Q4 2019 Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the cloud flare Q4 2019 earnings conference call.
At this time all participants are in a listen only mode. After the speakers presentation. There will be a question and answer session to ask a question. During the session. You want me to press Star one on your telephone.
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No I turn the conference over to your Speaker today, Jayson Noland head of Investor Relations. Thank you. Please go ahead Sir.
Thank you for joining us to discuss cloud flares financial results for the fourth quarter and fiscal year 2019 with me on the call. We have Matthew prints co founder and CEO Michelle's out one co founder and CEO and Thomas Seifert CFO by now everyone should have access to earnings announcement this announcement as well as our supplemental financial information.
And maybe found on our Investor Relations website.
As a reminder, well be making forward looking statements during todays discussion, including but not limited to anticipated product launches and the time and market potential for 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.
Their shares outstanding non-GAAP operating expenses free cash flow non-GAAP effective tax rate dollar base not retention rate.
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. Our actual results may differ significantly from those projected our suggested and 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 in financial condition. Please see our filings with the Securities and Exchange Commission as well as in today's earnings press release, unless otherwise noted.
Well 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 AOCI success. Six you may find a reconciliation of GAAP to non-GAAP financial measures in our earnings release on our Investor Relations website and for historical periods, a GAAP to non-GAAP reconciliation.
And can be found in the supplemental financial information referenced a few moments ago.
We would also like to inform you that we will be participating in the JMP technology conference in San Francisco on February 25th Morgan Stanley TMT Conference in San Francisco on March Threerd, and fourth and the Suntrust Technology and Internet Conference in New York City on March 10, now I'd like to turn the call over to Matthew.
Thank you, Jason and thanks to all of you on the phone for dialing into cloud players second quarterly earnings call as a public company.
19 was a great year for cloud flare. Our Q4 revenue finished at $84 million growing 51% year on year, we continue to see strong demand among larger and larger customers and finished Q4 with 550 customers paying us over $100000 per year, we posted a Q4.
Gross margin of nearly 79% and our gross profit for the period was up 55% year on year. We continue to view gross margin strength as evidence of the differentiated efficiency of our network and broad base of services delivered through one consistent platform.
For the full year 2019, we generated revenue of $287 million, which represents an increase of 49% year on year for comparison, our compound annual revenue growth rate over the last four years has been 50%.
We're pleased to have been able to maintain that consistently high topline revenue growth rate, even as the absolute revenue number has grown over the years, we've made smart investments in our product and our flexible network and we believe strategically position us to continue to take share as I T spend shifts from on premise hardware.
Software just scalable cloud services.
We finished 2019 with nearly 2.6 million total customers, including both free and paying an increase of 12% sequentially and 34% year on year.
We also grew the number of Internet properties using cloud flare by 10 million over the course of 2019, finishing the year with more than 26 million on our platform.
These properties include website, Apiay eyes, and mobile application that use our services to be secure reliable and performance.
While many of these customers don't pay us yet they are literally the top of our marketing sales and product development funnel.
Darren asset none of our competitors had been able to match.
From our earliest days, we believed in the theory of disruptive innovation as articulated by professor Clay Christiansen.
It was a professor of mine and over the years became a friend is theories of been instrumental in how cloud solar has gone to market, our efficient customer acquisition, our rapid development cycle and ultimately much of our success.
I was saddened to hear of his passing a few weeks ago I wanted to take this opportunity. Thank him for his mentorship and guidance over the years and to suggest for anyone who wants to understand our strategy is a pick up a copy of place seminal book the innovators dilemma, we learned a lot from clay and you can learn a lot about us by reading his work.
I wanted to walk through a handful of great customer wins from the last quarter. The first as a fortune 500 CPG company. They were undergoing a companywide initiative to move from on premise hardware to the cloud specifically looking to replace their legacy firewall boxes. They chose cloud flare because of the flexibility and scalability of.
Our platform ultimately moving more than 500 to the world's most famous consumer brand behind our network.
The result was assigned deal with an annual contract value of over $290000 and we think there's significant opportunity for us to expand the services, we provide them in 2020.
