Cloudflare (NET)

Cloud security and performance company Cloudflare (NYSE:NET) reported Q3 CY2025 results exceeding the market’s revenue expectations, with sales up 30.7% year on year to $562 million. Guidance for next quarter’s revenue was better than expected at $589 million at the midpoint, 1.5% above analysts’ estimates. Its non-GAAP profit of $0.27 per share was 15.4% above analysts’ consensus estimates.

Company Overview

With a massive network spanning more than 310 cities in over 120 countries, Cloudflare (NYSE:NET) provides a global network that delivers security, performance and reliability services to protect websites, applications, and corporate networks.

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 with traditional cybersecurity companies like Palo Alto Networks (NASDAQ:PANW) and Zscaler (NASDAQ:ZS), content delivery providers such as Akamai Technologies (NASDAQ:AKAM) and Fastly (NYSE:FSLY), and major cloud providers including Amazon Web Services (NASDAQ:AMZN) and Microsoft Azure (NASDAQ:MSFT).

A company’s long-term sales performance is one signal of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Luckily, Cloudflare’s sales grew at an exceptional 38.9% compounded annual growth rate over the last five years. Its growth surpassed the average software company and shows its offerings resonate with customers, a great starting point for our analysis.

Long-term growth is the most important, but within software, a half-decade historical view may miss new innovations or demand cycles. Cloudflare’s annualized revenue growth of 29% over the last two years is below its five-year trend, but we still think the results suggest healthy demand.

This quarter, Cloudflare reported wonderful year-on-year revenue growth of 30.7%, and its $562 million of revenue exceeded Wall Street’s estimates by 3.2%. Company management is currently guiding for a 28.1% year-on-year increase in sales next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 25.2% over the next 12 months, a deceleration versus the last two years. Still, this projection is healthy and suggests the market sees success for its products and services.

Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.

Cloudflare’s billings punched in at $624.4 million in Q3, and over the last four quarters, its growth was fantastic as it averaged 34.2% year-on-year increases. This alternate topline metric grew faster than total sales, meaning the company collects cash upfront and then recognizes the revenue over the length of its contracts - a boost for its liquidity and future revenue prospects.

The customer acquisition cost (CAC) payback period measures the months a company needs to recoup the money spent on acquiring a new customer. This metric helps assess how quickly a business can break even on its sales and marketing investments.

Cloudflare is very efficient at acquiring new customers, and its CAC payback period checked in at 26.9 months this quarter. The company’s rapid recovery of its customer acquisition costs indicates it has a highly differentiated product offering and a strong brand reputation. These dynamics give Cloudflare more resources to pursue new product initiatives while maintaining the flexibility to increase its sales and marketing investments.

What makes the software-as-a-service model so attractive is that once the software is developed, it usually doesn’t cost much to provide it as an ongoing service. These minimal costs can include servers, licenses, and certain personnel.

Cloudflare’s gross margin is good for a software business and points to its solid unit economics, competitive products and services, and lack of meaningful pricing pressure. As you can see below, it averaged an impressive 75.2% gross margin over the last year. Said differently, Cloudflare paid its providers $24.80 for every $100 in revenue.

The market not only cares about gross margin levels but also how they change over time because expansion creates firepower for profitability and free cash generation. Cloudflare has seen gross margins decline by 0.7 percentage points over the last 2 year, which is slightly worse than average for software.

In Q3, Cloudflare produced a 74% gross profit margin, marking a 3.7 percentage point decrease from 77.7% in the same quarter last year. Cloudflare’s full-year margin has also been trending down over the past 12 months, decreasing by 2.3 percentage points. If this move continues, it could suggest a more competitive environment with some pressure to lower prices and higher input costs.

Many software businesses adjust their profits for stock-based compensation (SBC), but we prioritize GAAP operating margin because SBC is a real expense used to attract and retain engineering and sales talent. This metric shows how much revenue remains after accounting for all core expenses – everything from the cost of goods sold to sales and R&D.

Cloudflare’s expensive cost structure has contributed to an average operating margin of negative 9.6% over the last year. This happened because the company spent loads of money to capture market share. As seen in its fast revenue growth, the aggressive strategy has paid off so far, and Wall Street’s estimates suggest the party will continue. We tend to agree and believe the business has a good chance of reaching profitability upon scale.

Analyzing the trend in its profitability, Cloudflare’s operating margin might fluctuated slightly but has generally stayed the same over the last two years. This raises questions about the company’s expense base because its revenue growth should have given it leverage on its fixed costs, resulting in better economies of scale and profitability.

Cloudflare’s operating margin was negative 6.7% this quarter.

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can’t use accounting profits to pay the bills.

Cloudflare has shown weak cash profitability over the last year, giving the company limited opportunities to return capital to shareholders. Its free cash flow margin averaged 10.4%, subpar for a software business.

Cloudflare’s free cash flow clocked in at $74.97 million in Q3, equivalent to a 13.3% margin. This result was good as its margin was 2.8 percentage points higher than in the same quarter last year. Its cash profitability was also above its one-year level, and we hope the company can build on this trend.

Over the next year, analysts predict Cloudflare’s cash conversion will improve. Their consensus estimates imply its free cash flow margin of 10.4% for the last 12 months will increase to 13.3%, it options for capital deployment (investments, share buybacks, etc.).

Companies with more cash than debt have lower bankruptcy risk.

Cloudflare is a well-capitalized company with $4.04 billion of cash and $3.50 billion of debt on its balance sheet. This $541.8 million net cash position gives it the freedom to borrow money, return capital to shareholders, or invest in growth initiatives. Leverage is not an issue here.

We were impressed by how significantly Cloudflare blew past analysts’ billings expectations this quarter. We were also glad its EPS guidance for next quarter trumped Wall Street’s estimates. Zooming out, we think this was a solid print. The stock traded up 4.7% to $233.01 immediately following the results.

Updated: December 3, 2025 at 9:05 PM EST

Before making an investment decision, investors should account for Cloudflare’s business fundamentals and valuation in addition to what happened in the latest quarter.

There is a lot to like about Cloudflare. For starters, its revenue growth was exceptional over the last five years. And while its operating margin hasn't moved over the last year, its efficient sales strategy allows it to target and onboard new users at scale. Additionally, Cloudflare’s gross margin suggests it can generate sustainable profits.

Cloudflare’s price-to-sales ratio based on the next 12 months is 27.4x. There’s no doubt it’s a bit of a market darling given the lofty multiple, but we don’t mind owning a high-quality business, even if it’s expensive. Investments like this should be held patiently for at least three to five years as they benefit from the power of long-term compounding, which more than makes up for any short-term price volatility that comes with high valuations.

Wall Street analysts have a consensus one-year price target of $242.46 on the company (compared to the current share price of $203.98).