CLOUDFLARE, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This section of this Form 10-K generally discusses 2022 and 2021 items and year-to-year comparisons between 2022 and 2021. Discussions of 2020 items and year-to-year comparisons between 2021 and 2020 are not included in this Form 10-K, and such disclosure can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2021 , which information is incorporated herein by reference. In addition to historical financial information, the following discussion contains forward-looking statements that are based upon current plans, expectations, and beliefs that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those other factors discussed in the section titled "Risk Factors" and in other parts of this Annual Report on Form 10-K. Our fiscal year end isDecember 31 . OverviewCloudflare's mission is to help build a better Internet. We have built a global network that delivers a broad range of services to businesses of all sizes and in all geographies-making them more secure, enhancing the performance of their business-critical applications, and eliminating the cost and complexity of managing individual network hardware. Our network serves as a scalable, easy-to-use, unified control plane to deliver security, performance, and reliability across their on-premises, hybrid, cloud, and software-as-a-service (SaaS) applications. Our Business Model Our business model benefits from our ability to serve the needs of all customers ranging from individual developers to the largest enterprises, in a cost-effective manner. Our products are easy to deploy and allow for rapid and efficient onboarding of new customers and expansion of our relationships with our existing customers over time. Given the large customer base we have and the immense amount of Internet traffic that we manage, we are able to negotiate mutually beneficial agreements with Internet Service Providers (ISPs) that allow us to place our equipment directly in their data centers, which drives down our bandwidth and co-location expenses. This symbiotic relationship that we have with ISPs and the efficiency of our serverless network architecture allows us to introduce new products on our network at low marginal cost. We generate revenue primarily from sales to our customers of subscriptions to access our network and products. We offer a variety of plans to our free and paying customers depending on their required features and functionality. •Contracted customers. Our contracted customers, which consist of customers that enter into contracts for our Enterprise subscription plan, have contracts that typically range from one to three years and are typically billed on a monthly basis. Our agreements with contracted customers are tailored and priced to meet their varying needs and requirements. Enterprise subscription plan agreements for our contracted customers generally include a base subscription and a smaller portion based on usage or per seat. •Pay-as-you-go customers. For our pay-as-you-go customers, we offer the ability to purchase our products through our website. We make our pay-as-you-go product solutions available in several configurations. For customers securing and accelerating their Internet properties using our external-facing infrastructure products, we offer Pro and Business subscription plans through our website per registered domain, and it is common for customers to purchase subscriptions to cover multiple Internet properties (e.g., domains, websites, application programming interfaces (APIs), and mobile applications). Our Pro plan provides basic functionality to improve the security, performance, and reliability of applications, such as enhanced web application firewall and image and mobile optimization. Our Business plan includes additional functionality often required by larger organizations, including service level agreements of up to 100% uptime, dynamic content acceleration, and enhanced customer support. Our pay-as-you-go customers may pay upfront for an annual Pro or Business plan. Our implementation period for pay-as-you-go customers can be extremely short with most customers implementing our services within a matter of minutes. Pay-as-you-go customers can subscribe to more than one solution and purchase add-on products and network functionality we offer to meet their more advanced needs. Our pay-as-you-go customers typically pay with a credit card on a monthly basis for add-on products. For pay-as-you-go or contracted customers who need a scalable zero trust solution to secure users and internal resources using our Cloudflare One products, we make these products available on a per seat basis. In addition, for developers building serverless applications, we offer 71
--------------------------------------------------------------------------------
Table of contents
our
Key elements of our business model include:
•Significant investment in ongoing product development. We invest significantly in research and development. Our focus on research and development allows us to continually enhance the capabilities and functionality of our global network with new products and product features that are innovative and powerful and can be quickly adopted by our customers and helps us grow our customer base, which allows us to serve a greater portion of the world's Internet traffic. That in turn provides us with greater knowledge and insight into the challenges that Internet users face every day. •Investments in our network for growth. We believe that the size, sophistication, and distributed nature of our network provide us with a significant competitive advantage. We intend to continue to make substantial investments in network infrastructure to support the growth of our business. As we invest in our network, we believe the service that we can provide our customers and the insight and knowledge that we can gain will continue to grow. •Efficient go-to-market model. We have built an efficient go-to market model that reflects the flexibility and ease of use our products offer to our customers around the world. This has enabled us to acquire new customers as well as to expand within our existing customer base in a rapid, cost-effective manner. In particular, we have invested heavily in our contracted customer sales efforts. •New customer acquisition. We believe that anyone that relies on the Internet to deliver products, services, or content or to operate its business can be aCloudflare customer. As such, we are focused on driving an increased number of customers onto our network and products to support our long-term growth. We continue to invest to build our direct sales force, increase brand awareness, leverage and expand channel partners, and improve the sophistication of our sales operations for contracted customers, particularly large customers. Additionally, through our pay-as-you-go offering, a customer can subscribe to one of our many plans and begin using our network within minutes, with minimal technical skill and no professional services. This has allowed us to acquire a large portion of our paying customers very rapidly and at significantly lower customer acquisition costs. •Expansion of our existing customers. We believe that our network enables a large opportunity for growth within our existing customer base given the breadth of products we offer on our infrastructure platform. Our relationships with customers often start with servicing a portion of their overall needs and expand over time as they realize the significant value we deliver. Once a customer has adopted one product on our network, it can easily add additional products. As we add more products and functionality to our network, we see opportunities to drive upsell as customers seek to consolidate onto one infrastructure platform to meet all of their security, performance, and reliability network requirements. We also intend to continue to invest in market awareness of our new products to improve growth within our existing customers. •International reach. Our global network, with