Multi cloud is another theme, we're seeing drive some of the largest corporations in the world to choose cloud flare, a fortune 50, food and beverage company came to us because they were concerned about being locked into a single public cloud provider. They wanted to protect their services with a consistent control plane, while ensuring that they could use multiple.
Public cloud backend.
We worked with them to seamlessly direct traffic between eight ws as your and Google cloud, while ensuring a consistent security performance and reliability profile.
Move 250 of their brands behind cloud flare under a three year contract at $400000 per year, we expect that over 2020, we'll be able to expand our relationship to cover more of this customers 1100 brands.
I also wanted to share an example of a wind featuring one of our newer products Magic Transit Magic Transit uses cloud players global infrastructure to protect and organizations entire network not just their web facing applications disturbing new trend. We're seeing is hackers targeting office networks, and thereby paralyzing company.
This is what happened to a fortune 500 financial services from last quarter like many similar firms they use remote desktop software. Unfortunately that meant when the hacker overwhelmed their office Internet connection it shut down the ability for all their employees to get any work done.
They turn to cloud flare and our magic transit product to get back on line.
Magic transit protected their infrastructure without introducing latency like other legacy hardware or scrubbing center based solutions. They signed a three year deal worth $400000 per year and are very happy customers. Here's another one the maker of one of the largest apiay and online applications in the world something almost.
Everyone listening to this call likely relies upon daily signed a three year deal worth $1.1 million per year. They came to cloud flair for a number of our services over particularly attracted to our workers edge computing platform workers allows them a speed of development and flexibility that they couldn't find anywhere.
Yes, we believe there's an opportunity to grow this customer as they onboard more of their workflows onto workers and this customer is not unique throughout the quarter. We saw workers as a differentiating factor in a large percentage of our new deals developers are realizing the power of edge computing and we believe cloud flares, leading this trend.
Yes.
Rounding out customer wins is a regional bank with more than 500 branch offices, what I like about. This example is how broadly they adopted cloud players integrated platform from day one.
They are using our performance firewall bought management rate limiting and workers products. They also chose classical or access our cloud based VPN for 15000 of their employees. The deal it's worth $370000 per year to us for them that represents a terrific ROI versus what they were.
Spending managing their legacy hardware and all the headaches it cost.
That's a good segue to talk about two significant announcements we made in Q4 cloud flow for teams and our acquisition of asked to system.
Fully grasped bull, it's important to understand new challenges I see organizations around the world phase.
When cloud floor was founded the Internet was a place people visited we still talked about surfing the web and the iPhone was only two years old in the last 10 years over 2 billion additional people have come online and the Internet has begun paramount in our personal and work lives.
We started cloud flair to solve one half of every IP organizations fundamental challenge how do you ensure the resources and infrastructure you exposed to the internet or fast reliable and safe from attack, that's what our performance firewall bought management rate limiting load balancing and many other infrastructure protection.
Products are for the World is moving away from hardware and software and instead need scalable cloud services that work everywhere in the world.
Thats the trend behind all of what we do to that end, we've built one of the world's largest cloud networks today. The cloud our network spans 200 cities worldwide and is within less than 100 milliseconds of nearly everyone connected to the internet.
What's powerful is that we built that network to be flexible not just to power. The original products deceive and not just to scale to meet the needs of any size organization, but critically to be easily extensible to new products over time.
Last month, we announced cloud flair for teams to solve the other half of every IP organizations challenge ensuring that the people and teams within the organization can access the tools they need to do their job, while staying safe from malware and other online threats.
Today, most enterprises are built on a legacy castle and mode infrastructure. This approach basis three key challenges on the modern Internet first attackers find their way across the moat into the castle second the shift to SaaS and public cloud makes it impossible to use on premise hardware to build a moat around.
And these new virtual castles and third an increasingly mobile and distributed workforce means fewer people are working in the corporate castle and therefore can't be protected by traditional hardware enabled mode.
Cloud Flair for team solve these challenges the cloud flow for Treme suite is built around two complementary products bottler access and cloud third gateway class our accesses the equivalent of a modern day VPN, providing fast and granular access control for internal and external applications, we've already seen.
