Cloudflare, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Cloudflare provides cloud services focused on security, performance, and reliability. Financial statements are unaudited.
Key financial results
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $172.3 million | $114.2 million | $462.8 million | $305.1 million |
| Gross margin | 78% | 76% | 77% | 76% |
| Operating loss | $26.5 million | $21.3 million | $86.6 million | $82.0 million |
| Net loss | $107.3 million | $26.5 million | $182.8 million | $85.3 million |
| Free cash flow (non-GAAP) | $(39.7) million | $(17.9) million | $(51.7) million | $(68.6) million |
- Revenue grew 51% in Q3 and 52% for the nine-month period. Management attributed growth primarily to new customers and customer expansion.
- Q3 paying customers rose 31% year over year to 132,390; customers with annualized revenue above $100,000 increased to 1,260 from 736. Dollar-based net retention was 124%, versus 116% a year earlier.
- Operating expenses increased 49% in Q3 to $161.3 million, led by sales and marketing, research and development, and general and administrative spending. Q3 non-GAAP operating income was $2.2 million, compared with a $4.5 million loss a year earlier; this measure excludes stock-based compensation and other specified items.
- Q3 net loss included a $72.2 million loss on extinguishment of debt related to the 2025 Notes exchange. Interest expense also rose, partly due to the 2026 Notes.
- Nine-month operating cash flow was positive $24.0 million, versus an $8.3 million outflow in 2020. Nine-month free cash flow remained negative, though improved year over year. Q3 operating cash flow was negative $6.9 million.
Liquidity, debt, and balance sheet
- At September 30, 2021, cash and cash equivalents were $618.2 million and available-for-sale securities were $1,195.6 million. Management said these resources were expected to cover working capital and capital expenditure needs for at least 12 months.
- Convertible senior notes had a net carrying value of $1.143 billion; aggregate principal was $1.469 billion. The company issued $1.294 billion of 0% notes due 2026 in August and exchanged approximately $400 million principal of its 2025 Notes for cash and 7.6 million Class A shares. The exchange left $175 million principal of 2025 Notes outstanding.
- The 2025 Notes were convertible at holders’ option through December 31, 2021, following satisfaction of the conversion condition. Cloudflare stated its current intent to settle principal on both note series in cash, but conversions could affect liquidity or dilute shareholders depending on settlement.
- Current assets were $1.931 billion and current liabilities $227.0 million. Accumulated deficit was $603.3 million. Operating lease liabilities totaled $104.6 million; additional contractual commitments include leases, bandwidth/co-location, and purchase agreements.
Outlook, risks, and unusual items
- No specific revenue or earnings guidance was provided in the supplied filing text. Management expects operating expenses to rise in absolute dollars as it invests in hiring, sales, research and development, and network infrastructure; it expects continued operating losses and negative operating cash flows for the foreseeable future. It expects gross margin to remain broadly consistent over the long term, with period-to-period variation possible.
- Management reported no currently anticipated material adverse impact from COVID-19, but emphasized uncertainty, including possible customer spending and collection effects and supply-chain delays for network hardware.
- Material risks include intense competition; customer retention and large-customer concentration/expansion challenges; service outages or security failures; reliance on co-location, ISP and interconnection partners; hardware supply constraints; evolving privacy and content laws; international and China operations; and the ability to achieve profitability and service or settle convertible debt.
- An OFAC voluntary self-disclosure concerning potential sanctions issues remained under review; the company said any loss was not probable and the possible range was not estimable. The filing also describes a Portuguese data-protection authority decision directing a customer to discontinue use of Cloudflare services, with potential broader regulatory implications.
- On October 15, 2021, after quarter-end, Cloudflare acquired a server-side rendering technology company for approximately $12.8 million; purchase accounting was still in progress.
Investor verification points
- Check the reconciliation and assumptions behind non-GAAP operating results and free cash flow, including stock-based compensation and capital expenditures.
- Review the convertible-note terms, 2025 Notes conversion window, potential cash settlement needs, and dilution effects of the exchange and future conversions.
- Monitor customer growth, large-customer expansion, retention, and deferred performance obligations of $545.4 million, of which 75% was expected to be recognized within 12 months.
- Track operating cash generation against infrastructure investment, contractual commitments, and management’s stated 12-month liquidity assessment.
- Follow the OFAC review, privacy/regulatory developments, China partner arrangements, and network hardware supply constraints.