🛡️ Cybersecurity Earnings
Software is dead? Not so fast
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In case you missed it:
Software has fallen.
Consider this. In the past four years:
The S&P 500 (SPY) is up nearly 70%
The Nasdaq 100 (QQQ) rose more than 90%.
Meanwhile, WisdomTree Cloud Computing (WCLD) is down 12%.
The past earnings season has been particularly challenging, with many software companies guiding below expectations.
It caused some wild moves: Salesforce had its first revenue miss since 2006 and dropped by 20%. MongoDB (MDB) and UiPath (PATH) fell by over 30% after lowering their forecast.
So, what’s happening? Here are some explanations from the earnings calls:
Elongated sales cycles.
Higher levels of budget scrutiny.
Challenging macro environment.
Consumption-based software is seeing a deceleration.
In short, customers want more bang for their software bucks and need to see a return on their investments, with AI and future-proofing being top of mind.
The AI tech stack has 3 layers:
📱 Top: Apps like ChatGPT or enterprise software like Microsoft Copilot, Salesforce Einstein, and Adobe Sensei.
🧠 Middle: Large Language Models (LLMs) are the brains behind AI applications, such as GPT-4, Gemini Ultra, Meta Llama 3, and Amazon Bedrock.
🤖 Bottom: Compute hardware and chips form the core of AI's capabilities, essential for training and inference.
The bottom layer (NVIDIA, AMD, ASML, TSMC) and the middle layer (AWS, Azure, Google Cloud) have already benefited from an AI revenue boost. However, the top layer (software) has yet to show a meaningful revenue acceleration like we have seen for hyperscalers in the past two quarters.
This makes sense. The top layer should be the one that takes the most time to manifest, as companies adapt to new ways to optimize their processes, particularly in the ERP, CRM, and BI verticals.
There is no doubt that AI applications will change our lives, at work and at home. But, like the Internet 30 years ago, it might take a long time to fully materialize.
There is a general negative sentiment around enterprise software, with the idea that AI will make the cost of software go to zero. Just as user-generated content has challenged the dominance of legacy media companies in the past 20 years, the lower barrier to entry could lead to a surge in applications that are “good enough” for a fraction of the price.
However, several counterarguments favor the incumbents:
Distribution: The main expense for most software companies isn’t research & development. It’s sales & marketing. Scale and distribution are the real moat.
Switching costs: A good freemium software is not enough to disrupt existing solutions. Slack and Zoom are exhibit A.
Margin improvements: The resources needed to develop new features will decline for everyone, giving market leaders more flexibility.
Total Cost of Ownership: Implementing and maintaining an Enterprise software solution isn’t like a Netflix subscription. TCO factors the software cost, the time, and expenses saved in the process. IT departments take a holistic view.
Not all software is created equal. Some verticals, like cybersecurity, enjoy tremendous secular tailwinds and stand to benefit significantly from AI disruption. As the threat landscape evolves and cyberattacks become more sophisticated, the need for robust security solutions is only increasing.
So today, let’s look at the most recent cybersecurity earnings to see how these companies are navigating the current environment.
Today at a glance:
Palo Alto Networks: Billing Issues.
CrowdStrike: Flex Drives Module Adoption.
Fortinet: Firewall Cycle Trough.
Zscaler: Zero Trust Momentum.
Cloudflare: Worker AI Opportunity.
Check out our Cybersecurity: Industry Showdown article for comprehensive definitions of cybersecurity acronyms and performance metrics.
1. Palo Alto Networks: Billing Issues
Palo Alto Networks, the largest pure-play cybersecurity company, has faced a challenging year, slashing its FY24 Billings guidance by $600 million or 5% in Q2 FY24. However, the company's focus on ‘platformization’ and becoming a one-stop shop for security needs is visible in its rapid growth in Next-Gen Security (NGS). It includes cloud-delivered security services like Prisma Access (SASE), Prisma Cloud (cloud security), and Cortex (security operations).
Key metrics in Q3 FY24 (ending in April):
Revenue grew 15% Y/Y to $2.0 billion ($10 million beat).
Operating margin was 9% (+4pp Y/Y).
Adjusted Earnings Per Share was $1.32 ($0.07 beat).
Noteworthy items:
NGS Annual Recurring Revenue (ARR) grew +47% Y/Y to $3.8 billion (up 9% sequentially). This growth area should help subscription revenue reaccelerate over time. CEO Nikesh Arora sees “a path with conviction towards being a $15 billion NGS ARR company.”
Remaining Performance Obligation (RPO) grew +23% Y/Y to $11.3 billion, a slight acceleration compared to +22% Y/Y in Q2 FY24—also indicating an impending recovery.
FY24 Billings are expected to grow 10% to 11% (unchanged since last quarter after the massive guidance cut, but with a narrower range).
Some customers have chosen deferred payments, impacting Billings growth in the short term, but this is expected to normalize over time.
Overall: While the slowdown in Billings growth remains a concern, Palo Alto Networks continues to show strength in its NGS offerings. The company showed operating leverage for the past nine quarters and expects FY24 earnings per share to be $5.57 in the mid-range, up from $5.50 previously. Despite the challenges, Palo Alto Networks is still outpacing smaller competitors like Fortinet in Billings growth (more on this in a minute).
2. CrowdStrike: Flex Drives Module Adoption
CrowdStrike has taken a lot of direct jabs at Palo Alto in recent earnings calls.