock the other revenue line possibilities we have with the MSSP ecosystem. For the first time, we have actually enabled them to sell new modules that happened last quarter for the first time. So it’s just the first innings of that opportunity. Right now, we are still laser focused on addressing core security needs like EDR and EPP. We are now extending it to Ranger and MDR as well as a resell. So, all in all, we feel that’s going to be a sustained and resilient part of our business, especially as you see SMBs trying to avoid not the technology and software costs, but really the overhead in recruiting more and more headcount into their security teams and are looking to offset that by procuring direct services, scale services from the MSSP ecosystem.

Obviously, that bodes well for us. We have a complete multi-tenanted solution for that MSSP ecosystem that actually allows them to be more productive in what they do. So, again, even in this environment, MSSP is definitely a shining point for us.

Saket Kalia: Very helpful, guys. Thanks very much.

Operator: Our next question comes from Alex Henderson with Needham. Your line is now open.