Cloudflare, Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; filed May 5, 2022. Unaudited results. Cloudflare provides cloud-based security, performance, and reliability services through subscriptions.
Financial performance and position
| Metric | Q1 2022 | Q1 2021 |
|---|---|---|
| Revenue | $212.2 million | $138.1 million |
| Gross profit / margin | $165.1 million / 78% | $106.0 million / 77% |
| Operating expenses | $205.1 million | $137.2 million |
| Operating loss | $40.0 million | $31.3 million |
| Non-GAAP operating income (loss) | $4.9 million | $(7.5) million |
| Net loss / diluted loss per share | $41.4 million / $0.13 | $40.0 million / $0.13 |
| Operating cash flow | $(35.5) million | $23.5 million |
| Free cash flow | $(64.4) million | $(2.2) million |
Revenue grew 54%, primarily from new customers and expansion within existing accounts. Paying customers increased 29% to 154,109; customers with annualized revenue above $100,000 increased to 1,537 from 945. Dollar-based net retention was 127%, versus 123%.
Cash and cash equivalents were $152.0 million and available-for-sale securities were $1.573 billion at quarter-end. Together, these totaled approximately $1.725 billion. Convertible notes had a net carrying amount of approximately $1.433 billion; total principal outstanding was approximately $1.452 billion. Accumulated deficit was $687.9 million. The investment portfolio was investment grade, with an average AA rating, and had $12.7 million of net unrealized losses.
Changes and notable items
- Revenue rose 54%; gross margin improved about one percentage point. Operating expenses increased 49%, including higher hiring, network costs, marketing, and research and development spending.
- Operating cash flow shifted from positive $23.5 million to negative $35.5 million. Management attributed the Q1 2022 outflow in part to receivables growth and timing of collections, accrued-liability decreases, and higher deferred customer-acquisition costs. Capital expenditure and capitalized software spending totaled $28.9 million, contributing to negative free cash flow.
- Stock-based compensation expense increased to $34.0 million from $18.0 million. Non-GAAP operating income excludes stock-based compensation and related payroll taxes, acquired-intangible amortization, and acquisition-related and other expenses.
- Cloudflare adopted ASU 2020-06 on January 1, 2022, changing convertible-note accounting and eliminating amortization of the notes’ debt discount. This contributed to lower reported interest expense versus Q1 2021, so the comparison is not directly like-for-like.
- In January, Cloudflare acquired Vectrix for approximately $7.6 million. The Area 1 Security acquisition, agreed at approximately $162 million, closed April 1, after quarter-end. The company expects approximately $300 million of stock-based compensation expense from certain performance-based options over a weighted-average period of about five years.
Outlook, risks, and contingencies
- Management expects operating expenses to increase in absolute dollars as it invests in hiring, sales and marketing, product development, and network infrastructure. It expects gross margin to remain consistent over the long term, but noted margins may fluctuate. The filing does not provide a clear quantitative revenue or earnings forecast in the supplied text.
- The company expects operating losses to continue and operating cash flow to fluctuate between positive and negative while it invests for growth. Management believes existing cash, cash equivalents, and available-for-sale securities will cover working capital and capital expenditure needs for at least 12 months.
- Key risks include sustained losses, competition, customer retention and large-customer sales cycles, security incidents or network outages, hardware supply constraints, international regulation and data-transfer requirements, and effects of COVID-19 and geopolitical uncertainty.
- The 2025 convertible notes became holder-convertible from April 1 through June 30, 2022. Cloudflare said it currently intends to settle the principal of both note series in cash, subject to the indentures and its settlement election.
- An OFAC voluntary self-disclosure concerning potential sanctions violations remained under review; the filing states that any loss was not considered probable and could not yet be estimated. Management reported no pending or threatened legal proceeding it believed likely to have a material adverse effect, while noting litigation outcomes are uncertain.
Important facts for investors to verify
- Whether customer growth, retention, and large-customer expansion sustain revenue growth as sales cycles lengthen.
- Whether cash-flow deterioration and network investment needs persist, and how liquidity changes after the Area 1 acquisition.
- The effect of convertible-note conversions, cash settlement, and potential dilution, particularly for the 2025 notes.
- The timing and income-statement impact of the expected approximately $300 million performance-option compensation expense.
- Developments in the OFAC review, data-protection regulation, cybersecurity and service reliability, and supply-chain constraints.