CLOUDFLARE, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. 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 the impact of the COVID-19 pandemic and those other factors discussed in the section titled "Risk Factors" and in other parts of this Quarterly Report on Form 10-Q. 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-premise, 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 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. •Pay-as-you-go customers. For our pay-as-you-go customers, 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 implementation period for pay-as-you-go customers is extremely short with most customers implementing our services within a matter of minutes. While our Pro and Business plans offer significant value to customers, customers can subscribe to 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. •Contracted customers. Our contracted customers, which consist of customers that enter into contracts for our Enterprise subscription plan, have contracts that range from one to three years and are typically billed on a monthly basis. Our contracted customer sales cycle typically lasts less than one quarter. 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. Key elements of our business model include: •Free customer base. Free customers are an important part of our business. These customers, like our pay-as-you-go customers, sign up for our service through our website and are typically individual 32 -------------------------------------------------------------------------------- Table of contents developers, early stage startups, hobbyists, and other users. 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. •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 that are innovative and powerful and can be quickly adopted by our customers and helps us grow our free and paying 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 offers 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 any person or business that relies on the Internet to deliver products, services, or content can be aCloudflare customer. As such, we are focused on driving an increased number of customers on our infrastructure platform to support our long-term growth. 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 paying customers very rapidly and at significantly lower customer acquisition costs. Additionally, we continue to invest to build our direct sales force and improve the sophistication of our sales operations. •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 network 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 with a single click. 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. •International reach. Our global network, with a presence in more than 200 cities and over 100 countries worldwide, has helped to foster our strong international growth. International markets represented 48% and 52% of our revenue in the three months endedMarch 31, 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. Opportunities, Challenges, and Risks We believe that the growth of our business and our future success are dependent upon many factors, including growing our customer base, expanding our relationships with existing paying customers, developing and successfully launching new products, 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 33 -------------------------------------------------------------------------------- Table of contents 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. COVID-19 Update In earlyMarch 2020 , COVID-19, a disease caused by a novel strain of the coronavirus, was characterized as a pandemic by theWorld Health Organization . SinceDecember 2019 , COVID-19 has spread rapidly, with nearly all countries and territories worldwide having confirmed cases of COVID-19, and a high concentration of cases inthe United States and many other countries in which we and our customers, vendors, and partners operate. In addition, in 2021, potentially more contagious and dangerous variants of the virus have emerged. The rapid spread of the virus and the new variants has resulted in authorities around the world periodically implementing and relaxing numerous measures to contain the virus, such as travel restrictions and bans, quarantines, shelter-in-place orders, and mandated business closures. The COVID-19 pandemic and these containment measures that have been in effect from time to time in various countries and territories have had, and are expected to continue to have, a substantial negative impact on businesses around the world and on global, regional, and national economies. Although vaccines for COVID-19 have been developed and are being administered inthe United States and other countries, the timing of administering these vaccines in countries around the world, and the long-term efficacy of these vaccines, remain uncertain. We are closely monitoring the impact of the ongoing COVID-19 pandemic on all aspects of our business. While we believe the COVID-19 pandemic has had certain impacts on our business that we discuss in further detail below, we do not believe there has been, nor are we currently anticipating, a material adverse impact from the effects of the ongoing COVID-19 pandemic on our business and operations, results of operations, financial condition, and cash flows. However, the progression of the pandemic is uncertain, rapidly changing, and hard to predict. For example, after the initial spread of the pandemic during the spring of 2020, many countries began loosening containment measures in the summer, but the rapid escalation of infection rates, as well as the ongoing discovery of numerous additional variants of the virus around the world, since the fall of 2020 has led, and is expected to continue to lead, to an increase in containment measures in certain countries and territories. As a result, the broader implications of the COVID-19 pandemic on our business and operations and our financial results continue to be uncertain. The duration and severity of the economic downturn from the ongoing COVID-19 pandemic may negatively impact our business and operations, results of operations, financial condition, and cash flows. To date, the COVID-19 pandemic has impacted our employees, our network, and our customers in a number of ways, and this impact could worsen if and to the extent the pandemic continues or becomes more severe. •Our Employees. Our top priority during the COVID-19 pandemic is protecting the health and safety of our employees around the world. As the COVID-19 pandemic expanded globally during the spring of 2020, we activated our business continuity plan and transitioned our employees to a fully remote working environment in nearly all of our locations around the world and restricted almost all