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Cloudflare (NYSE:NET) Reports Strong Q1, Provides Optimistic Full Year Guidance


Full Report / June 23, 2022
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Internet security and content delivery network Cloudflare (NYSE:NET) reported Q1 FY2022 results beating Wall St's expectations, with revenue up 53.6% year on year to $212.1 million. On top of that, guidance for next quarter's revenue was surprisingly good, being $227 million at the midpoint, 4.24% above what analysts were expecting. Cloudflare made a GAAP loss of $41.3 million, down on its loss of $39.9 million, in the same quarter last year.

Cloudflare (NET) Q1 FY2022 Highlights:

  • Revenue: $212.1 million vs analyst estimates of $205.6 million (3.16% beat)
  • EPS (non-GAAP): $0.01 vs analyst estimates of $0 ($0.01 beat)
  • Revenue guidance for Q2 2022 is $227 million at the midpoint, above analyst estimates of $217.7 million
  • The company lifted revenue guidance for the full year, from $929 million to $957 million at the midpoint, a 3.01% increase
  • Free cash flow was negative $64.4 million, down from positive free cash flow of $8.63 million in previous quarter
  • Gross Margin (GAAP): 77.8%, up from 76.7% same quarter last year

Founded by two grad students of Harvard Business School, Cloudflare (NYSE:NET) is a software as a service platform that helps improve security, reliability and loading times of internet applications and websites.

Cloudflare runs a large network of data centres around the world that serve as storage for their customers' content, shielding it from malicious attacks and delivering it in the fastest way possible.

The power of the product is in its size, used by tens of millions of internet properties, it is so big that it can protect customers even against state-sponsored attacks. And the massive volume of data flowing through the network allows their machine learning algorithms to improve every day.

The amount of content on the internet is exploding, whether it is music, movies and or e-commerce stores. Consumer demand for this content creates network congestion, much like a digital traffic jam which drives demand for specialized content delivery networks (CDN) services that alleviate potential network bottlenecks.

Cloudflare competes in the market for network and content delivery services with companies like AKAMAI (NASDAQ:AKAM) or Fastly (NYSE:FSLY) and partly with cloud cybersecurity and vendors like Zscaler (NASDAQ:ZS).

Sales Growth

As you can see below, Cloudflare's revenue growth has been exceptional over the last year, growing from quarterly revenue of $138 million, to $212.1 million.

Cloudflare Total Revenue

This was another standout quarter with the revenue up a splendid 53.6% year on year. But the growth did slow down a little compared to last quarter, as Cloudflare increased revenue by $18.5 million in Q1, compared to $21.2 million revenue add in Q4 2021. So while the growth is overall still impressive, we will be keeping an eye on the slowdown.

Guidance for the next quarter indicates Cloudflare is expecting revenue to grow 48.9% year on year to $227 million, in line with the 52.8% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 38% over the next twelve months.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Cloudflare's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 77.8% in Q1.

Cloudflare Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.77 left to spend on developing new products, marketing & sales and the general administrative overhead. This is a good gross margin that allows companies like Cloudflare to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity. It is good to see that the gross margin is staying stable which indicates that Cloudflare is doing a good job controlling costs and is not under pressure from competition to lower prices.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Cloudflare burned through $64.4 million in Q1, increasing cash burn year on year.

Cloudflare Free Cash Flow

Cloudflare has burned through $105.2 million in cash over the last twelve months, a negative 14.4% free cash flow margin. This low FCF margin is a result of Cloudflare's need to still heavily invest in the business.

Key Takeaways from Cloudflare's Q1 Results

Since it has still been burning cash over the last twelve months it is worth keeping an eye on Cloudflare’s balance sheet, but we note that with a market capitalization of $29.4 billion and more than $1.72 billion in cash, the company has the capacity to continue to prioritise growth over profitability.

We were impressed by the exceptional revenue growth Cloudflare delivered this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. Overall, we think this was a strong quarter, that should leave shareholders feeling very positive. The company currently trades at $44.3 per share.

Is Now The Time?

Cloudflare may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We think Cloudflare is a good business. Its revenue growth has been exceptional. And while its growth is coming at a cost of significant cash burn, the good news is its very efficient customer acquisition hints at the potential for strong profitability, and its impressive gross margins are indicative of excellent business economics.

The market is certainly expecting long term growth from Cloudflare given its price to sales ratio based on the next twelve months is 25.0x. There is definitely a lot of things to like about Cloudflare and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.

The Wall St analysts covering the company had a one year price target of $148.8 per share right before these results, implying that they saw upside in buying Cloudflare even in the short term.

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