a presence in more than 275 cities and over 100 countries worldwide, has helped to foster our strong international growth. International markets represented 47%, 48% and 49% of our revenue in the years endedDecember 31, 2022 , 2021, and 2020, respectively, and we intend to continue to invest in our international growth as a strategy to expand our customer base around the world. •Free customer base. Free customers are an important part of our business. These customers are typically individual developers, early-stage startups, hobbyists, and other users and, like our pay-as-you-go customers, sign up for our service through our website. Our free customers create scale, serve as efficient brand marketing, and help us attract developers, customers, and potential employees. These free customers expose us to diverse traffic, threats, and problems, often allowing us to see potential security, performance, and reliability issues at the earliest stage. This knowledge allows us to improve our products and deliver more effective solutions to our paying customers. In addition, the added scale and diversity of this traffic makes us valuable to a diverse set of global ISPs, improving the breadth and economic terms of our interconnections, bandwidth costs, and co-location expenses. Finally, the enthusiastic engagement of our free customer base represents a "virtual quality assurance" function that allows us to maintain a high rate of product innovation, while ensuring our products are extensively tested in real world environments before they are deployed to our paying customers. 72
--------------------------------------------------------------------------------
Table of contents
Opportunities, Challenges, and Risks
We believe that the growth of our business and our future success are dependent
upon many factors, including growing our paying customer base, particularly
large customers, expanding our relationships with existing paying customers,
developing and successfully launching new products and features, expanding into
additional market segments, expanding our base of free customers, and developing
and maintaining favorable peering and co-location relationships. Each of these
factors presents significant opportunities for us, but also poses material
challenges and risks that we must successfully address in order to grow our
business and improve our operating results. We expect that addressing these
challenges and risks will increase our operating expenses significantly over the
next several years. The timing of our future profitability, if we achieve
profitability at all, will depend upon many variables, including the success of
our growth strategies and the timing and size of investments and expenditures
that we choose to undertake, as well as market growth and other factors that are
not within our control. In addition, we must comply with complex, uncertain, and
evolving laws, rules, and regulatory requirements across federal, state, and
international jurisdictions. If we fail to successfully address these
challenges, risks, and variables, our business, operating results, financial
condition, and prospects may be adversely affected.
Impact of Macroeconomic Developments
Recent adverse changes in macroeconomic conditions such as high inflation, recessionary environments, and fluctuations in foreign currency exchange rates, may negatively impact our business and operations, results of operations, financial condition, and cash flows. In addition, negative impacts directly attributable to the COVID-19 pandemic and the Russian invasion ofUkraine caused further economic instability throughout 2022 and contributed to price increases for a wide variety of goods and services, resulting in significant inflationary pressure inthe United States ,Europe , and other countries around the world. In response to concerns over ongoing inflationary risks, theU.S. Federal Reserve and other central banks continuously raised interest rates significantly throughout 2022 and in the first quarter of 2023. In addition, the increase in global economic uncertainty has resulted in theU.S. dollar increasing significantly in value relative to the currencies of many of the countries in which our operations are located, including the British Pound and Euro. We are closely monitoring macroeconomic developments and global events, such as theRussia -Ukraine conflict and other areas of geopolitical tension around the world, and how they may impact our and our customers' businesses. For example, during the first half of 2022, potentially as a result of these various macroeconomic impacts on our customers, we experienced a lengthening of the sales cycle for our large customers, a slowdown in our pipeline of potential new customers, and a lengthening of the timing of payment from some of our customers. During the third and fourth quarters of 2022, new customer pipeline continued to improve quarter-over-quarter; however, our sales cycle continued to lengthen. While we experienced a higher level of churn in our paying customer base (which is when any of our paying customers cease to be a paying customer for any reason, including any pay-as-you-go customer converting to a free subscription plan) during the second and third quarters of 2022, retention in the pay-as-you-go customer base improved in the fourth quarter, returning to the levels we achieved in late 2020 through early 2022. To the extent challenging macroeconomic conditions persist, we may experience an extension and worsening of these effects as well as additional adverse effects on our business, financial condition, or results of operations in future periods. These effects could include, among others, increased slowness in purchasing decisions by existing and potential new paying customers, additional lengthening of the sales cycle for some of our existing and potential new paying customers, further reduction or delays in purchasing decisions by our paying customers, potential customer requests for concessions or delayed payments, potential losses of paying customers as a result of economic distress or bankruptcy (particularly among our small and medium paying customer base), potential reductions in new non-U.S. customers and expansion of sales to existing non-U.S. paying customers as a result of our products, which we currently only sell forU.S. dollars, becoming relatively more expensive for such customers, and increased costs for employee compensation and equipment purchases resulting from continued inflationary cost pressures. For further discussion of the challenges and risks we confront related to macroeconomic conditions and geopolitical tension around the world, please refer to Part I, Item 1A "Risk Factors" of this Annual Report on Form 10-K, including the risk factors titled "Adverse economic conditions, including reduced spending on products and solutions for network security, performance, and reliability, and the impacts of geopolitical developments and uncertainty, may adversely impact our revenue and profitability." and "TheRussia -Ukraine conflict, other areas of geopolitical tension around the world, or the worsening of that conflict or tensions, and the related challenging macroeconomic 73
--------------------------------------------------------------------------------
Table of contents
conditions globally and in various countries in which we and our customers
operate may materially adversely affect our customers, vendors, and partners,
and the duration and extent to which these factors may impact our future
business and operations, results of operations, financial condition, and cash
flows remain uncertain."
74--------------------------------------------------------------------------------
Table of contents
Non-GAAP Financial Measures and Key Business Metrics
We review a number of financial and operating metrics, including the following
non-GAAP financial measures and key metrics to evaluate our business, measure
our performance, identify trends affecting our business, formulate business
plans, and make strategic decisions.
