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

Good afternoon, and please welcome to the stage, Jackson Ader.

Great. Thank you. Me and me alone. Yes. Thanks, everybody. So we are here on the second, third, fourth day of the conference, depending on when you actually got in, but it is the last day of our KeyBanc Technology Leadership Forum. I think it's gone great. The change in location, I think people are excited about. So really happy that everybody has joined us. And we are thrilled to have Matthew Prince, best known as a Park City County. That's right.

I appreciate you changing the location this time. Easiest way to get me to come speak in an event is hosted in my hometown.

When I e-mailed, it makes too much sense. It made too much sense. It's like this should be the KeyBanc TLF presented by Matthew Prince.

Yes. Well, it was -- there was a deer in the road. So instead of it being a 5-minute drive, it was 6 to get here.

There was a moose and a baby moose right out here frolicking in the fountains.

You don't know how hard that was to arrange. But you're welcome.

Thank you. I missed it, by the way.

Well, there's an encore later.

Great. The Encore show.

The moose Wranglers are out there.

Matthew is the Co-Founder and CEO of Cloudflare. I don't think we need a ton of introduction. But why don't we just start out with some -- let's lay the foundation.

You -- and I'll stay ahead of time, and I don't mean to put pressure on you and freak my IR team now. But you e-mailed questions ahead of time, and some of them were like the deepest cuts on things. I was like, how did you know that?

Matthew, we know. So first of all, I was an associate on your IPO when I was in a prior life. And so knew the company then, right? But then, I mean, you will readily say, like I'm a cheap date. You're on podcast, you're being interviewed, you own a newspaper, you're out there. So it's -- don't give me too much credit here. All it takes is a few hours of listen.

ChatGPT.

Never. Never. Oh my goodness, you don't know me well enough, right? I'm not on enough podcast to tell you that I'm anti some of that. But -- so I appreciate that. So yes, so this will be fun. But we -- either way, we still need to lay some foundations because I think even as a covering analyst and having known the company for so long, I still do a terrible job of explaining what it actually is that Cloudflare does. You started the company, why don't you give it a shot.

If I'm at a party and someone asked me what I do, and I don't want to talk to them anymore. I'd say that Cloudflare makes the Internet faster and protects it from bad guys. And they say, "Oh, that's really nice," and then they walk away. If I do want to talk to them more, I say, what we did at Cloudflare was we looked at what the Internet became, and it was never supposed to be this. The Internet was the sort of academic side project. There was actually another project coming out of DARPA at the same time, which was the highly secure, supposed to be the robust network. Turns out like many of these things, the toy took off, the robust one died. But now we're stuck with all the mistakes that we made, where if you look at the original papers describing how the Internet work, there's often a section on security, and I would say, security is beyond the scope of this paper, right? Or they would say like how do we make sure these things are actually going to work together. People didn't really consider that from the beginning. And so what we think of as sort of the problem space that we're working on at Cloudflare is if you could go back and reengineer the Internet to be how it should have been if we had known what it was going to become from the beginning, what would that look like? And that has kind of led us to all of the things that we've delivered at Cloudflare.

Okay. One of the things that you say all the time.

And I am the one who probably chases people away at parties.

I thought you were going to say we're Fireworks. company, right? I mean that will do it. But you say a lot that every service runs on every server. That's like a big competitive differentiation. It's kind of the tagline of the technology, how big is this server? I mean, at this point, you've got more products than ...

I mean -- so the -- it's not that every server runs every service at any given time. It's every server is capable of running any service. And so we are constantly -- at some level, a big piece of what we do is a giant schedule, where we're moving code or traffic or load to wherever there's capacity across the network. And that allows us to then differentiate based on pricing. The reason we can have a free version of our service that doesn't actually impose that much cost on us is there's always somewhere on earth where there's a computer sitting at one of our servers sitting not running at its top kind of capacity. And so that's just -- that's like the space over the urinals in the bathroom. It's an asset that you didn't think that you could sell, but it turns out that someone said, well, we can put ads there and it became a resource. We've got that excess capacity. So we've built the ability to move code around or move load around in order to take advantage of that. And that's why like the utilization rates of our equipment are so much higher. It's why we can get so much more out of every dollar of CapEx spend than you can if you're one of the hyperscalers, which are fundamentally in a different business. They're in the business of buying a server and then basically selling it back over time for 5x what they originally bought it for. We're in the business of running code super efficiently across that. And so in the case of the hyperscalers, optimization is their clients' problem. In the case of us, optimization is our problem. And so that's what we are doing. And to answer your question, server is a -- I mean, it's a pretty beefy -- these servers are pretty beefy. We build them in generations. We actually describe on our -- if you're really curious, we describe in our blog in in-depth detail like why did we select this particular processor versus this processor? Why do we select this memory versus this memory? And we build them with a number of what are called ODMs, which are original design manufacturers, the same people that a Dell or a Cisco would use to design these. So companies like Quanta, Hive, largely out of Taiwan, and they're building servers very much to our spec. And we buy -- because every server can run every service, we buy them in essentially bulk once a year and then depot them around and then can deploy them very quickly as we need more in one particular region.

