Cloudflare, Inc. (NET) Earnings Call Transcript & Summary

Our next speaker is Matthew Prince, Co-Founder and CEO of Cloudflare. We want to welcome Matthew. Thanks so much for joining. And we can take your questions as we go along here, too. So this is interactive. So if you have a question, please raise your hand. But Matthew, incredible to watch your journey. I think 7, 8 years ago, we brought investors to your office, and you put up a slide, you don't need this, you don't need this, you don't need this. You need just one, and we heard that from Marc Benioff and everyone thought that wasn't going to happen. And we see the success, and success that you've created from this vision is pretty incredible.

I think maybe to just speak to where you're at now and the high-level vision of where the company is going, just at the stage of where you see the next several years going for the company?

Okay. I think it's some of little -- Cloudflare has always been a time machine where what we think of every day at the company is if we could go back to the late '60s, early '70s when the first protocols of how the Internet was being designed, were being laid down. And we could take every single step of that and say, how can we make -- everything that has to happen when you send an e-mail, everything that has to happen when you click on a link, everything that has to happen when you log into your corporate VPN faster, more reliable, more secure, more private and more efficient and cheaper. What would we have done differently? Because the Internet was never designed to be what it is today. And so fundamentally, what Cloudflare is, is that network, we all wish the Internet had been. And so I think our ticker is NET, is very descriptive of what Cloudflare is. And if you want to think about where we're going, it's look at every single thing that you do online today, and how can it be faster, more reliable, more secure, more private or more efficient. And that's what our team is working to build. And I think that's going to keep us incredibly busy for a long time. And I think that no matter what happens in the world. I know that 10 years from now, we're going to want an Internet that's faster, more reliable, more secure, more private, more efficient. And I think that's why clients have continued to slot to us.

You're fresh back from Davos, you mentioned...

COVID free, like most of the attendees there.

The economy is on everyone's mind. I'm curious kind of what you heard out of the conference in how you're thinking about what's happening for this over the next 6 to 9 months.

I think at the conference, people were pretty pessimistic. And I think that the mood, especially in Europe, right now is that the world is at war both literally, but also figuratively. And I think that we are in for a difficult next few years. In our last earnings call, we said Q1 of 2022 was by far the hardest quarter we've seen since Q1 of 2020, which was the COVID quarter. And I think one of the things that is unique about us is because our sales cycles are so fast, measured in less than a quarter typically. That let us see some of the kind of early warning signs late in 2021 and early in 2022. And that's allowed us to adjust and adapt. But I think companies that may have looked like they were doing very well in Q1 that have longer sales cycles, you're going to start to see them having pipeline problems in Q2, Q3, Q4. And so I think what has always been a real strength of Cloudflare has been that because we see things early and our feedback cycles are so fast, we can adapt to that. But anyone who tells you -- sits up here and tells you that they're not having to adapt how they're marketing, how they're going to market, how they're closing deals, how they're getting new logos, how they're getting new customers, doesn't have their business instrumented as we do.

We saw that with Workday and Snowflake saying, hey, there's some push out and marked an alpha site, world's fine, and I think we were expecting Mark to give in. But what's your sense? It seems like we're already seeing it show up a little bit. But do you -- it seems like where you said you're so mission-critical. Jefferies just committed to you for e-mail security. So we bought your e-mail security product from Area 1. Reliability and security of our network and speed of our network is -- we're not going to give that up. So it just seems like where you said is more mission-critical than maybe upgrading to an ERP system or putting a new sales system in. So it seems like relatively speaking, you're in a pretty good spot.

