Cloudflare, Inc.

Hello, everyone, and welcome to the CloudFlare Q4 2022 earnings call. All lines have been placed on mute to prevent any background noise. After today's remarks, there will be a question and answer session. If you have a question during this time, simply press star 1 on your telephone keypad. You may also press star 1 to remove your question. I would now like to hand the conference over to Mr. Phil Winslow, VP of Strategic Finance. Please go ahead, sir.

Thank you for joining us to discuss Cloudflare's financial results for the fourth quarter of 2022. With me on the call, we have Matthew Prince, our co-founder and CEO, and Thomas Seifert, our CFO. Michelle Zadlin, our co-founder, president, and COO, is unable to join us on the call today, as she is in Asia meeting with prospects and customers. 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, partners, operations, and future financial performance, our anticipated product launches and the timing and market potential of those products, and our anticipated future financial and operating performance. These statements and other comments are not guarantees of future performance and are subject to risks and uncertainties, much of which are beyond our control. Our actual results may differ significantly from those projected or suggested in any of our forward-looking statements. These forward-looking statements apply as of today, and you should not rely on them as representing our views of 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 SEC, 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. You may find a reconciliation of GAAP to non-GAAP financial measures that are included 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 months ago. We'd also like to inform you that we will be participating in Barrett's 2023 Silicon Slopes event on March 2nd, the Morgan Stanley Technology, Media, and Telecom Conference on March 8th, and William Blair's 7th Annual Tech Innovators Conference on March 14th. Now, before wrapping up, I would also like to invite you to join us for our Investor Day on Thursday, May the 4th, which is being held in conjunction with our user conference, CloudFlare Connect, in New York City. A live webcast will also be accessible from our Investor Relations website. Now, with that, I'd like to turn the call over to Matthew.

