Cloudflare reported revenue and EPS above consensus. However, 4Q23 revenue guidance missed consensus by ~1% due to geopolitical uncertainty and macro headwinds. The other positive thing to note was that Dollar-Based Net Retention Rate (DBNR) improved to 116% for 3Q23. Management believes DBNR will stabilize near these levels and it will take some time for its efforts to improve Go-to-Market execution to be shown in DBNR, which we see as a positive.
Despite the same macro headwinds that Cloudflare is facing along with other software companies, we believe there is strong demand and need for Cloudflare’s products such as Area 1 and its developer platform, Cloudflare Workers. Longer term, we believe NET will significantly benefit from the AI inference opportunity, which we previously highlighted in our Cloudflare: Bringing AI Inference to the Edge note. Currently NET has inference optimized GPUs in 75 cities globally as of the end of October 2023 and is on track to be in 100 cities by end of CY23.
Revenue and EPS
- Revenue: $335.6 (up 32% Y/Y) above consensus of $330.6M (+30% Y/Y).
- Non-GAAP EPS: $0.16 above consensus of $0.10
- NET gave 4Q23 revenue guidance of $352.5M, at the midpoint below consensus of $356.3M (+30% Y/Y)
· Commentary from call: “Moving onto the guidance for the fourth quarter and the full year, with broadening geopolitical uncertainty and increasingly mixed macroeconomic data points across geographies. The business environment in which we operate remain challenging to predict, and as a result, we continue to remain prudent and cautious in our outlook for the fourth quarter”. - Non-GAAP EPS guide: $0.12 above consensus of $0.10.
Margins
- Non-GAAP Gross Margin: 78.7% vs. 78.1% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Gross Margins expanded from 77.7% to 78.7% - Non-GAAP Operating Margin: 12.7% vs. 5.8% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Operating Margin expanded from 6.6% to 12.7% due to OpEx as a % of revenue going down 5% Q/Q and going down 6% Y/Y to 66% of revenue.
Cash Flow
- $34.9M (10% FCF Margin) vs. ($4.6M) (-2% FCF Margin) in 3Q22
· From 2Q23 to 3Q23, FCF Margins expanded from 6% to 10%
· Commentary from call “This is a business that can generate significant cash, and in 2023, we expect we will generate more than $100 million in free cash flow, well ahead of our original goal when we started the year, and the direct result of improved execution across our entire business.”
· Network CapEx: 8% of revenue.
· FY23: expects network CapEx to be 8-10% of revenue vs. 10-12% previously. However, they expect network CapEx to return to normalized levels over a period. We had highlighted earlier in our analysis that network CapEx is the primary reason why FCF can be minimal at times.
Key Business Metrics
- Paying customers: 182,027 (+17% Y/Y)
· Commentary from call: “We added a record number of net new customers year-over-year, spending more than $500,000 and $1 million on an annualized basis with Cloudflare”. - Paying customers with more than $100K ARR: 2,558 (+34% Y/Y)
- Dollar-Based Net Retention (DBNR): 116%
· Commentary from call: “We continue to believe the recent decelerating trend in DNR stabilizing near these levels”.
- DBNR expanded from 115% in 2Q23 to 116% in 3Q23.
Go-To-Market (GTM)
- NET’s pipeline close rates held firm.
· Commentary from call: “During the quarter, the pipeline generated by this new cohort was 1.6 times higher than those brought on at the same time a year earlier. These new account executives achieved more than 130% of their activity goals for the quarter”. - NET’s salesforce productivity remained stable and linearity in terms of when deals were closed was similar to Q2.
· Commentary from call: “I think that we have been able to hold things steady while making significant organizational changes and improvements across our sales and marketing organization is very encouraging. Beyond that, we’re beginning to see positive early signs from the sales team members we’ve brought on over the six months to replace underperformers.”
Conclusion
Cloudflare may require more than one entry. Cloud has been volatile, and NET can produce choppy reports. We plan to use technical analysis to its fullest.
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