CrowdStrike Earnings Review

Digging into the Results of this Disruptor.

Brad Freeman

May 31, 2023

1. Demand

Beat revenue estimates by 2.4% & beat its guidance by 2.3%.
Beat annual recurring revenue (ARR) estimates by 0.4%. Beat $161 million net new ARR estimates by 7.7%.

*ARR = annual recurring revenue; RPO = remaining performance obligations*

More Demand Context:

CrowdStrike stopped disclosing customers with 4+, 5+ and 6+ modules after Q4 2022 and began disclosing 5+, 6+ and 7+ module customers instead. Why? Because too many of them had 4+ modules. Great problem. More module adoption is not only a revenue driver, but a margin expander as well as there is virtually no added OpEx to sell additional modules after the first.

57.3% 3-yr revenue CAGR vs. 61.3% last Q & 66.8% 2 Qs ago.
Q2 pipeline set new records and gives Kurtz confidence in modest net new ARR growth in the back half of the year. Management did not formally update its “flat to modestly up” net new ARR growth, but Kurtz made it seem like “modestly up” was the actual base case.

2. Profitability

Beat subscription gross margin (GPM) estimates of 76.3% by a robust 370 basis points (bps). The 80% subscription gross margin it delivered also beat its guidance by 170 bps.
Beat EBIT estimates by 6.4% & beat guidance by 7%.
Met free cash flow (FCF) estimates.
Beat $0.50 EPS estimates by $0.07 & beat its guidance by $0.06.
Beat ($0.10) GAAP EPS estimates by $0.10. This was its first quarter of positive GAAP net income. This was powered by over $30 million in interest income and slower hiring during the quarter than CrowdStrike expects for the rest of the year. While it is rapidly racing to a sustainable inflection here, this was a one-off event that should not be expected next quarter. The -2.8% GAAP EBIT margin is a better sense of its underlying GAAP profitability as of today.

More Margin Context:

Q1 2021 was an abnormally strong quarter for cash collections. This propped up cash flow margins and made for a tough 3-year comp. CrowdStrike’s FCF margin target is 30% -- it’s comfortably ahead of that.
This was the first time CrowdStrike reached an 80% subscription gross margin. Its aforementioned investment in data center optimization is bearing fruit… on schedule and as expected.
Sales and marketing rose Q/Q due to timing of in-person events. This is not expected to be a durable trend.

3. Guidance

Full Year guidance update:

Raised revenue guide by 1.1% & beat estimates by 0.8%. Revenue is set to grow by about 34.5% Y/Y.
Raised EBIT guidance by 3.3% & beat estimate by 1%.
Raised $2.30 EPS guide by $0.06 & beat estimate by $0.05.
Reiterated less than 2% dilution for the year. This is very important.

Next Quarter:

Beat revenue estimates by 0.5%. Revenue is set to grow by about 35% Y/Y.
Beat EBIT estimates by 2.5%.
Beat $0.54 EPS estimates by 2 pennies.
Note that Q2 is always its seasonally worst quarter of cash flow generation.

4. Balance Sheet

Stock compensation was 12% less than expected. Stock comp as a percent of revenue fell from 23.8% of sales last quarter to 18.9% of sales this quarter. This compares to 21% of sales in the Y/Y period. Good progress. More progress needed.
$2.93 billion in cash & equivalents; FCF generation rose 44% Y/Y.
$741M in debt.

5. Call & Release Highlights

More on Demand:

Win rates remained strong against all competition.
- Called out a client who saved millions by switching from Microsoft to Falcon. The firm was going to spend more for an upgrade to Microsoft E5 licensing (from E3) than it would spend on the entire Falcon subscription in a year. This doesn’t included added cost savings from:
  - Reduced talent requirements and less complexity
  - A lack of inevitable, expensive future upgrades with Microsoft just to make its Defender product work.
- CrowdStrike continues to briskly take share from legacy vendors.
Landed a new cloud marketplace partner to expand its SMB go to market efforts within that segment.
Log management, identity and cloud continued to be the 3 product categories powering CrowdStrike’s emerging module growth. Extended Detection and Response (XDR) was cited as another, but this is really just an Endpoint Detection and Response (EDR) upgrade with added 3rd party data sources to extend and fortify protection beyond the endpoint.

