Cloudflare (NET 0.75%) is a cybersecurity company focused on protecting websites from the seemingly constant barrage of online threats. In addition to its security offerings, the company also provides hosting and other services for websites in order to keep people watching cat videos and doing other essential tasks online with ease.
The San Francisco-based company debuted on Wall Street in September at $18 per share and shares quickly soared to over $20 only to drop to around $16 apiece. Investors got a look at how the company is doing when it reported quarterly earnings on Nov. 7. Here are three big takeaways from that report.
Huge (unrealized) profit potential
Cloudflare is currently unprofitable, posting a nearly $41 million net loss in the third quarter. Over half of its approximate $74 million in revenue was vacuumed up by sales and marketing expenses, which tallied over $45 million in the quarter.
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This much revenue going toward sales efforts isn't unusual for a relatively young, fast-growing tech company, so this isn't too concerning at the moment. This is especially true in the way management justified the elevated costs during the earnings conference call. Thomas Seifert, chief financial officer, and Matthew Prince, co-founder and CEO, both pointed to an intense beefing-up of the quantity and performance of sales representatives across all of the company's global markets. The two executives said the investment was indeed paying off.
"...as we're growing that team, we monitor the productivity of ramped reps very carefully," Prince said. "And that [productivity] has held very, very steady over time, and that's given us the confidence to continue to invest. ... all of the measures that we looked at and consulted with, it became clear that this was the right time for us to step on the gas on sales and marketing."
Prince said as things progress, more customers will start with six- and seven-figure deals with the company. Once this happens, the company stands to rake in profit like it's nobody's business.
This is because of Cloudflare's high 78% gross margin, which means that for every sale, on average about 78% of the purchase price is profit, before factoring in general business expenses like sales and marketing. The other 22% is used for the costs of making the product.
Cloudflare's 78% margin is higher than the 65% gross margin reported by competitor Akamai Technologies, and the 55% gross margin posted by similarly young competitor Fastly.
Moving forward, investors should keep an eye out for continued maintenance of the company's high profit margin.
Cash issues
Being light on cash is never fun, and Cloudflare is no stranger to this.
At the end of Q3, the company had nearly $502 million in cash and equivalents, largely thanks to the dough it pulled in during its IPO. But before raising $565 million in September, Cloudflare was facing a cash crunch in the making. It had about $42 million in cash and equivalents as of June 30. This was just months after it raised $150 million in venture capital financing in March, which helped bolster an even lower cash balance of only $25 million as of Dec. 31, 2018.
To be fair, the company holds a bit more in the form of "marketable securities," which consist of US Treasuries, corporate bonds, and other similar financial instruments. This amount rang in at $143 million as of Sept. 30.
Still, cash is king, and Cloudflare has some struggles with it. The company reported free cash flow of negative $34 million in Q3, worse than the negative $22 million in Q3 2018. For now, this can be chalked up to the company's comparative youth and aggressive growth efforts, but if the company hits another cash crunch in the future, it may have to resort to a secondary stock offering or other less-than-pretty options.
New features could hurry profitability
Since spring 2018, the company has added two particularly attention-grabbing services: Workers, which is an application development and deployment environment, and Access, which allows a company's employees to use internal software away from the office, such as at home or on a train. Cloudflare claims Access is a direct competitor to BeyondCorp by Alphabet's Google.
While Cloudflare doesn't separate revenue generated from these two products, the company's executive team couldn't stop boasting about their successes during the Q3 conference call. Prince said that over 20% of the company's new enterprise customers have purchased Workers, which offers a limited free version or a premium edition starting at $5 per month.
While Prince didn't say how many customers that adds up to, you can make an inference. This year, the company has grown its paying customer count by a little over 13%, having added almost 10,000 new paying customers since the end of 2018. This would suggest Workers has added about 2,000 clients to its roster since January.
As for Access, Prince claims it equally presents a juicy growth opportunity. During the conference call, he talked about an unnamed industrial distributor that not only purchased Workers, but also purchased Cloudflare Access for 25,000 of its employees. Specific pricing information wasn't disclosed, but a calculator on Cloudflare's website quotes a monthly cost of $3 per employee, or "seat," which adds up to around $75,000 per month. Per-user pricing could allow Access to massively scale at minimal additional cost, making it a particularly attractive product.
But, if you think $3 per employee for Access or $5 a month for basic use of Workers seems low, you'd be forgiven. After all, the company agrees, at least in the case of Workers.
"The efficiency of our platform allows us to offer Cloudflare Workers at prices that are significantly below traditional public cloud computing providers while still maintaining an attractive gross margin," Cloudflare wrote in its IPO paperwork from August.
Workers and Access appear to be two shining-star features that are gaining significant traction as add-on upsells to the company's core offerings. But investors should keep an eye on retention rates for the new offerings, as well as if Cloudflare plans to make adjustments to the price points.