business travel. Since that time, we have reopened, to a limited extent, most of our offices so that those of our employeeswho have difficult or challenging remote work circumstances are able to work from one of our offices located in jurisdictions that permit returns to offices and where we believe such a return to office can occur safely. In addition, subject to the progress of vaccine distribution and lessening of infection rates in the various jurisdictions where we have offices, we currently are planning for the reintroduction of our employees to some or all of our offices later in 2021. Throughout the pandemic, our goal has been to ensure that our employees feel safe and secure, while having the flexibility and resources necessary to perform their jobs effectively. These efforts have included providing additional equipment to employees for working remotely and providing various benefits to promote our employees' physical and mental well-being. We believe our employees have been able to remain productive during the COVID-19 pandemic and that our operations have not been materially impacted by our employees primarily working on a remote basis, but the continuation of the pandemic will place strains on our employees. As the progression of the pandemic continues, we will continue to monitor and follow 34 -------------------------------------------------------------------------------- Table of contents guidance from authorities and health officials in the locations where we operate and modify our working environments around the world appropriately. To the extent current or future measures we implement result in decreased productivity, harm our company culture, or otherwise negatively affect our business, our financial condition, and operating results could be materially and adversely affected. We are continuing our efforts to increase our workforce to support the ongoing growth in our business, which currently is occurring through a virtual hiring and onboarding process. To date, we have not experienced difficulties in continuing to expand our workforce, but depending on the length and severity of the COVID-19 pandemic and its effect on our business, we may determine to slow our hiring. Any delays in expanding our workforce may result in key positions remaining unfilled, which could negatively impact our business, financial condition, or operating results. •Our Network. The initial change in everyday behavior caused by the COVID-19 pandemic resulted in an increased reliance on the Internet, increased Internet traffic, and a geographic migration of Internet traffic from office-focused areas (like city centers and business parks) to more residential areas (like suburbs and outlying towns). We believe that traffic on the Internet, and on our network that we use to provide our products to our customers around the world, will remain elevated if and for so long as the isolation mandates across the globe continue to remain in place or are reinstituted or where significantly greater numbers of workers continue to work remotely than was the case prior to the pandemic. Nevertheless, there is uncertainty about the impact on Internet traffic levels and work locations as the isolation mandates are lifted and as more workers return to working in office environments instead of remotely. Our business is dependent on our network providing our customers with secure, performant, and reliable network services every minute of every day. The pandemic has resulted not only in greatly increased traffic and strain on our network, but also adverse impacts on our ability to provision our network co-location facilities, including delays in our ability to obtain servers and other hardware and to ship and install such hardware at our network facilities. While we have been able to lessen these adverse impacts to date through our planning processes and use of alternative vendors, our ability to continue to provision our existing network facilities and expand into new network facilities may become more difficult and more expensive the longer the COVID-19 pandemic continues to negatively impact the vendors for our network hardware, which in turn could adversely impact our business and operations and results of operations. •Our Customers. The COVID-19 pandemic and the measures taken by governments around the world to contain the spread of COVID-19 are materially and adversely impacting many of our current and potential customers, and this impact could negatively impact our business and operations, results of operations, financial condition, and cash flows. During the first quarter of 2020, we experienced an increase in the sales cycle for our products with many customers. While we believe that increase could have been a result of a number of factors, it is possible that the pandemic contributed to the increase and that an increase could happen again during the ongoing course of the pandemic. We also initially experienced an increase in the proportion of our pipeline of prospective future customers that was lost, as well as an increase during the first quarter of 2020 of new and existing customers requesting concessions in terms of payment amounts and/or timing and earlier or additional termination rights than was the case prior to the pandemic. Depending on the future progression of the pandemic, we also may experience future slowing in our collections of outstanding accounts receivables from some of our customers. We expect these trends and risks to continue while the COVID-19 pandemic persists and they could intensify as the pandemic continues and the financial condition of some of our current and potential customers deteriorates. While we have sought to ameliorate these negative sales impacts through focusing on additional upselling opportunities with existing customers, concentrating our sales efforts on industries that are more insulated from the impact of the ongoing COVID-19 pandemic, and shifting our marketing strategy to better identify sales opportunities in the current environment, there can be no assurance that these efforts will be successful. For further discussion of the challenges and risks we confront related to the COVID-19 pandemic and otherwise, please refer to Part II, Item 1A "Risk Factors" of this Quarterly Report on Form 10-Q, including the risk factor titled "The effects of the ongoing COVID-19 pandemic have materially affected how we and our customers, vendors, and partners are operating our businesses, and the duration and extent to which this will negatively impact our future business and operations, results of operations, financial condition and cash flows remain uncertain." 35
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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.