Terrific adoption with organizations like Ericsson Ziff Davis and 23 in me adopting class our access and migrating away from their legacy hardware based VPN to a modern cloud solar powered zero Trust model.
Bottler gateway the other half of cloud server teams is the modern next generation firewall gateway ensures that your team members are protected from malware and your organizations policies are followed on any device anywhere in the world without sacrificing performance.
Importantly, both access and gateway are built a top our existing network and leverage all our extensive threat intelligence data that means they are secure fast reliable and scalable from small businesses to the largest most sophisticated enterprises leveraging our existing network also means we can deliver a class over teams at.
Price point that is extremely competitive while still maintaining attractive margin.
In January we announced the acquisition of best two systems as to develop to remote browser isolation technology that executes browser code in the cloud rather than on a user's device. This solution keep security threats safely isolated from end devices protecting against one of the biggest enterprise security threats.
We got to know the EPS to team and realize that their technology married with cloud players Extensible Global network. We're a perfect match, we believe eschews technology will enhance cloud so for teams ensuring it can protect even the most security conscious organizations without slowing them down.
In a welcome the entire as to team to cloud flare, we're thrilled to have them watch this space, they're off to a very fast start and we're excited to see what we built together with that I wanted handed off to Thomas who will walk through our financial results in more detail Thomas take it away.
Thank you Matthew and thanks, again to everyone for joining us.
Hello, flares strong fourth quarter in fiscal year 2019 performance was driven by solid revenue growth and accelerating momentum with an expanding enterprise customer base.
Total revenues for the fourth quarter grew 51% year over year to $84 million.
Total revenues for fiscal 2019 were $287 million up 49% year over year, demonstrating strong growth at scale compared to the prior years' growth of 43%.
From a geographic perspective for the quarter. The U.S. represented 51% of revenue an increased 55% year over year.
Our international business continued to perform well with the revenue from international operations, increasing 48% year over year and representing approximately 49% of total revenue.
See significant potential outside the U.S. and plan to continue to invest in October footprint.
Turning to our key metrics.
Added a record number of total customers during the quarter approximately 300000 to exit the year at roughly 2.6 million total free and paying customers.
We added over a 5800 paying customers in the fourth quarter, which represents an 8% sequential increase and brings the total number of paying customers to over 82000 that yeah, and an increase of 22% year over year.
Our Q4 large customer count increased 76% year over year to 550 total large customers, which reflects a net add of 237 large customers over the year and 75 over the quarter.
We do find large customers as customers with more than $100000, an annualized billings in the last months of the period.
Within our Q4 large customer cohort about half where existing large customers at the end of 2018, while the other half are a combination of new and expansion customers throughout 2019.
We believe this demonstrates our ability not only to retain but also land and expand large enterprise customers.
Our Q4 dollar based that retention was 112.1%, which reflects an increase of under 20 basis points from last quarter and an increase of under 60 basis points year over year.
So all of its not retention measures, our ability to retain and expand billings from existing customers than the prior year period.
Our measurement is net of contraction net of churn and excludes the benefit of free customers that upgrade to paid subscription.
We continue to see solid customer retention and we have ample opportunity to improve expansion, given our large and growing addressable market.
We received feedback from a number of few regarding the use of billings as the basis for our CPI.
As we move up market, we are seeing more contract stipulate longer duration billing terms and we believe it's important for operational metrics. We report the best aligned with how we'll do business in the future.
We believe moving to revenue base CPI is what better aligned with our peer group.
Publicly disclosed financials and our business model as we continue to scale. Therefore, beginning in Q1 2020, we will be shifting to revenue base KP eyes and away from billings as the basis for okay.
We will report to revenue plus Capex for the first time on our Q1 2020 earnings call, including eight quarters of revenue base historic both for comparison purposes.
Fourth quarter gross margin was 78.7% down 20 basis points sequentially and up 180 basis points year over year.
Network efficiency continues to be our key strengths of our business model, we are maintaining our long term gross margin target of 75% to 77% as we look for opportunities through use gross margin upside to invest back into the business.
