Speak to any CEO on the day their company goes public, and they will tell you that the IPO is just another step on their journey, that the company is not done yet, that they’re just getting started.
This is true. It is also true that going public is a major milestone for any company.
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CEOs like to downplay the moment as more incremental than transformational. You, on the other end of the phone or video call, nod, knowing that you are being told a bit of spin and knowing that the CEO also knows that you know. It’s a dance.
Still, that CEO is right that going public is not the end of their journey. Now they’re the CEO of a listed company and have to sit down with analysts and investors regularly to answer for their company’s performance. That’s a change.
To that end, three recent tech IPOs just reported their financial performance for the first time as public companies, and I want to talk about their results. Not only because I am far too curious how these former startups did, but also because going public often entails certain costs that can make newly public companies appear massively unprofitable right out the gate. Also, some headlines that I have seen this morning have me scratching my head.
So, let’s do a quick summary of results from Arm (chip design), Klaviyo (business software), and Instacart (grocery delivery and ads) and ask how they perform once we allow for IPO-related costs. After all, the better (or worse) these companies fare, the more (less) likely we are to see other private tech shops try to follow suit.
Earnings roll call
Arm reported revenue of $806 million in its second quarter ended September 30, up 28% from the $630 million it reported a year earlier. The company’s strong gross margins of more than 90% were not enough to generate enough gross profit, however, to cover its whole-cloth operating expenses of $916 million, leading to a $156 million operating loss and a $110 million net loss. The company was profitable in the same quarter a year earlier.
Why did the company grow so much and yet flip to a loss? Arm explains:
Total operating expense in Q2 FYE24 was $916 million, including $490 million of share-based compensation cost (equity settled) and $27 million for costs associated with the recent Arm IPO. . . .
Total share-based compensation cost (equity-settled) was $509 million with $19 million in cost of sales, $343 million in R&D and $147 million in SG&A. Share-based compensation costs were higher in Q2 than is expected in future quarters as the IPO triggered a one-time expense for previously granted shares. The future run-rate of share based compensation cost will depend on a number of factors, including the share price, but is currently expected to be between $150 million [and] $200 million per quarter.
Arm’s stock is down 6% in pre-market trading. The company’s results came in above analysts’ expectations, but its forecast wasn’t as rosy as expected.
So far, no harm, no foul. Arm did have huge costs due to its IPO, but investors seem more worried about its future performance.
Let’s talk Klaviyo next.
The marketing automation company’s Q3 results did not delight investors, leading it to shed around $1 billion in value. The issue was that its revenue forecast for the fourth quarter came in below analysts’ expectations. But the company did see its operating expenses spike to $419.2 million in Q3 2023, up from $112.2 million a year ago.
Here’s how local press described its earnings report:
As with Arm, Klaviyo’s operating costs also suffered from a one-time share-based compensation charge, which rose to just under $300 million. Previously, share-based compensation cost the company about a half-million dollars per quarter in the back half of 2022. Such is the price of going public.
That said, my favorite headline from the current run of results is: “Instacart reports a $2 billion loss, but sales that beat expectations.” Is that a fair riff? It’s factual, but as the company told investors:
From Q3’22 to Q2’23, GAAP operating expenses have steadily improved from 6.4% of GTV to 5.5% of GTV; however, in Q3’23, GAAP operating expenses represented 40.3% of GTV, primarily driven by $2,588 million or 34.5% of GTV of SBC, which was significantly elevated in the period of our IPO. This impact from SBC drove every operating expense line item to increase year-over-year as a percent of GTV, with the impact to R&D being the most significant.
It turns out that it is very easy to post a massive loss when you have revenue of $764 million (+4% year-over-year) but have to suffer a $2.6 billion share-based compensation charge driven by your recent IPO.
Situations like these are precisely when “adjusted” or non-GAAP metrics have some value because we really do care about how companies perform sans one-time expenses. In this case, Instacart’s adjusted operating costs were 5.6% of its gross transaction volume. That’s better than its year-ago result of 5.9% and is effectively in line with what it reported in the first and second quarters of this year.
The company’s shares are down following the report, but not because of an anticipated, one-time cost, headlines be darned.
So what?
Our trio of newly public tech companies reported a good set of results compared to their recent performance; their forecasts seem to have dinged their shares more than anything else.
And they are hardly alone in being cautious in their forecasts, or simply indicating that they aren’t going to grow as much as the market expects them to. What the three are, however, is not suddenly massively unprofitable. Recall this little exercise when we get more IPOs next year.