Cloudflare, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to Cloudflare's first quarter 2022 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, please press star, followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Jason Noland, head of investor relations, you may begin your conference.

Thank you for joining us to discuss Cloudflare's financial results for the first quarter of 2022. With me on the call, we have Matthew Prince, co-founder and CEO, Michelle Zatlin, co-founder, president, and COO, and Thomas Seifert, CFO. By now, everyone should have access to our earnings announcement. 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 our customers, vendors, and partners' operations and future financial performance, anticipated product launches and the timing and market potential of those products, the company's anticipated future revenue, financial performance, operating performance, non-GAAP gross margin, non-GAAP net income or loss, non-GAAP net income or loss per share, shares outstanding, non-GAAP operating expenses, free cash flow, non-GAAP tax expense, dollar-based net retention rate, 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-looking 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. Before finishing up, I'd like to invite you to join us for our Investor Day next week on Thursday, May 12th. It's being held in conjunction with our user conference, Cloudflare Connect, in New York City. This event will start at 9 a.m. Eastern and finish around 1145 with a live webcast accessible from our investor relations website. Additionally, we will be participating in the Jeffrey Software Conference in San Francisco on June 1st. Now, I'd like to turn the call over to Matthew. Thank you, Jason. We had a terrific quarter.

In Q1, we achieved revenue of $212 million, up 54% year over year. We added a quarterly record of more than 14,000 new paying customers, up 10% quarter over quarter, bringing our total paying customer count to over 154,000. We added 121 new large customers, those that pay us over $100,000 per year, up 63% year over year, to a total of 1,537. Today, 58% of our revenue comes from those large customers. Our largest customers continue to get larger and larger, those spending over $500,000 a year growing 68% year over year, and those spending over $1 million a year growing 72% year over year. We now have 12 customers and partners spending over $5 million per year with us, and yet we remain highly diversified with no customer representing more than 5% of revenue. Our land and expand motion continues to improve with dollar-based net retention hitting a new record of 127% in the quarter, up 400 basis points year over year. New products and an increased interest in consolidating behind a single trusted vendor for network services has been the key to our continued customer expansion. Efficiency has always been a hallmark of our business, and even in these inflationary times, we achieved a gross margin in the quarter of 78.7%, up 110 basis points year over year. That continues to be above our target gross margin range of 75% to 77%, and affords us the opportunity to selectively target competitors' customers, offering them bundles of products that work seamlessly together, reducing the number of vendors they need, and providing them with modern solutions, all while saving them money at the same time. We are finding this an especially compelling value proposition when it seems everyone else is raising prices or can't even say for certain when they'll be able to deliver their legacy hardware boxes. We closed our largest acquisition ever in the quarter, buying Area 1 security for $162 million. We have a very high hurdle rate for acquisition, being strongly biased towards internal development. But Area 1's technology and team are special. We started out as their customers. I remember shortly after we implemented their solution, writing to our chief security officer to ask if something was wrong. I hadn't seen any phishing reports in a few weeks, where usually our team would report double digits per day. Turned out, Area 1 and their incredible email security tech was the answer. By the way, if you're still seeing phishing messages in your inbox, tell your IT team to call us. We now have a great solution. Over the last few years, as a customer of Area 1, we got to know their team. At CloudFlare, we're a bunch of geeks. We're good at sniffing out when tech is real and when it's BS. The Area 1 team shares the same spirit, so they were fun to work with, and their tech definitely isn't BS. We talked to them briefly about a partnership, but it became quickly clear it made far more sense for them to join Cloudflare and fully integrate with our Zero Trust suite. Let me give you a sense of how that's going. We extended offers to all the Area 1 team, and even in this hot labor market, 98% of them chose to join Cloudflare. And I'm not giving up hope on that last one Area 1 team member who hasn't yet. I think that says something about how good a fit the two companies are together, the technologies and the culture. Email is the number one source of network threats. That no leading zero-trust vendor has truly integrated email security is a major blind spot the industry was guilty of. As you see others in the space now scramble to build, buy, or partner to fill the hole we pointed out in their offerings, Know that it's the best signal Cloudflare Zero Trust solution is resonating in the market and taking share no matter what they may say. And good luck to them. We got the best team and the best tech in the business. Let's talk about some customer wins in the quarter, starting with Area 1. In the second half of Q1, Cloudflare and Area 1 sales team started