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Cloudflare's Path to Profitability Is Becoming Clearer

By Brian Withers - Mar 5, 2021 at 7:17AM

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How and when this cloud player is expected to be in the black.

When a company posts a profit for the first time, it's a notable event. Especially since it doesn't usually come within the first few years of operation. Investors may be wondering: How does management advance a business that's losing money into one that's making a bottom-line profit?

On this clip from Motley Fool Live, recorded on Feb. 13, Fool.com contributor Brian Withers and Motley Fool analyst Tim Beyers discuss how the cloud infrastructure–as–a–service player Cloudflare (NET -7.74%) is making the transition and when it expects to get there.

Brian Withers: This is something that I think is a super highlight. Their operational metric, their operational expenses: sales and marketing, research and development and general, administrative. These are large expenses that they use to help fund growth. If you remember they had a 50% year-over-year revenue growth, so if these grow less than 50%, that means they're scaling them and all of them did across the board.

What that means is year over year, this operating margin improves and these costs allow them to get more dollars below the bottom line and takes them more toward their long-term model where they have a non-GAAP operating margin at 20%, but still spending 18-20% on R&D. You can see this is the biggest lever, sales and marketing going from 46% to sub-30%.

Tim Beyers: Can I add some context to that, Brian?

Withers: Yeah.

Beyers: Essentially, what that means, can you go back a slide? We see under the sales and marketing dollars going down from somewhere between 46 and 52% to 27-29% on the sales and marketing line. Essentially, what this means is that Cloudflare is expecting that as a customer signs on, they'll be a customer for a longer period of time. The incremental dollars they have to spend in order to get that customer to spend more over time is zero.

They are going to get customers, keep customers, sell them more stuff without spending new acquisition dollars to get them through the door, and so their sales and marketing spend will become dramatically more efficient over time. That's the assumption.

You can see that the R&D dollars, they are thinning slightly. But not a lot. Not a lot. It's at 20, 21%, that's roughly in the long-term range of where they want to be. They're not going to get more efficient necessarily with R&D. Not really, not compared to where they've been. Their presumption is our cost to acquire a customer that pays us subscriptions over a long period of time, that's going to go down because we believe we can keep customers in the fold with us for a long period of time. That's the story that they're telling with these numbers.

Withers: It also doesn't. I just don't want people to think that they're not going to add staff. Next year, they're targeting to grow in 37% was their guidance. In order to stay in this range, they got to add another 30% to the R&D team, 30 to 35%. Most of the R&D dollars is people. They're going to continue to grow staff. It's just, they're not going to grow staff as fast as they're growing the top-line.

Cool. Net income has improved as a percentage of revenue. I just wanted to point this out. They put up a $34 million loss for the quarter, but they got $1 billion in cash in short-term investments and that works out to just short of eight years at this rate. This rate won't be that rate.

They are targeted to become profitable at the end of next fiscal year, which is ahead of schedule what they expected in their IPO documents.

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