NET Earnings Call -Q3 22

The following are my notes from the NET earnings call, and specifically from the analyst Q/A portion of the call.

NET Analyst Question and Answer - Q3 22
CEO – Matthew Prince
CFO -Thomas Seifert

Q Customer growth?
A How can customers consolidate their vendors. $500K and $1M group of customers are growing faster than their smaller customers.

Q Where is the slowdown small, medium or large customers?
A Depends which segment you look at.

Q Fortune 500 penetration will get to 100% How do you balance what you do w/ the hyper-scalers
A NETs approach is to start from the inside and work its way out vs. the hyper-scalers doing it the other way. NET wants to be the link that links company’s offices. Parts of companies can live inside of NET. Increasingly seeing customers growing the place where companies can grow. Those applications for compliance, performance or reliability reasons, that’s where NET wants to live. Organically w/o M&A, NET believes it can reach $5M. NET sees themselves as the glue between the hyper-scalers. The hyper-scalers don’t need to fail for NET to succeed.

Q Are customers looking to lock into NET for short term or long term contract commitments?
A NET is flexible either way and it’s a big lever they have.

Q When you acquired Area 1, how is where they can take you going and how are you doing against Palo Alto or Zscaler?
A Area 1 is a natural gateway and a threat intelligence team and a great way to attract customers and a deeper and more thorough understanding of what their channel team can do for them. Area 1 email security allows customers to naturally turn to NET for other services. When a customer is considering a zero trust solution, when NET is being considered against Palo Alto and Zscaler, CEO loves their win rates and ability to compete.

Q Are you seeing rationalization around expansion and how will this play out mechanically in the next few quarters?
A If you’re purely usage based model, it’s an area customers are looking to save $. If you’re a seats based model, people are less likely to cut $. While NET offers both, they see it as an expansion driver and not having a problem offering both scenarios. Less about their customers saying how can we use less of you, and instead customers are saying the opposite.
Q Future optimization
A Rule of 40 is pretty compelling to CEO. If they’re growing north of 40%, then they can deliver on the enormous opportunity. They have the levers to optimize how they manage the business. Today, they’re still operating above the rule of 50.

Q Security services is getting stronger in light of macro.
A NET has been consistent talking about macro pressures in the last 3 quarters. Digging down into security business, when Russia invaded Ukraine, security companies thought it would be a tailwind, and that is not what happened. However in the last couple of months, they’ve started to see a lot more cyber attacks coming out of Russia and other countries. It’s actually been showing up in Q3 rather than in Q1 like everyone thought. Not seeing a big change in how consistently they’ve talked about this at NET.

Q What’s implied in the caution in your outlook? Do you expect to see the macro backdrop or stay where it is?
A Subscription based model, much of what they saw in Q3, they anticipate much of the same in Q4. Have not anticipated an improvement and there’s nothing that signals that it will get better any time soon.

Q Provide color around pipeline of renewals.
A Don’t think they’ve seen an uptick in overall churn. Haven’t changed how they’ve handicapped the renewal forecast. They bill monthly and not annually and so they don’t see a massive influx of $ in 1 quarter in an annual scenario of billing.

Q Customers aren’t buying firewalls.
A Had a series of head fakes from the hardware security vendors. In the grand course of history, you can’t solve these problems by shipping someone a box and artificial incentives. This is good for NET.

Q Pricing strategy and trade down to customers that have better TCO. What’s rationale?
A Pay as you go is small and less than 20% of revenue. The value they see in pay as you go is that pay as you go customers turn into their largest customers, used it as an individual/person, fell in love with NET and became a champion who advocated for NET when they went to a large company. That’s their secret sales force.

A It’s a compete number and a true number. The KPI’s they shared, these coerts art growing.

Q M&A environment. Given the cash you have are there opportunities to add scale, etc?
A Different companies are built differently. NET is more like an Apple who grew organically than a CISCO who grew by acquisition. NET is typically against M&A due to the benefits of efficiency. That’s not to say they won’t acquire a company with a great product and a great team of people.

Note: I may have missed a couple of questions at the beginning of the Cloudflare call while I was on the BILL earnings call.
I hope this is helpful information for everyone. Nice to be on the newly formatted message boards and appreciate the new, modern features and benefits.


Thanks sjo, always love reading your earnings call notes. I followed NET’s call and as usual there’s a lot digest. Just a quick note:

Please correct me if I’m wrong but I heard a part of this one differently.

The hyper-scalers approach is to start from the inside and work their way out. NETs is the opposite - start from the outside and work their way in. NET wants to be the network. The glue as you said. Some applications and use cases can live entirely within the network - i.e. NET. [That is: they’re increasingly working their way in, although not seeing or relying on offerings like R2 being a replacement. Can be, but doesn’t have to.]

Organically w/o M&A and only taking their current offerings into account(!), they’re confident that they’ll be able to reach $5 billion revenue within 5 years.


Good catch Raylight. Thank you. You’re correct re: NET starting from the outside and then moving to the inside. My recollection is that NET’s goal is to reach $5B organically and was not made by management with the assumption that they would reach $5B without the need to supplant their competitors or grow through M&A.


Didn’t wanna trust my recollection so listened again and transcribed Mathew’s answer to the best of my ability. Confident is my interpretation.