Year Ended December 31,
2022 2021 2020
(dollars in thousands)
Gross profit $ 742,631 $ 509,292 $ 330,004
Gross margin 76 % 78 % 77 %
Loss from operations $ (201,203) $ (127,684) $ (106,768)
Non-GAAP income (loss) from operations $ 35,679 $ (7,024) $ (33,892)
Operating margin (21) % (19) % (25) %
Non-GAAP operating margin 4 % (1) % (8) %
Net cash provided by (used in) operating
activities $ 123,595 $ 64,648 $ (17,129)
Net cash used in investing activities $ (235,696) $ (709,322) $ (515,273)
Net cash provided by financing activities $ 6,347 $ 847,486 $ 504,912
Free cash flow $ (39,769) $ (43,090) $ (92,091)
Net cash provided by (used in) operating
activities (as a percentage of revenue) 13 % 10 % (4) %
Free cash flow margin (4) % (7) % (21) %
Paying customers 162,086 140,096 111,183
Paying customers (>$100,000 Annualized Revenue) 2,042 1,416 828
The following table summarizes the revenue by region based on the billing address of customers who use the Company's products:
Year Ended December 31,
2022 2021 2020
(dollars in thousands)
Percentage Percentage Percentage
Amount of Revenue Amount of Revenue Amount of Revenue
United States $ 515,722 53 % $ 342,578 52 % $ 218,191 51 %
Europe , Middle East , and
Africa 258,291 26 % 172,129 26 % 109,274 25 %
Asia Pacific 133,353 14 % 96,537 15 % 76,177 18 %
Other 67,875 7 % 45,182 7 % 27,417 6 %
Total $ 975,241 100 % $ 656,426 100 % $ 431,059 100 %
Non-GAAP Financial Measures
In addition to our results determined in accordance with generally accepted
accounting principles in the United States (U.S. GAAP), we believe the following
non-GAAP measures are useful in evaluating our operating performance. We use the
following non-GAAP financial information to evaluate our ongoing operations and
for internal planning and forecasting purposes. We believe that non-GAAP
financial information, when taken collectively, may be helpful to investors
because it provides consistency and comparability with past financial
performance. However, non-GAAP financial information is presented for
supplemental informational purposes only, has limitations as an analytical tool,
and should not be considered in isolation or as a substitute for financial
information presented in accordance with U.S. GAAP. In particular, free cash
flow is not a substitute for cash
75--------------------------------------------------------------------------------
Table of contents
provided by (used in) operating activities. Additionally, the utility of free cash flow as a measure of our liquidity is further limited as it does not represent the total increase or decrease in our cash balance for a given period. In addition, other companies, including companies in our industry, may calculate similarly-titled non-GAAP measures differently or may use other measures to evaluate their performance, all of which could reduce the usefulness of our non-GAAP financial measures as tools for comparison. A reconciliation is provided below for each non-GAAP financial measure to the most directly comparable financial measure stated in accordance withU.S. GAAP. Investors are encouraged to review the relatedU.S. GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparableU.S. GAAP financial measures, and not to rely on any single financial measure to evaluate our business.
Non-GAAP Income (Loss) from Operations and Non-GAAP Operating Margin
We define non-GAAP income (loss) from operations and non-GAAP operating margin asU.S. GAAP loss from operations andU.S. GAAP operating margin, respectively, excluding stock-based compensation expense and its related employer payroll taxes, amortization of acquired intangible assets, and acquisition-related and other expenses. We exclude stock-based compensation expense, which is a non-cash expense, from certain of our non-GAAP financial measures because we believe that excluding this item provides meaningful supplemental information regarding operational performance. We exclude employer payroll tax expenses related to stock-based compensation, which is a cash expense, from certain of our non-GAAP financial measures, because such expenses are dependent upon the price of our Class A common stock and other factors that are beyond our control and do not correlate to the operation of our business. We exclude amortization of acquired intangible assets, which is a non-cash expense, related to business combinations from certain of our non-GAAP financial measures because such expenses are related to business combinations and have no direct correlation to the operation of our business. We exclude acquisition-related and other expenses from certain of our non-GAAP financial measures because such expenses are related to business combinations and have no direct correlation to the operation of our business. Acquisition-related and other expenses can be cash or non-cash expenses incurred in connection with the acquisition, and include third-party transaction costs and compensation expense for key acquired personnel. Year Ended December 31, 2022 2021 2020 (dollars in thousands) Loss from operations$ (201,203) $ (127,684) $ (106,768) Add: Stock-based compensation expense and related employer payroll taxes 217,766 117,334 63,516 Amortization of acquired intangible assets 15,169 2,946 3,081 Acquisition-related and other expenses 3,947 380 6,279 Non-GAAP income (loss) from operations$ 35,679 $ (7,024) $ (33,892) Operating margin (21) % (19) % (25) %
Non-GAAP operating margin (non-GAAP income (loss) from operations as a percentage of revenue)
4 % (1) % (8) %
Free Cash Flow and Free Cash Flow Margin
Free cash flow is a non-GAAP financial measure that we calculate as net cash
provided by (used in) operating activities less cash used for purchases of
property and equipment and capitalized internal-use software. Free cash flow
margin is calculated as free cash flow divided by revenue. We believe that free
cash flow and free cash flow margin are useful indicators of liquidity that
provide information to management and investors about the amount of cash
generated from our operations that, after the investments in property and
equipment and capitalized internal-use software, can be used for strategic
initiatives, including investing in our business, and strengthening our
financial position. We believe that historical and future trends in free cash
flow and free cash flow margin, even if negative, provide useful information
about the amount of cash generated (or consumed) by our operating activities
that is available (or not available) to be used for strategic initiatives. For
example, if free cash flow is negative, we may need to access cash reserves or
other sources of capital to invest in strategic initiatives. One limitation of
free cash flow and free cash flow margin is that they do not reflect our future
contractual commitments. Additionally, free cash flow does not represent the
total increase or decrease in our cash balance for a given period.
