SentinelOne, Inc. (S) Earnings Call Transcript & Summary

Thanks very much for joining us. I know you've all been waiting for this and sorry about the confusion with the other room, but we are here. And we -- today, I'm hosting Tomer and Dave from SentinelOne. I prepared a whole list of questions to ask about the company, the background, et cetera, but I'm going to flip the page, and I'm going to ask the questions about the quarter. Because I think that all of you are here for to understand 2 basic questions. Number one is to understand the accounting issues that the company had and understand how much more risk there is in the business. And number two, to understand the competitive landscape. These are -- I got from your questions before this, and all the questions were around the same 2 topics. So I'm going to start with the same 2 topics, Dave and Tomer and thank you so much for joining us today.

And I'm going to make it kind of in an organized way. The correction to the ARR was $27 million, 5% of total, right, ARR. And the question is, can you take us first through the correction? What were the sources? I know this is -- you explained it on the conference call, but what were the sources? And the second question after that is talk about your checks and balances that you have in place that may help to mitigate such issues in the future?

Yes. No, for sure. And look, we got into this quarter that I think that what is important to say about it, it was actually not a very bad quarter, I think with all the noise around the adjustment. I think we still need to kind of set a few things straight. We delivered 75% ARR growth post-adjustment. So all these numbers include adjustment, incredibly strong. We missed our own mark on where we wanted to go. It was a $3.5 million miss that put revenue growth at 70% year-over-year in some of the toughest environments out there. It also came with net retention rate close to 130%. Again, one of the best marks in the industry. Obviously, we need to perform better, but let's remember also from which bar we're starting and coupled that with 97% gross retention rate. As we finish the quarter and given that revenue discrepancy, we're very surprised because typically, we got good predictability into revenue. We don't expect to miss revenue and then we started to dig in and trying to understand what was the difference? Why didn't we see the revenue that we expected to see. We went back, and we basically started looking at 2 different factors that impacted about 200 accounts out of the 10,000 overall contracts that we've been able to parse, which is the entirety of our customer base pretty much in the course of the 2 weeks leading to earnings. We saw that there was lack of controls for a portion of our upsell opportunities where people entered upsell opportunities that were in aggregate amount of both the renewal and the upsell but did not churn properly the renewal portion of it, which created an expectation of that renewal ARR to be there come the date for that renewal. Again, about 200 accounts that we found that discrepancy. We worked incredibly hard to make sure that by earnings, and this was concluded 2 days prior to earnings, was brought into the Board's attention, the Audit Committee to our auditors. We work incredibly hard to make sure that we give you the full scope of everything that's there. And that adjustment amounts to about half of that overall $27 million number. The other half was more elective. We could have also elected to do it at a different time. But given that we saw that this adjustment is anyway going to be bad news, there's no going around it. We said, let's just make sure that we total all the different elements that we want to total. And we also decided to change our consumption methodology recognition into ARR basically indexing all of our consumption business, which is about 10% of our overall ARR, we're talking about $50 million of ARR that is consumption base in our business post-adjustment. And we took down all consumption metrics to the committed contract values alone, which means no upside, no downside, if anything, our ARR at this point is a bit understated but all in all, we elected to take out the volatility in the consumption model from our ARR calculation. It's not because the consumption is not there. It's because we started seeing patterns of consumption changes that we thought could create more volatility and less predictability into the future. And we said, we don't want that. That's not serving, not to us, not to our shareholders, and we took that out. We did both of these things in tandem. That was the all-in $27 million figure. There's nothing beyond that. There's nothing different. If at all, I can say that after reviewing 10,000 contracts and having Dave's team not sleep for approximately 2 weeks. It's squeaky clean, like I would probably can point to a lot of other companies where if you audit all of their contracts, you're probably going to find something. So now we know this is the scope. This is it. We've added new controls, obviously, to make sure that this will not happen again, lock down all the fields in sales force. There's a 3-way approval that needs to happen for any adjustment of any opportunity, any deal sizes. So we recognize the mistakes. We saw them, we fix them, put new controls. There's nothing else outside of that in our business. Terribly apologize to all of you for that ever happening. Definitely, caught us as well by surprise but that is it. And even if you factor in all of these changes, that 5% of ARR, that probably means that last year, we grew 100%, not 105%. So in the grand scheme of things, I mean, our fundamentals are intact. All other metrics are intact. There is no impact to revenue, no impact to operating margin, no impact to deferred revenue, none of that. This was all about future expectations in ARR that were not there, and we needed to remove and that is it. I mean, Dave, if you want to add something?

