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Darktrace
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=== Limited uptick in average contract ARR despite higher platform adoption === Average contract ARR (defined as period-end ARR divided by period-end number of customers) stood at $65k as of Dec-21 and is roughly flat vs. the level as of Jun-19. The limited increase in average contract ARR over this period is despite the higher platform adoption the company has delivered in recent years (number of customers purchasing more than one product up from 47% in 2019 to 88% in 1H22). According to Darktrace, the limited increase in average contract ARR is driven by the following factors: * Impact of new product cycles on average contract ARR; * Limited uplift in net ARR retention rate. ==== Impact from new product cycles ==== SMB/mid-market customers (with shorter sales cycles) tend to adopt new products first, causing a temporary dip in average contract ARR; this is followed by a gradual increase in ARR as larger enterprise deals are closed – the dip in average contract ARR during 2019-1H21 (see Figure 20) is explained by the roll-out of new product modules (Cyber AI analyst, Antigena Email, etc.) in 2019. With Darktrace expected to roll out the ‘Prevent’ product suite around Jun-22, the company expects average contract ARR to go through a similar transition (dip followed by gradual increase) from early FY23. ==== Limited uplift in net retention rate ==== Darktrace reported net ARR retention rate of 105.1% as of Dec-21, up from 99.9% as of Dec-20 and 101.7% as of Jun-19. The improvement in net ARR retention rate is a function of stabilizing 1-yr gross ARR churn (which declined to 6.4% as of Dec-21, from 8% as of Dec-20 and 8.8% as of Jun-19) and some higher upsell and cross-sell across Darktrace’s installed customer base. These results are driven by a recovery in Darktrace’s SMB/mid-market customer base post pandemic and the positive impact from the scaling of customer success function (created in 2H20). Having said this, Darktrace does not expect net ARR retention rate to move up significantly from the current level – this is due to: * Darktrace’s SMB/mid-market heavy customer base (~85% of Darktrace customers generate sub-$100k in contract ARR) that is characterized by relatively higher churn vs. larger enterprise customers; Darktrace sees normalized 1-yr gross ARR churn at ~6% level; * A significant portion of the platform being sold upfront, leaving limited room for upsells and cross-sells; and * The company’s focus on acquiring new customers to capture the sizable addressable opportunity (150k+ potential addressable customers) – i.e. higher emphasis on “land, land, land” over “land & expand”. '''Figure 19: Evolution of period-end constant currency ARR ($, m)<ref>Source: Company data; rates established at the start of each year; for FY22, constant currency rates were 1.3835 and 1.1878 for GBP and EUR, respectively; FY ends in Jun.</ref>''' [[File:Figure 19.png]] '''Figure 20: Period-end cc average contract ARR ($, '000s)<ref>Source: Based on company data; calculated as period-end cc ARR divided by period-end number of customers; FY ends in Jun.</ref>''' [[File:Figure 20.png]] '''Figure 21: One-year gross cc ARR churn (%)<ref>Source: Company data; FY ends in Jun.</ref>''' [[File:Figure 21.png]] '''Figure 22: Net ARR retention rate (%)<ref>Source: Company data; FY ends in Jun.</ref><br />'''[[File:Figure 22.png]] While JP Morgan acknowledges the skew in Darktrace’s customer base towards SMB/mid- market enterprises, the above factors do not entirely explain why the company has not delivered any significant uplift in average contract ARR. Darktrace operates in a highly competitive market with broadly similar offerings available from competing vendors. This likely limits the company’s ability to price its products at a premium and increases retention costs. This could partly explain why the company has not seen a meaningful contract ARR uplift despite selling more product modules to its customer base (additional features bundled together to drive retention). This will not impact gross margin necessarily as providing a new product module such as AI analyst or Antigena autonomous response does not require shipping an additional appliance (for on-premises deployments) and may not result in a commensurate increase in hosting costs for cloud-delivered solutions. In addition, JP Morgan believes that larger enterprises that have well-resourced security teams and know-how are less likely to use Darktrace solutions as a replacement for a standalone EDR, SIEM or network security solutions; these enterprises will likely continue to stitch together best-of-breed point security solutions or license additional modules from existing XDR vendors to add specific network visibility / threat analytics use-cases. Broader Darktrace platform adoption is more likely across price- conscious and budget-constrained SMB/mid-market customers characterized by lower deal values. These factors may likely limit the increase in average contract ARR values, in JP Morgan's view. JP Morgan acknowledges that it is likely too early to judge the success of Darktrace’s cross- sell strategy as the company continues to prioritize new customer acquisition and has a relatively young customer success function. However, in the absence of data that demonstrates the company’s strong up-sell and cross-sell potential, JP Morgan continues to model a modest increase in average contract ARR going forward. Thus, ARR growth, in JP Morgan's view, will continue to be driven by new customer acquisition. JP Morgan believes that high competition in the markets Darktrace operates in will likely make new customer acquisition and retention tougher going forward. This will likely result in either higher gross logo/ARR churn or higher customer incentives needed (to drive retention) and continued high spend on sales and marketing expenses to hunt for new customers to offset churn.
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