76--------------------------------------------------------------------------------
Table of contents
Year Ended December 31,
2022 2021 2020
(dollars in thousands)
Net cash provided by (used in) operating
activities $ 123,595 $ 64,648 $ (17,129)
Less: Purchases of property and equipment (143,606) (92,986) (56,375)
Less: Capitalized internal-use software (19,758) (14,752) (18,587)
Free cash flow $ (39,769) $ (43,090) $ (92,091)
Net cash used in investing activities $ (235,696) $ (709,322) $ (515,273)
Net cash provided by financing activities $ 6,347 $ 847,486 $ 504,912
Net cash provided by (used in) operating
activities (as a percentage of revenue) 13 % 10 % (4) %
Less: Purchases of property and equipment (as a
percentage of revenue) (15) % (14) % (13) %
Less: Capitalized internal-use software (as a
percentage of revenue) (2) % (2) % (4) %
Free cash flow margin (4) % (7) % (21) %
Key Business Metrics
In addition to our results determined in accordance with U.S. GAAP and the
non-GAAP measures discussed above, we also review the key business metrics
discussed below to assist us in evaluating our business, measuring performance,
identifying trends, formulating business plans, and making strategic decisions.
There are a number of limitations associated with the use of key business
metrics as analytical tools, however, and we do not rely upon any single key
business metric to evaluate our business. In addition, other companies,
including companies in our industry, may calculate similarly-titled business
metrics differently or may use other measures to evaluate their performance, all
of which could reduce the usefulness of these business metrics as tools for
comparison to such companies.
Paying Customers
We believe our ability to grow the number of paying customers on our network provides a key indicator of growth of our business and our future business opportunities. We define a paying customer at the end of the quarter as a person or entity who has generated revenue and has an active contract with us or one of our partners during such quarter, excluding (i) customers that were not acquired through ordinary sales channels, (ii) customers using only our registrar product, and (iii) customers using our consumer applications, such as 1.1.1.1 and WARP, which agreements and customers together represent an insignificant amount of our revenue. An entity is defined as a company, a government institution, a non-profit organization, or a distinct business unit of a large company. An active contract is defined as a customer relationship for which we have provided services during the quarter. The number of paying customers was 162,086, 140,096, and 111,183 as ofDecember 31, 2022 , 2021, and 2020, respectively.
Paying Customers (>
While we continue to grow customers across all sizes, over time, our large customers have contributed an increasing share of our revenue. We view the number of customers with Annualized Revenue greater than$100,000 as indicative of our penetration within large enterprise accounts. To measure Annualized Revenue at the end of a quarter, we take the sum of revenue for each customer in the quarter and multiply that amount by four. For example, if we signed a new customer that generated$1,800 of revenue in a quarter, that customer would account for$7,200 of Annualized Revenue for that year. Our Annualized Revenue calculation excludes (i) agreements that were not entered into through ordinary sales channels, (ii) revenue generated from customers using only our registrar product, and (iii) customers using our consumer applications, such as 1.1.1.1 and WARP, which agreements and customers together represent an insignificant amount of our revenue. Our Annualized Revenue metric also includes any usage charges by a customer during a period, which represents a small portion of our total revenue and may not be recurring. As a result, Annualized Revenue may be higher than actual revenue over the course of the year. The number of paying customers with Annualized Revenue greater than$100,000 was 2,042, 1,416, and 828 as ofDecember 31, 2022 , 2021, and 2020, respectively. We believe this trend will continue as 77 -------------------------------------------------------------------------------- Table of contents customers increasingly adopt cloud technology and we are able to compete with an increasing share of our customers' legacy hardware solutions by adding new capabilities to our global network.
Dollar-Based Net Retention Rate
Our ability to maintain long-term revenue growth and achieve profitability is dependent on our ability to retain and grow revenue generated from our existing paying customers. We believe that we will achieve these objectives by continuing to focus on customer loyalty and adding additional products and functionality to our network. Our dollar-based net retention rate is a key way we measure our performance in these areas. Dollar-based net retention measures our ability to retain and expand recurring revenue from existing customers. To calculate dollar-based net retention for a quarter, we compare the Annualized Revenue from paying customers four quarters prior to the Annualized Revenue from the same set of customers in the most recent quarter. Our dollar-based net retention includes expansion and is net of contraction and attrition, but excludes Annualized Revenue from new customers in the current period. Our dollar-based net retention excludes the benefit of free customers that upgrade to a paid subscription between the prior and current periods, even though this is an important source of incremental growth. We believe this provides a more meaningful representation of our ability to add incremental business from existing paying customers as they renew and expand their contracts. Our dollar-based net retention rates for the three months endedDecember 31, 2022 , 2021, and 2020 were 122%, 125%, and 119%, respectively. Components of Our Results of Operations Revenue We generate revenue primarily from sales to our customers of subscriptions to access our network and products, together with related support services. Arrangements with customers generally do not provide the customer with the right to take possession at any time of our software operating our global network. Instead, customers are granted continuous access to our network and products over the contractual period. A time-elapsed output method is used to measure progress because we transfer control evenly over the contractual period. Accordingly, the fixed consideration related to subscription and support revenue is generally recognized on a straight-line basis over the contract term beginning on the date that the service is made available to the customer. Usage-based consideration is primarily related to fees charged for our customer's use of excess bandwidth when accessing our network in a given period and is recognized as revenue in the period in which the usage occurs. The typical subscription and support term for our contracted customers is one year and subscription and support term lengths range from one to three years. Most of our contracts with contracted customers are non-cancelable over the contractual term. Customers may have the right to terminate their contracts for cause if we fail to perform in accordance with the contractual terms. For our pay-as-you-go customers, subscription and support term contracts are typically monthly. Cost of Revenue Cost of revenue consists primarily of expenses that are directly related to providing our service to our paying customers. These expenses include expenses related to operating in co-location facilities, network and bandwidth costs, depreciation of our equipment located in co-location facilities, certificate authority services costs for paying customers, related overhead costs, the amortization of our capitalized internal-use software, and the amortization of acquired developed technologies. Cost of revenue also includes employee-related costs, including salaries, bonuses, benefits, and stock-based compensation for employees whose primary responsibilities relate to supporting our paying customers. Other costs included in cost of revenue include credit card fees related to processing customer transactions and allocated overhead costs. As our customers expand and increase the use of our global network and products driven by additional applications and connected devices, we expect that our cost of revenue will increase due to higher network and bandwidth costs and expenses related to operating in additional co-location facilities. However, we expect to continue to benefit from economies of scale as our customers increase the use of our global network and products. We intend to continue to invest additional resources in our global network and products and our customer support organizations as we grow our business. The level and timing of investment in these areas could affect our cost of revenue in the future.