Yes. I think that the world is about to get sorted into must-haves and nice to haves. And I think we had an early preview of that. If you look at highly impacted industries in the midst of COVID. And if you look at -- if you were in the hotel or hospitality space, if you were in travel and leisure. And you said, what did those industries cut back in Q1 of 2020, and what do they keep spending on. My hunch is that that's going to be a good predictor for what happens for all industries today. And what we saw was -- and you can go back and -- I mean, it's one of the other things about being public because you can actually go back and listen to our earnings calls. We were really concerned, and we reserved a ton for what we thought of as highly impacted industries, which we're incredibly diversified in terms of the industries that we have and the geographies we service and all those things. But we do have some hospitality. We do have some travel. And we thought, boy, these guys they're going to have a real hard time and we didn't know for sure whether we were a must-have or nice to have. And it turned out that all of those customers continue to pay their bills, some -- maybe not all, some of them went out of business. But we were in a position where I think we proved that we are a must-have for companies. So I think the world is about to go through something that's really hard. And I -- and that's -- it's going to hurt a lot of people out there, but I can't -- I wouldn't trade places with any other company right now because we are typically, the low-price leader in what we do. The ROI for what we deliver is incredibly high. We're consolidating spend across a number of different vendors that are out there. The box vendors that we fundamentally are competing with literally can't even deliver product right now because the supply chains are so much stuff for them. And I think all of those things position us extremely well in what is going to be a very difficult environment. And then you add to that, the fact that the world is more unstable, cyber-attacks are on the rise, the importance of the Internet is only going up. I think those are all things that, as I look out at it, this is going to be tough. We have not -- we've lived for the last 13 years, a pretty charmed existence. We haven't lived through a major recession, I think we're about to. But I really like the positioning that we're in. And I think it actually -- we will come out of it significantly stronger as a company.

And with the supply chain issues, have you been able to measure kind of the share that you feel like you're gaining on that side?

It's interesting in -- there are sort of in 3 head fakes in the hardware space that have sort of delayed the inevitable kind of march of history away from on-premise boxes to the cloud. The first was the Trump Tax Cuts, which pulled forward CapEx spend. So a lot of people put a bunch of money in kind of on-premise hardware boxes. The second was the start of COVID, where people were just scrambling to keep the lights on. And all of a sudden, they had to double down on what they were already doing in order to do that. The third is, I think, what's happening right now, where if you go to any of the big box vendors, they're basically saying to customers, you need to put money down today in order to even get in line. And by the way, we're going to charge you more than what you paid for the exact same piece of equipment, and we can't guarantee a delivery date. And so I think that what you're seeing when you see backlog going up from a bunch of these hardware companies and that looks on the surface side, that's a positive thing. I actually think that that's really upsetting customers because charging more for something that you can't deliver and essentially exporting them at some point, the end of history for the hardware companies is happening, and I think three strikes and you're basically out.

So you have a more bearish view, I think, than a lot of CEOs right now. Do you reinstrument -- maybe I'm wrong, but you're pretty fair about what you're seeing. You've been very clear in the past what you see is what you see. Do you change your approach and how you're running business into this environment? Do you -- I think you've said that financially you're trying to keep pushing really high growth at breakeven. Do you think about, hey, should we show a little more margin? Or do you feel like, hey, we just got to keep pushing the top line?

So I -- so the answer is obviously, yes, that you respond to what the macro conditions are, but probably not at that level. If we weren't at breakeven, then I would be trying to get there. If we weren't sort of right on the cusp of cash flow positive and we were the end of 2022, and we dip below that and said we will continue to be in Q2 but expect to return to cash flow positive in the second half of this year, then we would be changing those things. But again, I think that that's -- and we know exactly what the levers are. We're really well instrumented to know what the levers are to be able to control our business. But if we can continue to grow at north of 40%, then I can't think of anywhere even in difficult times to put dollars back into -- to put dollars other than back into our business. And the opportunity is so large that I think it makes a ton of sense for us to continue to do that. I mean we subscribe very much to sort of the rule 40, except right now we just don't want to be in sort of a negative operating margin position. I think to the comments of being more bearish, I hope what we've demonstrated is that we do what we say and we say what we do. And we're not be asserts, like we call it when we've got -- when there's something that's good, we go and there's something is bad. And we -- one of the core values at Cloudflare, the 3 core values of Cloudflare transparency, curiosity and being principles, right? And we really believe in those things. But transparency, which internally, like I'm on Thursday, going to give an all-hands meeting, where I'm going to say, guys, the world is getting really hard, and that's going to have to force us to really think about the places in our business where we're not world class and tighten up those places. And again, that's going to -- for some people, it's going to be very scary. I think it's an incredible opportunity for great companies. And what you see from companies like -- that emerge out of 2008, 2009 is that it clears the deck of a whole bunch of sort of tenders that are out there. It helps companies actually focus on being nimble and efficient, which we've been from the beginning, and they emerge significantly stronger. But anyone who's telling you that the world isn't hard right now. I mean we're in the midst of what may be a world war, literally. And that is going to affect how people think about their IT budget. It's going to affect how hiring work. It's going to affect a lot of things in the business. And again, I wouldn't trade places with any other company but that doesn't mean it's not going to be hard.

