The SentinelOne (S) position was started in our portfolio because I saw that there was a huge negative overreaction on June 6, 2023 as management was pivoting to profitability and the company's fundamentals remained solid, which can be found in this article.
Furthermore, I delved deeper into the company to find that the company had multiple levers to expand margins and reach its breakeven goals, which can be found in the article here.
In this FY3Q24 quarter, SentinelOne showed the market that it is starting to head in the right direction after a difficult start to the 2024 fiscal year.
Specifically, in the quarter, SentinelOne showed strong execution amidst a difficult environment, showing its strong focus to improve margins and cash flows while still growing the company sustainably.
FY3Q24 quarter
For FY3Q24, ARR and revenue came in 1% and 5% ahead of consensus expectations, growing 43% and 42% respectively to reach $663.9 million and $164.2 million respectively.
Both new customer business and existing customer expansion drove revenue growth. Net new ARR was strong in the quarter as a result of strong demand for endpoint security and adjacent Cloud, Data, and Identity solutions.
Gross margins also exceeded expectations, coming in at 79.3%, beating market expectations by 360 basis points.
This compares to 71% gross margin in the prior year and 77% gross margin in the prior quarter, an 8-percentage points improvement from the prior year and 2 percentage points improvement from the prior quarter.
The 79% gross margin achieved in FY3Q24 is also within its long-term target range of 75% to 80% or higher.
The strong gross margin improve indicates that pricing remains healthy and, in addition, that SentinelOne is able to reap the benefits of its growing scale and improving unit economics.
In particular, for pricing, SentinelOne is seeing pricing stable or higher as a result of larger deal sizes, and new enterprise deals, which improves margins. There was a new bundle effort in FY3Q24 with the Enterprise bundle, the fourth and highest level above the Complete tier providing more capabilities and better value to enterprises at a higher price point.
FY3Q24 operating margins improved by a huge 32 percentage points to negative 11%. This is the ninth consecutive quarter that SentinelOne has been able to deliver more than 25 percentage points of expansion in operating margins from the prior year.
On an absolute basis, operating losses were reduced by more than 60% to negative $18 million in FY3Q24, while free cash flow outflows were also improved by about 60%.
Operating margins benefited not just from the improvement in gross margins, but also the slower operating expenses growth. Operating expenses growth of 12% for FY3Q24 matched F2Q24's low watermark, which helped deliver the 11 percentage points operating margin beat.
Headcount increases was the largest driver for operating expenses growth in the quarter, while R&D decreased to just 22% of revenues in FY3Q24, down from the 33% of revenues as of FY2Q24.
I think that SentinelOne has been executing well in this regard to proactively manage costs, improve margins and free cash flows. As a result of its efforts, management expects to reach positive free cash flow in the second half of FY2025.
SentinelOne continues to have a pristine balance sheet with $1.1 billion in cash and no debt.
Guidance
Management painted a difficult operating and macro environment but suggested that the company is winning amidst the current environment.
With that, SentinelOne revised its revenue and margin expectations upwards for the full fiscal year of 2024.
The demand picture remains consistent with the prior quarter as the higher interest rate environment, longer deal cycles and more approval layers are causing some headwinds for the industry.
That said, the SentinelOne team is executing well thus far, leading to strong win rates and the company outperforming the industry.
For FY4Q24, management expects revenue to grow 34% from the prior year, to $169 million.
With that, for the full year, management expects revenues to grow 46% from the prior year to $616 million, This full fiscal year 2024 revenue guidance was revised upwards by 2%.
Likewise, net new ARR guidance was raised by 3% from the earlier $195 million to $200 million.
I liked the positive commentary we are seeing with regards to SentinelOne's demand momentum and competitive position.
Management stated that they are confident in its ability to achieve the higher growth guidance set out for the rest of FY2024 as a result of the traction they have seen in the business and the continued strong competitive position of SentinelOne.
In particular, the company is seeing durable new business generation as well as the growth trends of the company.
In addition, there are encouraging signs of traction in other solutions outside of endpoint security, like in cloud, data, identity, and AI. These adjacent solutions are expected to bring long-term growth opportunities for SentinelOne.
For gross margins, management expects FY4Q24 gross margins to come in at 77.5%, which is an improvement of 2.5 percentage points from the prior year.
Operating margins for FY4Q24 is expected to come in at negative 14%, improving 23 percentage points from the prior year.
FY4Q24 free cash flow margin is expected to improve sequentially as a result of the better outlook for operating margins and the seasonality of cash collections.
Gross margins for the full year FY2024 were revised from the earlier 76% to the current 77% gross margins. This revision upwards was due to the scale benefits and data efficiencies that the company is reaping.
Operating margins guidance for FY2024 is raised by 5 percentage points, from the earlier negative 25% to the current negative 20%. On a fiscal year perspective, the operating margin is expected to improve by more than 29 percentage points relative to the prior year.
Customer growth and market share
Customer growth is one that the market has been nitpicking about.
The bears in the market are pointing to the slowing customer growth, given that SentinelOne saw 500 new customers in FY3Q24. This was higher than last quarter's 300 adds, but lower than the prior four quarters average of 600.
However, I argue that that is the most meaningful metric, given that it does not include the customers served by SentinelOns's MSSP partners.
MSSPs has been a scalable channel for SentinelOne to meet the needs of the small and medium sized businesses. Given that each MSSP only counts as one customer, but may serve thousands of actual end customers, this means that the above customer growth metric is not exactly very meaningful.
Given that the customer additions in FY3Q24 was relatively weak, this suggests that strong small and medium business growth was the main contributor for the strong top-line growth in the quarter, while enterprises were relatively weaker.