So would you not have the capabilities to be able to kind of be so interchangeable on the products that you can actually meter and sell if you didn't start with the foundation of trying to build a better Internet, which is like a network to begin with. And actually Phil, because I left my notes over here. I will be right back.

I just -- I'll talk to the empty chair. Just think of me like who is the actor? Clint Eastwood. I will talk to the empty chair. It's sort of -- all of a sudden, I don't really look like Clint Eastwood, but here we are. I think that early on, like there was a fight. I mean, we were at about 8 employees, and there was a fight. We were in an office over in nail salon in Palo Alto, California. And half of the team thought we should have specialized equipment to deal with each of the different functions that we had. And they said, that's how everybody else does it. We should do it that way. And the other half of the team said, if we do it the same way as everyone else does, we won't ever have a competitive advantage. And so we did the harder thing, which was design the software to be able to spread load out and service everything and be much more flexible and valuable. And there are places that has made our lives harder. But I think over time, it's given us just a huge advantage because it's fundamentally different than how anyone else thinks of a service like this.

Okay. So it's funny that you characterize -- see, this is why it's important to have the notes because I'm jotting down the follow-up. But you characterize yourself as fundamentally pricing on the hyperscaler side, it's like if we go to a metered or usage-based pricing, good for Cloudflare, bad for them. But some of the bullish Cloudflare investors in the room would say, I think they can be the next hyperscaler. But what -- like what -- how do you respond to that? Why won't you be the next hyperscaler? What is different about that than what you do?

I think there's space for both of us. And I think we've actually kind of carved out lanes that are different. The way that I like to describe this is companies at some level resemble job functions that are kind of classic job functions. And I think if you look at an AWS or a Google or Microsoft, the fundamental job function that they most closely resemble is that of the DBA, the database administrator. And if you look at the KPIs that everybody at those companies look to in terms of success beyond the financial KPIs, it's how much of a customer's data do we store ourselves. And so for them, the database is central. And even if you look at AWS sort of diagrams, it's always like the data store, the sort of that -- whatever that is, S3 or whatever is the center and that's the center and everything else kind of hangs off of it, and they're all about hoarding a customer's data. If any of you've worked with database administrators, they can be a prickly group. They are kind of like the database is central and nothing. They're quirky. There is another quirky job function, also prickly group, which is the network administrator. And that is much closer to what Cloudflare is. And so the KPI that we think about and that we all measure towards beyond the financial KPIs is of our customers, how many of their endpoints are connected to our network. And so that's what we're trying to maximize for. And so the Amazons of the world will always build some network services, but they will always be secondary to their storage services. Because if you think about it, there's a real tension between a network and a database. The database is all put the data in and don't let it leave, right? The network is all get -- move the data around as much as possible. Whereas Cloudflare, we will build storage services, and there are strategic reasons we do that, but they will always be secondary to our network services. And so I think fundamentally, we are the network, and that is primary for us. And as that network, we fundamentally have an advantage and can play well with all of the different hyperscalers because we win on one hyperscaler, right? We're going to be 100% AWS, nothing else. I have yet to find any company at scale. They may say that. Nobody actually does it. They always have -- when we bought this company, and they were using Google Cloud, so we maintained our Google Cloud instance over here. As long as the more multi-cloud the world is, the more the network matters. And the more the network matters, the more it's powerful for us. And so I think we will compete at the margins with the hyperscalers. But fundamentally, I think what's unique about us is we are this network, and that is something that you need in addition to any of the hyperscalers you might also use.

Aren't the hyperscalers kind of moving in that direction, though? There was a big fuss about egress fees a few years ago. I think at the time, you said that you were really impressed with the way that Oracle was handling their egress. Like they're moving away from database, keep it in, charge people a bunch of money from getting it out.

