NET Q1 2022 Conference Call

Long time lurker and first-time poster. Thank you to Saul for creating this board and sharing your wisdom freely with everyone. Switched to this style of investing in 2021 and am also severely under water now but I appreciate the clarity of this approach and the confidence it gives me to weather the storm and add to great companies where I can.

Been editing these conference call notes for my own understanding and learning for two quarters now and thought I’d give it a try to share it with this board in the spirit of steering the discussion back to individual high-growth companies. I highly recommend reading the conference call for yourself as there are many other interesting tidbits in it.

May 5 – Conference Call Highlights
• Revenue of $212 million, up 54% year-over-year.
• Q2 Revenue guidance of $227.5 on the high end (49% YoY)
• For the full year 2022, we expect revenue in the range of $955 million to $959 million, representing an increase of 45% to 46% year-over-year.
• RPO, came in at $688 million, representing an increase of 10% sequentially and 57% year-over-year.
• Added 14,000 new paying customers, up 10% quarter-over-quarter, bringing our total paying customer count to over 154,000 (29% YoY)
• Added 121 new large customers (over $100,000/year) up 53% year-over-year to a total of 1,537. Today, 58% of our revenue comes from those large customers.
• Customers over $500,000 a year are up 68% year-over-year, and those spending over $1 million a year, growing 72% year-over-year.
• Now have 12 customers and partners spending over $5 million per year. One has over $15 million per year
• DBNRR hit a new record of 127% in the quarter, up 400 basis points year-over-year.
• Gross margin in the quarter of 78.7%, up 110 basis points year-over-year.
• Total number of employees increased 42% year-over-year, bringing our total number of employees to approximately 2,750.
• Received 133,000 job applications and saw attrition ticked down, while many others are struggling to hire
• Intent to grow our operating expenses in line with the revenue staying here or at breakeven and reinvest excess profitability back into the business to address the enormous opportunity in front of us.

On Workers Platform
• I think that if you study developer platforms, for them to really reach escape velocity, takes between 8 and 12 years. And so Workers was launched in late 2017, so we’re continuing to develop it. We’re on that curve.
• one major social network, that’s a very sophisticated developer team that chose to build using Workers.
• What we found is that once a team like that sees the power of what they can do with Workers, that really excites them, both within the organization they’re at and also as they change jobs and go to other places where they take the technology with them.
• it’s going to be some time before it’s dramatically contributing to revenue. But I am pleasantly surprised at how many developers are flocking to the workers ecosystem, and we’ll be talking a lot more about it next week.

On Internet Traffic
• Growth across our network of 75.8%, quarter-over-quarter growth of 15.9%
• It’s worth remembering that we don’t bill primarily based on usage. We bill in a much more predictable way. And so I think that, that is a good indication that we are taking share from the rest of the industry.
• People are not just using Cloudflare for moving bits around, but they’re using Cloudflare in order to do intelligent processing of those bits, and that intelligence, which is really driven by like our Workers’ edge computing product, as well as some of our security products, that’s actually growing faster than bandwidth. And I think that, that delta shows why we’re able to continue to grow revenue at the 54% that we did in the quarter.
• In terms of Cloudflare’s percentage of Internet traffic, I think it’s – we don’t really – we know what our numerator is, but we don’t know what the denominator is. And I don’t think there’s a good source of that.
• We look at some proxies for that in other places. One is what percentage of the top million websites are behind us. And that number is around 20% today. I think what that underrepresents is a lot of our other products. It doesn’t consider products like our zero trust products, it doesn’t take into account things like Magic Transit and other products.

On Area 1 Acquisition
• We closed our largest acquisition ever in the quarter, buying Area 1 Security for $162 million. We have a very high hurdle rate for acquisitions being strongly biased towards internal development but Area 1 technology and team are special. We started out as a customer. I remember shortly after we implemented their solution, writing to our Chief Security Officer to ask if something was wrong, I hadn’t seen any phishing reports in a few weeks, where usually our team would report double digits per day. It turned out Area 1 and their incredible e-mail security tech was the answer.
• We talked to them briefly about a partnership, but it became quickly clear and made far more sense for them to join Cloudflare and fully integrate with our zero trust suite.
• Let me give you a sense of how that’s going. We extended offers to all the Area 1 team, and even in this hot labor market, 98% of them chose to join Cloudflare. And I’m not giving up hope on that last one Area 1 team member who hasn’t yet. I think that says something about how good it fit the 2 companies are together, the technologies and the culture.
• E-mail is the #1 source of network threats that no leading zero trust vendor has truly integrated e-mail security is a major blind spot the industry was guilty of.
• One-click deployment, where it’s a customer of ours clicks a single button and instantly, they get the benefits of the Area 1 solution, and they can continue to use whoever their existing e-mail provider is, whether that’s Outlook and Microsoft Office or its G-suite or if it’s something that they’re hosting on-premise. Much like Cloudflare, Area 1 is a proxy, but it’s just a proxy for e-mail traffic.
• So for instance, when you get an e-mail from an unknown sender, we can automatically isolate that e-mail using our browser isolation product so that any link that you click on in that link don’t actually render on your laptop, but they’re actually rendered at the edge of our network. So any malicious content that’s in those links, we can stop.

Russia and Ukraine
• I mentioned the region at the end of the last earnings call. A number of you reached out to say that the theme was out of place at the time. Unfortunately, it proved pressure. At Cloudflare, our global network serves as an early warning sensor for what’s happening across the Internet.
• In the month leading up to the invasion, we saw characteristic cyber probing and other warning signs that were similar to what we’ve seen in Georgia and Crimea years earlier.
• Concerned, we’ve briefed Western government and offered our services to critical infrastructure providers and government institutions in Ukraine well before the physical invasion began. Many organizations there took us up on our offer of protection.
One of the stories of the war has been the relative lack of cyberattacks. That’s not exactly accurate. There have been attacks. However, the number that have been successful are thankfully few. I’m proud of the role that Cloudflare has played to that end.
• One surprising thing that happened in the quarter was that our app rose to #1 in the Russian app stores. We build that app and give it away to consumers for free as the world’s largest test bed for a key component of our zero trust solution.
• Some of you may wonder why am I telling you about it during the earnings call. Because it turns out doing the right thing and being there when some on the Internet needs us has always been core to Cloudflare and has always turned out to be good business for us over the long term. It’s why I love my job. Successfully operating inside the hostile network environment that is Russia today makes our mobile app better for our enterprise zero trust customers. Ensuring Ukrainian critical infrastructure stays online means we can stand up to the biggest nation state-sponsored attacks for our largest government, financial services and other off-targeted customers, and briefing government on what’s about to happen proves the power and unique insight we get from our global network.
We’re in the trust business. We always have been. And in Q1, we built a lot of trust. We continue to have a seat at the table in conversations around the future regulation of the Internet alongside today’s tech giants.