Gross Profit and Gross Margin
78--------------------------------------------------------------------------------
Table of contents
Gross profit is revenue less cost of revenue and gross margin is gross profit as a percentage of revenue. Our gross profit and gross margin have and are expected to continue to fluctuate from period to period due to the timing of acquisition of new customers and our renewals with existing customers, expenses related to operating in co-location facilities and network and bandwidth costs to operate and expand our global network, and amortization of costs associated with capitalized internal-use software. We expect our gross profit to increase in absolute dollars and our gross margin to remain consistent over the long term, although our gross margin could fluctuate from period to period depending on the interplay of all of these factors.
Operating Expenses
Sales and Marketing
Sales and marketing expenses consist primarily of employee-related costs, including salaries, benefits, and stock-based compensation expense, sales commissions that are recognized as expenses over the period of benefit, marketing programs, certificate authority services costs for free customers, travel-related expenses, bandwidth and co-location costs for free customers, and allocated overhead costs. Sales commissions earned by our sales force and the associated payroll taxes that are direct and incremental to the acquisition of channel partner and direct customer contracts are deferred and amortized over an estimated period of benefit of three years for the initial acquisition of a contract and over the contractual term of the renewals for renewal contracts. We plan to continue to invest in sales and marketing to grow our customer base and increase our brand awareness, including marketing efforts to continue to drive our pay-as-you-go business model. As a result, we expect our sales and marketing expenses to increase in absolute dollars for the foreseeable future. However, we expect our sales and marketing expenses to decrease as a percentage of our revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.
Research and Development
Research and development costs consist primarily of employee-related costs, including salaries, benefits, and stock-based compensation expense, consulting costs, depreciation of equipment used in research and development, and allocated overhead costs. Research and development costs support our efforts to add new features to our existing offerings and to ensure the security, performance, and reliability of our global network. We expect our research and development expenses to increase in absolute dollars for the foreseeable future as we continue to invest in research and development efforts to enhance the functionality of our global network and products. We expect our research and development expenses to decrease as a percentage of our revenue over the long term, although our research and development expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses. General and Administrative General and administrative expenses consist primarily of employee-related costs, including salaries, benefits, and stock-based compensation expense for our finance, legal, human resources, and other administrative personnel, professional fees for external legal services, accounting, and other consulting services, bad debt expense, and allocated overhead costs. We expect our general and administrative expenses to continue to increase in absolute dollars for the foreseeable future to support our growth as well as due to additional costs associated with legal, accounting, compliance, insurance, investor relations, and other costs as a result of operating as a public company. However, we expect our general and administrative expenses to decrease as a percentage of our revenue over the long term, although our general and administrative expenses may fluctuate as a percentage of our revenue from period to period due to the timing and extent of these expenses.
Non-Operating Income (Expense)
Interest Income
Interest income consists primarily of interest earned on our cash, cash equivalents, and our investment holdings.
Interest Expense
79
--------------------------------------------------------------------------------
Table of contents
Interest expense consists primarily of contractual interest expense and
amortization of the debt issuance costs on our 0.75% Convertible Senior Notes
due 2025 (the 2025 Notes) and 0% Convertible Senior Notes due 2026 (the 2026
Notes, and together with the 2025 Notes, the Notes). Upon adoption of the
Accounting Standards Update (ASU) 2020-06 effective January 1, 2022 , the Company
is no longer recording the conversion feature of its convertible senior notes in
equity. Instead, the Company combined the previously separated equity component
with the liability component, which together is now classified as debt, thereby
eliminating the subsequent amortization of the debt discount as interest
expense.
Loss on Extinguishment of Debt
Loss on extinguishment of debt consists of loss recognized from privately-negotiated exchange agreements with certain holders of the 2025 Notes to exchange approximately$400.0 million in aggregate principal amount of the 2025 Notes for an aggregate of$400.7 million in cash (including accrued interest) and approximately 7.6 million shares of our Class A common stock (the 2025 Notes Exchange). Other Income (Expense), Net
Other income (expense), net consists primarily of gain on sale of property and equipment and foreign currency transaction gains and losses.