working together. We saw a number of customer wins from existing CloudFlare customers adding Area 1, as well as from Area 1 pipeline deals that accelerated after news broke of our acquisition. Practitioners trust CloudFlare and know that if we buy a company, the tech works and will scale. New customers who onboarded to Area 1 in the quarter included a major Asian airline, a U.S. bulge bracket investment bank, and a Fortune 1000 trucking company. Let me dig into that trucking company example a bit. They were an existing CloudFlare customer. They were in the midst of a pilot testing a wide range of email security vendors. In those tests, Area 1 caught twice as many phishing emails as the next best competitor. That the tech was now part of CloudFlare made the decision a no-brainer. The trucking company signed a 7,500-seat, $385,000 two-year deal. Watch this space. There's going to be a lot more stories like this one. We continued to see success with our other Zero Trust products. A Midwestern U.S. state bought 75,000 seeds in a three-year, $5.1 million deal. The state was replacing legacy hardware and had decided to move to a cloud-based solution when they began talking to us. It was a competitive deal, but they preferred CloudFlare's tightly integrated approach that gave them a single pane of glass with integrated policies and threat intelligence. They also loved our performance and network that had presence inside their state borders. This was an example of a sale in partnership with a major systems integrator, which we expect will be part of more and more of our Zero Trust sales. We're confident our implementation of these products has plenty of margin to support a robust partner ecosystem. A large Indian media platform chose CloudFlare over Zscaler and Palo Alto Networks for their Zero Trust network. They signed a $150,000 deal for 5,000 seats. They appreciated how much more tightly integrated our solutions were than the competition. We're going head to head with Zscaler and Palo Alto networks more and more, and we like our win rates when we do. A European Fortune 500 automotive company adopted Cloudflare's Zero Trust approach to help manage their global fleet of more than 10 million vehicles. They signed a contract worth $320,000 per year. We're seeing more and more of these IoT Zero Trust use cases and believe there's significant opportunity to expand with this customer. Speaking of expansion, a Fortune 500 software company expanded their relationship with us, bringing their annual run rate to $15 million per year. The new contract expanded our relationship to another internal IT division, helping them build their future, scalable, secure, modern network. They repeatedly let us know we were the only vendor they trusted in the space for such a mission-critical service. On the theme of trust, a large social network signed a $3 million five-year contract. They're using our global network to authenticate the security of one of their messaging products. They built the authentication application on workers, our serverless compute platform. That workers can keep up with their tremendous scale and volume is a testament to its effortless scalability. Sticking with workers, a large Australian software company adopted workers to help power a collaboration tool. They signed a $145,000 contract. They're using workers' durable object functionality to build real-time global synchronization into the product. What we're seeing with workers is that there's a natural expansion as smart software teams realize what they can do when they can write code and effectively deploy it directly into the internet fabric. We expect this customer will continue to use workers for more of their projects now that they've proven success with this one. A Fortune 500 healthcare company signed a $1.2 million three-year deal. It's a pretty standard network security and performance use case for us, replacing legacy hardware. What I thought was interesting was that the IT team had moved from a large financial services customer of ours. As they changed jobs, they brought CloudFlare to their new employer. I think we're going to see a lot more of this as practitioners who succeeded in their last job by leaning on us are moving on and moving up in their careers to new opportunities. A Fortune 500 financial services company went all in on Cloudflare. They said that they see us as the future. They signed a $1.5 million three-year deal. It was driven by their chief security officer. From start to finish, the sales cycle was around four months. They ripped out a number of legacy vendors and consolidated a number of network services behind us. They were tired of trying to find best of breed with every product and instead ending up with a Frankenstein mess. They realized they could with us, have the best-of-breed network that was tightly integrated where the features all efficiently work together. We expect they will continue to grow their contract now that they've bought fully into CloudFlare's architecture. One last story. A Fortune 1000 gaming company signed a $3.3 million three-year contract. I love this story. They were using AWS but found their security couldn't prevent the attacks they were seeing. After struggling to keep their application online, AWS's team eventually told them, You should just use Cloudflare. And so they did. We're excited to let them and lots of other customers know that R2 is progressing to open beta next week, and we expect we'll be able to save them lots of AWS egress fees as well. I wanted to close by talking about what we're seeing in Russia and Ukraine. I mentioned the region at the end of the last earnings call. A number of you reached out to say it seemed out of place at the time.