Portfolio Update & Cloudflare Earnings Review

The Growth Curve #004

I’ve had a lot of life changes recently. About a month ago, I shared how I was let go from my full-time job which has allowed me to focus more on this newsletter.

This week’s news is a bit more positive. I was recently promoted to the rank of Major in the Air National Guard. I served on Active Duty from 2011 - 2018 and have been in the Guard since 2018. It is definitely challenging to continue serving in the Guard while trying to juggle family, a full-time job, losing full-time jobs, this newsletter, YouTube, etc.

It requires sacrifice…I spend time away from family at least once a month and that’s hard. But serving in the military is what I’m most proud of from a professional aspect of my life and I believe sacrifice is an important component of living a fulfilling life.

In no way am I saying that serving in the military makes me or anyone else special. It is a personal choice and there are countless other careers/things people can do to sacrifice and serve others. I appreciate anyone who works hard and treats others with respect.

Anyways, I apologize for the lack of updates this week. I was busy! I guess one quick takeaway is that the more I focus on my family, doing meaningful work (whatever that is to someone), and things generally other than checking my portfolio daily, the better I feel.

There’s more to life than investing and I’m going to be sure that my investing process aligns with that.

Okay, back to worrying about investments 😂

It’s been a great month for The Growth Curve portfolio. After some strong earnings reports and a recovery in the overall market, the portfolio is now in the green. Since February 15th, 2022, we have contributed $84,707 and the current value is $87,373 so we’re up $2,694.

Paid subscribers can always see the current portfolio at this link.

Cloudflare (NET) Q2 2022 Earnings Review

posted a very strong quarter beating on revenue, adjusted earnings, and providing revenue guidance above analyst expectations. Most importantly, Co-Founder & CEO Matthew Prince shared some insights into how Cloudflare is positioned for long-term success.

Q2 2022

Revenue: $234.5M (+54% YoY), beat expectations by $7M

Non-GAAP EPS: $0.00, beat by $0.01

GAAP Gross Profit Margin 76.2%, down from 77% in Q2 2021. Non-GAAP Gross Profit Margin: 78.9% up from 78% in Q2 2021.

Cash from operations was $38.3M compared to $7.5M in Q2 2021. Free cash flow was negative $4.4 million, or 2% of revenue compared to negative $9.8M, or 6% of revenue in Q2, 2021.

Dollar-based net retention rate: 126%, down 1% from Q2, 2021

Q3 2022 Guidance

Revenue: $250M to $251M, vs expectations of $247M

Non-GAAP net income per share of $0.00 to $0.01 vs expectations of $0.01

FY 2022 Guidance

Revenue: $968M to $972M, vs expectations of $959M

Non-GAAP net income per share of $0.03 to $0.04 vs expectation of $0.03

Q2 2022 Business Highlights

  • Added 212 large customers in the quarter, bringing the total number of large customers to $1,749

  • Large customers now represent 60% of revenue, up from 50% six quarters ago

My takeaway: Cloudflare delivered impressive growth and guidance given the current macro environment. I believe Cloudflare benefits from being in the sweet spot of IT spend. They offer services that improve the security, application performance, and reliability of their customers which are all “must-haves” not “nice-to-haves”. Through their platform model, they also offer customers the benefit of consolidated from several vendors for different services down to one which can reduce IT problems and save money. Finally, Cloudflare’s services cost a fraction of what an organizations entire IT/cloud budget is which means Cloudflare can continue growing nicely riding the tailwind of cloud adoption even in a macro down turn.

I’m not saying Cloudflare’s stock won’t take a hit in a prolonged recession..it will. I’m saying that the market opportunity is large enough, and Cloudflare is still small enough, that there is the opportunity for 10+ years of growth ahead (if they execute well).

Conference Call Notes

One of my concerns with when the company first came public was whether or not they would be able to make the transition from serving mostly small and medium sized businesses to serving enterprise customers. This is no longer a concern:

We added a record 212 new large customers, those paying us more than $100,000 per year and now have 1,749 customers over that threshold. These large customers now represent 60% of our revenue, up from 50% six quarters ago. This trend illustrates how large established enterprises increasingly formed the foundation of cloud business. In fact, today, 29% of the Fortune 1000 are already paying Cloudflare customers, a nearly threefold increase over when we went public less than three years ago.

Dollar-based net retention rate is one of the most important metrics for SaaS/Cloud companies because it’s a true indicator of how well a company serves its customers, how well they are innovating and releasing new products, and ultimately whether or not they’ll be able to eventually become profitable. Getting current customers to spend more is a heck of a lot cheaper than constantly having to spend more on marketing to acquire new customers (especially if you have high customer churn which negatively impacts dollar-based net retention).

Our dollar based net retention remained strong at 126%, down 1% over last quarter. While there may be some noise in that number from quarter to quarter, we won't be satisfied until it's above 130% and best of breed among the companies we consider peers.

In the next section, Matthew Prince shares some transparency into Cloudflare’s sales cycle and shared an important aspect of SaaS companies that offer mission critical products and have generally short sales cycles. These companies can see changes in the pace of business through data coming directly from how their customers are using their products. When they see those changes, they can quickly adjust their approach to selling or providing customer service thanks to their short sales cycle. I define this as being agile organizations.

I want to dive deeper into this concept, but a couple of companies come to mind as best of breed here: . I’ll do more work on this concept in future posts

In Q1, our pipeline generation slowed, sales cycles extended, and customers took longer to pay their bills. We watched those metrics closely throughout Q2 and saw them all at least stabilize. They're not where we throw a parade yet, but the metrics are trending in the right direction. Given our visibility early in the economic downturn, we rapidly adjusted our go to market message. We shifted our messaging to focus on ROI helping customers save money and consolidating spend from multiple point solution vendors behind classic, broad platform. Messages about saving money and using fewer vendors particularly resonate a year ago, but they do today. Having a broad platform to solve so many customers problem while at the same time saving the money as the super power in times like these. As I look at our wins in the first half of the year, I believe it's fair to say that it's harder today than it was a year ago to sign up a new customer. But it's gotten easier to talk to our broad set of existing customers about doing more with us. And customers are leaning forward to hear about how we can save the money, reduce their IT complexity, all while increasing their security, performance and reliability

Finally, Prince shared his thoughts on how Cloudflare is approaching the road ahead which has changed from very clear and obvious to a “less certain” road ahead. I love the analogy he uses and believe he is taking the right approach

I believe this is a time for prudence and caution. The metaphor I've been using with our team is to talk about the different conditions you may face driving a car on the road.

A year ago we could see for miles and the road was clear, so it made sense to open up the throttle. Today we find ourselves in what my grandmother used to call a tulip bog. The road ahead is less certain. So it makes sense to keep our hands on the wheel, our eyes on the road, and let up a bit on the accelerator. Whether we're in one or not recession sucks. They hurt everyone. No company is recession proof, but some are more recession resilient than others. Some things I know are universally true. No matter how bad this recession may get, companies aren't going to abandon the Internet. They're not going to give up on the cloud and go back to on-premise boxes and package software. Hackers aren't going to stop hacking, so cyber security will remain a must have not a nice to have. And we're already seeing evidence of all of this with our gross renewal rate in every region for the first half of the year hitting all-time highs since we went public. We are not recession proof, but I wouldn't trade places with any other CEO right now.

What prince highlighted here is exactly why I want to own companies offering critical services to their customers. Cloud adoption might slow down temporarily, but the market is here to stay, hackers are going to keep hacking, and all recessions come to an end eventually.

Have a great Sunday. Coverage of earnings and the rest of the important portfolio news to come this week!

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