Cloudflare (NET)

Internet security and content delivery network Cloudflare (NYSE:NET) reported revenue ahead of Wall Street’s expectations in Q1 CY2025, with sales up 26.5% year on year to $479.1 million. The company expects next quarter’s revenue to be around $500.5 million, close to analysts’ estimates. Its non-GAAP profit of $0.16 per share was in line with analysts’ consensus estimates.

Company Overview

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

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.

A company’s long-term performance is an indicator of its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Luckily, Cloudflare’s sales grew at an excellent 34.3% compounded annual growth rate over the last three years. Its growth surpassed the average software company and shows its offerings resonate with customers, a great starting point for our analysis.

This quarter, Cloudflare reported robust year-on-year revenue growth of 26.5%, and its $479.1 million of revenue topped Wall Street estimates by 2.1%. Company management is currently guiding for a 24.8% year-on-year increase in sales next quarter.

Looking further ahead, sell-side analysts expect revenue to grow 25.6% over the next 12 months, a deceleration versus the last three years. Despite the slowdown, this projection is noteworthy and implies the market is forecasting 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 $514.9 million in Q1, and over the last four quarters, its growth was fantastic as it averaged 27.9% year-on-year increases. This performance aligned with its total sales growth, indicating robust customer demand. The high level of cash collected from customers also enhances liquidity and provides a solid foundation for future investments and growth.

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 quite efficient at acquiring new customers, and its CAC payback period checked in at 30.2 months this quarter. The company’s rapid recovery of its customer acquisition costs indicates it has a strong brand reputation, giving it more resources pursue new product initiatives while maintaining the flexibility to increase its sales and marketing investments.

One of the best parts about the software-as-a-service business model (and a reason why they trade at high valuation multiples) is that customers typically spend more on a company’s products and services over time.

Cloudflare’s net revenue retention rate, a key performance metric measuring how much money existing customers from a year ago are spending today, was 111% in Q1. This means Cloudflare would’ve grown its revenue by 11% even if it didn’t win any new customers over the last 12 months.

Despite falling over the last year, Cloudflare still has a good net retention rate, proving that customers are satisfied with its software and getting more value from it over time, which is always great to see.

Software is eating the world. It’s one of our favorite business models because once you develop the product, 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 robust unit economics are better than the broader software industry, an output of its asset-lite business model and pricing power. They also enable the company to fund large investments in new products and sales during periods of rapid growth to achieve outsized profits at scale. As you can see below, it averaged an excellent 76.9% gross margin over the last year. That means Cloudflare only paid its providers $23.12 for every $100 in revenue.

This quarter, Cloudflare’s gross profit margin was 75.9%, marking a 1.7 percentage point decrease from 77.5% in the same quarter last year. Zooming out, the company’s full-year margin has remained steady over the past 12 months, suggesting its input costs have been stable and it isn’t under pressure to lower prices.

While many software businesses point investors to their adjusted profits, which exclude stock-based compensation (SBC), we prefer GAAP operating margin because SBC is a legitimate expense used to attract and retain 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 8.7% 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.

Over the last year, Cloudflare’s expanding sales gave it operating leverage as its margin rose by 5.2 percentage points. Still, it will take much more for the company to reach long-term profitability.

Cloudflare’s operating margin was negative 11.1% 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 decent cash profitability, giving it some flexibility to reinvest or return capital to investors. The company’s free cash flow margin averaged 10.4% over the last year, slightly better than the broader software sector.

Cloudflare’s free cash flow clocked in at $52.87 million in Q1, equivalent to a 11% margin. This result was good as its margin was 1.6 percentage points higher than in the same quarter last year. We hope the company can build on this trend.

Over the next year, analysts predict Cloudflare’s cash conversion will slightly improve. Their consensus estimates imply its free cash flow margin of 10.4% for the last 12 months will increase to 12.3%, it options for capital deployment (investments, share buybacks, etc.).

One of the best ways to mitigate bankruptcy risk is to hold more cash than debt.

Cloudflare is a well-capitalized company with $1.91 billion of cash and $1.48 billion of debt on its balance sheet. This $439 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 happy its revenue outperformed Wall Street’s estimates. On the other hand, its EPS guidance for next quarter missed although full-year EPS guidance was maintained from previous. Overall, this was a mixed quarter. The stock traded up 2.9% to $128.17 immediately following the results.

Updated: May 16, 2025 at 10:01 PM EDT

The latest quarterly earnings matters, sure, but we actually think longer-term fundamentals and valuation matter more. Investors should consider all these pieces before deciding whether or not to invest in Cloudflare.

There are several reasons why we think Cloudflare is a great business. For starters, its revenue growth was impressive over the last three years. On top of that, its efficient sales strategy allows it to target and onboard new users at scale, and its gross margin suggests it can generate sustainable profits.

Cloudflare’s price-to-sales ratio based on the next 12 months is 24.5x. A lot of good news is certainly baked in given its premium multiple, but we’ll happily own Cloudflare as its fundamentals really stand out. It’s often wise to hold investments like this for at least three to five years, as the power of long-term compounding negates short-term price swings that can accompany high valuations.

Wall Street analysts have a consensus one-year price target of $143.97 on the company (compared to the current share price of $153.84).

Want to invest in a High Quality big tech company? We’d point you in the direction of Microsoft and Google, which have durable competitive moats and strong fundamentals, factors that are large determinants of long-term market outperformance.

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