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This Cybersecurity Stock Crushed Q2 Earnings

By Trevor Jennewine and Jason Hall – Sep 13, 2021 at 12:39PM

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CrowdStrike continues to grow its business at a rapid pace.

CrowdStrike Holdings (CRWD -0.06%) is a cybersecurity company. Its Falcon platform helps clients safeguard devices and workloads in any environment, from private data centers to the public cloud. More importantly, its ability to crowdsource information across a growing customer base has made its AI models uniquely effective in preventing attacks. As a result, CrowdStrike has earned a reputation for industry-leading threat detection.

In this Backstage Pass segment, recorded Sept. 1, contributor Trevor Jennewine and Jason Hall review CrowdStrike's strong second-quarter earnings.

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Trevor Jennewine: CrowdStrike has really grown its platform a lot in recent years. There are 19 different modules here now that span from endpoint security to log management, and the company in the last year has released a couple of new modules, and I wanted to show this because I'm going to come back to the importance of the different modules in a minute.

But they've released several new modules in the last year like the Humio Log Management -- that was an acquisition -- and they acquired Preempt Security to bring Zero Trust identity into the fold. Then a couple of other cloud security-based modules, so it's growing its platform. Like I said, I'll come back to that when we talk about gross margin in just a second.

The company's revenue growth, or annual recurring revenue, all in that 70% range. The company is still losing money. Operating loss was $47 million, which was actually a bigger loss than the $30 million from the second quarter, so a worsening loss. Net loss also was a loss of $0.25 per share versus $0.14 per share last year. However, the non-GAAP EPS came in at $0.11 per share, and that was a little bit ahead of Wall Street's expectations. They also beat on the top line, so this was actually a beat and raise, which works well with the title of the show.

Jason Hall: There we go.

Jennewine: Strong cash position on the balance sheet, $1.8 billion versus about $740 million in debt. We talked about some of their customer numbers here. The 81% customer growth year over year, which is very strong, and like you said, it's actually accelerating sequentially. They have a lot of the Fortune 100 companies in there.

Hall: On that one real quick, I think it's important actually because the fact that customer growth is growing at a higher rate than its revenue, I think bodes really well, because one thing we know that CrowdStrike does, you talked about those different modules is customers come on and they do one or two things, and then it works, and they add more modules over time, so they grow their spend. To me, this is a leading indicator that the revenue growth rate that we're seeing, I'm not saying it's going to accelerate, but that there could be some sustainability to these very high rates of revenue growth we're seeing.

Jennewine: Management spoke to that in the earnings call. They mentioned a strong pipeline, and so this shows the adoption of different modules over time. If we go back three years to 2019, there was 41% of their customers had four or more modules, and that's up to 66% now, and they actually used to measure like three, four, and five modules, and now they're measuring four, five, and six modules. Management said, at some point in the future, they might be measuring how many clients have 10, 11, 12 modules, just because they are seeing that increased adoption. The big takeaway here is that based on management's commentary, after that first module, everything is pretty much profit. They covered all their expenses with that first module. As customers buy more modules, the company becomes increasingly profitable. You've actually seen the gross margin go up significantly over time, it was in the 36% range five or six years ago, and it's up in the high 70% [range] now, and that's where the company thinks they'll keep it. The gross margin year over year was flat. But I think like you mentioned, Jason, they're adding customers so quickly that they have this land-and-expand strategy. It takes them a little while to gain some traction and see those customers pick up new modules. But gross margin has doubled in the last five or six years.

Hall: A couple of things on this I think are really valuable. I want to talk about a couple of terms that are really, I think investors should understand and know, and that's incremental margin and operating leverage. It's why we love these cloud-based software businesses that build these recurring revenue models because the first thing is incremental margin. Incremental margin you hit on, and it's that first module basically pays for the customer. It covers the operating costs. Every module they add, every additional dollar that that customer spends is far more profitable and that's the incremental margin. Ninety-five percent of that dollar goes toward operating costs and you make a 5% margin on it. With that second dollar, you might only need 20% or 25% of those dollars to cover operating costs, so now, it's 75% margins, or 80% margins, the incremental margins are enormous, and that's what they were talking about. That's incremental margins and that comes from operating leverage, this is a business that it's fixed operating costs. We love this about software companies and cloud companies with these recurring models is their fixed costs are very low. It's not like a steelmaker that for every extra ton of steel they need to produce, they have to buy all the equivalent feedstocks and they have to add the capacity to their foundry, and then they have to ship the completed product out and take on all of these costs. For every new customer that they add a module to, their costs are nickels on the dollar. It's incredible. It's really incredible their operating leverage is so much higher for these businesses. Keep going here.

Jennewine: Let's see here. The other thing I wanted to get on the retention rate, I think we might have touched on this a little bit, but their goal was to keep retention over 120%. This measures any new modules that a customer purchases or any churn if a customer cancels. You see that 124.8% retention rate.

Hall: What that means is, if a customer gave them a dollar last year, this year, they're giving them $1.25.

Jennewine: Exactly. They also have their gross retention on long here at the bottom, which is excluding any up sells basically, so they're keeping 98% of their clients, which is fantastic.

Hall: Churning less than 3% its customers is powerful.

Jennewine: See here. This slide just shows the way they've expanded their platform, adding these new modules. It's helped them grow their market opportunity. You always have to take these with a grain of salt, but the company sees plenty of room in the near-term, and then even moving further out by 2025 they see over $100 billion market opportunity.

Trevor Jennewine owns shares of CrowdStrike Holdings, Inc. The Motley Fool owns shares of and recommends CrowdStrike Holdings, Inc. The Motley Fool has a disclosure policy.

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