Turning to operating expenses for.
Total operating expenses were $84.3 million for the fourth quarter up 10% sequentially and 44% year over year, we increased our headcount in Q4 to end the year with a total headcount of 1200 70 employees.
Sales and marketing expenses were $43.8 million for the quarter, representing an increase of 8% sequentially and 57% year on year. The increase was largely due to headcount increases as both marketing programs as we had sales capacity and continue investment in our enterprise go to market so for Mark.
Shifting as a percentage of revenue increased to 52% from 50% in Q4 last year.
Research and development expenses were $21.9 million in the quarter, representing an increase of 9% sequentially and 47% year over year as we continue to add additional products and functionality to our platform.
R&D as a percentage of revenue decreased to 26% from 27% in Q4 last year.
General and administrative expenses were $18.6 million for the quarter, representing an increase of 18% sequentially and year on year. The increase in Gionee is due to additional investments to both our teams and other expenses related to become a publicly traded company.
DNA as a percentage of revenue decreased 22% from 29% in Q4 last year.
We are seeing operating leverage in our model as we scale for growth and begin to capitalize on the investments we are making on an annual basis, we're making progress towards achieving our plan to show initial operating leverage in Chile, followed by R&D before ultimately shorting leverage in sales and marketing on the long term based.
Operating loss in the fourth quarter was $18.3 million, an operating margin of negative 21 point and per cent compared to a negative 28.7% in the same period last year.
690 basis point improvement driven by both network efficiency and improved operating leverage and she and eight and R&D.
Net loss in the quarter was $16.4 million or a net loss per share of six cents.
Our effective tax rate for Q4 was negative 3.1 person.
Net loss for fiscal 2019 was $69.5 million or a net loss per share of 48 cents.
Our effective tax rate for fiscal 2019 was negative 2.3%.
We ended the fourth quarter was $637 million in cash cash equivalents and marketable securities.
You for free cash flow was negative $23.5 million or 28, percentof revenue improving from a negative $29 million or at 52% off revenue in the same period last year.
While we are encouraged by the performance in the quarter, we expect to see continued variability in cash flow margins due to ongoing fluctuations and working capital and the growth in our enterprise business.
This mess you mentioned, we're pleased to welcome DS two team to cloud clear, we're planning to be generally available in the second half 2020, where the pros isolation products built using as to technology, but we do not expect to see a meaningful revenue contribution this fiscal year.
Now moving onto guidance.
As a reminder, except for revenue. These numbers are all non-GAAP, which excludes stock based compensation expenses amortization of acquired intangible assets and any associated tax effect.
For the first quarter, we expect revenue in the range of $87 million to $8 million, representing an increase of 41% to 43% year over year.
We expect operating loss in the range of $20 million to $19 million.
We expect net loss per share in the range of six to five cents, assuming approximately 297 million common shares outstanding.
We expect an effective tax rate of negative 2.2%.
For the full year Twentytwenty, we expect revenue in the range of $389 million to $393 million.
Representing an increase of 36% to 37% year over year.
We expect operating loss in the range of $65 million to $61 million.
We expect net loss per share in the range of 21 from 19 cents, assuming approximately 303 million common shares outstanding.
We expect an effective tax rate of negative 2.9%.
We anticipate operating leverage in the second half of fiscal Twentytwenty.
In summary, we had an excellent quarter and we're pleased to close out our first fiscal year, the public company with strong execution.
I wanted to thank our employees customers partners and investors without whom we could not have achieved with from quarter and our success over the years, we look forward to building on our men in the years ahead with that I'd like to open up for questions. Operator, Please poll for questions.
At this time, if you would like to ask your question. Please press Star then the number one on your telephone keypad, we will pause for just a moment chicken Paul the Q and a roster.
Your first question comes from the line of Phil Winslow from Wells Fargo. Your line is open.
Hi, Thanks for taking my question Congrats on a very close the year.
Just wanted to focus on those large customers obviously a.
Very significant number added this quarter.
At any point of you've been recording it reporting it and then obviously you've talked about increased investment in.