Three Months Ended
March 31,
2021 2020
(dollars in thousands)
Gross profit $ 105,971 $ 70,429
Gross margin 77 % 77 %
Loss from operations $ (31,254) $ (36,071)
Non-GAAP loss from operations $ (7,490) $ (14,393)
Operating margin (23) % (40) %
Non-GAAP operating margin (5) % (16) %
Net cash provided by (used in) operating activities $ 23,494 $ (14,276)
Net cash provided by (used in) investing activities $ 47,776 $ (8,772)
Net cash provided by (used in) financing activities $ 7,379 $ (4,678)
Free cash flow $ (2,219) $ (30,603)
Net cash provided by (used in) operating activities (as a
percentage of revenue) 17 % (16) %
Free cash flow margin (2) % (34) %
Paying customers 119,206 89,223
Paying customers (>$100,000 Annualized Revenue) 945 556
The following table summarizes the revenue by region based on the billing
address of customers
Three Months Ended March 31,
2021 2020
(in thousands)
Percentage Percentage
Amount of Revenue Amount of Revenue
United States $ 71,222 52 % $ 44,215 48 %
Europe, Middle East, and Africa 35,532 26 % 23,106 26 %
Asia Pacific 22,879 16 % 17,604 19 %
Other 8,422 6 % 6,325 7 %
Total $ 138,055 100 % $ 91,250 100 %
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 provided by (used in) operating activities.
Additionally, the utility of free cash flow as a measure of our liquidity is
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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
with U.S. GAAP. Investors are encouraged to review the related U.S. GAAP
financial measures and the reconciliation of these non-GAAP financial measures
to their most directly comparable U.S. GAAP financial measures, and not to rely
on any single financial measure to evaluate our business.
Non-GAAP Loss from Operations and Non-GAAP Operating Margin
We define non-GAAP loss from operations and non-GAAP operating margin as U.S.
GAAP loss from operations and U.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
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.
Three Months Ended
March 31,
2021 2020
(dollars in thousands)
Loss from operations $ (31,254) $ (36,071)
Add:
Stock-based compensation expense and related employer payroll taxes 23,064 14,617
Amortization of acquired intangible assets 700 731
Acquisition-related and other expenses - 6,330
Non-GAAP loss from operations $ (7,490) $ (14,393)
Operating margin (23) % (40) %
Non-GAAP operating margin (non-GAAP loss from operations as a percentage of revenue)
(5) % (16) %
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.
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Three Months Ended
March 31,
2021 2020
(dollars in thousands)
Net cash provided by (used in) operating activities $ 23,494 $ (14,276)
Less: Purchases of property and equipment $ (22,268) (11,405)
Less: Capitalized internal-use software $ (3,445) (4,922)
Free cash flow $ (2,219) $ (30,603)
Net cash provided by (used in) investing activities $ 47,776 $ (8,772)
Net cash provided by (used in) financing activities $
7,379
17 % (16) %
Less: Purchases of property and equipment (as a percentage of revenue)
(17) % (13) %
Less: Capitalized internal-use software (as a percentage of
revenue) (2) % (5) %
Free cash flow margin (2) % (34) %
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.
Beginning with the quarter ended March 31, 2020 , we transitioned the method for
calculating our key business metrics from a billings-based methodology to a
revenue-based methodology. We believe the change in methodology to GAAP-based
metrics provides improved disclosures for our investors by better aligning our
key business metrics with GAAP and our financial statements and will provide a
better representation of these important components of our operating model and
business performance as we continue to grow our business.