AI:

AI unsurprisingly was a key call theme. Kurtz spoke on AI being in CrowdStrike’s DNA since inception. With training such a vital aspect of AI model building, data seasoning becomes even more important. Data is what is used to train. CrowdStrike’s decade of protection data and leading market share within its endpoint bread and butter puts it in prime position to quench that data thirst. According to leadership, this is a “durable competitive advantage” and gives CrowdStrike an easy path to being a prominent piece of this generative AI wave. It sees language learning models (LLMs) as racing to commoditization, but sees its unique data set and experience as a long term edge.

Leadership offered the example of its managed detection and response (MDR) department and how scale was not economically rational without intimately infusing automation and AI throughout the processes. Its special skills here are why 22 of the top 25 MDR vendors in the World are built with the Falcon platform.

In terms of AI’s impact on the threat landscape, like Palo Alto and some others, CrowdStrike talked about these models making it far easier for adversaries to conduct high caliber threat campaigns. This should be a secular demand accelerant for its services. While it has always used AI in its own modules, CrowdStrike is diving deeper here by creating more automated support for analysts to transform beginners into tier 3 experts. To manifest this vision of lowering the skill barrier to better protect environments, CrowdStrike debuted Charlotte AI to deliver that automated support. Finally, it’s now collaborating directly with AWS to together build new AI-based applications equipped with Falcon-level protection.

Consolidation to Lower Total Cost of Ownership:

CrowdStrike Falcon delivers an average 200% return on investment for clients.
Closed 50% more 8 module deals than in the Y/Y period.
Called out 2 different Fortune 100 company wins in the quarter that both standardized on the Falcon platform with 8+ modules. The new Dell partnership also delivered them a large 8 module win.

Public Sector Win:

CrowdStrike secured Impact Level 5 Provisional Authorization from the Department of Defense. This will let federal agencies (including the Department of Defense) use Falcon to protect all unclassified assets. Along these lines, CrowdStrike won a top 20 U.S. government contractor and the business of a “major U.S. Federal Agency.”

Macro:

Added deal scrutiny and sales cycle elongation continued to weigh on CrowdStrike’s business despite the upbeat results. Importantly, its full year guidance assumes zero macro improvement. If any improvement does come, there will likely be more upside.

Final Notes:

Debuted CrowdStream to more broadly and intuitively collect all available data sources to feed its XDR offering.
Deepened its Google partnership (like with Amazon) to debut an XDR offering native to its Chrome operating system. CrowdStrike continues to work more and more closely with both Google and Amazon.

6. Take

The quarter was rock solid across the board. Share gains remain robust and margin expansion remains brisk. All of its new products continue to gain traction, support cross-selling and grow its addressable market. Try to find another company growing over 40% Y/Y with 30%+ free cash flow margins (and still 14% ex-stock comp).

There are no weak spots to pick at. Some are trying to concoct fundamental sources of disappointment, but that is likely related to the share price reaction and not actual numbers.

The stock ran aggressively into the print and the firm trades for 65x earnings. It was due to take a breather and (in our view), that’s likely the reason for the share price weakness. Fixating on today’s share decline is missing the forrest for the trees. All of the numbers were comfortably ahead of consensus and the thesis remains firmly intact. That’s what matters.

When the worst part of a report was “it should’ve beaten and raised by a wider margin” or “some buy-side analysts expected more net new ARR” you know the quarter went well. With the annual net new ARR guide reaffirmed (and unofficially raised), paired with this quarter’s net new ARR being a full 8% ahead of sell-side estimates, there’s nothing concerning there in our view.

Considering the premium valuation and that it’s already a large chunk of the portfolio, I’ll be deliberately slow and picky with adding into weakness. If that weakness grows severe enough, I will add. Based on where the price sits in after-hours trading, I will not add tomorrow.