I don't see any of them moving away from in any significant way. Egress is the cost of taking data out. No one has actually lowered their egress fees in any meaningful way in the last 10 years because it's their lock-in. It's how they actually keep things. And part of the reason we built some storage products is it actually was a way for us to kind of neutralize that advantage that the hyperscalers would sometimes try and leverage for us. But we don't see -- we actually see less competition from the hyperscalers over the last few years rather than more.

Okay. Let's go more to kind of some current events. You guys put up recent quarter some upside, raised the guidance. If you can kind of like rank order what you think went right for you. And then we'll talk about the durability of those things.

I think that -- I mean, the real journey that we've been going through over the last 2 years is transitioning from a product-led growth company where I mean, when you worked on our IPO, the knock on us was we didn't know how to do enterprise sales. And I'd be like, look at all these enterprise customers, of course, we know how to do enterprise sales. We did not know how to do enterprise sales.

It happen then.

It was -- enterprises would use us because we had great products, but then we would sort of be like, great, you bought that product, and we can put your logo on our deck, but we never went and actually sold them anything more because we didn't build relationships with them. And they would come to like events with us. And they would say, if you just spent time understanding our procurement team, we would spend 10x as much with you. We were like, what's the procurement team. And so again, like ...

Yes. They are like Visa, Mastercard, yes.

We were naive at that. Now I think that, that's the right path that you take in order to build big iconic durable companies because you start with product, you build great product. And then you, over time, layer in great sales. Like that's much better than starting with great sales and always be scrambling where you're selling essentially vaporware. We've had great product forever. What we hadn't had is a really sophisticated go-to-market machine. And so when we brought on Mark Anderson, who is one of the lead will be in the hall of fames for kind of enterprise sales leaders over time, and he's brought in a really great team, and we've just up-leveled that team. I think that's what is -- that's what we always said we would see sort of the upswing in the second half of 2025, came a little bit earlier than we thought. I think the real standouts have been Asia and APAC. And why APAC first? APAC because it was smallest, and it was the easiest for us to make just as big a change as we have. But you're seeing that now ripple through EMEA. You're seeing that now ripple through North America. And I think that, that playbook -- there's no reason you can't take that playbook and run it around the rest of the world. And I think that's what gives us confidence in the back half of the year.

Enterprise sales, Hall of Fame. Can't wait to take my kids to that.

Mark Anderson. Yes, it's pretty exciting.

So CJ Desai, also a new addition. I mean, talked about Mark. CJ, I don't know, maybe if I might call it opportunistic, right, to be able to add him to the company. Like what has been the biggest change that CJ or impact that CJ has made in addition to market?

I think that -- so Michelle, who's my co-founder and I have largely divided the business up where the go-to-market side of the business has been Michelle has owned and support and HR and those things. And then I have tended to own product engineering, legal, finance. And we're not co-CEOs, but because she hates being the center of attention, but that -- we kind of operate that way. And she, over the last 2 years, I mean, is the unsung hero of Cloudflare, who has really rebuilt that whole org. And if I look back at the history of Cloudflare, there's always something broken. Like there's always something that's mess. I tend to think of it as like a triangle, each of these things in the pucks or slides between those things. And after sales is one point in the triangle, the next thing that came was going to be shipping, which was how do you actually get products out the door. And we just needed to mature that organization. And I was like -- pardon the vernacular, but s***, that's going to be hard work for me to go upgrade that org. And one day, the phone rings and CJ decides like I want to come work for Cloudflare. And I was like, well, that was easy. And Michelle is like, come on, seriously. And so -- and he's just been amazing. I think the places that it's shown up most actually are he is -- he has taken that sort of wisdom of being a product and engineering leader, but then he's the most sales-driven, customer-focused product and engineering leader I've ever met. And he cares enormously and has a Rolodex. You walk down the street in New York with CJ. and he's like, hey, Bob, what else? He knows everyone. And he's trusted in these places because he's gone in and presented a road map and delivered on that road map when he was at Oracle, when he was at ServiceNow, and that was great. I think the other thing with CJ is -- and CJ got a chip on his shoulder because what happened to him at ServiceNow, I tend to think was deeply unfair. And he's got something to prove. And he's like, I took a company from $1 billion to $10 billion. I can do it again. I can do it faster, and that's what we're doing at Cloudflare and so he's just been great to work with and it made my job super easy.

