Cloudflare Earnings: Poor Sales Execution Offsets Push to Profitability as Macro Tightness Persists

We are maintaining our $60 fair value estimate for narrow-moat Cloudflare NET after the firm reported a mixed first quarter, with better-than-expected profitability offset by a weaker sales outlook for the remainder of the year. While we continue to have a positive view on Cloudflare’s overall business and management’s push to expand margins, we were surprised to hear of the sales execution challenges stemming from underperforming salespeople. We expect Cloudflare to resolve these personnel-related challenges in the coming quarters and anticipate these issues will dissipate over time. Although our view is not shared by many investors, we believe the market’s selloff—Cloudflare’s share price dropped more than 20% after the earnings report—is overly punitive. We believe that long-term investors could benefit by purchasing the shares at a discount.

Cloudflare’s top line clocked in at $290 million, representing a 37% year-over-year increase, with the firm experiencing particularly robust growth in the United States and Europe. Although the top-line performance for the quarter was in line with our estimates, management noted a deterioration in sales conditions as the quarter progressed. This deterioration was particularly evident in Cloudflare’s expansion motion, with larger clients delaying purchasing decisions, resulting in the firm’s net retention rate falling to 117% from 127% a year ago.

However, the firm’s bottom line came in higher than our expectations as Cloudflare continued to moderate its operating expenditures in a tough macro environment. Adjusted operating margin for the quarter was 6.7%, up from 2.3% a year ago and our estimates of around 4%.