Sales marketing so give us just some color on.
On just the trends there, particularly in terms of investments that you're making to go to go to market. What are you seeing in terms of productivity ran time and how are you thinking about that in 2020.
Yes, thanks, Phil.
So I think that we are able to.
Achieves the growth in large customers in two ways. The first is obviously signing new logos and that's about half of the new ads of of large customers that we have the other half is that we are good at landing with customers and then expanding over time and that's the other half of the new customers.
That crossover into that large customer.
Count as we address larger customers, we're building out our real field sales team.
Helps support that I think Mark Anderson, who joined our board has been very helpful in coaching that team and and seeing that productivity from that but what I've been really happy with and what continues to give us confidence in investing behind our sales and marketing efforts are that they rate at which salespeople or ramp.
Paying and the productivity per salespeople continues to be very strong and and that that that's given us the confidence to continue to invest behind that and really add see that large customer adds that we've seen.
Great. Thanks, but it's also one follow up obviously, we've been big fans of workers for while I'm curious if there any sort of use cases that have jumped out to surprise you.
Yes, I think there's there's one from the last quarter we had.
Ed really innovative.
Fast growing public software company.
I had actually adopted cloud flare in Q3 of of last year, they significantly increased their their spend increasing it.
Multiple times with their original spend was to adopt our workers platform and what they were specifically doing was actually building a very sophisticated multi cloud set up they were concerned about being locked into just one public cloud provider and so they used workers.
In order to very effectively steer traffic between multiple different cloud providers and I mentioned. Another example earlier on how multi cloud is really driving a lot of usage. There I think that was one of the things that I was surprised about in terms of in terms of workers a lot of the use cases that were seeing or.
Our extending cloud players functionality and so you can think of workers as making us have the most programmable load balancer in the world. The most programmable firewall in the world and we're constantly impressed by the way that our customers are using workers in order to get the most out of our platform.
Great. Thanks, guys.
Your next question comes from the line of Keith Weiss from Morgan Stanley. Your line is open.
Excellent. Thank you guys for taking the question and.
Very nice quarter as well.
In addition to sort of really good customer growth you saw this quarter initially, particularly as large customers were seeing that net expansion rate start to tick up and growth rates start to tick up.
Is it too early for these new products.
For her and magic transit to be the cause of that net expansion rate to increase.
Like revenue per customer to increase or is it was starting to have like a real positive benefit on the numbers as of yet.
Yes, I think that we've been really impressed by how our investment investment in research and development is turning into revenue very quickly we're seeing similar adoption rates in workers, even as the total customer count is going up and we're seeing products like.
Access and Magic transit drive larger and larger deals and I think that that will be something that we'll continue.
With that we see good evidenced that that will continue going forward and and again that gives us confidence to continue to invest in R&D, what's powerful about cloud flare is our core asset is this extremely flexible network that we've built and so as we add new products to that network part of our ability to delay.
Delivered to customers as we can say a customer that's using one product you without changing the network of using you can get the benefit to the other product and then from a financial perspective that also allows us to achieve that gross margins that we've achieved because we've already born the cost of building the network out adding those additional products is it.
Is it becomes a relatively de minimis cost because again, it's running on the same hardware in the same facilities that we've already built out to provide our their surfaces. So we're really encouraged by the adoption of out of the new products and that is definitely contributing to to the growth that we're seeing.
Got it and if I could sneak in one follow up.
Heard a lot of noise out there a lot of people talking about the edge in sort of what they can do in terms of program ability at the edge.
Can you talk today about what you're actually seeing in reality, what it can then competitive environment looks like out there and then how class there.
Wins in that environment.
Yeah, I think I think that.
I think theres, a lot of interest and and natural cycle for where development will be done we'll be at at the edge.
What people different people mean by that is different some people mean that that's going to be hardware, that's deployed thats different than how we think of it.
Others think of it sort of the way we think of it which is that you can put compute really very very close into the network near where people are around the world.
I think whats differentiated with US is that every single quarter, we're signing up developers who are building applications that weren't previously possible using our edge and and so I think that we we really do see the developers are deploying real code in production across us I think over time.