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 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 that has an active contract with us or one of our partners.
The number of paying customers was 119,206 and 89,223 as of March 31, 2021 and
March 31, 2020 , respectively.
Paying Customers (>$100,000 Annualized Revenue)
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 our
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
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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 945 and 556 as of March 31, 2021 and March 31, 2020 , respectively.
We believe this trend will continue as 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 professional services and 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 ended March 31, 2021 and
March 31, 2020 were 123% and 117%, respectively.
Components of Our Results of OperationsRevenue
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 typically 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 terms 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
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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
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. However, 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)
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Interest Income
Interest income consists primarily of interest earned on our cash, cash
equivalents, and our investment holdings.
Interest Expense
Interest expense consists primarily of contractual interest expense and
amortization of the discount and debt issuance costs on our $575.0 million
aggregate principal amount of 0.75% Convertible Senior Notes due May 2025 (the
Notes) that were issued in May 2020 .
Other Income, Net
Other income, 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 in the United States . We maintain a full valuation allowance on our
federal and state deferred tax assets as we have concluded that it is more
likely than not that the deferred tax assets will not be realized.
Results of Operations
The following tables set forth our condensed consolidated results of operations
for the periods presented in dollars and as a percentage of our revenue for
those periods:
Three Months Ended
March 31,
2021 2020
(dollars in thousands)
Revenue $ 138,055 $ 91,250
Cost of revenue(1) 32,084 20,821
Gross profit 105,971 70,429
Operating expenses:
Sales and marketing(1) 69,974 46,965
Research and development(1) 39,527 33,354
General and administrative(1) 27,724 26,181
Total operating expenses 137,225 106,500
Loss from operations (31,254) (36,071)
Non-operating income (expense):
Interest income 544 2,569
Interest expense (10,234) (67)
Other income, net 148 485
Total non-operating income (expense), net (9,542) 2,987
Loss before income taxes (40,796) (33,084)
Benefit from income taxes (833) (338)
Net loss $ (39,963) $ (32,746)
_______________(1) Includes stock-based compensation expense as follows:
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Three Months Ended
March 31,
2021 2020
(dollars in thousands)
Cost of revenue $ 414 $ 267
Sales and marketing 5,645 3,163
Research and development 8,364 6,090
General and administrative 3,615 3,377
Total stock-based compensation expense
Three Months Ended
March 31,
2021 2020
Percentage of Revenue Data:
Revenue 100 % 100 %
Cost of revenue 23 23
Gross margin 77 77
Operating expenses:
Sales and marketing 51 51
Research and development 29 37
General and administrative 20 29
Total operating expenses 100 117
Loss from operations (23) (40)
Non-operating income (expense):
Interest income - 3
Interest expense (7) -
Other income, net - 1
Total non-operating income, net (7) 4
Loss before income taxes (30) (36)
Benefit from income taxes (1) -
Net loss (29) % (36) %
Comparison of Three Months Ended March 31, 2021 and 2020
Revenue
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Revenue $ 138,055 $ 91,250 $ 46,805 51 %
Revenue increased by $46.8 million , or 51%, for the three months ended March 31,
2021 , compared to the three months ended March 31, 2020 . The increase in revenue
was primarily due to the addition of new paying customers, as our number of
paying customers increased by 34% for the three months ended March 31, 2021
compared to the three months ended March 31, 2020 , as well as the expansion
within our existing paying customers, which was reflected by our dollar-based
net retention rate of 123% for the three months ended March 31, 2021 .
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Cost of Revenue and Gross Margin
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Cost of revenue $ 32,084 $ 20,821 $ 11,263 54 %
Gross margin 77 % 77 %
Cost of revenue increased by $11.3 million , or 54%, for the three months ended
March 31, 2021 compared to the three months ended March 31, 2020 . The increase
in the cost of revenue was primarily due to an increase of $4.3 million in
expenses related to operating in co-location facilities and network and
bandwidth costs for operating our infrastructure platform for our expanded
customer base as well as increased capacity to support our growth, an increase
of $2.0 million in depreciation expense related to purchases of equipment
located in co-location facilities, an increase of $1.5 million related to the
amortization of capitalized internal-use software costs and an increase of $1.3
million in employee-related costs due to a 44% increase in headcount in our
customer support and technical operations organizations.