No, that's exactly it. I mean when we first noticed it, we reached out to Tomer immediately, reached out to our General Counsel to external legal, to our auditors, to the Audit Committee, to the Board. So like the path of -- from the point where you identified it to the point where we made this a full scope and it was, can we possibly get through the entire audience of analysis. I think that happened. Within, I don't know, 12 hours before we started the process. And then we just kept going. And obviously, ARR is not a GAAP metric. It is a number that gets reviewed by auditors, but it's more of a cursory review where they make sure it ties out. They look at the logic. We are working with them to make sure that we have better controls around it because it is a public reporting number that we have out of the key metric. So we are working with them to make sure we have the tightest of controls around this metric going forward. So it's not going to be an issue. But yes, I agree. Totally apologetic for it.

Does anyone in the audience has any question about accounting because we're going to make it interactive. That's the easiest way to do it. If you have any other questions, just raise your hand. And if not, I'll move on to the next topic. No, we're good. Perfect.

In the corner, I think.

I think you covered it. Oh, here we go. If you don't mind, just wait for the mic. Yes. Here you go.

It isn't specific accounting, but I'd be curious about the chain of events like how -- where did it start? Was it sales reps and who found out in that whole process, I think you walked a bit through it, but I'd like to understand a little bit of color and basically what -- some of the color around how to -- what you're doing to avoid it or anything like that happening again, kind of plugging those gaps?

Sure. I can walk through some of the time line. So you would expect...

Let's do it in 2 minutes.

Sure. You would expect that 1/4 of your previous quarter's ARR should become revenue in a given quarter. And with that, maybe you have some adjustments for churn, late deployment, but they should be things that are pretty easily identified. Obviously, that was one component of it, and we looked at that. And then we said, okay, that doesn't make up the revenue shortfall, obviously. The next question was, did we miss any potential billings out there? Did we have a multiyear renewal that we missed, something that would -- should be expected to come through and did not. And we went through the entire population of those, felt really good about that. Great, our systems work properly. The next piece was the consumption piece, which was, okay, well, we've seen some disconnects where we saw consumption swings where some of the consumption was elevated in previous quarters based on excess usage in a given quarter, which created the expectation that we would have that revenue in the next quarter. So that was a piece of the adjustment as well. And even that didn't make up the revenue miss. So I am a former auditor as well as most of my team. The next question was, is there anything in the ARR expectation that led us to believe that we should have had revenue that was coming? So we started at the most -- the biggest contracts and just worked our way down. And we started to find this dynamic within the upsell. The renewal or early renewal to upsell sales motion where we'd sort of identified this was a larger issue than we had anticipated. And I think when I first reached out to you, Tomer, it was a few million dollars and then I reached out again, and it was higher and I reached out again, and it was higher, and we said, okay, let's -- how do we possibly get through the entire population. And then when you look at that and you say, okay, well, that's about a $13 million, $14 million adjustment, expectations about $3.5 million, that would have put us above our revenue guidance for the year.

Okay. Perfect. Thank you. My next question is about the business itself. So you took the ARR growth in the last 3 quarters from 50% to 47% to 35%. And 35% is on the basis of post adjustment, meaning -- if I add back the 27% to the previous year, the decline is actually bigger. So there is quite substantial decline in the ARR growth versus your previous expectation. So the question is what drives it? I'll give you the background. Some of the investors are concerned that the competitive environment is much more fierce or much more negative than you're willing to admit or one is willing to admit. So the question is what drives the decline in ARR?

