NET

Cloudflare, Inc.

50.50
USD
10.02%
50.50
USD
10.02%
38.96 221.64
52 weeks
52 weeks

Mkt Cap 13.83B

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Cloudflare Stock: Capitulating Despite Quality Q1. Here's Why

Summary Cloudflare reported excellent overall numbers for Q1 2022, although you wouldn't know it. Several metrics showed outstanding progress, and guidance was raised. Market conditions could not get much worse for a stock like Cloudflare; where does it go from here? Cloudflare Stock Capitulates We wouldn't know it from the stock action. But Cloudflare (NYSE:NET) produced quality Q1 results. We also wouldn't know it from the pundit reaction. If this report were released six months ago, analysts and commentators would be singing the praises of another beat and raise. This is not the market of six months ago. Revenue Cloudflare reported revenue of $212 million for a 53% year-over-year (YoY) gain. The company also increased guidance for 2022 from $929 million to a midpoint of $957 million. This is a significant jump considering we are still just five months into the year. While the percentage growth is slowing slightly, this has more to do with the law of larger numbers. As shown below, the increase in revenue dollars is accelerating. The company is now forecasting to add over $300 million in revenue on 46% YoY growth this year. Considering that revenue is recurring, the company's annual recurring revenue (ARR) will likely exceed $1 billion quite handily, although this figure is not reported. In addition, the dollar-based net retention rate (DBNR) reached a record 127%. This is a critical metric as it shows the increase in the amount of money existing customers are spending. It is much more profitable to increase sales from existing customers than to cultivate new ones. Speaking of customers, the rapid customer growth continues, and the growth in large customers is encouraging. Large customers, who provide over $100,000 in ARR, reached 1,537 on a YoY increase of 63%. Large customers provide well over 50% of the company's revenue despite Cloudflare having over 154,000 paying customers overall. Again, this is a crucial figure. It is much more efficient to service a smaller number of large customers. Our largest customers continue to get larger and larger. Those spending over $500,000 a year, growing 68% year-over-year, and those spending over $1 million a year, growing 72% year-over-year. We now have 12 customers and partners spending over $5 million per year with us. And yet, we remain highly diversified, with no customer representing more than 5% of revenue. Profitability The non-GAAP gross margin of Cloudflare was a rounding error away from 80% in Q1 and exceeded the company's target model handily. This is a terrific sign for future profitability. On the other hand, GAAP profits continue to be challenging and are likely not imminent. The company lost over $40 million from operations, exceeding the Q1 2021 loss of $31 million. Most of this GAAP loss is due to stock-based compensation (SBC). A quick look at the statement of cash flows shows that SBC nearly doubled YoY from $18 million in Q1 2021 to almost $34 million in Q1 2022. So I think that we've been very consistent at saying that we are going to hold as close to breakeven on our operating margin as we can. I said on a previous call that if we showed massively positive earnings per share, that would mean something that we did something wrong because if we can continue to grow at the rates that we're guiding towards, there's nowhere else we should be putting that money other than back into the business to grow the business as quickly as possible. And so I think that we are doing that; we've been very consistent in delivering that message. I don't think there's anything that has changed about that strategy. And again, I think we're managing towards a breakeven on operating margin. -Mathew Prince, Chairman, and CEO Opportunities Mathew Prince has some interesting comments about opportunities in the public sector on the earnings call. This could provide further sales to entities with very deep pockets. As I mentioned in an earnings preview article, Cloudflare has recently been involved in defending against cyberattacks in Ukraine and elsewhere. Federal is a big opportunity for us ... we think we'll continue to unlock that. We got word actually today that we have thumbs up from our sponsoring agency and are just waiting kind of in line with the overall federal agency to get that approved. That is not holding us back from working with Accenture as well as other partners, and we've continued to see significant interest. I think the thing that I would come back to is the amount of trust that we have built in the sort of C-level equivalent of the federal government. The number of calls that our team, and including myself, have received from the people who are really trusted with securing the U.S. infrastructure, to understand what's going on in Ukraine, to ask us for help, protecting the infrastructure in the United States, I think that, that speaks incredibly well of us. We actually launched, in partnership with CrowdStrike, as well as Ping Identity, in the quarter the Critical Infrastructure Protection Act. I was really honored by the White House is stepping up and saying that, that was something that they recommended any hospitals, utilities, or energy companies adopt as quickly as possible. So I think that we have an enormous amount of goodwill within the government. I think we are moving forward and think that there is an enormous opportunity to continue to deliver on that goodwill. -Mathew Prince, Chairman, and CEO The acquisition of Area 1 shows another current focus of Cloudflare - defending against phishing attacks. Phishing is one of the most dangerous threats companies face daily - especially giant corporations. It only takes one employee to click on a nefarious email and expose the company to breach. Training employees is critically important; however, it is much better to stop phishing emails from getting to employees' inboxes when it only takes one error. Area 1 will provide just 1% of Cloudflare's revenue in 2022. However, technology is crucial. It will be up to Cloudflare to perfect it and sell it. Is Cloudflare Stock A Buy? Overall, Cloudflare's earnings report was very positive. However, the climate is tremendously unfavorable. Rising rates, the collapse of tech stocks, and the panic selling of many investors contribute to an incredibly rocky period. The company has a tremendous future and could soon again warrant the buy rating, but the first two things must happen. The market must finish capitulating and regain solid footing. Second, the valuation must fall back in line with peers. As shown below, the convergence continues, but it is not complete. For now, it is time to watch and wait. This article was written by My philosophy is to invest in equities with focus on companies which produce generous amounts of positive cash-flow and have growth opportunities to benefit medium to long-term investors. I have a diversified portfolio including growth and value equities, REITs, dividend stocks, and like to use options for income when the opportunity arises. I have over 15 years of experience in the market. I am a practicing CPA, however I have learned about investing more from avid reading, market watching, experience, and of course making mistakes over the years. Also, am an admitted Excel junkie. I try to remember Mark Twain's wisdom: "It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so"Thank you very much for reading and please feel free to leave me a message in the comments or send a private message. All the best! Credentials: CPA, B.S. and M.S. in accounting, CFE. Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Comment

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