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Cloudflare Q3 Earnings: What Investors Should Know

By Trevor Jennewine and Tim Beyers – Nov 16, 2021 at 11:04AM

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This cloud computing company is firing on all cylinders.

Cloudflare (NET 7.28%) is on a mission to build a better internet. The company provides a range of cloud services, all designed to improve the performance and security of its clients' business-critical infrastructure. Cloudflare has become a key enabler of digital transformation, and its stock has skyrocketed 220% over the past year. Can that outperformance continue?

In this Backstage Pass video, which was recorded on Nov. 5, 2021, Motley Fool contributor Trevor Jennewine and Fool analyst Tim Beyers discuss the company's third-quarter earnings report, while providing context on Cloudflare's competition.

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Trevor Jennewine: Cloudflare, this a cloud computing company and its platform really is aimed at accelerating performance, reliability, and security of the internet. It puts that to a lot of different use cases, both external and internal. Looking at Q3 earnings, revenue came in at $172 million, that was up 51%. Non-GAAP profit was flat, so no profit. So, a beat on the top and the bottom lines, and the non-GAAP profit was a slight improvement over last year. If you look at the GAAP numbers, the GAAP net loss was $0.34 per diluted share, and that was a miss on that metric. But all in all, the company continues to grow its topline quickly.

A few other highlights: Customers surpassed 132,000 in the quarter. That was up 31%. Enterprise customers reached 1,260, up 71%. The enterprise customers are those that are spending over $100,000 each year, so the company has really seen a lot of traction with those big customers. Revenue retention rate was 124%, so the customers are spending more over time. All those metrics look good.

During the conference call, management mentioned that they're seeing a lot of traction with Cloudflare One. It combines zero-trust security with network as a service: It's designed to replace traditional corporate networks. It supports remote work, helps accelerate the corporate network, make it more secure, and it's a substantial growth opportunity for the company going forward. It's good to see that progress. They also had some good news regarding their web development platform, Cloudflare Workers. Forrester Research recently recognize them as a leader -- I don't know if our viewers have ever seen a Forrester Wave, but Cloudflare is by far the highest and the furthest to the right -- so they are outpacing bigger players like Amazon, Microsoft, and Fastly. Fastly is not one of the bigger ones, but we will get to Fastly a little bit later.

Turning to the Q4 outlook, revenue expected at $185 million, up 48%. Looking for a non-GAAP net loss of one cent to break even. All things considered, a pretty strong quarter. I'd love to get Tim's thoughts here.

Tim Beyers: I think it was a good quarter, too. I mean, I would say, Trevor, this is a really good business. It has a good business design. It's built around security. There is a risk that I'll talk about in a second, but it's a very strong business. There is a lot of cash on the balance sheet. It is investing well and it's innovating really well. I think of the metrics that you pointed out there, the one that I would key on is the enterprise customer growth, 71%. The regular customer growth, 31%. Meaning that there is a nice ramp of customers who have come on board and then dramatically increase their spend. That's what leads to better margins. That's what leads to better cash flows.

It's a really good business. You can start small and you can scale, which is great. They've been doing that since the beginning. So, ere's the risk: In terms of what Cloudflare is going for -- they're going after Amazon. They are going after Zscaler. And they're not being shy about it. You can say great, or you could be like maybe tap the brakes a little bit. Because as good as Cloudflare is, if Amazon does decide to squash them -- which they don't have any good reason to want to do that right now -- but it becomes a problem if Amazon does want to do that.

Here's the way that Cloudflare is antagonizing Amazon. The way they're doing it is they introduce this product called R2. R2 is essentially just a snarky way of saying, you know those S3 buckets which are basically they're very simplistic but really widely used cloud storage instances that just about every developer in the world uses. It's called an S3 bucket. Cloudflare says, "We can do that and we can do it better. Not only is it so much better, it's not an S, it's an R. Not only is it three, it's two." It's that order of magnitude better. They literally did that just to be snarky and ridiculous, which I love and I hate at the same time.

But there's no doubting, I mean, if we're going to be honest and give them credit here, they are executing. One of the things that Matthew Prince said during the call, which I think is really interesting and very important if you're going to evaluate Cloudflare fairly, just they have a huge customer base, the vast and like 90 percent of them are free. But that free customer base are the Alpha testers for the new stuff and they are relentless about putting out new stuff all of the time. They throw it into that group of free-tier members who just try stuff out. Their R&D dollars, a little bit like Datadog, are pretty efficient, which is nice. They do have to be relentless in this area because they're poking multiple bears and that's dangerous. So they have to keep being really good at this. They are setting the bar high, but there's no doubt they are executing.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Trevor Jennewine owns shares of Amazon, Fastly, and Zscaler. The Motley Fool owns shares of and recommends Amazon, Cloudflare, Inc., Datadog, Fastly, Microsoft, and Zscaler. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

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