Cloudflare, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; unaudited U.S. GAAP financial statements. Cloudflare provides global cloud services focused on security, performance, and reliability. Revenue is primarily subscription and support revenue.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $290.2 million | $212.2 million | +37% |
| Gross profit / margin | $219.7 million / 76% | $165.1 million / 78% | Margin down 2 percentage points |
| Operating loss / margin | $(47.3) million / (16)% | $(40.0) million / (19)% | Loss widened; margin improved |
| Non-GAAP operating income / margin | $19.4 million / 7% | $4.9 million / 2% | Improved |
| Net loss | $(38.1) million | $(41.4) million | Loss narrowed |
| Operating cash flow | $36.4 million | $(35.5) million | Improved |
| Free cash flow | $13.9 million / 5% margin | $(64.4) million / (30)% margin | Improved |
Revenue and customers: Revenue growth reflected new customers and expansion within existing accounts. Paying customers were 168,159, up 13% year over year using the company’s corrected prior-year count. Customers with annualized revenue above $100,000 increased to 2,156 from 1,537. Dollar-based net retention declined to 117% from 127%. International customers contributed 47% of revenue in both periods. Channel partners generated 14% of Q1 2023 revenue, versus 11% a year earlier.
Expenses and cash generation: Cost of revenue rose 50%, faster than revenue, contributing to lower gross margin. Sales and marketing increased 37%, R&D 22%, and G&A 27%. Stock-based compensation was $57.4 million, versus $34.0 million. Operating cash flow turned positive, though working-capital movements included a $32.8 million increase in receivables and a $19.4 million increase in deferred contract acquisition costs. Capital expenditures and capitalized software totaled $22.5 million.
Liquidity and debt: At March 31, 2023, cash and cash equivalents were $256.4 million and available-for-sale securities were $1.459 billion; the investment portfolio was investment grade, with an average AA+ rating. Current assets were $1.954 billion and current liabilities $444.5 million. Convertible notes had a net carrying value of $1.437 billion, comprising $1.294 billion principal of 0% notes due 2026 and $158.4 million principal of 0.75% notes due 2025. Management said existing cash, equivalents, and securities should cover working capital and capital expenditures for at least 12 months.
Changes, outlook, and risks
- Management reported a significant lengthening of sales cycles in Q1, particularly for expansions, a significant decline in conversion of pipeline opportunities to sales, and increased days sales outstanding. It warned some or all of these trends may continue in 2023.
- Management expects continued investment and operating losses; it gave no specific numerical revenue or earnings guidance in the provided filing text. It expects gross margin to remain consistent over the long term, but says it may fluctuate.
- The 2025 notes became convertible at holders’ option from April 1 through June 30, 2023 after a stock-price conversion condition was met. Cloudflare stated its current intent is to settle note principal in cash. The 2026 notes’ conversion conditions were not met in Q1.
- In April 2023, the board approved amendments to certain performance options, effective May 1. Cloudflare anticipated approximately $28 million of additional stock-based compensation expense over an average period of about 4.4 years; the accounting assessment was still being finalized.
- Commitments included $120.7 million of future bandwidth and co-location-related payments and $97.4 million of open purchase agreements. Operating lease liabilities totaled $143.6 million; a further $46.7 million of undiscounted payments related to leases not yet commenced.
- Risks highlighted include macroeconomic pressure on customer spending and collections, customer churn and slower sales, competition, network outages and cybersecurity incidents, international regulation and data-transfer requirements, and dependence on network and interconnection partners. Cloudflare’s new JD Cloud agreement for China, executed in April 2023, extends to March 2026 on less favorable economic terms than the prior agreement.
- An OFAC voluntary self-disclosure concerning potential sanctions violations remained under review; the company said potential losses were not probable or estimable. Management said no pending or threatened legal proceeding was likely to have a material adverse effect, while noting litigation outcomes are uncertain.
- Management reported disclosure controls and procedures were effective at a reasonable-assurance level and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Reconcile the paying-customer comparison: one table shows 154,109 for Q1 2022, while the filing identifies 148,184 as the corrected count after a system error; management’s stated 13% growth uses the corrected figure.
- Track sales-cycle duration, pipeline conversion, collections and receivables, churn, and retention, given the deterioration described by management and the 117% net retention rate.
- Assess the 2025 notes’ conversion and cash-settlement implications, including the amount ultimately converted or repurchased and related liquidity needs.
- Monitor stock-based compensation and dilution, including the anticipated incremental expense from the amended performance options.
- Follow the OFAC review, regulatory and customer-content litigation exposure, and the financial and operating implications of the revised JD Cloud terms.
- Compare GAAP results with non-GAAP measures: non-GAAP operating income excludes stock-based compensation and related payroll taxes, acquired-intangible amortization, and acquisition-related items.