Provision for (Benefit from) Income Taxes
Provision for (benefit from) income taxes consists primarily of income taxes in certain foreign jurisdictions in which we conduct business, as well as state income taxes inthe United States . We have a full valuation allowance on ourU.S. federal,U.S. state, andU.K. deferred tax assets as we have concluded that it is more likely than not that the deferred tax assets will not be realized. 80
--------------------------------------------------------------------------------
Table of contents
Results of Operations
The following tables set forth our consolidated results of operations for the
periods presented in dollars and as a percentage of our revenue for those
periods:
Year Ended December 31,
2022 2021 2020
(in thousands)
Revenue $ 975,241 $ 656,426 $ 431,059
Cost of revenue(1) 232,610 147,134 101,055
Gross profit 742,631 509,292 330,004
Operating expenses:
Sales and marketing(1) 465,762 328,065 217,875
Research and development(1) 298,303 189,408 127,144
General and administrative(1) 179,769 119,503 91,753
Total operating expenses 943,834 636,976 436,772
Loss from operations (201,203) (127,684) (106,768)
Non-operating income (expense):
Interest income 14,877 1,970 6,588
Interest expense (4,984) (49,234)
(24,964)
Loss on extinguishment of debt - (72,234)
-
Other income (expense), net 577 (794)
171
Total non-operating income (expense), net 10,470 (120,292)
(18,205)
Loss before income taxes (190,733) (247,976)
(124,973)
Provision for (benefit from) income taxes 2,648 12,333
(5,603)
Net loss $ (193,381) $ (260,309) $ (119,370)
_______________(1)Includes stock-based compensation expense as follows:
Year Ended December 31,
2022 2021 2020
(in thousands)
Cost of revenue $ 6,251 $ 2,583 $ 1,225
Sales and marketing 50,317 27,277 16,019
Research and development 103,276 44,196 26,090
General and administrative 42,933 16,081 13,000
Total stock-based compensation expense
81
--------------------------------------------------------------------------------
Table of contents
Year Ended December 31,
2022 2021 2020
Percentage of Revenue Data:
Revenue 100 % 100 % 100 %
Cost of revenue 24 22 23
Gross margin 76 78 77
Operating expenses:
Sales and marketing 48 50 51
Research and development 31 29 30
General and administrative 18 18 21
Total operating expenses 97 97 102
Loss from operations (21) (19) (25)
Non-operating income (expense):
Interest income 2 - 2
Interest expense (1) (8) (6)
Loss on extinguishment of debt - (11) -
Other income (expense), net - - -
Total non-operating income (expense), net 1 (19) (4)
Loss before income taxes (20) (38) (29)
Provision for (benefit from) income taxes - 2 (1)
Net loss (20) % (40) % (28) %
Comparison of the Years Ended December 31, 2022 and 2021
Revenue
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Revenue $ 975,241 $ 656,426 $ 318,815 49 %
Revenue increased by $318.8 million , or 49%, for the year ended December 31,
2022 compared to the year ended December 31, 2021 . The increase in revenue was
primarily due to the addition of new paying customers, which increased by 16%
during the year ended December 31, 2022 , as well as expansion within our
existing paying customers, which was reflected by our dollar-based net retention
rates remaining over 120% during the four quarters ended December 31, 2022 .
Cost of Revenue and Gross Margin
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Cost of revenue $ 232,610 $ 147,134 $ 85,476 58 %
Gross margin 76 % 78 %
Cost of revenue increased by
82--------------------------------------------------------------------------------
Table of contents
network for our expanded customer base, as well as increased capacity to support our growth, an increase of$15.7 million in depreciation expense related to purchases of equipment located in co-location facilities, an increase of$14.2 million in employee-related costs due to a 7% increase in headcount in our customer support and technical operations organizations, and an increase of$12.7 million related to the amortization of acquired developed technology and capitalized internal-use software costs. The remainder of the increase was primarily due to$11.5 million of increased third-party technology services costs, registry fees, and payment processing fees.
Gross margin did not significantly fluctuate during the year ended
Operating Expenses
Sales and Marketing
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Sales and marketing $ 465,762 $ 328,065 $ 137,697 42 %
Sales and marketing expenses increased by $137.7 million , or 42%, for the year
ended December 31, 2022 compared to the year ended December 31, 2021 . The
increase was primarily driven by $92.8 million in increased employee-related
costs due to a 40% increase in headcount in our sales and marketing
organization, including an increase of $22.8 million in stock-based compensation
expense. The remainder of the increase was primarily due to an increase of $20.4
million in co-location and bandwidth expenses for free customers, an increase of
$11.4 million in expenses for marketing programs due to investments in brand
awareness advertising, third-party industry events, and digital performance
marketing, an increase of $5.6 million in travel-related expenses, an increase
of $3.0 million in subscriptions, and an increase of $2.9 million in allocated
overhead costs.
Research and Development
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Research and development $ 298,303 $ 189,408 $ 108,895 57 %
Research and development expenses increased by $108.9 million , or 57%, for the
year ended December 31, 2022 compared to the year ended December 31, 2021 . The
increase was primarily driven by $112.5 million in increased employee-related
costs due to a 31% increase in headcount in our research and development
organization, including an increase of $61.7 million in stock-based compensation
expense. The remainder of the increase was primarily due to an increase of $2.3
million in allocated overhead costs, partially offset by increased capitalized
internal-use software development costs of $7.6 million .
General and Administrative
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
General and administrative $ 179,769 $ 119,503 $ 60,266 50 %
General and administrative expenses increased by $60.3 million , or 50%, for the
year ended December 31, 2022 compared to the year ended December 31, 2021 . The
increase was primarily driven by $47.7 million in increased employee-related
costs due to a 24% increase in headcount in our general and administrative
organization, an increase of $6.7 million in travel-related expenses, an
increase of $6.3 million in rent and office related costs, primarily driven by
the new Austin lease that commenced in the three months ended September 30,
2021 , an
83--------------------------------------------------------------------------------
Table of contents
increase of$3.0 million in third-party accounting, consulting, and legal services, and an increase of$2.8 million in software subscription costs, cloud computing services, and payment processing fees. These increases were partially offset by$8.7 million of decreased allocated overhead costs.
Non-Operating Income (Expense)
Interest Income
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Interest income $ 14,877 $ 1,970 $ 12,907 *
Interest income increased by $12.9 million , for the year ended December 31, 2022
compared to the year ended December 31, 2021 . The increase was primarily driven
by an increase in interest rates.
______________
* Not meaningful
Interest Expense
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Interest expense $ (4,984) $ (49,234) $ 44,250 (90) %
Interest expense decreased by $44.3 million , or 90%, during the year ended
December 31, 2022 as compared to the year ended December 31, 2021 . The decrease
was primarily driven by the adoption of ASU 2020-06. Upon adoption of the ASU,
the Company is no longer recording the conversion feature of its convertible
senior notes in equity. Instead, the Company combined the previously separated
equity component with the liability component, which together is now classified
as debt, thereby eliminating the subsequent amortization of the debt discount as
interest expense. The remainder of the decrease was due to the decrease in the
debt principal as a result of the 2025 Notes Exchange. Refer to Note 7 to our
consolidated financial statements in Part II, Item 8 of this Annual Report on
Form 10-K for more information regarding the Notes.