Do he and Mark work well together? I mean...

Super well together. Yes. I mean, Mark was his biggest internal champion when we were thinking about him. And I remember kind of thinking if our president revenue is suggesting who's going to be our product and engineering leader, then obviously, we're not going to hire that person. And then it turned out he was just amazing.

So this is one of the questions that your team struck from the record. And I hope that I don't offend you here, but...

You're not going to offend.

I think this was like maybe 10, 11 years ago at the time Cloudflare was 3 or 4 years old. And you said you only had 3 lines of code left even at that time, hundreds of thousands of lines of code, you only had 3 lines of code left. Michelle always operationally focused like Six Sigma Black Belt, right? Lee was kind of the genius architect, right, technical genius. And so yes, you got to think yourself. Now it's like, all right, we brought Mark, we brought CJ. Like what is Matthew the CEO? Like what is it that makes you the right CEO for the company for the last 10 years, for the next 10 years?

I'm P.T. Barnum, I think, at some level. I mean, what am I good at? I'm actually good.

That's what I'm asking and that was the offensive part.

Yes. I think I'm good at packaging up the amazing work that our teams do and then building that into a story that we can tell to customers, that we can tell to investors that people can see what that vision is and I think that, that's been something that I am surprised, like I went to a lot of schools. So I studied English literature in computer science and college. I went to law school, then I went to business school. Of those degrees, the one that has turned out to be the most useful as the CEO of the company is the English literature degree. To be able to communicate and write and align a team as quickly as possible is, I think, super important. And what I try and coach our managers and leaders is you might be great at engineering, but if you want to actually be a great manager, you've got to learn to speak and write as clearly as possible. And I think that's just a big part of our culture. You look at our blog, you look at those things. I think there's a lot of kind of that, that has come from me. I also think like I was actually a terrible early-stage start-up. I was always worried about I'd be like, well, if we do that, what legal framework is that going to implicate because I went to law school and all these things. That matters right now. The fact that I went -- like my parents for a long time are like, that was kind of a waste of 3 years when he went to law school. Today, as we're thinking about some of the things we're doing, and I'm like that time when I was an antitrust lawyer, that's going to be really useful right now because there's a lot of the Internet that is behind us, and we might have those challenges as we go forward.

Yes. So we'll get into your educational background, again, and its relevance to today. But speaking of storytelling, you've got multiple acts going on, right? Do you mind just kind of telling the story of what we are talking about, Act 1, Act 2, Act 3 and then we'll get into Act 4.

Sure. So at some level, the whole story of Cloudflare is we started out with something that was a pretty simple idea, which was how could you put a firewall in the cloud? And the reason we thought that was important was we saw that software was shifting to the cloud. We saw hardware was shifting to the cloud. We thought eventually all the network services were going to shift to the cloud as well. And that was the story we told at our IPO, and it was really kind of the foundation of what we were doing. And Michelle and I, we were in business school together. We saw this and being a plucky business students, we were like that is a market opportunity. Let's go run after that market opportunity. And so we were putting the firewall in the cloud. The first problem that we had was in order to make that firewall kind of effective, we needed data. And so the question is how do you get data? And we knew eventually to be a big business, we had to sell to the big banks and things like that. But they weren't going to buy us unless we could actually provide some value to them. So we needed data to flow through the system. So we're like, well, if we create a sort of free stripped down version and make that available. We had no idea how wildly successful that would be. But as a result of that, all of a sudden, we had just a huge series of problems where people were complaining that our performance wasn't fast enough. So we had to solve that. And we tried just to get back to performance neutral. We were a little bit better at that. So all of a sudden, we were making the Internet faster. So now we had a new feature we could sell. We had all these hacker kids that would sign up because they like the free service and then they would try and attack each other. We didn't start out as a DDoS mitigation service, but we needed to do it because we couldn't just fire customers when they got DDoS attacked or when it works so we had to build that. We didn't want to build DNS. We went out to Ultra and Dine and said, is there some way we can do this, but we had all these free customers, and they all wanted to charge based on the number of domains. So then we had to build that. So over time...

How did you know how to do that stuff? Like how did you know it's like, all right, well, now we're...

