Cloudflare, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the CloudFlare Q1 2020 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Jason Noland, Head of Investor Relations. Thank you. Please go ahead, sir.

Thank you for joining us to discuss CloudFlare's financial results for the first quarter 2020. With me on the call, we have Matthew Prince, co-founder and CEO, Michelle Zatlyn, co-founder and COO, and Thomas Seifert, CFO. By now, everyone should have access to our earnings announcements. This announcement, as well as our supplemental financial information, may be found on our investor relations website. As a reminder, we'll be making forward-looking statements during today's discussion, including but not limited to the impact of the COVID-19 pandemic on our and our customers', vendors', and partners' operations and future financial performance, anticipated product launches, and the time and market potential of those products, The company's anticipated future revenue, financial performance, operating performance, non-GAAP gross margin, non-GAAP net loss from operations, non-GAAP net loss per share, shares outstanding, non-GAAP operating expenses, free cash flow, non-GAAP effective tax rate, dollar-based net retention rate, free and paying customers, and large customers. These statements and other comments are not guarantees of future performance, but rather are subject to risks and uncertainty, some of which are beyond our control including but not limited to the extent and duration of the impact of the COVID-19 pandemic and adverse conditions in the general domestic and global economic markets. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. These forward statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties that could impact our future operating results and financial condition, please see our filings with the Securities and Exchange Commission, as well as in today's earnings press release. Unless otherwise noted, all numbers we talk about today, other than revenue, will be on an adjusted, non-GAAP basis. All current and prior period financials discussed are reflected under ASC 606. You may find a reconciliation of GAAP to non-GAAP financial measures in our earnings release on our investor relations website. For historical periods, a GAAP to non-GAAP reconciliation can be found in the supplemental financial information referenced a few moments ago. We would also like to inform you that we will be virtually participating in the J.P. Morgan Global Tech, Media, and Communications Conference on May 12th through the 14th and the Baird Consumer Tech and Services Conference on June 2nd through the 4th. Now, I'd like to turn the call over to Matthew.

Thank you, Jason. Let me start by saying what feels almost awkward to say given the circumstances. We had a very strong quarter. Our Q1 revenue finished at $91 million, up 48% year-on-year. We posted a gross margin of 78%, showing the continued efficiency of our platform. We made substantial progress on our path toward profitability, Realizing over 1,000 basis points of operating leverage improvement year on year. That's the easy part. As I said in our first earnings call as a public company, we've been practicing mock earnings calls for years to the point that they already feel like business as usual. However, as I sat down to write up these remarks, I have to confess I struggled because what we're all living through is definitely not business as usual. So, in many ways, this isn't going to be a usual earnings call. Settle in, buckle up. I wanted to take a bit more time to walk through four areas I've been focused on. Our team, our platform, our business, and our customers. And, in particular, I wanted to give you more of a sense of what we're seeing, not just in the last quarter, but focusing on March and April as the world reacted to COVID-19. First, our teams. We are very fortunate that the first customer of all of Cloudflare's products is Cloudflare ourselves. We are digital natives, and we're able to use our products like Cloudflare for Teams to transition to productive and secure remote work. Our Network Operations Center, Security Operations Center, and Technical Support Center all continue to be fully, securely, and reliably staffed 24-7. But it's not just about technology. It's also an inspiring mission that empowers a team. Cloudflare's mission is to help build a better internet. Had this been a banking or agricultural crisis, we would likely have felt as powerless as many of our friends and colleagues at other companies do right now. But this was a crisis that caused us all, worldwide, to lean on the internet more than ever before. Undoubtedly, the superheroes of this crisis are the medical professionals and scientists taking care of the sick and searching for a cure to this disease. But the faithful sidekick, the Ant-Man to Captain Marvel, has been the Internet. And as one of the guardians of the Internet, I'm proud of how our team has risen to the occasion to support our customers, new and old, as they deal with unprecedented challenges. I wanted to take this opportunity to thank all our team. You are working incredibly hard to ensure the Internet continues to function while the