Cloudflare, Inc. — Q2 2023 Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2023. The unaudited statements are prepared under U.S. GAAP; the company cautions that interim results are not necessarily indicative of full-year results.
Business context
Cloudflare provides cloud services for network security, performance, and reliability. It earns most revenue from subscriptions and related support, serving customers through direct and channel sales. The company reported one operating segment.
Financial performance and liquidity
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Revenue | $308.5M | $234.5M | $598.7M | $446.7M |
| Gross profit / margin | $233.3M / 76% | $178.7M / 76% | $453.0M / 76% | $343.8M / 77% |
| Operating loss | $56.2M | $64.5M | $103.4M | $104.6M |
| Net loss | $94.5M | $63.5M | $132.5M | $104.9M |
| Operating cash flow | $64.5M | $38.3M | $100.9M | $2.8M |
| Free cash flow (non-GAAP) | $20.0M | $(4.4)M | $33.9M | $(68.8)M |
Q2 non-GAAP operating income was $20.3M, a 7% margin, compared with a $0.9M loss in Q2 2022. GAAP operating margin improved to negative 18% from negative 28%. Stock-based compensation was $68.4M in Q2 and $125.8M for the first half.
At June 30, cash and cash equivalents were $159.3M and available-for-sale securities were $1,425.3M. Current assets were $1.818B and current liabilities were $473.1M. Total liabilities were $1.891B; convertible notes, net, totaled $1.317B, including $35.3M of 2025 Notes classified as current and $1.281B of 2026 Notes. Accumulated deficit was $972.4M.
Material changes versus comparable periods
- Revenue grew 32% year over year in Q2 and 34% for the first half, attributed to new paying customers and expansion among existing customers.
- Paying customers increased to 174,129 from 151,803; customers with annualized revenue above $100,000 rose to 2,352 from 1,749. Dollar-based net retention declined to 115% from 126%.
- Gross margin was flat at 76% in Q2 and slipped to 76% from 77% for the first half. Cost of revenue grew faster than Q2 revenue, reflecting network capacity, depreciation, and third-party costs.
- Operating loss narrowed, but net loss increased, principally reflecting a $50.3M loss on extinguishment from repurchasing $123.0M principal amount of 2025 Notes for $172.7M cash, including accrued interest.
- Operating cash flow and free cash flow improved substantially year over year. First-half financing cash outflow was $167.4M, mainly from note repayments and an indemnity-holdback payment.
Outlook, commentary, and risks
- Management said Q2 sales-cycle and pipeline-conversion trends improved from Q1, but warned macroeconomic uncertainty could cause slower purchasing, longer sales cycles, delayed collections, higher churn, and customer requests for concessions to recur. Sales productivity also weakened late in 2022 and in Q1 2023; improvement efforts may take time.
- The company expects continued investment in sales and marketing, research and development, and network infrastructure. It expects operating expenses to rise in absolute dollars; it expects gross margin to remain consistent over the long term, while acknowledging period-to-period fluctuations. No numerical full-year revenue or earnings guidance is stated in the provided filing text.
- Remaining performance obligations were $1.036B at June 30; the company expected to recognize 75% as revenue within 12 months. This is contracted performance obligation value, not a guarantee of future results.
- Management believes existing cash, cash equivalents, and available-for-sale securities will cover working capital and capital expenditure needs for at least 12 months. It expects continued operating losses and cash-flow variability for the foreseeable future and notes that additional capital may be needed.
- In July 2023, Cloudflare settled the remaining $35.4M principal of its 2025 Notes with cash and approximately 0.5M Class A shares; no 2025 Notes remained outstanding after settlement. The $1.294B principal amount of 0% 2026 Notes remains due in August 2026.
- An OFAC voluntary self-disclosure concerning potential sanctions violations remains under review; the company says any potential loss is not probable and cannot yet be estimated. It identifies possible fines, penalties, reputational damage, and market-access impacts. Management reported no pending or threatened legal proceeding it believes likely to have a material adverse effect.
- Key risks include macroeconomic conditions, customer retention and expansion, competition, network outages or security incidents, privacy and regulatory obligations, international operations and the JD Cloud relationship in China, and continued losses. Disclosure controls were assessed as effective at a reasonable assurance level, with no material change in internal control reported.
Important facts for investors to verify
- Whether retention, large-customer growth, and sales productivity stabilize, given the decline in dollar-based net retention to 115%.
- Whether operating cash flow and non-GAAP free cash flow remain positive after considering working-capital movements, infrastructure spending, and contractual commitments.
- The level and effect of stock-based compensation, including its contribution to operating costs and dilution.
- The outcome of the OFAC review and any developments in regulatory, privacy, or customer-content litigation matters.
- Cash and liquidity needs, the terms and repayment capacity for the 2026 Notes, and the completed July 2023 settlement of the 2025 Notes.
- Whether macroeconomic pressures, network and co-location costs, and international or China-related risks affect growth, margins, or customer demand.