Someone else had done it. So I figured we could do it too. I mean -- and we hired smart engineers. And again, and so we just kind of kept building the different bits. Over time, that developed into a series of products that we call Act 1. And that the acts are basically temporal on when we built them, but they all come from the same place, which was we had problems to solve, we needed to solve them for ourselves. And so the Act 1 products are all what technically would be called reverse proxy products. They're how do you protect or accelerate or make available those applications or services that you're exposing to the rest of the world. So we built all that. And then at some point, we're like, gosh, we're becoming a big company. And we have all these employees and they're doing things and people try to hack them and infect them and do things. So we need something to be able to protect them. And we didn't -- at first, we have like a Cisco like VPN that we were using, but we were increasingly distributed around the rest of the world. And so we were like we should do a cloud-based version of this. And so Zscaler was around, so we called them. And we're like, these guys' security isn't very good and they're actually not that fast. And so people -- we've demoed it and they didn't perform very well.

The Zscaler you're talking about?

Yes, totally. And so our team was like, we're not going to use that. We'll just build it ourselves. So the next thing you know, we're building freaking a Zscaler competitor, which turns into -- and we built it for ourselves and then customers will be like, wow, that's pretty neat. I mean I can demo to you on stage how much more effective our version of that is than anyone else. And people were like, that's cool. Can we buy that, too? And so then that became a whole another class of products, which are Zero Trust, SASE, CASB, DLP, all of those different things, but they were all because we needed that. In 2017, we hit a wall. And it was -- I remember, I was actually here in Park City on vacation, and my wife went out to the grocery store and she came back and she was like, so strange. I went to pay for the groceries and like all the cash registers were down and I was like, yes, it was my fault. And she's like, no, there are a lot things in the world that are your fault, but you don't control the cash register. So I was like actually NCR is a customer and we had a big outage and it took them all down. And the reason we had an outage, that was not the worst story of that day. The worst story of that day was getting a call from a very senior executive at FedEx, who said, how much longer before you're back online? And I was like, we're getting back, I'm so sorry. And I was like FedEx isn't the customer, and they're like, yes, what Garmin is and all of our planes require Garmin to be able to land or take off. And some of them are running low on fuel. So imagine you're an engineer. The reason that we had that outage was we pushed a bad piece of code. And we had a pretty brittle system for pushing code, and it didn't work very well and scaling it was hard. We had a whole team that managed it. And we had all these ideas. We had all this stuff to build. But it would back up because we got so scared about pushing new code out. And so I sat with this guy from a company that we just acquired named Kenton Varda with another guy who was our CTO at the time, John Graham, coming at a little Mexican restaurant across from our office. And Kenton, on a salsa stained placemat, sketched out, here's how a developer platform in the future should look. And so we're like, okay, here's a small team, go build it. And he did. He went around in the corner, built it. 2017, we do it, released it to our team first. The idea was you could sandbox things, you could isolate it to individual customers, you could roll code out in progressive ways, would auto scale, had all these security guarantees that were in place, super, super, super fast. Our team fell in love with it. Same story. They then show it to our customers. Our customers are like, how do you guys innovate so fast? I'm like, oh, let's show us your developer platform. They're like, can we buy that? That turned into Act 3, right? So that's what Workers is today. And customer zero for all of these things always is Cloudflare. We create problems and then we go and we solve them. And so that's temporarily how these things work. When we are at our best, though, we don't talk about individual features with customers. And when we talk in earnings calls about how we're doing these pool of funds deals, what that really is, is a customer saying, I don't exactly know what I'm going to use with Cloudflare, but I am confident I'm going to spend at least X million dollars with you. So let me just put in place a commitment and I'm going to send that with you. You give me a rate card, as you add new products, just put them on the rate card and let's go. And we're seeing more and more people saying, we want the entire platform. And that's really powerful for us. And you can see today, we just announced we've got this new bundling where we're kind of merging together Act 1, Act 2, Act 3 into these really coherent bundles. The place that's going to be really powerful for us and where we've struggled is with partners because like we internally understand how all the pieces fit together and we can put that together. Now that we've got sort of that understanding, we've been able to model it out, now we can hand that playbook to partners, and you're going to watch the partner side of our business just take off, I think, over time.

Okay. So in a pool of funds deal, is it incumbent upon the customer? Or is there somebody internally at Cloudflare that like goes to them and says like, "Hey, just so you know, you have access to all of these different things, maybe try this, maybe try this?" Or is it like the customer has to be -- they have to be curious. They have to be tinkers. They have to be trial and error?