Sure. Let's start with that 50%. I mean 50% was an indicative number we gave Q3 of last year when the environment fell completely apart. We missed a quarter -- our quarterly target, our competitors missed their quarterly targets, everybody was missing everything. Most companies at that point in time, I think, took some view as to what they think they can do next year. We tried as well. At that point in time, we were growing 100% triple-digit ARR at that point in time. I think what we wanted to accomplish more than most, more than anything, is to just give any form of indication of the ballpark revenue we should be expecting next year. We wanted to let people know it's not going to be the classical 20% deceleration year-over-year in a normal environment, but it's going to be something around 50% from the line of sight we had, from what we knew back then. So that was the first kind of view into this year guidance. It wasn't a fully-fledged guidance. It was Q3 last year, that's what we knew. That's what we put out there. Towards the end of the year, again, we kind of look at better what we believe the conversion mechanics are in this environment, trying to factor in deal elongation, obviously, deal deferral. And I think we factored the majority of that in, but I think we missed a couple of things. One, I think we did not anticipate the level of downgrades, which part of it was that consumption adjustment. We just saw customers in Q4 going up above and beyond their consumption, their contractual consumption, but come Q1 indexing down pretty significantly. And we started believing that's going to be a more dramatic trend, and that could present some volatility in the business. So we took care of that. I think the other thing is a bit more in our own operating philosophy, where I think what happened in the past couple of years, given such tremendous momentum and economic environment is that we were really used to running our business with pretty much no buffers whatsoever. No margin of error. I mean we always overachieved. We always had great quarters. Consumption was always on the up and up. On the flip side, you look at some other companies out there obviously, with every given quarter, they got almost $100 million of buffer different setting expectations, the difference in setting expectations to kind of play around with, which means that in a very volatile environment, you get this factor that you can enjoy. I, at some point, just didn't feel we have enough of that. And we kind of came back and said, look, we need to give everybody a more stable, more predictable view. This is not an environment where the level of volatility can provide something that I think all of us can stomach. Does it mean that the growth will be there or not, I don't know. I'm not a prophet. But I do know that we needed more margin of error in our business, and that was a big part of it. Let me touch on competitive, the competitive environment. The competitive environment is s***, we're fighting an incredibly dirty competitor that can't win with technology and thus uses every other tactic to win. These are things that we don't do. We don't conduct ourselves this way. So the competitive environment is not a healthy one. I wouldn't say it's a healthy competitive environment. I think if you look at by proxy at the network, security market. You see established players. Everybody controls their own estate. They don't go after each other. They don't need to go after each other and they're not panicking about any one of the others. In endpoint, things are very different, given that this is all about net new estate addition as well. This is a market which is still a good chunk of it is in the hand of incumbents. There's a lot of new accounts to win even though we see for us, for our competitors, that part is slowing down, especially in this environment, people just generally don't really want to make a lot of changes. And I think that, that goes into that very tough competitive environment. It's a narrative induced environment. But when we put our technology in front of customers, we win. When we say we have sustained competitive win rates, we mean it. I mean that part is a tried and tested number. When we go into these opportunities, our technology time and time again, wins. We need to get better at changing that narrative. We need to get better in opening the aperture for the top of the funnel opportunity that we have. And there's another thing I want to share with everybody. I mean you've kind of seen us talk more and more about our maturation process from an endpoint company and into a platform company. And that also has a tax about what we do. We're definitely maturing and evolving our go-to-market organization and have been doing so in prior quarters as well. So our sellers can actually be proficient in selling a fully-fledged platform in our future capabilities. Our security data lake capability, which is highly differentiated from that same competitor that probably lingers around in your mind is a massive market opportunity for the long term for SentinelOne we don't want to discount that. We want to continue and build into our long-term success. And some of it obviously takes away from the amount of focus that we put only on endpoint. So if you think about 100% of our sales people population, instead of all of them being focused on endpoint, there is a degree of them that are focused on cloud opportunities, there are degree that's focused on security data lake opportunities, some of those are kind of building up. Cloud is already a substantial part of our business. It's definitely also a more pristine market in terms of competition. All of that funnels through what I believe is the right approach for revenue diversification into the future, and it's what we're going to continue doing, while obviously we're able to produce meaningful growth in endpoint and without this year. So all in all, I think it's all of the above, let's not ignore the competition, but there are other factors in play. And generally, we look at this as a much more of a longer-term market opportunity than what happens this year or even what happens specifically with endpoint dynamics.

Do you think competition is an important topic just because there are so many players with a solution, not the similar solution, just a solution. And the question is whether price is a factor with customers, meaning if you have someone who's committing suicide with pricing, does it impact your ability to sell or the technology matters?

