Cloudflare, Inc. (NET)

Business overview

Business Overview Cloudflare’s mission is to help build a better Internet. Over the past decade, the technology industry has been undergoing a massive transition from on-premises hardware and software that customers buy, to services in the cloud that they rent. Organizations find themselves at different points in this transition to the cloud. Regardless of where organizations are in their transition, they all face a common set of challenges: they exist in a complex, heterogeneous infrastructure environment which exacerbates the fundamental problems of the Internet more than ever, and the on-premises hardware boxes that they once relied upon to solve these problems were never designed to work in such an environment.

As more workloads move to the cloud and workforces become increasingly distributed globally, there is no point in installing additional hardware boxes on premise. An on-premises box will not solve the problems organizations now face. Nor can a business ship a hardware box to a cloud vendor. Even if they wanted to, there is literally no place to install such a box in the cloud. The result is that a major architectural shift at the network layer is underway. Previously, enterprises would often string together a diverse set of on-premises hardware boxes from different vendors to solve their network challenges.

As these solutions move to the cloud, the network latency, support complexity, and cost of overhead makes stringing together multiple point-cloud solutions that only address specific network needs also untenable. Customers are therefore looking to consolidate behind a single, global provider that operates in the cloud — what has been described as a “Connectivity Cloud". Cloudflare is a leader in this Connectivity Cloud category. We deliver 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 on-premises, hybrid, cloud, and software-as-a-service (SaaS) applications.

We serve comprehensive customer needs across security and connectivity, and increasingly, the distributed and programmable nature of our network is resulting in customers building their applications on top of our network, too — including both traditional applications and those that are enhanced with artificial intelligence (AI). Our Network We have built an efficient, scalable, programmable network that allows us to rapidly develop and deploy our products for our customers and that is architected to be flexible, scalable, and get more and more efficient as it expands. Our network is built to run every service on every server in every city. This design enables us to grow capacity quickly and inexpensively and to allow us to shift customers and traffic across our network efficiently.

We refer to this architecture as “serverless” because it means we can deploy standard, commodity hardware, and our product developers and customers do not need to worry about the underlying servers. We are also expanding the capabilities of our network servers to enable AI workloads that are suited to take into account the widely distributed nature of our network. Additionally, our software is designed to manage the deployment and execution of our product developers’ code and our customers’ code across our network. Because we manage the execution and prioritization of code running across our network, it means that we are both able to improve the performance of our highest paying customers, and also effectively leverage idle capacity across our network.

We have chosen to utilize this idle capacity to create a free tier of service which has generated substantial global scale for us. In turn, this scale makes us attractive partners for Internet Service Providers (ISPs) globally, which reduces our co-location and bandwidth costs. As our network grows, these dynamics become even more powerful. Today, our network spans more than 330 cities in over 125 countries worldwide and interconnects with over 13,000 networks globally, including major ISPs, cloud services, and enterprises. 9 Increasingly, we are finding that our customers are also using our network to build their applications too. We believe this programmable feature of our network is attractive to our customers for a number of reasons, including: • the global reach of our network and how it puts our customers’ applications closer to the world's Internet-connected population; […]

Management discussion and analysis

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Attracting, expanding, and retaining sales to large customers involve risks that may not be present, or that are present to a lesser extent, with sales to smaller customers, including: • competition from companies that traditionally target larger enterprises and that may have pre-existing relationships or purchase commitments from such larger enterprise customers, including companies that seek to bundle sales of their new or existing products that are competitive to our products, or that may have more experienced sales personnel or greater budgetary resources available or committed to such larger enterprise customers; • longer evaluation periods, more detailed evaluations, and more cumbersome contract negotiation and approval processes, including potential requirements for such purchasing decisions to be approved by senior executives of such companies; • increased purchasing power and leverage in negotiating pricing terms and other contractual arrangements with us, which may result in us being subject to additional, or greater levels of, contractual risks than our sales to smaller customers; • requirements for more technically complex configurations, integrations, deployments, or features; • greater customer support or assistance with migrating their systems from another vendor to our network and products; • more stringent requirements in terms of the security, performance, and reliability of our products and our network and our support and compliance obligations related to our products; • increased usage of our global network that may require us to incur greater network infrastructure expenditures; and • longer sales cycles and the associated risk that substantial time and resources may be spent on a potential customer that elects not to purchase, expand, or continue to purchase our products.

Historically, the implementation period to start using, or expanding the use of, our products has been short, with most customers under our pay-as-you-go plans implementing usage of our products within a short period of time and our sales cycle for customers under our Enterprise plan lasted less than one quarter. Since the first half of 2022, however, we have experienced occasional lengthening of our average sales cycle for our new and existing large customers, and the lengthening of our sales cycle to our large customers could reoccur in the future. In addition, as our sales force continues to target an increasing number of large customers for new and expanded product sales, these larger enterprises often undertake a more significant evaluation and negotiation processes than we have experienced in the past, which could further lengthen our sales cycle materially.