Gross margin did not significantly fluctuate during the three months ended
March 31, 2021 as compared to the three months ended March 31, 2020 .
Operating Expenses
Sales and Marketing
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Sales and marketing $ 69,974 $ 46,965 $ 23,009 49 %
Sales and marketing expenses increased by $23.0 million , or 49%, for the three
months ended March 31, 2021 compared to the three months ended March 31, 2020 .
The increase was primarily driven by $16.8 million in increased employee-related
costs due to a 45% increase in headcount in our sales and marketing
organization, including an increase of $2.5 million in stock-based compensation
expense. The remainder of the increase was primarily due to an increase of $2.8
million in co-location and bandwidth expenses for free customers and an increase
of $2.6 million in expenses for marketing programs due to investments in brand
awareness advertising, third-party industry events, and digital performance
marketing, partially offset by a decrease of $1.5 million in travel-related
costs due to the COVID-19 pandemic.
Research and Development
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Research and development $ 39,527 $ 33,354 $ 6,173 19 %
Research and development expenses increased by $6.2 million , or 19%, for the
three months ended March 31, 2021 compared to the three months ended March 31,
2020 . The increase was primarily driven by $5.0 million in increased
employee-related costs due to a 36% increase in headcount in our research and
development organization and an increase of $2.5 million in stock-based
compensation expense. These increases in employee-related costs were partially
offset by a decrease of $5.7 million expense related to the payments to former
S2 employees, which was recognized in the three months ended March 31, 2020 . The
remainder of the increase was primarily a result of decreased capitalized
internal-use software development costs of $1.5 million .
General and Administrative
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Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
General and administrative $ 27,724 $ 26,181 $ 1,543 6 %
General and administrative expenses increased by $1.5 million , or 6%, for the
three months ended March 31, 2021 compared to the three months ended March 31,
2020 . The increase was primarily due to $4.0 million in increased
employee-related costs, driven by a 39% increase in headcount in our general and
administrative organization. The increase was partially offset by $0.8 million
in decreased bad debt expense.
Non-Operating Income (Expense)
Interest Income
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Interest income $ 544 $ 2,569 $ (2,025) (79) %
Interest income decreased by $2.0 million , or 79%, for the three months ended
March 31, 2021 compared to the three months ended March 31, 2020 . The decrease
was primarily driven by decreased interest rates on our investment portfolio.
Interest Expense
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Interest expense $ (10,234) $ (67) $ (10,167) *
______________
* Not meaningful
Interest expense increased by $10.2 million for the three months ended March 31,
2021 compared to the three months ended March 31, 2020 . The increase was
primarily driven by the contractual interest expense and amortization of the
discount and debt issuance costs on our Notes, which were issued in May 2020 .
Other Income, net
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Other income (expense), net $ 148 $ 485 $ (337) (69) %
______________
* Not meaningful
Other income, net did not significantly fluctuate during the three months ended
March 31, 2021 , as compared to the three months ended March 31, 2020 .
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Benefit from Income Taxes
Three Months Ended
March 31, Change
2021 2020 $ %
(dollars in thousands)
Benefit from income taxes $ (833) $ (338) $ (495) *
_______________
* Not meaningful
The net change in income taxes for the three months ended March 31, 2021
compared to the three months ended March 31, 2020 is $0.5 million . The benefit
from income taxes of $0.8 million for the three months ended March 31, 2021 was
primarily related to excess tax benefits from stock-based compensation
deductions in the United Kingdom , offset by withholding taxes in the U.S. and
income tax expense from profitable foreign jurisdictions. The benefit of $0.3
million for the three months ended March 31, 2020 was primarily related to the
partial release of the U.S. valuation allowance in connection with the
acquisition of S2 and excess tax benefit from stock-based compensation
deductions in the United Kingdom , offset by withholding taxes in the U.S. and
income tax expense from profitable foreign jurisdictions.