Yes. I think that 2 years ago, price didn't matter that much. I think in this environment, price matters a lot. I think that competitors out there that are willing to just discount to do zero-dollar deals, they win some share and they deflect some share loss. There's no question about it. It's still in the grand scheme of things, it's still anecdotal. Like people can sustain a business, obviously, we're giving zero-dollar accounts. So they're doing it where they are fearful the most. We've not done a single zero-dollar deal in our existence. We don't do loss profile deals at all, nor can we allow maybe someone like a big established network player that has already milked the network segment for the revenue doors can now throw in some stuff into the estate. So no new vendors are getting introduced into their estate but that's not a long-term approach as well. And the functionality there is not what people are looking for. And I think that you're going to see some folks get the solution pretty quickly. As we've seen with Microsoft as an example. And even Microsoft, which is obviously another significant force in this market. Some people think about it and they do their best to present it. There's a free dollar free licenses type of an offering. It is not. It really is not. And I think we're also doing a better and better job now to show people the hidden cost of E5 and how much you're actually spending given the data costs, the management costs, which are all tangible line items for the CFO to review. So again, it's not a zero-dollar market. I don't think it makes sense that people today think about paying more for an AI-based spellchecker than they are on endpoint protection. I mean it's not healthy for cybersecurity.

Got it. Specifically on Microsoft. In the high end, there are different players. We see Microsoft more in the low end where bundling is important. How do you handle the bundling efforts of Microsoft? How do you handle the fact that it's a bigger company with more broader security portfolio?

Yes. Look, part of it is recognized that they're going to be there. I mean, right? I mean we're going to have some of the accounts on the market go with Microsoft, that's a fact of life. I mean we can't negate the entire effect, but these are statistics. So at the end of the day, you got to really ring fence what you feel is going to be the share that Microsoft is going to take away that is reflected in our win rates, and we keep very close tabs on it. Specifically, I think you're seeing more and more that if you're able to articulate, a, the hidden cost of using something like Microsoft, and it's actually not that hidden. You just need to bring it to bear because Microsoft obviously will not do it for you. But then also, obviously, talk about the technology positioning and the foundation for the future in what you're procuring from a vendor like ours or maybe the other pure plays, you also get to realize something very simple. Microsoft is not a security platform. It's a bunch of products used together into a big portfolio of security products. It's not one cohesive platform out of which you consume different products. You've got products and products families, one on top of the other that don't really give you that same cohesive coverage, sometimes not even coverage to their own operating systems. So you get customers out there that they might even want to go with E5, but they can get -- they can get the coverage. They can get the coverage to Microsoft's own operating system, nonetheless to Linux environments, cloud environments, asset inventory, identity security. All of those are very, I think, adjacent things to what Microsoft is doing in its core. And a lot of these offerings, they don't talk together, they don't mesh together. They're not priced together, they're not licensed together, especially if you go and start to think about the overall opportunity for an enterprise security platform, you also see that Microsoft might have different components, but there's some more work for them to do. I think in that, if you look at the security data lake market that's forming, you actually see very different players that are going with that approach. I mean you see us, which we kind of ushered that concept into the market, and you see Google security analytics, and you see AWS Security Lake and you don't see a lot of the others that took a more kind of EDR approach versus this approach versus same approach, versus the log approach and giving you 7 different consoles to do 20 different things. So I think there's also something to be said about how the market is forming and it still remains to be same.

One of the other questions I got was, how do you manage to compete in the market being a smaller company? What I mean by that is, when you consider some of your competitors, they are much bigger, right? And some of them are platform players like Palo Alto, like Microsoft. You may call it individual products, but it's still a big platform as is. You're more focused, you're smaller, but you have state-of-the-art technology. Where is the line between being too small to be very advanced with technology? Where are the use cases where customers tell you, I need you despite your size, your size does not matter to us or customers that take the opposite approach, like we only need check the box on and -- antivirus, I'm taking it to the extreme, check the box, and we're going to go with bigger companies?