world has needed it more than ever before. I'm proud of how well you've all kept up our level of productivity and excellence, and most importantly, honored to see you support each other, as well as our millions of customers, as we live through these challenging times together. Companies are really just collections of people, and this crisis has reaffirmed to me, we have a great team. Second, our platform. The growth in internet traffic has been unprecedented. Across our platform, we saw as much growth in traffic in 12 weeks as we have seen in the previous 12 months. The flexibility of our platform, where every server in every city can run every Cloudflare service, has allowed us to continue to spread load and serve all our customers. Stress does make systems better, and our engineering team has used this time as a way to make our platform more efficient. For instance, our firewall team released a series of improvements that shaved 40% of the processing time off every request. That means we are doing full deep packet inspection and threat analysis in a fraction of a millisecond at our tremendous scale. It also means that our network has actually gotten faster during this crisis while at the same time acquiring less hardware. We expect these and many more innovations will pay dividends to us for years to come. One of the concerns we had early in the crisis was our supply chain. Cloudflare sources the hardware that powers our network through multiple ODM partners. These partners, as well as the many component manufacturers they rely on for parts, are largely based in Asia, where the virus first hit. Beginning in early January, in light of the at-the-time unnamed virus, our infrastructure team thoroughly analyzed our supply chain, identifying potential bottlenecks. We moved up some purchases of key components we thought may become constrained, This proved prescient. Thus far, we've been able to continue to receive the equipment we needed without meaningful delay in order to expand our network during this time of unprecedented demand. And the demand has been unprecedented. We've seen Internet traffic use nearly double through March and April versus the beginning of the year. While global traffic is still increasing, regionally, we are seeing network traffic plateau. Different categories of traffic have grown more than others. Demand for educational and kids content, arts and crafts, and parenting content have all more than doubled. On the other hand, traffic to sites about sports scores, travel, and real estate has declined. The scalability and flexibility of our unified platform with its ability to serve our diverse customer base and distribute load globally has served us very well. Third, our business. I've given you the Q1 highlights, but let me zoom into March and April and give you more granularity in what we're seeing. Beginning in March, we saw a modest uptick in the length of our average sales cycle. That added a few days to our closing deals. However, our average sales cycle still remains well under a quarter and, even with the modest uptick, is shorter than it was just 12 months ago. Our sales in March were strong, finishing ahead of our plans. What was surprising to us was how much of March's business closed in the last week of the quarter. Our ability to close new business has continued without a break through April, and to date, we are tracking well to our plan for new business this quarter. Our read is that much of the world took a bit of a pause for a few weeks in mid-March while companies figured out their remote procurement processes. But once those were figured out, Deals for Critical Services, like those Cloudflare provides our customers, got done. One more view into what the data are showing us. We track our sales pipeline closely. While many things may still impact win rates, we are encouraged that we added more new pipeline in February than in January, more in March than in February, and more in April than in March. I'm proud of our team, and while the demand is there, we have no intention of slowing down. Part of the key to our success comes back to our short sales cycle and our ability to sell services without sending account or professional service teams on premise. Businesses, large and small, have an acute need for a fast, reliable, secure network now more than ever. They come to us every hour of every day, and we can have them up and running as quickly as a few hours or minutes compared to our competitors' weeks or months. Because of our short sales cycle, we can adapt quickly. As we came to understand that certain industries were going to be particularly impacted by the current crisis, we shifted our sales resources to thriving verticals so our teams could still make their quarter. One surprise for the quarter was our pay-as-you-go business. This segment is for customers who sign up with a credit card on month-to-month agreements and without talking to anyone on our sales team. Today, it's a small portion of our revenue, but it's our root. Where we started over nine years ago, and so it's still very important to us. We were concerned this segment may be more impacted because of its exposure to small businesses and individual developers.