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. In September
2019 , we completed our initial public offering (IPO) in which we issued and sold
40,250,000 shares of Class A common stock at a price per share to the public of
$15.00 . We received net proceeds of $565.0 million from sales of our shares in
the IPO, net of underwriters' discounts and commissions. In May 2020 , we issued
$575.0 million aggregate principal amount of the Notes in a private offering to
qualified institutional buyers pursuant to Rule 144A promulgated under the
Securities Act, from which we received total net proceeds, after deducting
initial purchaser discounts and debt issuance costs, of $562.5 million .
As of March 31, 2021 , we had cash and cash equivalents of $187.5 million ,
including $7.2 million held by our foreign subsidiaries. Our cash and cash
equivalents primarily consist of cash, highly liquid money market funds, and
commercial paper. We also had available-for-sale securities of $847.7 million
consisting of U.S. treasury securities, U.S. government agency securities,
commercial paper, and corporate bonds. As of March 31, 2021 , 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 $460.5 million as of
March 31, 2021 and negative annual cash flows from operations. We expect to
continue to incur operating losses and generate negative cash flows from
operations for the foreseeable future 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. Our assessment of the period
of time through which our financial resources will be adequate to support our
operations is a forward-looking statement and involves 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 the ongoing COVID-19 pandemic 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. 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
and the length and severity of the COVID-19 pandemic. We may be required to seek
additional equity or debt financing. 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.
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Cash Flows
The following table summarizes our cash flows for the periods presented:
Three Months Ended March 31,
2021 2020
(in thousands)
Net cash provided by (used in) operating activities $ 23,494 $ (14,276)
Net cash provided by (used in) investing activities $ 47,776 $ (8,772)
Net cash provided by (used in) financing activities $
7,379
Operating Activities Net cash provided by operating activities during the three months endedMarch 31, 2021 was$23.5 million , which resulted from a net loss of$40.0 million , adjusted for non-cash charges of$55.6 million and net cash inflow of$7.9 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$18.0 million for stock-based compensation expense,$15.2 million for depreciation and amortization expense,$9.0 million for amortization of convertible note discount and issuance costs,$6.1 million for amortization of deferred contract acquisition costs,$5.3 million for non-cash operating lease costs,$1.9 million for net accretion of discounts and amortization of premiums on available-for-sale securities,$1.5 million for provision of bad debt, partially offset by$1.5 million for deferred income taxes. The net cash inflow from changes in operating assets and liabilities was primarily the result of a$14.6 million increase in deferred revenue, a$10.1 million increase in accrued expenses and other current liabilities, a$6.2 million increase in accounts payable, partially offset by a$10.9 million increase in deferred contract acquisition costs due to the addition of new customers, a$9.2 million increase in accounts receivable, net, which increased due to our growing customer base and timing of collections from our customers, a$5.4 million decrease in operating lease liabilities, and a$1.4 million increase in other non-current assets. Net cash used in operating activities during the three months endedMarch 31, 2020 was$14.3 million , which resulted from a net loss of$32.7 million , adjusted for non-cash charges of$32.9 million and net cash outflow of$14.5 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$12.9 million for stock-based compensation expense,$10.6 million for depreciation and amortization expense,$4.5 million for non-cash operating lease costs, and$3.5 million for amortization of deferred contract acquisition costs. The net cash outflow from changes in operating assets and liabilities was primarily the result of an$8.1 million increase in accounts receivable, net, which increased due to our growing customer base and timing of collections from our customers,$6.5 million increase in deferred contract acquisition costs due to increased sales commissions from the addition of new customers, a$4.8 million decrease in operating lease liabilities, and a$1.7 million increase in prepaid expenses and other assets, partially offset by a$6.4 million increase in deferred revenue. Investing Activities Net cash provided by investing activities during the three months endedMarch 31, 2021 of$47.8 million resulted primarily from the maturities of available-for-sale securities of$261.8 million , which was partially offset by the purchases of available-for-sale securities of$188.4 million , capital expenditures of$22.3 million , and the capitalization of internal-use software development costs of$3.4 million . Net cash used in investing activities during the three months endedMarch 31, 2020 of$8.8 million resulted primarily from the purchases of available-for-sale securities of$110.6 million , cash payments related to acquisition of S2 of$13.6 million , capital expenditures of$11.4 million , and the capitalization of internal-use software development costs of$4.9 million . These activities were partially offset by proceeds from maturities of available-for-sale securities of$131.6 million . Financing Activities Net cash provided by financing activities of$7.4 million during the three months endedMarch 31, 2021 was primarily due to$8.1 million of proceeds from the exercise of vested and unvested stock options, partially offset by a$0.5 million payment of tax withholding on RSU settlements. 