Cloudflare Q4 2020 conference call notes

Summary
Cloudflare add 92 large customers in the Q, and enterprise customers are driving the revenue upwards. Paying customers grew by about 10,000 with many customers converting from free to paid. The enterprise customers are pushing up DBNRR. Guidance was ‘thoughtful and prudent’.

Matthew Prince - CEO

  • 126M revenue, +50% YoY
  • full year revenue of 430M, +50% YoY
  • other business metrics very strong
  • paying customers up to 111k, up 10% QoQ, strongest quarterly growth in several years
  • large customers (100k+ ARR) continue to be strongest growth area
  • 92 new large customers in Q4, total count 828
  • revenue from large customers increased sequentially to 49% from 47% in Q3
  • sales team continues to close larger and larger enterprise accounts
  • large customer segment growing the fastest because of new logo wins
  • land and expand is picking up steam
  • DBNRR is going up from the larger customers pushing total number up to 119%
  • DBNRR increased 300bps sequentially
  • driven by customer adoption of expanding product portfolio
  • more customers adopting Cloudflare for Teams, and Magic Transit
  • customers are achieving the corporate network of the future
  • Cloudflare One also resonating with customers
  • R&D delivering so sales can sell more
  • every product launched is designed to be adopted by developers first
  • Q4 had more than 50k developers wrote and deployed their first Cloudflare Worker
  • number of developers has more than doubled since reported in Q2
  • engineering team at leading software company approached Cloudflare about securing dev environment
  • this project was led by developers at the company from the bottom up
  • they knew they needed better access control, and picked Cloudflare Access (Teams suite)
  • one theme keeps coming up: Cloudflare is the only company with a Zero Trust solution built for the needs of developers
  • 70k annual deal to start, and expect to be able to grow with this company
  • Fortune 500 oil and gas conglomerate signed a 3-year 1M deal to implement portion of Cloudflare One
  • included Magic Transit, DDOS mitigation, firewall, and DNS
  • replaced their legacy telecom providers, beat out a number of point cloud solutions in sales cycle
  • customer appreciated ease of use, technical innovation, and they way multiple products fit together in unified solution
  • Fortune 500 US financial provider 3-year 1.6M deal to replace legacy telecom spend and move to Cloudflare One architecture
  • impressed with product roadmap and pace of innovation
  • Fortune 500 Asian financial services 4-year 8.5M deal, implementing Cloudflare One to modernize corporate network
  • IT led, sales team engaged with customer built a relationship and won the business
  • solution engineering team was able to use Cloudflare Workers platform to seamlessly migrate from the previous provider
  • Fortune 500 pharma company, 450k per year deal with Magic Transit service
  • the company has a threat from a hacker targeting their network
  • had a call with the customer on Friday, and had them onboarded over the weekend
  • Fortune 500 semiconductor company, 3-year 1.4M deal to replace a legacy network provider
  • the buyer appreciated the technical innovation, the way the products seamlessly work together, and performance
  • customer described Cloudflare as the company of the future
  • Fortune 1000 enterprise software provider, 3-year 2.6M deal to implement Cloudflare across their organization
  • they came to Cloudflare to improve their performance in China, something they struggled to do with any other provider
  • impressed with Workers Edge computing platform
  • reflections on 2020, remarkable year for Cloudflare and internet
  • protected elections this year, and operation FairShot to more fairly distribute covid vaccine
  • FairShot built on Workers platform, deployed at tremendous scale in weeks
  • a lot of tailwinds, but some headwinds too
  • April traffic growth put pressure on the business, less than 5% of revenue comes from usage based products
  • traffic spike increased costs, but revenue does not automatically follow
  • customers love the predictability of the cost, last thing they want is a surprise bill
  • consistent pricing is differentiator, but team has to do hard work, wringing out every penny of efficiency
  • gross margin 78% in Q4, down 50 basis points YoY, keep the internet working and only costs 50 bps