Were you more bearish coming out of Davos?

No. I mean, you can go back and listen to our Q1 earnings call.

I know you've been bearish. I'm just curious if something happened in the last week or you're like...

No. It's just -- nobody is telling the truth. I mean, guys, do all know it, like the world can't harder. Anyone who's not telling you that is lying to you. The world has gotten harder, and it's going to be good for us, hard in the short term. But in 24 months, we will come out with our ship being significantly more efficient with us owning a significantly larger share of the market and us being an absolute critical unreplaceable part of how every corporate network is run.

You've had a very high bar. You said it's harder to get into Cloudflare than you're [indiscernible] at Harvard. When you think about -- you mentioned also you don't do a lot of deals, but you did a deal with Area 1, which would love to hear your view. And I think we're already seeing it inside where we've seen a big issue, which is e-mail. It's a huge threat. Just maybe talk through what you're seeing there? And ultimately, do you feel like you can do more deals now if it gets harder. There's going to be some great bargains. Are you willing to be more acquisitive? Or is this, "Hey, we're going to give this one a shot, let it run and then we'll see or...

I think our bias for M&A is very much against it. We have seen company after company after company screw up their culture, screw up their technology stack, screw up their margins by trying to cobble together sort of Frankenstein solutions. And so if there are -- company -- and again, this is tons of respect, but companies like Cisco, which are just acquisition machines, but not R&D machines versus companies like Apple, which -- every once in a while buys a beats and they buy core technologies, but you can never, again, beats the exception that proves the rule. Like they are fundamentally an R&D machine. We are much more on the Apple side than we are on the Cisco side. And I don't think anything about that's going to change. That said, there are some very smart teams out there that are building core technologies that might be interesting opportunities for us. Four months ago, like the multiples were crazy, and we wouldn't have considered it. And I think in the private markets, especially that has yet to reset, but it's inevitable that it will. And so if we find great teams that are doing smart things, then we can do it. In the case of Area 1, the Area 1 team came to us. And if you look at the multiple on that deal, it was actually a pretty reasonable multiple for the growth rate and everything and the revenue and everything that they were doing. But they pitched us on how much it made sense. And we kept saying, no, no, no. You're a great vendor, will be a private partner. But ultimately, I think that it just was a very natural fit. We thought there was a lot of chemistry between the teams. We've got the cultures aligned really well. And they gave us 3 different things, which were interesting. The one was obviously a new product, which is e-mail security, which Jefferies is a customer of. The second was a world-class threat intelligence team that wasn't full of BS because most threat intelligence teams are totally full of BS. And these guys, I mean, they're a world-class threat intelligence team that isn't full of it. And then the last thing is that they gave us a lot of DNA that around the go-to market for the channel, which is something that we think is incredibly important and if anything, we've been underinvested in. And so we're excited about that. I mean that's a trifecta in terms of an acquisition, but that's the bar that we want to set for teams and talent and anything that we're potentially acquiring. So I think it's more likely today than it was 4 months ago that we would be acquisitive. I think if the Area 1 deal continues to go as well internally, I think that will give us more confidence to be able to do it, but our bar is still extremely, extremely high.

Questions for Matthew? Warriors or Celtics?

My wife is from Boston, but where is Jazz at the end of the day, but that was a sad end to anyone.

Any questions? I can keep going. Raise your hand. I'm too depressing, I guess. The go-to-market, yes, when you think about what you're doing there, can you walk through -- we get the question, it seems like you're really cracking the code on the enterprise, you're getting better and better and better. How much of that is a feet on the street versus the technology versus just getting referenceability? Like what's the what's the recipe there for your success and what you see going forward?