In addition, our sales efforts typically involve educating our prospective large customers about the uses, benefits, and value proposition of our network and products. Our sales force develops relationships directly with our customers and our channel partners through account penetration, account coordination, sales, and overall market development. Potential large customers often view the subscription to our products, including any expansion of those subscriptions, as a significant strategic decision and, as a result, in some cases require considerable time to 24 evaluate, test, and qualify our network and products prior to entering into or expanding a relationship with us. As a result, we spend substantial time and resources on our sales efforts without any assurance that our efforts will produce a sale.

Subscriptions to our products, including expanded subscriptions, often are subject to budget constraints, multiple approvals, and unanticipated administrative, processing, and other delays. In addition, some of our subscription agreements with our large customers may have more customer favorable early termination rights, less favorable limitations on liability, indemnification and other legal provisions for us, greater usage-based pricing than is the case with our customary subscription-based agreements with our contracted customers and our pay-as-you-go customers, or generate lower margins than other contracted customers. For example, subscription agreements with certain of our largest customers are structured on a "pool of funds" model in which the customer commits to spend at least a specified amount on our products during the subscription period.

These "pool of funds" arrangements do not require the customer to subscribe for specific products or spend any specific amounts during any month, quarter or, if applicable, year of the subscription period, but the funds must be utilized during the subscription period under the terms of these subscription agreements. […]

Key risk disclosures

Risk Factors of this Annual Report on Form 10-K. Below are summaries of some of these risks, any one of which could materially adversely affect our business, financial condition, results of operations, and prospects. In that event, the market price of our Class A common stock could decline, and you could lose part or all of your investment. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, may also become important factors that adversely affect our business. Our Risk Factors are not guarantees that no such conditions exist as of the date of this report and should not be interpreted as an affirmative statement that such risks or conditions have not materialized, in whole or in part.

• We have a history of net losses and may not be able to achieve or sustain profitability in the future. • We have experienced rapid revenue growth, which may not be indicative of our future performance. • Adverse economic conditions, including reduced spending on products and solutions for network security, performance, and reliability, may adversely impact our revenue and profitability. • Conflicts and geopolitical tension around the world or any worsening or expansion of those conflicts or tensions, other geopolitical events such as elections and other governmental changes, and any related challenging macroeconomic conditions globally and in various countries in which we and our customers operate may materially adversely affect our customers, vendors, and partners, and the duration and extent to which these factors may impact our future business and operations, results of operations, financial condition, and cash flows remain uncertain.

• If we are unable to attract new paying and free customers, our future results of operations could be harmed. • Our business depends on our ability to retain and upgrade paying customers, expand the number of products we sell to paying customers, and, for certain of our products, expand our paying customers' usage of such products, and, to a lesser extent, convert free customers to paying customers, and any decline in renewals, upgrades, expansions, usage, or conversions could adversely affect our future results of operations. • If we are unable to effectively attract, expand, and retain sales to large customers, or we fail to mitigate the additional risks associated with serving large customers, our business, results of operation, and financial condition may suffer.

• Activities of our paying and free customers or the content of their websites or other Internet properties, as well as our response to those activities, could cause us to experience significant adverse political, business, and reputational consequences with customers, employees, suppliers, government entities, and others. • We face intense and increasing competition, which could adversely affect our business, financial condition, and results of operations. • If we do not effectively attract, train, and retain our sales force to be able to sell our existing and new products and product features, we may be unable to add new contracted customers, or increase sales to our existing customers and our business would be adversely affected.

• We rely on our co-founders and other key technical, sales, and management personnel to grow our business, and the loss of one or more key employees or the inability to successfully attract, integrate, and retain qualified senior management and other personnel, or the failure of new members of our management team to successfully lead and scale our business, could harm our business. • Problems with our internal systems, networks, or data, including actual or perceived breaches or failures, could cause our network or products to be perceived as insecure, underperforming, or unreliable, our customers to lose trust in our network and products, our reputation to be damaged, and our financial results to be negatively impacted.

• If our global network that delivers our products or the core co-location facilities we use to operate our network are damaged, interfered with, or otherwise fail to meet the requirements of our business or local regulations, our ability to provide access to our network and products to our customers and maintain the performance of our network could be negatively impacted, which could cause our business, results of operations and financial condition to suffer. 7 • Detrimental changes in, or the termination of, any of our co-location relationships, ISP partnerships, or our other interconnection relationships with ISPs could adversely impact our business, results of operations, and financial condition. […]

Source and methodology

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