Thomas Seifert - CFO

  • Outstanding Q4 exceeded high end of guidance, exceptional year
  • since 2016 been growing at 50% growth rate
  • US 53% revenue (+54% YoY), EMEA 26% revenue (+60% YoY), APAC 16% revenue (+33% YoY)
  • deal with JD to build up in China, relationship off to an excellent start
  • Baidu renewed its contract in Q4 for next 6 months
  • transitioning from Baidu to JD as primary partner in China, may cause temporary short term headwinds to growth in region
  • expanding internationally is priority
  • opened 3 new international offices: Tokyo, Paris, Toronto
  • 3.5M total free and paid customers, +38% YoY
  • Q4 record quarter of paying customer additions, adding over 10,000 paying customers sequentially
  • added over 27,000 paying customers YoY
  • 111k paying customers, +32% YoY
  • acceleration in new paying customers was driven by increased new product adoption from free to paid
  • 828 large customers, +57% YoY
  • added 92 large customers sequentially, and over 300 in 2020 total
  • saw significant expansion from large enterprise customers which drove DBNRR
  • enterprise go to market effort generated significant ROI
  • efficiency remains core of business demonstrated by consistently high gross margin
  • 78.1% gross margin, 80 bps sequentially
  • network capex was 9% for the Q and 12% for the year, in line with guidance
  • expect network capex to be variable but trend down as a percentage of revenue
  • operating expenses, increased 1% sequentially and decreased 18% YoY
  • another strong hiring Q, with an increase of 41%, total headcount 1788
  • S&M 58M 46% of rev, R&D 25.7M 20% of rev, G&A 20M 16% of rev
  • operating margins improving 1750 bps YoY
  • operating loss 5.5M, compared to 18M in same period of last year
  • net loss 7M in the Q, per share -.02
  • balance sheet, 1B cash
  • free cash flow -23.5M, 19% of revenue, compared to 28% of revenue in same period last year
  • operating cash flow -8.8M, 7% of revenue, some seasonality impacting but January looking strong
  • covid impacted industries cohort, 8% of rev in Q1, 7% in Q2 and Q3, consistent at 7% in Q4
  • customer concession well below expectations, in line with historic levels
  • seeing increasing customer spend in Q4, and high sales efficiency
  • RPO strong 384M, increase of 12% sequentially and 75% YoY
  • raised guidance, Q1 rev 130-131M (+42-44% YoY), operating loss -8M
  • full year 2021, 589-593M (+37-38% YoY), operating loss 25M to 21M

