Cloudflare, Inc. (NET) Q3 2023 Earnings Call Nov. 02, 2023

Here is a summary of the earnings call.

Matthew Prince - Co-Founder and CEO

Q3 Performance Overview:

• Achieved Q3 revenue of $335.6 million, up 32% YoY.

• Added 206 new large customers (>$100,000/year), totalling 2,558 large customers, up 34% YoY.

• Net retention increased 1% to 116%.

Go-to-Market Strategies:

• Refined go-to-market strategies, maintaining pipeline close rates and sales force productivity.

• Positive early signs from sales team additions in the past six months.

• New cohort generated 1.6x higher pipeline compared to the previous year.

• Achieved more than 130% of activity goals.

Financial Efficiency:

• Gross margin remained strong at 78.7%, exceeding the target range.

• Operating profit reached $42.5 million, marking the fifth consecutive record quarter.

• Operating margin stood at 12.7%, almost tripling YoY.

• Generated positive free cash flow of $34.9 million, with a margin of 10.4%.

• Expected to generate over $100 million in free cash flow in 2023, ahead of the original goal.

Connectivity Cloud Concept:

• Recognized Cloudflare as a "connectivity cloud" during the 13th anniversary.

• Highlighted the contrast with first-generation clouds that hoard data.

• Emphasized the importance of a connectivity cloud for connecting systems securely and efficiently.

Customer Wins:

• Secured significant contracts with government agencies, healthcare, consulting, semiconductor, public utility, ad tech, and technology companies.

• Highlights include replacing legacy solutions, consolidating point solutions, and providing comprehensive network-wide solutions.

• Demonstrated expertise in privacy and regulatory compliance.

AI and Inference Expansion:

• Accelerating efforts in AI with partnerships and infrastructure.

• Introduced Workers AI to enable powerful AI inference close to users.

• Deploying inference-optimized GPUs in 75 cities globally, aiming for 100 by the end of 2023.

• Expecting widespread deployment of GPUs by the end of 2024, making Cloudflare a widely distributed cloud-AI inference platform.

• Rapid adoption of AI capabilities by developers, with thousands leveraging the platform.

• Growing customer interest in putting hundreds of billions of inference tasks on Cloudflare's infrastructure monthly.

Cybersecurity and Modern Warfare:

• Recognizing the ongoing importance of staying ahead of global cybersecurity issues.

• Acknowledging the role of cybersecurity in modern warfare and the cyber battlefield.

Thomas Seifert - CFO

Q3 Financial Performance:

• Total revenue for Q3 reached $335.6 million, marking a 32% YoY increase.

• Geographically, the U.S. contributed 52% of revenue (30% YoY growth), EMEA 28% (36% YoY growth), and APAC 13% (27% YoY growth).

• Paid customer base grew by 17% YoY to 182,027 customers.

• Large customers (spending over $1 million annually) increased by 34% YoY to a total of 2,558, with 206 added in the quarter.

• Dollar-based net retention rate was 116% in Q3, up 100 basis points sequentially.

Financial Efficiency:

• Gross margin in Q3 reached 78.7%, a 100 basis point increase sequentially and a 60 basis point increase YoY.

• Network CapEx accounted for 8% of revenue, benefiting from infrastructure efficiency.

• Despite investments in AI, network CapEx is expected to be 8% to 10% of revenue in fiscal 2023, returning to normalized levels over time.

• Operating expenses represented 66% of revenue, with an 11% YoY increase in total employees.

• Sales and marketing expenses were $129 million, representing 3% sequential and 38% YoY decrease as a percentage of revenue.

• Research and development expenses were $54.2 million, with a 1% sequential and 18% YoY decrease as a percentage of revenue.

• General and administrative expenses were $38.5 million, with a 2% sequential and 11% YoY decrease as a percentage of revenue.

• Operating income was $42.5 million in Q3, a significant increase from $14.8 million in the same period last year.

• Operating margin reached 12.7%, a 690 basis point YoY increase.

Net Income and Balance Sheet:

• Net income in Q3 was $55.3 million, with a diluted net income per share of $0.16.

• Ending Q3 with $1.6 billion in cash, cash equivalents, and available-for-sale securities.

• Generated $34.9 million in free cash flow, equivalent to 10% of revenue.

Full-Year Guidance:

• For Q4 2023, Cloudflare expects revenue between $352 million and $353 million, representing a 28% to 29% YoY increase.

• Anticipates Q4 operating income in the range of $28 million to $29 million, with an effective tax rate of 7%, and diluted net income per share of $0.12.

• Full-year 2023 revenue is projected to be in the range of $1.286 billion to $1.287 billion, reflecting a 32% YoY increase.

• Full-year 2023 operating income is expected to be in the range of $110 million to $111 million, with a diluted net income per share of $0.45 to $0.46, and an effective tax rate of 8%.

• Expects to generate over $100 million in free cash flow for the full year 2023.

Closing Remarks:

• Emphasizes a commitment to operational excellence and delivering shareholder value.

• Acknowledges the trust of customers in solving complex modernization challenges.

• Highlights a focus on fiscal responsibility and being good stewards of investors' capital.

Q&A followed.