We'll see more competition from from others in the space, but right now if you're looking for a programmable edge network, we're seeing that we're winning those deals.
Excellent thanks, very much guys.
Your next question comes from the line of Sterling Auty from JP Morgan Your line is open.
Yes, Thanks, Hi, guys, Matt I think some of your answers I touched on this but I was hoping you put a finer point when you look at the $100000 plus customers added in the quarter would.
How would you characterize what is the most popular mix of solutions that they are taking to get to that level of spend with you.
Yes, I think that we we see the same mix of of products.
That that kind of fall across three categories for us So security performance and reliability about half of our customers are going to are there about half of our customer spend can be attributed to those security products and then the other two are split about 25%.
25% as it does or those are sort of a rough ballpark, we don't see a significant difference.
Across the size of customers in terms of how that product mix shifts.
And so that's held fairly consistent overtime and it's also held fairly consistent in terms of what it is that in terms of the size of of the customer and so on where we are seeing that customers that have come to us to buy something like our firewall product are very.
Interest and products like access as well so those are natural extensions, but it's about 50% that comes from our security products and the other 50% comes from performance and reliability.
That makes sense and then one follow up you mentioned your prepared remarks, taking share and I think you're in a little bit of a unique situation in terms of when you say taking share I'm curious how much of that is coming in terms of wins versus vendors like versus the de das vendors specifically for example.
Versus kind of the this the trend that you mentioned were edge network computing is now moving more to an Internet service. So you really taking share against that necessarily vendor that you would compete against but it's the way that the customers are changing their compute architecture I know theres a way that you can.
Centralize that floors that would be great.
Yes, I think that the majority of the market that we see ourselves taking share from and that we see here from our customers as the replacement from legacy hardware or software based solutions into a scalable cloud network.
And that is definitely one direction, but but the other direction that you that you and thats the majority, but the other direction is.
Also from looking at vendors that are doing one thing, particularly well.
Whether thats just doing de das or just doing load balancing or just doing SD Wan and all of those functionality is what we're hearing from customers is that they want a unified network that provides all of that functionality together and so we think over time that integrated network beats any of the pie.
I think cloud solutions that are out there.
And and we see and we see customers coming from both but but really sort of trend of shifting away from hardware and software is the majority of what we're looking at today and I think that that that's going to continue for the foreseeable future.
Got it thank you.
Your next question comes from the line of Brent Thill from Jefferies. Your line is open.
Hey, guys. This is Howard on for Brian. Thanks for taking the question I want to add my congratulations on a strong finish the year and the launch of our plan for teams.
Matthew So gately seemed like a like a natural use case extension to cloud players core strengths and load balancing smart routing and virtual tunnels and it confirms our belief of the potential deposits or network and it's really exciting to us. So I know that gateway is still an early days, but you just mentioned SD when and I can't help.
But the jump the gun and little bit and so as we look forward to what's possible on on the cloud for network, So where does the potential disruption at the SD Lan market follow on on your roadmap. Thanks.
You know so Howard thanks for thanks for joining us we.
I think that the network that we've built.
It is is is purpose built to be able to move data from any point on earth to any other point, our earth faster more reliably more securely and more efficiently, meaning cheaper than anyone else and so I think that as we look out at natural places too.
[music] extends what it is that we're delivering anytime you're trying to move data and you care about one or more of those those characteristics and I think anytime you're moving data you'd probably care about all of them.
That's a potential opportunity for us to extend our network and so we think that what we've built with cloud flair for teams is a natural extension.
That can help people solve what the core problems are.
How do we make sure that the applications that I need to provide to my employees. So that they can get their work done are provided in a secure way and as my employees access the internet how can I make sure that they're getting a great experience, while still be protected from malware and so I think you will continue to see us make investments in that space.
And.
And again from the access we've already seen a lot of early early wins and I think youre going to start to see from Gateway and then eventually from the asked to acquisition and browser isolation that there is a real real opportunity for us to continue to expand and leverage the network that we've built.
Okay, Thanks, Matthew and and for Thomas I, just had a follow up.