Questions

  • always looking for ways get free to paid, and get more customers in funnel
  • three areas growing paid customers:
    1. total customer count very strong
    1. new feature automatic platform optimization (APO) driver for WordPress sites
    1. customers on free version of Teams product, strong conversion to paying customers
  • angst over surprise bills, cyber attack would equal bigger bill, means provider and attacker both costing you
  • important to keep core services on fixed/predictable basis, after 2020 companies want predictability
  • Teams product grows with the number of seats
  • a lot of success converting free to paid with Teams
  • now taking them from small customers to larger and larger customers over time
  • extending concessions to industries impacted by pandemic, payment terms continued to be free for some
  • building relationship with the impacted customers, positive feedback
  • once an org starts using the Teams product then gives an opportunity to expand product over time
  • customers coming to Cloudflare One with specific needs like access controls
  • customers really care about how the overall platform fits together
  • once a customer is using 4 or more of products it’s very difficult to compete with Cloudflare because of broad suite
  • increasing ability to land big deals early
  • multi-million dollar RFI/RFP, have the team to win those deals, really good sign
  • land and expand continues to pick up steam
  • bringing on great sales people, customers spending 1-10M want someone to build a relationship with
  • sales org performing well, onboarding employees fast, investing in sales capacity
  • big commitment to sales and marketing, as long as ROI good, worked really well
  • DBNRR lagging indicator, sell more products to customers over course of year, expected to pick up
  • not satisfied with DBNRR yet, conservative definition of DBNRR
  • R&D team to deliver products, supplements sales team to sell over time
  • upsells are pushing up the DBNRR
  • SolarWinds making people aware of Zero Trust solutions, really acts like a bulkhead on ship
  • SolarWinds had castle/moat approach which is not good
  • Zero Trust means attacker cannot move laterally
  • will be a tailwind after the incident
  • Cloudflare is the most developer friendly and most effective
  • customers that care about performance in China will benefit from JD partnership
  • Baidu partnership started in 2014, wanted to upgrade the network in China, wanted even more performant
  • JD team really impressed with technical acumen, extensive network across the region
  • JD building over 150 POPs (points of presence)
  • payment from Baidu will diminish, JD payment will pickup, headwinds very small baked into guidance already
  • no intention of slowing down rate of innovation, similar product weeks like in 2020 with really great launches
  • durable objects an area of expansion, and beta users giving good feedback
  • deliver more value to network is the goal
  • 90% of product and engineering is getting feedback from users and making things better
  • EPI team, emerging product innovation team, makes up 10% of engineering
  • finding next products to shake the industry
  • thoughtful and prudent about guidance
  • law of large numbers, and still uncertainties out there, being prudent, thinking through opportunities but weighing risks
  • Access product, applications exposed to internal users, WAF/DDOS are popular
  • Customers like to manage all security needs through one pane of glass
  • Every single server will try and run every single piece of software that Cloudflare has
  • Means every resource can adapt and run any product
  • Can add new products to a customers bill without adding any cost on infrastructure
  • product team always looking at what the excess resources that are available on the network
  • very competitive on ROI basis very competitors and can bundle in smart ways
  • strong year in US and Europe
  • Europe very strong growth and standout
  • more European customers willing to adopt
  • a number of European governments are adopting Cloudflare
  • Asia is in a transition year, and not as strong
  • Asia is complicated market, multitude of various bandwidth providers, chicken and egg problem
  • hard to get the pricing right without the bandwidth
  • still took on customers that would be unlikely to continue with Cloudflare to get the bandwidth there
  • the 8.5M deal with the financial firm will be a ‘lighthouse’ customer in the region
  • CISOs/CIOs never again want to deal with legacy providers
  • workplace in future will be flexible on where/when people will work
  • Cloudflare will be leader as companies make transition to the new workplace
  • building to be able to move data between data between cloud providers
  • a lot of success getting cloud providers to adopt
  • connective tissue between cloud and applications, Cloudflare as a network to connect multiple applications
  • only accept half a percent of applications for jobs
  • strong raw numbers of applications, coming from other enterprise sales orgs, early to seasoned leaders
  • invested heavily in building out sales capacity
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Thanks so much for that very nice and well done Cloudflare Conference Call Summary. We appreciate it.
Saul

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First I’d like to correct my prior post stating RPO growth, in fact this was 12% sequentially, not 17% as I had posted previously. My apologies.

From Q4 CC, my favorite two parts from Mathew Prince, CEO/Founder-
1. We didn’t raise prices on our customers when they needed us most. We didn’t sacrifice the quality of our service. We did what we do, invented new technology and got more efficient and going in 2021 look out we’re a lean, mean innovation machine and we have no intention of slowing down. despite this they raised GM from 77% to 78%.

What I see as the leverage for accelerating growth of Cloudflare from here, as much or more than the Blitzscaling https://www.strategy-business.com/article/The-Blitzscaling-B… similar to Crowdstrike, DataDog, Zoom, is Cloudflare’s somewhat unique ability to use feedback loops built into their business model that allow them to push out best practices to all their customers, through multi tenancy - the main benefit of cloud architecture. Perhaps or perhaps not utilizing AI/ML in the following example , Cloudflare is learning from the developers on their platform.
Mathew Prince from this latest CC-
2. The engineering team at one of the leading software companies themselves building tools for developers approached us about better securing their own development environment. This project wasn’t imposed by the IT organization from the top down but instead led by developers of the company from the bottom up. They knew having seen increasing threats and attacks like the one that impacted solar wind they needed better access control. They led the process define the best solution and they chose CloudFlare access, part of our Cloudflare team suite in our conversations with them one seemed kept coming up. Cloudflare is the only company with a zero trust solution that really understands and is built for the needs of developers. It’s a 70,000 annual deal to start and we expect we’ll be able to grow with this customer but I think it’s an indication of something more important. Developers are the future of IT and having won their trust we expect will help us win, retain and expand more and more customers over time.

