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Security shop Carbon Black files to go public

Today Carbon Black filed to go public, publishing its S-1 document with a $100 million IPO figure as a placeholder.

The security-focused firm based in Massachusetts raised more than $190 million during its life as a private company, including a $54.5 million Series F in 2015 and a more modest $14 million Series F extension in 2016.

Today we’ll take a quick peek at the filing, which joins a number of other technology listings in an active IPO cycle. Carbon Black follows notable debuts such as Spotify and Dropbox, along with other, smaller debuts.

Into the numbers!

The big picture

Carbon Black is a big SaaS shop, something it makes plain in the early sections of its S-1 by noting that its revenue mix has increasingly skewed toward subscriptions. Indeed, according to Carbon Black, the firm’s “[r]ecurring revenue represented 77%, 83% and 88% of our total revenue in 2015, 2016 and 2017, respectively.”

That matters for investors as it helps them understand the company’s growth pace and its cash costs. SaaS companies are notorious for being predictable beasts, but also animals that have slipping growth rates in percentage terms and high upfront cash costs to generate their recurring top line.

Carbon Black is a great example of the model. The firm has grown its subscription (et al.) revenue line item greatly in recent years, but with the cost of rising deficits and high sales and marketing costs (as a percent of revenue and gross margin).

To save us both from reading a slower restatement of fact, here are the company’s guts and bolts, as we like to say:

Carbon Black’s revenue growth for calendar 2017 comes to 39.4 percent, down from 64.7 percent the year before.

Notably, the firm’s net loss fell during 2016, only to rise again in 2017. Companies often post rising deficits as they pursue growth. This is doubly true for SaaS companies willing to pay cash today for revenue growth tomorrow. In simpler terms, SaaS companies pay customer acquisition costs upfront but generate the benefits later on. And if a company is bolstering its sales costs during a growth cycle, the red ink can stretch quite far toward the horizon.

But there’s nuance to the firm’s losses, which we need to understand.

Losing money, and losing money

There’s a fun line item in the above called “[a]ccretion of preferred stock to redemption value,” which has risen and fallen over the past few years.1 This allowed Carbon Black to post a net loss decline in 2016, making its growth that year look particularly attractive. However, the return of that accretion cost pushed 2017’s net loss to a period-high.

Backing out that cost, and focusing on the company’s net loss result pre-accretion expenses, the firm’s net loss has instead posted steady growth as the firm has scaled.

Balling that up, from the above chart we can deduce that Carbon Black is growing at a goodly clip from a revenue base over the $100 million mark, with steadily rising operating losses (speaking loosely) and high sales and marketing costs.

What’s missing? A path to profitability, really. And that’s something the firm’s quarterly results don’t help with, as we will now see:

Let’s walk through that data set together. First, check the rightward progression of the firm’s net losses. Its losses go up with near-steady regularity. Next, execute the same exercise, but with the firm’s “Loss from operations” line. It’s a similar story.

So, as the firm grows, we can safely deduce that it’s an increasingly unprofitable affair. Mostly.

Turning to how the firm spends money, Carbon Black’s quarterly spend on sales and marketing, in percentage-of-revenue terms, was 65 percent in its most recent quarter. That was down from 67 in the year-ago quarter and as high as 71 percent in the first quarter of 2016. Since the first quarter of 2016 to the last of 2017, research and development costs have risen a single point; general and administrative costs fell from 22 percent of revenue to 14 percent. Those modest savings have pushed the firm’s percent-of-revenue losses into the low thirties.

Where they have stuck.

For Carbon Black, the question will be whether it can grow into profitability in the medium-term, or if its growth simply feels expensive compared to other companies; in a liquid market, every investment comes with opportunity costs.

At a minimum, and to Carbon Black’s credit, the security world doesn’t seem to be slowing much.

Odds & ends

Returning to the financials, how Carbon Black calculates its revenue retention is interesting, as it is more conservative than what we often find in similar IPO filings. In this case, Carbon Black doesn’t just compare revenue growth among a customer cohort over time from the clients it didn’t lose; instead, it calculates a more inclusive metric that includes customer churn.

But then Carbon Black goes a bit further, adding that it also “exclude[s] the impact of any add-on purchases from these customers during the measurement,” making its retention metric even stricter than we might have guessed. Regardless, we can read the results: “[Carbon Black’s] retention rate was 93% in 2015, 92% in 2016 and 93% in 2017.” That’s steady enough.

In closing, let’s talk bank accounts. How much cash does Carbon Black have on hand? The answer is not that much: $36.1 million. That’s a low-enough figure that we can presume that the firm is going public not because it simply wants to, but because it needs to raise new capital.

That’s no sin, mind, but let’s dismount with cash flow results to see if we are right. The firm’s free cash flow in 2016 came to negative $25.3 million. It fell, however, to just negative $13.8 million in 2017. Enough to run the company out of oxygen in just a few years. However, with, say, another $100 million in the bank, Carbon Black would have more than enough cash to scale — provided it doesn’t start to consume more cash to grow.

More when it prices — assuming this entire exercise isn’t just an attempt to get bought.

  1. Explained on page F-43 of the S-1, this cost is the “increase [in] the carrying values of the Series B, C, D, E, E-1 and F redeemable convertible preferred stock” over time. This accounting charge leads to “decreases to additional paid-in capital and an increase to accumulated deficit,” but has no bearing on operating results.

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