On the just the strong large enterprise fractions of our average ASP. These are the growing or the relatively unchanged and and also related to the enterprise.
So how much of the.
It seemed at the guidance implies there is going to be continued investments throughout the year. So it. So how much of the continued investments is related to further building out direct sales force that's targeted at larger enterprises.
So the investments occur across a multitude of factors. We are we guided to grow 36 was 37% year over year that requires infrastructure and not only in in sales headcount. We also opening offices in new offices in Europe and in.
Asia and got we also running a a brand campaign that goes along with our.
Evolvement going up market. So its investment that is not only in headcount but.
Across a broader set of factors, especially in the first and second quarter I think our ASP performances rise this stable.
Across.
Our Pos to larger number of customers and expanding with existing customers.
It's not the.
The the result of a pricing strategy, we are increasing and prices.
Okay. Thank you.
Your next question comes from the line of Matt Hedberg from RBC capital markets. Your line is open.
Hey, guys. Thanks for taking my question, so well done this quarter I wanted to ask about teams as well.
Thank you called it protecting the other half.
I am wondering there can you help us with the go to market strategy, there driving more adoption for teams I mean, obviously you had some success with access thus far but just the strategy different there sort of curious.
Yes, we have we've been very pleasantly surprised that salesforce that we've built a bit to sell what has been cloud players traditional products has been able to take our cloud but for teams products to market. It isn't always the exact same buyer, but usually.
The person that we have sold our existing products too.
Is he sits next to or reports to or the person who would be the cloud over teams by reports to them and so there is there's a real adjacent see that we've been able to navigate so far so our first strategy with class are for teams is to go out to the exist.
Being clouds are customers and let them know that this is a new service that we're offering and it and were able to extend that and that's work. That's worked well what's been what's been I think a pleasant surprise has been that corollary to that has also been the case, where people who have heard about cloud server teams have come to us.
And that were often then seeing closers core services like firewall and load balancing and bought management as natural add ons and so I think that we've been happy so far with the way that our existing sales team has been able to sell the product.
And we're making sure that they have all the enablement resources to be able to do that but it dovetails.
Much dovetails very nicely together with the existing products we've been selling.
That's great and then and then maybe more of a philosophical question 2020, there's a number of very large events. This year.
The potential to drive significant the higher traffic patterns that you Olympics, you a selection or just even just the general streaming floors.
Historically speaking how do these large spikes of traffic help help you guys.
So I so.
I think that there and you are under the question is is the question around.
Especially around the OLED. So the actually let me divide that into two two half. So let's look at the Olympics versus let's look at the us presidential election.
So for.
A number of companies that are what I would think of as CDN companies that they have been looking to the OTI space as as a big driver of of revenue and I know, it's sometimes natural to try and comp us against those companies, but I think it really is not a fairly.
Accurate comp to us we have explicitly stayed away from trying to bid on any of that revenue because it at some level.
We see it if you are just moving bets.
That that isn't very differentiated in terms of the value that you're delivering and overtime that revenue is sort of like eating junk food and it tends to decay over over the long the long term and so we built a giant cashing network, because we wanted to be able to deliver highly.
Added products and security and other other.
There are places, but we have traditionally stayed far away from what has been the bread and butter of a lot of other streaming services. So I think that something like the Olympics won't change materially one direction or another what happens in our case on the other hands elections.
There is something that we we are we are deeply involved with because cyber security are unfortunately has become front and center in elections and campaigns in 2016 election. The vast majority of US presidential candidates were cloud flare customers and we're seeing a similar trend going into.
2020, we think thats. So important that we've actually worked with defending digital campaigns to work with the federal election Commission. So that we can offer cloud flare services at no cost to campaigns that might face risks and we think thats an incredibly important thing we.
I don't have dealt cloud flare without a stable and functioning democracy in the United States and so we think it's our duty to do what we can to help protect that that has real spillover effects, where as we announced that we saw it drive.
Corporate interest in its and its end and enterprise interest.
But but I think that.
We are hopeful that we can make 2020 into into at an election season that is that is less charge with cyber security than than than it was in 22016, and we're really proud of that work.