Thank you, Phil. It's great to have you on this side of the table. We had another strong quarter in spite of continued challenging macroeconomic conditions. We generated $274.7 million of revenue, up 42% year over year. We achieved a record operating profit of $16.8 million, representing an operating margin over 6%. While we continue to invest to capture the huge market ahead of us, we believe that during economic slowdowns like the one we're in the midst of, it's important to show discipline and optimize for efficiency. We have our hands on the levers of our business and are adjusting them based on the macroeconomic conditions. Our free cash flow in the quarter was $34 million, representing a free cash flow margin of 12% and allowing us to generate $29 million of free cash flow in the second half of 2022. While there will be some variability in our free cash flow quarterly, we expect to be free cash flow positive in 2023 and the years after that. We achieved a gross margin over 77% above a long-term target range of 75 to 77%. Our dollar-based net retention ticked down to 122%, while our gross renewal rates remain as high as ever. Like others in the industry, we're seeing customers take longer to sign new and expansion deals with us. Procurement departments are definitely in the mode of measure two or three times before cutting one. We still see a clear path to a dollar-based net retention over 130% as we ramp seed-based products like Zero Trust and storage-based products like R2. and we won't be satisfied until we get there. We added 134 large customers, those that pay us over $100,000 per year, and now have 2,042 large customers, including 33% of the Fortune 500. Revenue from large customers grew 56% year over year, and they now contribute 63% of our total revenue. We were fortunate that given our visibility into the overall internet traffic and e-commerce trends, we started to see a slowdown in the economy all the way back in December of 2021. Based on that, around this time last year, we began slowing our pace of hiring to ensure we didn't get over our skis. That's paid off and kept us from having to take more drastic actions like many of our peers. It's also given us the ability to sensibly invest in our team as amazing talent comes on the market. To give you some sense, In 2022, we had over 400,000 people apply for approximately 1,300 positions at Cloudflare. That demand to work at Cloudflare has allowed us to continue to hire incredible talent while remaining disciplined in overall compensation. We are committed to incremental equity compensation dilution well below many of our peers, targeting less than 3% net burn rate annually. Tough economic times like these make you assess your strengths and weaknesses. Cloudflare has long had a product and engineering team that delivered an innovation engine that is the envy of the industry. Jen Taylor, who leads that team, briefed me recently on everything we have lined up for the year ahead, and that engine is definitely not slowing down. Our next innovation week is in March with Security Week, where we'll be launching a number of new products and feature enhancements, especially around our Zero Trust products. While our innovation engine is the best in the industry and has unlocked the $125 billion total addressable market we have ahead of us, if we're honest with ourselves, our go-to-market organization hasn't yet been fully optimized. As our products have become more complicated and we are selling to larger and larger customers, it's increasingly clear that we need to step up our game in marketing and sales. I introduced Mark Boroditsky, who joined last quarter to lead our sales organization. Last week, he briefed me and Michelle on his first 100 days. My initial reaction, if I'm honest, was embarrassment over some of the basic things we should have been doing better. But my second reaction was excitement because there are so many opportunities for us to improve. In addition to Mark, Brent Ramai joined us last quarter to lead our marketing team. Brent was previously CMO at FireEye and CMO of core services at AWS. His career perfectly prepared him for CloudFlare's delivery of cloud security services. We've seen early results with Brent's team generating pipeline in Q4 and January of Q1 coming in ahead of our target. We've been leaders on the product and engineering side. Now we're focusing on becoming a leader in the go-to-market side as well. I hear the excitement from our existing sales and marketing teams at the rigor and discipline Mark and Brent are bringing to those teams. And what I'm watching carefully is another important pipeline, the pipeline of new sales talent. we're seeing incredible people from the leading sales team in the world apply to work at Cloudflare. We aim for nothing less than to build one of the leading sales organizations in the world. That's all exciting. And while I believe there's a substantial opportunity for us to improve our go-to-market engine, I'm also cognizant that these efforts can take time. That's why we're not relying on any improvement in sales or marketing efficiency or any rebound in the economy as we look at the year ahead and formulate our guidance. So focusing on the present, Let me highlight some customer wins from the quarter. A Fortune 500 energy company signed a three-year $1.6 million deal that was a takeout of a first-generation zero-trust networking competitor. We were replacing both their secure web gateway and zero-trust network access products. Because the competitor's network is actually broken into multiple distinct clouds as compared with our unified network, their reliability and performance were underperforming the customer's expectations. We were able to replace the competitor's feature set and more. The customer ultimately purchased gateway, access, remote browser isolation, and DNS filtering. The customer was attracted to our better pricing, performance, and ease of use, as well as the single pane of glass manageability of our platform. We worked with a large channel partner to win and service this customer and expect we'll be doing more with them going forward. A Fortune 500 financial services company expanded their relationship with Cloudflare, signing a three-year, $1.1 million deal. They've been a Cloudflare customer since 2014, using our core application services. Like we're hearing from many of our customers, they wanted to consolidate vendors, reduce costs, and have more flexibility and control over their traffic flows, as well as implementing a zero trust architecture. They wanted to move away from legacy on-premise hardware to modern cloud-based services. The customer loved that we have a single pane of glass solution and that our technology is built from the ground up on a single platform rather than a Frankenstein solution bolted together through M&A. They purchased Access, Gateway, Remote Browser Isolation, Magic WAN, and Magic Firewall. They're terrific customers. A Fortune 500 telecom signed a $400,000 one-year deal to bring a portion of Cloudflare's Zero Trust services to their consumer base. They're bundling Cloudflare's DNS content filtering into their consumer security bundle. After evaluating competition, they found Cloudflare's solutions to be the most secure and reliable on the market. This deal is not only valuable for the obvious reasons, but also because it will feed data back to our Zero Trust security products to further extend their lead over the competition. A leading generative AI company signed a one-year, $1 million deal. The company had been a user of our free tier since 2017. And this deal originally started out as a relatively small gateway DNS opportunity to replace Cisco Umbrella. However, when their browser-based application debuted in late November, demands of the company's AI-generated content absolutely exploded with unprecedented rates of adoption. Their Azure front door setup quickly proved insufficient at handling the massive load on their services from legitimate users, as well as keeping fraudulent users from exhausting their resources. They started off with CDN, DDoS, font management, gateway DNS, and more. We are actively exploring various paths for expansion to support their incredible growth, as well as emerging use cases of their AI models and applications with Cloudflare Workers, API Shields, imagery sizing, and more. We saw success with other AI companies in the quarter as well. Given the resource constraints they all face, as well as how attractive they are as a target to fraudulent users, CloudFlare security solutions are an obvious choice for all of them. But many of them came to us for other reasons as well. AI companies in particular need to find wherever it's most cost effective to run their models across multiple different cloud providers. They are, by their very nature, multi-cloud. But the data egress policies make it prohibitive to move large training sets between the cloud and our CloudFlare workers. What we're finding with these AI companies is that R2 and other workers' products naturally become the glue at the center of a multi-cloud ecosystem. R2 has become the natural neutral place for these AI companies to store their training data in order to make sure it can be inexpensively and efficiently accessed from anywhere. It's obvious in retrospect, but it's the use case we didn't anticipate. Today, our largest R2 customer is another AI company using us for exactly the purpose of being a neutral place to store their training data. And, of course, being a neutral network super cloud that stitches together the traditional public cloud isn't a problem exclusive to AI. A European financial services company signed a five-year $1.8 million deal replacing a dozen different security and network vendors with Cloudflare. This company settles hundreds of millions of securities transactions annually for the largest banks and governments in the world. As a result, security and regulatory compliance are paramount for them. They wanted to consolidate and simplify their numerous point solutions into a single pane of glass solution. After receiving regulatory approval, the customer signed on for multiple solutions across our core application services portfolio, as well as both zero trust and network services of Cloudflare One, including access, DNS filtering, and magic transit. In addition to consolidating their spend across multiple point solution vendors onto Cloudflare's broad platform, our data localization suite in particular won them over. Competing vendors simply do not have an equivalent solution. As companies increasingly face localization and data residency requirements becoming law in various geographies, our differentiated data localization suite is becoming more and more critical to customers. A public utility company in Africa signed a $2.8 million, 75-month deal to help support a really cool industrial IoT rollout. They're using Cloudflare's intelligent network to monitor 3,300 sensors tracking shipments of materials. This is another use case of Cloudflare's network we wouldn't have imagined on our own, but one we're uniquely positioned to deliver for the customer and now opens even more markets and opportunities. The state of North Carolina signed a three-year, $3 million deal. The state had originally come to us under our Athenian project for free help with election security. They learned the power of Cloudflare using us to protect their elections infrastructure and signed the deal to expand Cloudflare's protection across 50 state agencies. Finally, I'm happy to report that after a longer than expected wait at the proverbial DMV, we officially received Cloudflare's FedRAMP certification. The certification covers nearly our full suite of products with a notable exception of area one email security product, which we acquired after we started the FedRAMP process, but we expect to add it to our certification at the FedRAMP renewal. Our first federal contract after our certification was a great start. We were awarded the $7.2 million five-year deal to operate the .gov registry. We were awarded the contract because of our modern infrastructure, technical prowess, relentless innovation, and proven ability to defend against the largest cyber attacks. Every email sent to the White House, every agency's webpage, and most of the other ways the U.S. government connects to the Internet now depend on CloudFlare and our network. We're proud to have won this business. But the public sector space is only 3% of our revenue today. So we believe it's only the beginning of what we'll be doing in the future. With that, I'll turn it over to Thomas. Thomas, take it away.