I think, regardless, we see with the products that we have in market today, a clear path to getting to five billions of dollars of revenue. And that isn’t assuming any M&A. We believe that as to organic… organically we can get to five billions of dollars of revenue in the next five years, with the products [.] that are in market today.

It’s tied to a stronger wording before the Q&A. Was a pretty long answer, so I’m hiding it here:

Full transcription of Mathew's answer (around 0:38 in the call)

I think that our approach is very different than the hyperscalers. The hyperscalers sort of start from the inside and work their way out, and we are starting from the outside and working our way in. And what I mean by that is, fundamentally what Cloudflare is is a network. And we want to be the best network to connect to anything online. To connect cloud to cloud, cloud to home office, cloud to remote office, cloud to branch office. Anything that is having to be connected by a network - we want to be that network. There are things that make a ton of sense to live in the network itself, so for instance a shared object that you’re going to use across Google and Microsoft and AWS. Storing that with R2 makes a ton of sense because we’re not gonna charge you the egress tax to be able to access that across all of those different platforms. You’re also going to for some applications want to make some parts of the application as fast and as scalable and as reliable as possible. and so those parts can live inside of Cloudflare.

So our strategy is not to completely recreate every single thing that the hyperscalers do. We wanna be the best network that is there and there’ll be places at the margins where we absolutely will compete with them, and again I think increasingly we are seeing that companies are able to build entire applications using the Cloudflare stack in a way that is much more modern and much more reliable. but we’re never gonna be the place that you can lift and shift the [?], that’s just not what we’re building. Instead we’re [re?]building this for applications that need to live inside the network, for either the performance, reliability, compliance… requirements. And the data that has to live inside the network for those things and reasons. We wanna be the network to be able to do that.

I think, regardless, we see with the products that we have in market today, a clear path to getting to five billions of dollars of revenue. And that isn’t assuming any M&A. We believe that as to organic… organically we can get to five billions of dollars of revenue in the next five years, with the products [.] that are in market today.

And so, I think that we don’t have to… the hyperscalers don’t have to fail for us to succeed. We actually see ourselves as much more of that glue between them, and whether companies want to be multi-cloud or not, they all are. And so that glue is critically important, and again I think we provide the only solution as we see companies that are try to struggle with reconciling that increasingly multi-cloud world.


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To put some numbers around the roadmap for Cloudflare to get to $5 billion over five years without M&A:

Over the past year (trailing four quarters), NET had $894 million of revenue. So taking that as the starting point:

A) STEADY GROWTH SCENARIO - assuming steady revenue growth over the entire 5 year period, it would take an average +41% compounded growth per year to get there:

$0.9 B
$1.3 B Year 1
$1.8 B Year 2
$2.5 B Year 3
$3.5 B Year 4
$5.0 B Year 5

B) GRADUAL CONSISTENT GROWTH DECELERATION SCENARIO - Alternatively, assuming that the law of large numbers applies and there is gradual growth slowdown over the next five years…starting at +50% for next year (which is slightly higher than what they realized this past quarter +47%), what deceleration rate would it take to get to $5 B in five years?

-4.5% per year deceleration:

$0.9 B
$1.3 B Year 1 +50.0%
$2.0 B Year 2 +45.5%
$2.8 B Year 3 +41.0%
$3.8 B Year 4 +36.5%
$5.0 B Year 5 +32.0%

So nothing that looks unrealistically impossible here, but still very lofty goals, to be sure. Of course, there will be more ebbs and flows (growth accelerations and slowdowns) over a five year period that are more extreme than the two simplistic scenarios above, but they could conceivably get there.

For me, I tend to think of investment goals as the best investments having the potential to double in three years and triple in five years. Hitting these numbers would mean quintupling over five years (revenue, not necessarily investor returns depending what happens with the multiple over that period, which could be better or worse).

But let’s say theoretically growth is only half of the 41% in the scenario A above, that would still lead to a +75% revenue increase over three years and more than +150% over five years. If I make another assumption that today, the market is pricing in less than even that (not to mention tech stocks being very out of favor at the moment), we could see stock price multiple expand at least a little bit over that stretch and still bring something close to a double over 3 years and triple over 5 from where we are today.

Cloudflare is a pretty small percentage of my portfolio. The potential going forward is there, it’s just a company that I personally feel is harder for me to get my arms around and understand why I am comfortable that they will get there. At least, I feel like I have a better sense of that path for some of my other holdings, which have all been similarly beaten down in valuation lately, so it’s likely I’ll keep NET fairly small for now.



Thanks for all the posts in this (surprisingly to me) short thread.

I am on the same page with you. I have been suspicious of NET all along in terms of the delta between narrative and numbers. So long as it remained a steady, reliable performer that felt okay. Now, I don’t see the risk/reward in NET as all that appealing because from here one should be able to get great returns over a decade or so with less risk. I have large for me indirect holdings in SNOW and CRWD so those are not on the radar but I also have an AYX position (that I don’t think is popular here nowadays). I got it after their previous ER and the latest one seemed really good to me as well. So AYX is in the running as well as more DDOG and/or depending on their ER, S. I wanted to add to MELI but it is 25% of my direct holdings as is, so nope.


I have to say I am quite suprised how some people complain about the growth rate dipping below 50%. While this is the case, Cloudfare remains one of the most stable growth machines out there. I do not see any reason to reduce my position size, rather I want to increase it.
Find another company that executes on this level as Cloudfare does.