In Q4 more than 50,000 new developers wrote and deployed their first Cloudflare worker. That rate of new developers building on workers for the first time in a quarter has more than doubled since we last reported it in Q2..

These two points in the context of the entire CC makes a compelling case for holding shares, it doesn’t sound like hope to me.

Lots of love,

Jason

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Wpr101, thanks for the detailed write up. I won’t re-state his thoughts having gone through the report. Some more thoughts along w a question for the group:

(1) More of a bias for BIG customers now. Lot of examples of multi-year/multi-million dollar deals in Matthew’s opening remarks. This was more $FSLY’s play, but now also a play for $NET. Good.
(2) More products at play and being developed like $DDOG and $CRWD. More focus on ease for Devs to get going w products.
(3) In Q4 more than 50,000 new developers wrote and deployed their first Cloudflare Worker. That’s up from 27,000 last quarter. Listen, this is huge. I believe a big part of the future is building applications around the Edge ---- and if that many developers are now doing it on Cloudlflare Worker, that’s a huge moat.
(4) Great to see all the lift in customer growth. Acceleration QoQ in paying customer growth to 10% this Q. Largest number of paying customer quarterly increase of all time. Good.

(5) QUESTION. Building on #4, I can surmise that perhaps the revenue didn’t grow beyond 50% this Q ---- perhaps due to timing in the Q of the all the customer signups…BUT, shouldn’t we have seen RPO balloon much more than 12% QoQ (prior Q was 25% QoQ)? RPO went up from $342M to $384M this Q. For all those deals (presumably all done on 1, 2, 3 year contracts), would have expected an acceleration there.

Would love to hear thoughts on #5. Thank you.

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Hi JKB,

On your #5, RPO is about signed contracts which I would presume in case of NET apply only to large customers.

Remember, NET’s has really long tail of little customers… I would bet their 10,000 new customer addition is probably 95%+ in that little category (may be as small as $100 / year… for sure <$1K / year)…
(BTW, Mozilla firefox offers Cloudflare secure connection at $3 per month and Cloudflare VPN at $15 / month to retail clients like me)

And they said that their large customers made up 47% of revenue previous quarter vs 49% in last quarter…

So what am I saying addition of 10K new customers is just building a funnel… that does not translate to RPO growth right away… in the future, may be… but I would really resist the temptation of extending the customer count growth into even future RPO or revenue growth… just because this company has very strong long tail…

For sure RPO growth significantly decelerated from Sept quarter when it was 81% y/y… however it was just 51% y/y in June quarter and so at 75% for deember quarter, its not bad at all…

Because RPO is a lumpy metric depending on signing of deals with large customers, it would be better to measure it on rolling four quarter basis and just compare it to revenue growth… however, I could not find enough historical RPO information… so for now, it seems like RPO growth is slightly ahead or similar to revenue growth and thats all that matters in keeping confidence…

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(5) QUESTION. Building on #4, I can surmise that perhaps the revenue didn’t grow beyond 50% this Q ---- perhaps due to timing in the Q of the all the customer signups…BUT, shouldn’t we have seen RPO balloon much more than 12% QoQ (prior Q was 25% QoQ)? RPO went up from $342M to $384M this Q. For all those deals (presumably all done on 1, 2, 3 year contracts), would have expected an acceleration there.

I have a note from last quarter that ‘excluding the large partnership would mean 73% RPO growth YoY’ as opposed to 81%. Sounds like in the last quarter, one of their largest customer renewed and boosted the number a lot, possibly extending duration as well. Most companies don’t rely on RPO/billings because the two factors of contract duration, and contract renewal timing has huge impacts on the number and makes it an unreliable metric.

Another thing to note is the mix of customer statistics is different:

Q2: added 80 large, not sure on new paid (wasn’t in my notes), 3 million total
Q3: added 99 large, 4,800 new paid customers, 3.2 million total
Q4: added 92 large, 10,000+ new paid customers, 3.5 million total

It looks like large customer adds is not accelerating that heavily, but the portion of revenue from large customers is accelerating. What I take from that is that the large customers they do have are spending more.