Loss on Extinguishment of Debt
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Loss on extinguishment of debt $ - $ (72,234) $ 72,234 *
______________
* Not meaningful
Loss on extinguishment of debt decreased by $72.2 million for the year ended
December 31, 2022 as compared to the year ended December 31, 2021 . The decrease
was driven by the loss on extinguishment of debt we recognized in connection
with the 2025 Notes Exchange. Refer to Note 7 to our consolidated financial
statements in Part II, Item 8 of this Annual Report on Form 10-K for more
information regarding the Notes.
84--------------------------------------------------------------------------------
Table of contents
Other Income (Expense), net
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Other income (expense), net $ 577 $ (794) $ 1,371 *
______________
* Not meaningful
Other income (expense), net did not significantly fluctuate during the year
ended
Provision for (Benefit from) Income Taxes
Year Ended December 31, Change
2022 2021 $ %
(dollars in thousands)
Provision for (benefit from) income taxes $ 2,648 $ 12,333 $ (9,685) *
______________
* Not meaningful
We recorded an income tax expense of $2.6 million during the year ended
December 31, 2022 as compared to an income tax expense of $12.3 million for the
year ended December 31, 2021 . The provision for income taxes of $2.6 million for
the year ended December 31, 2022 was primarily related to withholding taxes in
the U.S. and income tax expense from profitable foreign jurisdictions, offset by
the partial release of the U.S. valuation allowance in connection with
acquisitions. The provision for income taxes of $12.3 million for the year ended
December 31, 2021 was primarily related to withholding taxes in the U.S. , income
tax expense from profitable foreign jurisdictions, the recording of a valuation
allowance on the Company's U.K. deferred tax assets, and income tax expense
related to an acquisition.
Liquidity and Capital Resources
Since our inception, we have financed our operations primarily through net
proceeds from the sale of our equity and debt securities, as well as payments
received from customers using our global network and products, and we expect to
continue to finance our operations using the same sources for the foreseeable
future. In May 2020 , we issued $575.0 million aggregate principal amount of the
2025 Notes in a private offering to qualified institutional buyers pursuant to
Rule 144A promulgated under the Securities Act, from which we received total
proceeds, net of initial purchaser discounts and commissions and debt issuance
costs, of $562.5 million . In August 2021 , we issued $1,293.8 million aggregate
principal amount of the 2026 Notes in a private offering to qualified
institutional buyers pursuant to Rule 144A promulgated under the Securities Act,
from which we received total proceeds, net of initial purchaser discounts and
commissions and debt issuance costs of $1,274.0 million . Concurrently with the
completion of the offering of the 2026 Notes, we also entered into
privately-negotiated exchange agreements with certain holders of the 2025 Notes
to exchange approximately $400 million in aggregate principal amount of the 2025
Notes for an aggregate of $400.7 million in cash (including accrued interest)
and approximately 7.6 million shares of our Class A common stock.
As of December 31, 2022 , we had cash and cash equivalents of $204.2 million ,
including $23.6 million held by our foreign subsidiaries. Our cash and cash
equivalents primarily consist of cash and highly liquid money market funds. We
also had available-for-sale securities of $1,445.8 million consisting of U.S.
treasury securities, commercial paper, and corporate bonds. As of December 31,
2022 , the Company's investment portfolio consisted of investment grade
securities with an average credit rating of AA. We have generated significant
operating losses from our operations as reflected in our accumulated deficit of
$839.9 million as of December 31, 2022 . We expect to continue to incur operating
losses and cash flow that may fluctuate between positive and negative for the
foreseeable future
85--------------------------------------------------------------------------------
Table of contents
due to the investments we intend to make in our business, and as a result we may require additional capital resources to execute on our strategic initiatives to grow our business. We believe that our existing cash, cash equivalents, and available-for-sale securities will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. For the period beyond the next 12 months, we believe we will be able to meet our working capital and capital expenditure needs from our existing cash, cash equivalents, and available-for-sale-securities, the cash flows from our operating activities and, if necessary, proceeds from potential equity or debt financings. Our assessments of the period of time through which our existing financial resources will be adequate to support our operations and our expected sources of capital for the future operation of our business after such period of time are forward-looking statements and involve risks and uncertainties. Our actual results could vary as a result of, and our near- and long-term future capital requirements will depend on, many factors, including our growth rate, subscription renewal activity, the timing and extent of spending to support our infrastructure and research and development efforts, the expansion of sales and marketing activities, the timing of new introductions of products or features, the continuing market adoption of our global network and products, and the impact of macroeconomic conditions to our and our customers', vendors', and partners' businesses. We may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights, and such acquisitions and investments could increase our need for additional capital. We have based our estimates on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect. Additionally, some of the factors that may influence our operations are not within our control, such as general economic conditions. We may be required to seek additional equity or debt financing from time to time in the future. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all. If we are unable to raise additional capital when desired, or if we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, operating results, and financial condition would be adversely affected. As ofDecember 31, 2022 , our material cash requirements include contractual obligations from the Notes, purchase commitments and lease obligations. Refer to Notes 6, 7, and 8 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for more information regarding these material cash requirements. In addition to the contractual obligations described above, as ofDecember 31, 2022 , we had$11.0 million recognized as total restricted cash on our consolidated balance sheet which mainly consisted of$10.5 million of indemnity holdback consideration associated with business combinations.