On top of that, management is focused on optimizing ARR per customer. In FY3Q24, the ARR per customer grew 15% from the prior year to $60,000 per customer.
Lastly, SentinelOne is seeing consolidation on its platform as customers with more than $100,000 ARR was up 33% from the prior year, and customers with more than $1 million ARR grew even faster than that. As such, it does seem like SentinelOne continues to have success with large enterprises, and that is driving the higher ARR per customer.
In terms of customer momentum in FY3Q24, management shared that the company managed to secure several new federal agencies and that many large enterprises across different sectors chose the Singularity platform, across different offering.
In terms of market share, SentinelOne continues to grab market share from incumbents as well as next-generation vendors, as evident from the strong top-line growth we have seen in FY3Q24.
Management continues to expect the company to be able to grab market share as a result of investment in its competitive advantages. Thus, the company remains highly selective in its investments and has focused largely on data, AI, cloud and of course, endpoint, as key areas for investment.
This continued innovation and investment is expected to continue to drive strong top-line growth and margin expansion.
There is further upside from two main drivers. Firstly, the acquisition of PinnacleOne brings two highly respected security industry leaders significantly adds to the brand given their expertise in strategizing with boards and executives. The new consultative advisory practice that could also serve as a new route to market. Secondly, the Chubb partnership is having a positive impact on the small and medium business area as SentinelOne is seeing a lot of lead generation.
Expanding emerging solutions
SentinelOne is seeing some traction in its emerging solutions outside of endpoint security.
In particular, Singularity Cloud and Singularity Data were the fastest growers in FY3Q24. These two solutions grew triple digits and when taken together, made up 20% of the quarter's bookings.
For Singularity Cloud new customer wins and existing logo expansions were driven by Cloud Workload Protection capabilities.
For Singularity Cloud, while it is growing triple digits today, it is likely still just single digit percentage of ARR.
As SentinelOne expects to launch multiple new offerings and solutions over the next 12 months like CSPM, CIEM, and shift-left developer security to the platform.
I think that the timing of these launches is good for the company to drive upsell into these new products and solutions as the cloud platform buying motions start to materialize. As a result, SentinelOne can establish itself as an early leader in the market if it continues to bring innovation and launches quickly to the market to meet customer demands.
For the Singularity Data Lake solution, it has seen a considerable move upwards in demand after the acquisition of a leading SIEM vendor. This boosted enterprise interest and in particular, management is seeing that SentinelOne is currently displacing SIEM vendors.
One example that was given by management was that there was a federal agency that replaced their legacy SIEM solution entirely with Singularity Data Lake.
There was another example that management gave in the FY3Q24 quarter, where a customer that used Splunk for 15 years replaced it with SentinelOne's Singularity Data Lake, along with its endpoint and cloud security solutions. On top of that, the customer also deployed Purple AI to transition into a fully integrated autonomous experience.
There are select customers offered Purple AI, and these customers are receiving promotional type pricing as management is trying to gauge the price point customers are willing to pay for the offering. It is expected to be generally available in the first quarter of next year.
Clearly, both Singularity Cloud and Data have got a very nice long-term potential for SentinelOne. In particular, both products have the ability to land new pipeline on a standalone basis, highlighting the attractiveness of the solution.
In addition, the focus here is not for maximum near-term upside, but rather, to expand and grow gradually in the market over time. I would also highlight that Data deals are significantly larger than endpoint deals, and Cloud pricing is typically four to even five times that of endpoint pricing.
NRR stabilization
One of the key positives in the quarter was that net revenue retention("NRR") stabilized. In FY3Q24m NRR came in at 115%, which was flat sequentially.
Firstly, management stated that there was no change to the ramped deal dynamic, which suggests strong upsell in the quarter.
Secondly, there are also upside for NRR given it benefits from the expansion within MSSP partners, which account for 25% of ARR, along with its expanded product portfolio. Today, SentinelOne has significantly more products than it did one year ago. As a result, it is well positioned to upsell at renewal.
With these factors in mind, the NRR of 115% in FY3Q24 is seen as a floor by the management team if the demand trends continue to stabilize.
In addition, unlike other peers, the average contract duration has increased from 21 months a few quarters ago to 23 months today. This has been a structural tailwind for bookings.
Valuation
As a result of the stabilizing environment, better outlook and improvements in profitability, the financial forecasts have likewise been revised upwards to reflect this.
As a result of healthy topline growth and improvements in profitability, the forecasts for SentinelOne have been revised upwards to reflect that.
The 1-year and 3-year price targets also goes up to $26.40 and $33.70 respectively, which represents 10x and 8x P/S respectively.
Conclusion
Not only was the revenue and top-line strong in FY3Q24, the expansion of margins was also a huge positive in the quarter, giving rise to strong results across the board.
More importantly, given the market environment we are in today, after the FY3Q24 results, there is a renewed confidence in the company's ability to post not only strong growth, but also do so sustainably.
With the expectation that SentinelOne will be able to reach positive free cash flows in the second half of FY2025, this should also boost sentiment.
I should also add that this ability to pivot to breakeven was one of the key investment theses and I had the confidence that the company is able to achieve that due to the analysis I did earlier as to how the company is able to achieve this.
While there were earlier fears that SentinelOne was losing share as a result of earlier headwinds and challenges faced, the company showed the market that those were just anomalies and that the company's competitive position remains solid, and that it is actually gaining share instead.
With all that, I think that the sentiment around SentinelOne is improving and moving in the right direction, and that 2024 could be the year for the company.
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