Cloudflare, Inc. — Q2 2021 Form 10-Q
Business context and period: Cloudflare provides cloud-based security, performance, and reliability services. This unaudited quarterly report covers the three and six months ended June 30, 2021, compared with the same periods in 2020.
Financial and operating performance
| Metric | Q2 2021 | Q2 2020 | Change |
|---|---|---|---|
| Revenue | $152.4 million | $99.7 million | +53% |
| Gross profit / margin | $117.4 million / 77% | $75.6 million / 76% | Margin +1 percentage point |
| Operating expenses | $146.3 million | $100.3 million | +46% |
| Operating loss / margin | $(28.9) million / (19)% | $(24.7) million / (25)% | Loss widened; margin improved |
| Net loss | $(35.5) million | $(26.1) million | Loss widened |
| Net loss per share, diluted | $(0.12) | $(0.09) | |
| Operating cash flow | $7.5 million | $4.0 million | |
| Free cash flow (non-GAAP) | $(9.8) million | $(20.2) million | Improved |
For the six months ended June 30, revenue was $290.5 million, up 52%; gross margin was 77% versus 76%; operating loss was $60.1 million versus $60.8 million; and net loss was $75.5 million versus $58.9 million. Operating cash flow was $30.9 million, compared with cash used of $10.3 million; free cash flow was $(12.0) million versus $(50.8) million. Free cash flow is a non-GAAP measure defined as operating cash flow less property and equipment purchases and capitalized internal-use software.
Growth reflected new customers and expansion in existing accounts. Paying customers increased 32% year over year to 126,735; customers with annualized revenue above $100,000 rose to 1,088 from 637. Dollar-based net retention was 124%, up from 115%. The United States generated 52% of Q2 revenue; international markets generated 48%.
Balance sheet, debt, and liquidity
- At June 30, 2021, cash and cash equivalents were $247.6 million and available-for-sale securities were $786.0 million, totaling approximately $1.03 billion. The investment portfolio was investment grade, with an average AA rating.
- Total assets were $1.45 billion; current liabilities were $200.5 million; total liabilities were $644.8 million. The accumulated deficit was $496.0 million.
- The company had $575.0 million principal amount of 0.75% convertible senior notes due May 2025; their net carrying value was $401.4 million. Q2 interest expense was $10.4 million, primarily reflecting coupon interest and amortization of the debt discount and issuance costs.
- Management said existing cash, cash equivalents, and securities should cover working capital and capital expenditure needs for at least 12 months, while noting that forecasts depend on business performance and other uncertainties.
Material changes, outlook, and risks
- Revenue growth outpaced cost of revenue, keeping gross margin broadly stable. Operating expenses rose as Cloudflare expanded hiring, sales and marketing, research and development, and general infrastructure; stock-based compensation was $20.6 million in Q2.
- Management expects operating expenses to rise in absolute dollars as it invests in growth, product development, sales, and network infrastructure. It expects continued operating losses and negative operating cash flows for the foreseeable future; no specific numerical revenue or earnings guidance is provided in the filing.
- The notes became convertible at holders’ option from July 1 through September 30, 2021 after the stock-price conversion condition was met. Cloudflare stated its current intent to settle the notes’ principal in cash. Conversion, repurchase, or refinancing could affect liquidity; capped calls are intended to reduce dilution or excess conversion payments, subject to a cap.
- Cloudflare disclosed an unresolved voluntary self-disclosure to OFAC concerning potential U.S. sanctions violations involving use of its services by certain restricted parties. The review remained open; no loss was recorded because a loss was not considered probable and the possible range was not estimable. The company said penalties, market restrictions, and reputational harm could result.
- Other key risks include cybersecurity incidents and service outages, reliance on data-center and ISP relationships and hardware supply, competition, customer retention and large-customer sales, evolving privacy and content rules, and dependence on JD Cloud & AI for its China network. The filing also describes copyright-related litigation and adverse decisions in Italy and Germany. COVID-19 and the Delta variant could disrupt customers, operations, and hardware provisioning.
- A subsequent event was a July 2021 Austin office lease with approximately $46.2 million in fixed payments over its term, plus operating costs. Management reported disclosure controls were effective at a reasonable-assurance level and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether customer additions, enterprise growth, and 124% net retention continue to support revenue growth.
- Whether operating expense growth and stock-based compensation translate into improved GAAP profitability and sustainable free cash flow.
- The timing and cash, dilution, and accounting consequences of any conversion of the $575 million notes, including the September 30, 2021 end of the disclosed conversion window.
- Developments in the OFAC review, including any potential penalties or business restrictions, and updates on content-related litigation or regulatory requirements.
- Whether network investment, co-location and bandwidth commitments, hardware availability, and the China partnership can support growth without impairing service or margins.