Cash Flows
The following table summarizes our cash flows for the periods presented:
Year Ended December 31,
2022 2021 2020
(in thousands)
Net cash provided by (used) in operating activities $ 123,595 $ 64,648 $ (17,129)
Net cash used in investing activities $ (235,696) $ (709,322) $ (515,273)
Net cash provided by financing activities $ 6,347 $
847,486
Operating Activities
Net cash provided by operating activities during the year endedDecember 31, 2022 was$123.6 million , which resulted from a net loss of$193.4 million , adjusted for non-cash charges of$396.3 million and net cash outflow of$79.3 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$202.8 million for stock-based compensation expense,$102.3 million for depreciation and amortization expense,$45.1 million for amortization of deferred contract acquisition costs,$36.3 million for non-cash operating lease costs,$4.8 million for provision for bad debt, and$4.7 million for amortization of convertible note issuance costs. The net cash outflow from changes in operating assets and liabilities was primarily the result of a$67.9 million increase in deferred contract acquisition costs due to increased sales commissions from the addition of new customers, a$56.2 million increase in accounts receivable, net, which increased due to our growing customer base and timing of collections from our customers, a$31.7 million decrease in operating lease liabilities, a$9.6 million decrease in accounts payable related to operating activities, a$7.7 million increase in prepaid expenses and other current 86
--------------------------------------------------------------------------------
Table of contents
assets related to operating activities, a
Net cash provided by operating activities during the year endedDecember 31, 2021 was$64.6 million , which resulted from a net loss of$260.3 million , adjusted for non-cash charges of$321.6 million and net cash inflow of$3.4 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$90.1 million for stock-based compensation expense,$72.2 million for loss on extinguishment of debt,$66.6 million for depreciation and amortization expense,$46.2 million for amortization of convertible note discount and issuance costs,$29.3 million for amortization of deferred contract acquisition costs,$25.1 million for non-cash operating lease costs,$8.7 million for deferred income taxes,$8.4 million for net accretion of discounts and amortization premiums on available-for-sale securities,$3.8 million for provision for bad debt, which were partially offset by$29.4 million for exchange of convertible senior notes attributable to the accreted interest related to debt discount. The net cash inflow from changes in operating assets and liabilities was primarily the result of a$64.4 million increase in deferred revenue, a$58.9 million increase in accrued expenses and other current liabilities, which were partially offset by a$55.4 million increase in deferred contract acquisition costs due to increased sales commissions from the addition of new customers, a$35.8 million increase in accounts receivable, net, which increased due to our growing customer base and timing of collections from our customers, a$23.1 million decrease in operating lease liabilities, and a$4.6 million decrease in other noncurrent liabilities.
Investing Activities
Net cash used in investing activities during the year endedDecember 31, 2022 of$235.7 million resulted primarily from the purchases of available-for-sale securities of$1,133.0 million , capital expenditures of$143.6 million , cash paid for acquisitions, net of cash acquired of$88.2 million , and capitalization of internal-use software development costs of$19.8 million . These activities were partially offset by the maturities of available-for-sale securities of$1,148.8 million . Net cash used in investing activities during the year endedDecember 31, 2021 of$709.3 million resulted primarily from the purchases of available-for-sale securities of$1,589.3 million , capital expenditures of$93.0 million , capitalization of internal-use software development costs of$14.8 million and cash paid for acquisitions, net of cash acquired of$5.6 million . These activities were partially offset by the maturities of available-for-sale securities of$967.5 million and sales of available-for-sale securities of$25.7 million . Financing Activities Net cash provided by financing activities of$6.3 million during the year endedDecember 31, 2022 was primarily due to$15.3 million proceeds from the issuance of Class A common stock pursuant to the 2019 Employee Stock Purchase Plan (ESPP) and$10.1 million of proceeds from the exercise of vested and unvested stock options, which were partially offset by$16.6 million of repayments of convertible senior notes, and$2.5 million payment of tax withholding on Restricted Stock Unit (RSU) settlements. Net cash provided by financing activities of$847.5 million during the year endedDecember 31, 2021 was primarily due to$1,293.8 million of gross proceeds from issuance of the 2026 Notes,$21.5 million of proceeds from the exercise of vested and unvested stock options, and$15.0 million proceeds from the issuance of Class A common stock pursuant to the ESPP, which were partially offset by$370.6 million cash consideration paid in the 2025 Notes Exchange,$86.3 million purchases of capped calls related to the 2026 Notes,$19.8 million cash paid for issuance costs on the 2026 Notes,$3.6 million payment of tax withholding on RSU settlements, and$2.2 million payment of the indemnity holdback for the acquisition ofS2 Systems Corporation . Off-Balance Sheet Arrangements As ofDecember 31, 2022 , we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. 87
--------------------------------------------------------------------------------
Table of contents
Critical Accounting Estimates
Our consolidated financial statements are prepared in accordance with U.S. GAAP.
The preparation of these consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosures. Such estimates
include, but are not limited to, allowance for doubtful accounts, deferred
contract acquisitions costs, the period of benefit generated from the deferred
contract acquisition costs, the capitalization and estimated useful life of
internal-use software, valuation of acquired intangible assets, the assessment
of recoverability of intangible assets and their estimated useful lives, useful
lives of property and equipment, the determination of the incremental borrowing
rate used for operating lease liabilities, the valuation and recognition of
stock-based compensation awards, uncertain tax positions, and the recognition
and measurement of current and deferred income tax assets and liabilities. None
of these estimates are critical accounting estimates for the preparation of our
consolidated financial statements. Our estimates are based on historical
experience and various other assumptions that we believe to be reasonable under
the circumstances, and we evaluate our estimates and assumptions on an ongoing
basis. Due in part to the Russia -Ukraine conflict, and other geopolitical and
macroeconomic conditions, there is ongoing uncertainty and significant
disruption in the global economy and financial markets. We are not aware of any
specific event or circumstance that would require an update to our estimates or
assumptions or a revision of the carrying value of assets or liabilities as of
February 24, 2023 , the date of issuance of this Annual Report on Form 10-K.
These estimates and assumptions may change in the future, however, as new events
occur and additional information is obtained. Our actual results could differ
from these estimates.
Recent Accounting Pronouncements
Refer to Note 2 to our consolidated financial statements in Part II, Item 8 of
this Annual Report on Form 10-K for more information regarding recently adopted
accounting pronouncements.
© Edgar Online, source
