Cloudflare, Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Unaudited results; filed August 4, 2022. Cloudflare provides cloud services focused on security, performance, and reliability.
Financial performance and liquidity
| Metric | Q2 2022 | Q2 2021 | First half 2022 | First half 2021 |
|---|---|---|---|---|
| Revenue | $234.5 million | $152.4 million | $446.7 million | $290.5 million |
| Gross profit / margin | $178.7 million / 76% | $117.4 million / 77% | $343.8 million / 77% | $223.4 million / 77% |
| Operating loss | $64.5 million | $28.9 million | $104.6 million | $60.1 million |
| Net loss | $63.5 million | $35.5 million | $104.9 million | $75.5 million |
| Net loss per share | $0.20 | $0.12 | $0.32 | $0.25 |
| Free cash flow | $(4.4) million | $(9.8) million | $(68.8) million | $(12.0) million |
- Revenue grew 54% year over year in both Q2 and the first half. Management attributed growth to customer additions and expansion within existing customers.
- GAAP operating margin was (28)% in Q2 versus (19)% a year earlier; first-half operating margin was (23)% versus (21)%. Non-GAAP operating result was a loss of $0.9 million in Q2 and income of $4.0 million for the first half; these measures exclude stock compensation and other items.
- Q2 operating cash flow was $38.3 million, compared with $7.5 million a year earlier. First-half operating cash flow fell to $2.8 million from $30.9 million. First-half capital spending and capitalized software were $61.6 million and $10.0 million, respectively.
- At June 30, cash and cash equivalents were $142.7 million and available-for-sale securities were $1.499 billion. Total restricted cash was $11.1 million. Management said available cash, equivalents, and securities should meet working-capital and capital-expenditure needs for at least 12 months.
- Convertible notes had a net carrying value of approximately $1.434 billion: $1.277 billion of 2026 notes and $156.4 million of 2025 notes. Principal outstanding totaled approximately $1.452 billion. The 2026 notes bear 0% interest; the 2025 notes bear 0.75% and mature in 2025. Management intends to settle principal in cash upon conversion.
Changes and operating metrics
- Q2 gross margin declined one percentage point year over year. Operating expenses rose 66% to $243.3 million, including higher hiring, stock-based compensation, sales and marketing, and research and development costs. First-half stock-based compensation was $88.8 million versus $38.6 million.
- Paying customers totaled 151,803, up 20% year over year; customers with annualized revenue above $100,000 rose to 1,749 from 1,088. Dollar-based net retention was 126%, compared with 124% a year earlier.
- Management reported a meaningful Q2 reduction in pay-as-you-go paying customers, partly as customers moved to free plans. It also reported a longer sales cycle for large customers, slower potential-customer pipeline growth, and slower collections from some customers.
- A system error overstated Q1 2022 paying customers by 5,925; the corrected Q1 count was 148,184. The filing says the revenue impact was less than $0.2 million.
- Remaining performance obligations were $760.4 million at quarter-end; 76% was expected to be recognized as revenue over the next 12 months.
Outlook, risks, and unusual items
- No numerical full-year revenue or earnings guidance is provided in the filing. Management expects operating expenses to increase in absolute dollars and operating losses and operating cash flow to fluctuate as it invests in network infrastructure, research and development, and sales and marketing. It expects gross margin to remain consistent over the long term, while noting period-to-period variation.
- Management said COVID-19, the Russia-Ukraine conflict, inflation, rising interest rates, and currency movements had not materially harmed results to date, but identified lengthening enterprise sales cycles, slower pipeline activity, delayed payments, and pay-as-you-go customer losses as current effects. Further deterioration could weigh on demand, renewals, collections, costs, and international sales.
- Cloudflare acquired Area 1 Security in April for approximately $156.6 million in cash, stock, and holdbacks, and acquired Vectrix in January for approximately $7.6 million. Area 1 added $120.8 million of goodwill; acquisition accounting and integration may affect future results.
- Adoption of ASU 2020-06 on January 1, 2022 changed convertible-note accounting, increased reported debt carrying value, and eliminated amortization of the notes’ debt discount. This materially reduced year-over-year interest expense comparisons; first-half 2022 interest expense was $2.6 million versus $20.7 million.
- A June 2022 network configuration change caused an outage of about 1.5 hours affecting traffic at 19 co-location facilities. The company said it had no material impact on results or financial condition.
- An OFAC voluntary self-disclosure concerning potential sanctions violations remained under review; the potential loss was not considered probable or estimable. The company reported no pending or threatened legal proceeding likely to have a material adverse financial effect.
- Other key risks include competition, customer retention and upgrades, network security and availability, data and privacy regulation, dependence on co-location and ISP relationships, international regulation and operations, and possible dilution or cash demands from convertible notes. Class B shares carry 10 votes per share, concentrating voting control.
Investor verification priorities
- Track pay-as-you-go customer trends, renewals, enterprise sales cycles, collections, and customer expansion; review the corrected Q1 customer count and calculation methodology.
- Assess whether revenue growth can offset rising operating expenses and stock-based compensation, and monitor GAAP losses alongside non-GAAP results.
- Reconcile operating cash flow and free cash flow with capital expenditure, acquisition spending, and investment maturities; monitor liquidity against contractual commitments.
- Review convertible-note principal, conversion and cash-settlement provisions, and any future share dilution or cash requirements.
- Follow the OFAC review, Area 1 integration and purchase accounting, and any further service outages or related customer credits.