46 -------------------------------------------------------------------------------- Table of contents Net cash provided by financing activities of$4.7 million during the three months endedMarch 31, 2020 was primarily due to$7.1 million of payments of tax withholding on RSU settlements partially offset by$2.7 million of proceeds from the exercise of stock options. Contractual Obligations and Commitments
The following table summarizes our contractual obligations as of
Payments Due by Period as of
Less than 1 More than 5
Total Year 1-3 Years 3-5 Years Years
(in thousands)
Non-cancelable:
Open purchase agreements(1) $ 20,543 $ 3,752
57,091 17,893 27,717 8,993 2,488
Operating lease obligations(3) 71,270 15,600 30,675 15,760 9,235
0.75% Convertible Senior Notes Due May 2025 575,000 - - 575,000 -
Interest obligations(4) 17,777 3,234 8,625 5,918 -
Other commitments(5) 2,187 2,187 - - -
Total $ 743,868 $ 42,666 $ 78,039 $ 607,164 $ 15,999
(1)Open purchase commitments are for the purchase of services under
non-cancelable contracts. They were not recorded as liabilities on the condensed
consolidated balance sheet as of March 31, 2021 as we had not yet received the
related services.
(2)Long-term commitments for bandwidth usage and co-location with various
networks and Internet service providers. The costs for services not yet received
were not recorded as liabilities on the condensed consolidated balance sheet as
of March 31, 2021 .
(3)Office space and equipment under non-cancelable operating leases, primarily
due to our headquarters in San Francisco, California and for our offices in
Austin, Texas ; San Jose, California ; London, United Kingdom ; Lisbon, Portugal ;
and Singapore . Total payments listed represent total minimum future lease
payments.
(4)Represents aggregate interest obligations for the Notes that are payable in
cash, excluding non-cash amortization of debt issuance costs. For further
details on our debt, refer to Note 7 to the condensed consolidated financial
statements included in this Quarterly Report on Form 10-Q.
(5)Indemnity holdback consideration associated with the S2 acquisition. For
further details on the S2 acquisition, refer to Note 13 to the condensed
consolidated financial statements included in this Quarterly Report on Form
10-Q.
The contractual commitment amounts in the table above are associated with
agreements that are enforceable and legally binding. Obligations under contracts
that we can cancel without a significant penalty are not included in the tables
above. Purchase orders issued in the ordinary course of business are not
included in the tables above, as our purchase orders represent authorizations to
purchase rather than binding agreements.
In addition to the contractual obligations set forth above, as of March 31,
2021 , we had $9.3 million recognized as total restricted cash on our condensed
consolidated balance sheets which consisted of $6.7 million in letters of credit
outstanding in favor of certain landlords for office space and $2.6 million in
short-term restricted cash, which primarily consisted of a payment obligation in
connection with the acquisition of S2. The letters of credit renew annually and
expire on various dates through 2028.
For additional discussion on our leases and other commitments, refer to Note 8
to our condensed consolidated financial statements included elsewhere in this
Quarterly Report on Form 10-Q.
Off-Balance Sheet Arrangements
As of March 31, 2021 , 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.
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Critical Accounting Policies, Significant Judgments and Use of Estimates
Our condensed consolidated financial statements are prepared in accordance with
U.S. GAAP. The preparation of these condensed consolidated financial statements
requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenue and expenses, and related disclosures. 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 to the ongoing COVID-19
pandemic, 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 May 7, 2021 , the
date of issuance of this Quarterly Report on Form 10-Q. 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.
Our significant accounting policies are discussed in Note 2 to our consolidated
financial statements included in our Annual Report on Form 10-K for the fiscal
year ended December 31, 2020 . There have been no significant changes to these
policies for the three months ended March 31, 2021 , except as described in Note
2 to our condensed consolidated financial statements included elsewhere in this
Quarterly Report on Form 10-Q.
Recently Issued Accounting PronouncementsRefer to Note 2 to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q for more information regarding recently issued accounting pronouncements.
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