Yes. Look, this environment, for sure, is harder for smaller vendors. And I think everybody that has followed their story should recognize that. I do think that there's a balance there between getting the care and the technology because it's not just the technology. If something goes wrong in your Microsoft environment, their size doesn't matter. It actually works into your disadvantage. They don't really care. That's a fact of life. You got no one to call to, you got no one that will help you. I think that's different with some of the pure plays and specifically different with us. I think we're able to do that. We have grown significantly more than any other company in our scale. So we're reaching bigger and bigger scale every single day. It is absolutely harder for us as a smaller vendor in this environment. And I think we factor some of it into what we can do. It's not coming into, I think, manifestation in, oh, they're too small. I'm not going to go with them. Our financial viability is as good as anybody else's, it's more in -- we don't have the reach that some of the bigger platform vendors have. We don't have the same marketing budgets. We don't have the same narrative control, and we don't have the same channel ecosystem. Even though I think we've made significant strides. We're now bigger than almost any other endpoint vendor outside these top 3 that we've talked about. We just can give you a clue on what we've done in 2 years of being a public company. So all in all, I can say that -- we have a favorable position competitively. I think our technology is by far better than what the others are putting into the space. I think we continue to push innovation in ways that the others just can't and that is why we continue and win. But yes, being a smaller vendor in this market, in any market, I think right now in this economic environment is not an easy thing, and it's definitely not an advantage.

We only have a few minutes left, and I still have 2 more questions. I'm going to switch to finances first, and then I'll go back to fundamentals. But Dave path to profitability, one of the biggest risks in a weak environment is that investors start to become more sensitive to profitability. So talk about path to profitability.

Sure. So everything we've been doing, honestly, for the past couple of years has had this fiscal '25 breakeven or better even. That was the goal. That's where we wanted to be. And every effort we've made has been towards that if you look we've been shaving off 25, 30 points of EBIT losses as a percentage of revenue every year. And now we're guiding in that 25% to 29% range. We did a restructuring event, the day of earnings so that helped to rightsized our expenses with our new kind of lowered expectations for the year in terms of ARR. That was done because we were looking to move to lower-cost regions for some of this for diversification. We were looking at areas of the company that, honestly, we should reinvest in more and reallocating resources. In terms of our sales force, we have capacity to do far more than what we're calling out this year -- or sorry, than what we're anticipating from Going calling this year. So there's a lot of opportunity for us too with essentially minimal headcount growth, still exceed the numbers that people are expecting for us to do next year. That's our goal. We've been really tight and focused on expenses because it became something that we couldn't avoid. When the economy changed, we weren't showing up on anyone's radar. We were -- if I look back at the IPO, we were losing 120-plus percent EBIT margin. Now we're at 25%. It's 2 years. You look at our gross margin then, we were 53%, I think, going into the quarter of the IPO, and now we're 75%. So we've made tremendous advancements in just our economic profile to get to that. We just started from a really small scale, which makes it a lot harder when you're trying to grow, compete against a Microsoft to Palo or CrowdStrike. But everything we're doing is to get to that margin profile where we can get to that and turn to profit later.

Got it. Any questions from the audience? No, we're good. I can keep going with my last question. Tomer, platform, where do you think you have -- from memory, about 10 modules that you're selling, maybe more, maybe less, but around that number. What are the important ones? And where do you take the platform from here?

Yes. We got about 20 different capabilities. And by the way, part of that realigning of cost was to make sure we can actually focus on the ones that are important and are important to our future. To us, identity, security data lake, cloud beyond endpoint, I mean these are the important aspects of what we do. Security data lake is a massive target opportunity, $40 billion, if you look at security analytics, going and disrupting kind of the same industry in earnest, if you couple that with what can be done today with AI on enterprise-wide horizontal data lake, you get to a complete new reality in cybersecurity. It's no longer about a chat bot for EDR data and name it whatever you want. It is about fundamentally changing how you think about security in the enterprise lens and the company-wide lens versus these point product lens. And AI can enable that, AI can look at all that data, AI can give you that scale and AI can supercharge you to automate your environment to a point that maybe we'll get some advantage over the attackers because right now, I'm just reminding everybody the attackers are out innovating every single company out there today. Nobody has enough defenses today versus the capabilities that the attackers have now with LLMs and generative AI. And that part is the most dangerous piece of all of cybersecurity. So beyond the competitive hoopla, we need to also make sure that we provide for a better secure world, and that was our goal always.

Great. Thank you.

Thank you very much.

Thank you.