Cloudflare, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; filed November 12, 2019. Cloudflare provides cloud-based network security, performance, and reliability services. The company completed its IPO in September 2019.
Financial results and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $73.9 million | $50.1 million | $203.1 million | $137.2 million |
| Gross profit / margin | $57.9 million / 78% | $38.9 million / 78% | $157.9 million / 78% | $106.6 million / 78% |
| Operating loss | $41.1 million | $36.5 million | $78.0 million | $67.8 million |
| Net loss | $40.9 million | $38.0 million | $77.7 million | $70.5 million |
| Free cash flow (non-GAAP) | $(33.6) million | $(22.1) million | $(72.7) million | $(49.2) million |
Revenue grew 48% year over year in both the quarter and nine-month period. Q3 operating expenses rose 31% to $99.0 million; sales and marketing and research and development grew substantially. Nine-month operating cash use was $30.3 million, compared with $31.0 million a year earlier. Nine-month investing cash use was $65.0 million, including capital spending and purchases of securities.
At September 30, cash and cash equivalents were $501.7 million, marketable securities $143.4 million, and long-term investments $16.2 million. Current assets were $695.7 million versus current liabilities of $77.1 million. The IPO raised $565.0 million net of underwriting discounts and offering costs. The company reported an accumulated deficit of $273.6 million. Note payable was approximately $0.04 million; build-to-suit lease financing obligation was $10.5 million. Contractual commitments totaled $103.3 million, including leases, bandwidth and co-location, and purchase commitments.
Changes and operating indicators
- Gross margin held at 78%. Paying customers increased to 77,057 from 61,285; customers with annualized billings above $100,000 rose to 475 from 277.
- Dollar-based net retention declined to 110.9% from 114.4%.
- Nine-month operating loss widened despite higher revenue. Management cited growth investments, increased staffing, infrastructure costs, and IPO-related stock compensation. Non-GAAP operating loss was $18.1 million in Q3 and $52.9 million for nine months; these measures exclude stock-based compensation and acquired-intangible amortization.
- Remaining performance obligations were $188.7 million; the company expected to recognize 84% within 12 months and 16% over the following three years.
Outlook, risks, and unusual items
- No numerical revenue or earnings guidance is provided in the filing. Management expects operating losses and negative operating cash flows to continue for the foreseeable future, with operating expenses increasing as the company invests in growth. It believes available cash, cash equivalents, and marketable securities can fund working capital and capital expenditure needs for at least 12 months.
- IPO-related accounting included $21.0 million of cumulative stock-based compensation expense when specified equity awards’ performance conditions were met. Q3 total stock-based compensation was $22.9 million. By comparison, 2018 included a $23.3 million charge associated with secondary stock sales.
- The company reported a June 2019 route leak and July 2019 network outage; neither materially affected reported results, but future disruptions could. Service-level commitments may expose it to credits, refunds, or customer termination rights.
- Cloudflare submitted voluntary disclosures to OFAC and U.S. export-control and Census authorities concerning potential sanctions, export-control, and reporting violations. No loss was accrued because a loss was not considered probable and the possible range was not estimable; fines, penalties, reputational damage, and market-access impacts remain possible.
- Risks include cybersecurity and service availability, customer-content-related liability and litigation, international regulation, competition, and dependence on third-party network and co-location relationships. Management said no pending or threatened legal proceeding was then expected to have a material adverse effect, while noting litigation outcomes are inherently uncertain.
- Management assessed disclosure controls as effective at a reasonable assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue growth and large-customer expansion can continue while retention has softened.
- How operating expense growth, stock-based compensation, and infrastructure investment affect the path to profitability and cash burn.
- Whether the $188.7 million of remaining performance obligations converts to revenue on the expected schedule.
- Developments, potential penalties, and financial exposure from the voluntary regulatory disclosures and customer-content litigation.
- Execution and service reliability following the disclosed route leak and outage, and the adequacy of liquidity against contractual commitments.