So today, 13 of the top 20 companies in the world use us. With IPO, we were at 10% of the Fortune 1000. Today, we're at something like 26%. I think if you fast forward 10 years, maybe not every, but virtually every company on earth will use us for something. And the answer is, I think it's all of those things. It's one, yes, building great products and building great technology of things that people have to have, right? It's not like tomorrow. No matter what happens in the economy, people won't just be like, yes, you know that Internet thing, it was kind of a fad, right? There's still going to be a real need for you to have a network like the one that we uniquely have built and are positioned to deliver. I think you absolutely do need a sales team. I'm not here to tell you that you can get away with selling 8-figure deals without having somebody that's building their relationships and that they have, they're able to call. And we are -- we increasingly are doing very large 8-figure deals. And so we think we have to do that. I think what's different about us is that in all things in our business, we always try to invest behind the demand as opposed to ahead of the demand. And so what I mean by that is, when we are thinking about hiring a new sales leader to cover a region or cover an industry, we don't just go kind of higher head hunter, look for somebody who's got the right resume, hire them and then pray that they're going to do a good job. Instead, because of the fact that we've made it easy for customers to onboard with Cloudflare early, we use the feedback from those customers, including in the hiring process of the sales team. And we literally will go to a customer and say, who do you want your sales rep to be of all of the different people. And oftentimes customers are the best reference for us to get that. So if you took a snapshot in time and you fast forward 10 years from now, our sales team looks just exactly like you would expect it. We would have named account reps, we'd have offices in all the major regions around the world, we'd have offices, and we're building towards that. I think the difference is not the snapshot, it's how you get there. And we're always investing behind it. The same thing we do with products. So we launched a product called R2, which is our object store. And everyone was like, "Oh, is that going to blow up your CapEx. You have to spend a whole bunch of money, but the answer is no because of how we think about products. And again, if we invest behind the resource as opposed to investing in front of it. So we've deployed all these servers all around the world. And every single quarter, our infrastructure team and our product team get together, and they asked the question, where are we running hot, right? Where do we need to deploy more resources and then where do we have excess resources? And one of the things that we realized was we had a whole bunch of access storage that was running around the world. And so we can actually build a product to take advantage of that. And then as we see demand pick up, then invest behind that demand. And so I think philosophically, that's always how we've thought about the business. And I think that's -- again, you end up in the same place on go-to-market, but how you get there makes it more likely that you'll do it successfully and less likely that you'll make a mistake.

Everyone says you're the fourth cloud, meaning Amazon, Azure, Google, is that an aspiration do you want to be there? Or is it...

No, I think -- we -- what we want to be is the fabric that connects everything including the clouds together. I look at -- if you look at sort of the history of like PCs and the technology industry, you look at Intel. Intel then started out as a CPU company. Intel started out as a memory company. Because at the time, memory was the most expensive component on a computer, and that was what they were optimizing for. But what they realized was that the real place that was a value was being in the -- being the fabric that controlled how the memory works, how the long-term storage work, how the video driver worked, who the audio driver worked. And so the CPU became that central fabric. In our case, I don't think we need to replicate nor do we want to replicate being yet another AWS, yet another Azure, yet another Google, yet another Ali. Instead, what I think we want to be is the fabric that makes it so that customers can pick and choose between the various cloud providers and use the benefits of what they want. And so when -- my thinking on this was, I think, relatively naive, 8 years ago when we started thinking about it. I thought a multi-cloud as being -- you take the same application, you run it on multiple clouds. That's not what anyone does. On the other hand, what everyone does is they end up having done an acquisition. So we bought Area 1. They've got a bunch of stuff that runs in AWS. So all of a sudden, we've got an AWS build, right? And then we've got some other things that are running over in this other place. We've got some other things that are running in those other places. And what we ideally want to be able to do as a customer of the clouds -- and again, we don't use them for much. But is we want to say, listen, Amazon does a few things really, really well? We want to use them. Google does a few things really, really well, we want to use them. Microsoft does few things well, we want to use them. But we want to be able to connect all those things together super efficiently. And I think we are the company that is best positioned to essentially be the fabric or the mesh or using the analogy to Intel, the CPU that hooks together all of those clouds and lets you use the best features from each of them. And so I think we don't necessarily want to be the next cloud. We want to be the next Internet. And that, if you can do it, I think, is actually maybe even bigger opportunity.

Thanks so much for joining. Really appreciate your time.

Thanks, Brent.