A lot of the new paid customers are from Cloudflare Teams switching from free, but also not sure what percent. Total customers (paid + unpaid) is ticking up nicely, and based of those numbers they added 290,000 unpaid customers in a single quarter! As they mention it makes a great sales funnel since they already have people on the platform they can upsell.

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Remember, NET’s has really long tail of little customers… I would bet their 10,000 new customer addition is probably 95%+ in that little category (may be as small as $100 / year… for sure <$1K / year)…
(BTW, Mozilla firefox offers Cloudflare secure connection at $3 per month and Cloudflare VPN at $15 / month to retail clients like me)

And they said that their large customers made up 47% of revenue previous quarter vs 49% in last quarter…

It seems clear the overall market makers aren’t too impressed with these results.

carver
only 1/2 as long as I was

1 Like

It seems clear the overall market makers aren’t too impressed with these results.

The market has a long term track record of being wrong about our stocks, so I wouldn’t get too caught up over short term price blips like this when the underlying business fundamentals are great (which they are).

Sometimes, when the market repeatedly punishes our stocks over longer terms (like 6 months or more), it is wise to ask if we are missing something. This is sort of what Saul did with Elastic way back when.

But when the market misreads an earnings report, which feels like it happens most of the time, it presents short term buying opportunities. DDOG got sold off into the mid 70’s after its Q2 report and then again sold off into the mid 80’s after its Q3 report. Both were great buying opportunities.

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But when the market misreads an earnings report, which feels like it happens most of the time, it presents short term buying opportunities.

Or they don’t, and it doesn’t. Then it results in lost opportunities and stagnation.

10,000 new customers, the vast bulk of whom might be spending $5/month, doesn’t fill me with longing to hold as many shares as I did. It may be that, not for the first time, I’m wrong. C’est la vie.

Frankly, the way Prince et al touted their results seemed a bit overblown to me. I will look back over the next couple of quarters to see how wrong I was.

Cheers!

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It seems clear the overall market makers aren’t too impressed with these results.

These were the analyst target changes the next morning. Does this look as if people are worried?


 __* Cloudflare Inc        : BTIG raises price target to $103 from $97__ 
 __* Cloudflare Inc        : Jefferies raises target price to $100 from $95__ 
 __* Cloudflare Inc        : JP Morgan raises target price to $91 from $83__ 
 __* Cloudflare Inc        : Morgan Stanley raises target price to $88 from $81__ 
 __* Cloudflare Inc        : Needham raises target price to $105 from $75__ 
 __* Cloudflare Inc        : Piper Sandler raises target price to $94 from $84__ 
 __* Cloudflare Inc        : RBC raises target price to $100 from $85__ 
 __* Cloudflare Inc        : Wells Fargo raises target price to $105 from $70__ 

I calculated it out and they raised their average target price from $83.75 to $98.25. That’s a 17% average raise based on one quarter’s results. And the current price is about $82. And these guys are always overly conservative in a big way. I don’t usually pay attention to analysts because they usually are so overly conservative with regard to our stocks, but geez, if they raised their estimates every quarter by 17% it would compound out to 87% for the year!

10,000 new customers, the vast bulk of whom might be spending $5/month, doesn’t fill me with longing to hold as many shares as I did. It may be that, not for the first time, I’m wrong. C’est la vie. Frankly, the way Prince et al touted their results seemed a bit overblown to me. I will look back over the next couple of quarters to see how wrong I was.

I guess 50% revenue gains, in spite of being in the middle of a pandemic, is a clear sign to sell out your position. My, how spoiled we are, considering that just three or four years ago we would have given anything for a company growing at 50%.

Disclosure: I added a little to my Cloudflare this morning at an average price of $81.80

Saul

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“and, if you could point to where I indicated I “sold out my position”, I’d be grateful.”

and if you could point to where he indicated you did to begin with?

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A gentle reminder that at the time of earnings Cloudflare was up over 20% for the year. It is February. It is still up more than 8%. This is a buying opportunity, in my opinion. I added this morning. To DDOG, too.

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