Helpful. Thanks.
Your next question comes from the line of Pat Walravens from JPM Securities. Your line is open.
Okay, great. Thank you and congratulations you guys Thomas one for you.
How should we think about the.
The operating leverage.
Coming throughout the year I mean, you guided you guided for Q1 for the full year, but.
How do we think about how Q2 Q3 Q4 will play out.
Yes.
As I said before it if we think that operating leverage is going to show in the second half at pass in part to do with US making sure that we have the infrastructure the programs to branding campaigns.
Place at the beginning of the year that carry us through to achieve the 36, the 37% topline guidance. We gave so we guide that EPS for the first quarter I think we will be flattish on that on that CPI getting into Q2, and then you will see leverage and.
The second half in the third and fourth quarter as we eat up.
The infrastructure that we have put in place in order to approach so bill.
Flattish in the first half and then picking up in the second half.
Okay, Great and then how should we think about.
What the.
Dollar exchange rate should do you get a little uptick this quarter.
Well, we said, we I'm not going to provide guidance on this number. However, we also said that for us.
Our it's really a lagging indicator because it covers a very broad funnel.
Of customers so expanding this across our large customer footprint, which is now at about 82000.
Paying customers will require effort. So the number is going to tick up it's going to tick up slowly and hopefully steadily but it's a lagging indicator of their performance, we see on the product and new customer acquisition side.
All right Thats very helpful. Thank you.
Your next question comes from a line of Alex Henderson from Needham Your line is open.
Great. Thanks.
So I was hoping you could talk a little bit about the degree of friction.
In the selling process and specifically.
How much benefit you get.
You are going through the selling process as a result of your superlative penetration of the coding community.
And Dev ops, a world and to what extent as you move from that into large accounts.
You are able to cut off a portion of the.
The time, it takes to sell something and the amount of effort to take to sell something if you were to compare your motion with the.
Frictionless the history of your original architecture.
40 went after the large enterprises too.
Companies that don't have that frictionless, starting point that don't have that development.
Download and trial.
Capabilities that would have to go to a c., so and sea level.
Direct without that.
Without that for benefit can you talk little bit about our that would put you.
Terms of getting the deal done faster and having a higher probability of success on closure as result of it.
Yes, Alex It I think thats, something which is probably an underappreciated aspect of our business and and I think we've even internally it's taken us a while to understand how differentiated.
That's really that's really made us.
Cloud flare started.
He very much in making sure that we could onboard people incredibly easy our tagline used to be.
Take five minutes and supercharge, your infrastructure and and and that's literally what it takes I encourage anyone on the phone that has a personal hobby blogger website to just goes try this signup process and see how quick and easy and painless. It is.
And you can do that without having to talk to anyone that self service nature flows through our entire product suite and I think what we didn't appreciate what's how important that would be for even large customers, where our sales team is able to say something like well why don't you just try it.
For a little bit and see how it goes and there is nothing better than proving the value than having somebody actually just be able to sign up try it for a little bit and see what's happening what what is better.
Positive surprise for US is that we've talked in the past about what our average sales cycle is and its and it has less than a quarter, but even as we have continued to go up market and even as we've seen such large growth among our large customers. Our sales cycle is trending towards a faster pace not towards us.
Slower pace and again I think the VAT that stems back to the work that we did to make the signup process as easy as it has.
The converse of that is.
Your type relationships with coating community.
As we start thinking about the power shift away from.
Administration.
Net ops and even security ops towards the coding world that also is a really difficult thing for other companies to to be able to get penetration into.
How much the factories that.
As an impediment.
Mode for competitors.
Yes, I think it's hard for me to quantify but I will say that when we look out across our customer base.
We have a lot of fans and customers that are developers that are rooting for us and so.
What I was just talking to one of our senior sales people is on side. It at a prospect they had a large fortune 50.
Company they.
They have a formal RFP process and and that the people who are on that committee. It included people who were developers in addition to kind of your traditional c. So.
Our CIO suite and.
He was he said several of them came to came to the meeting where we are in cloud flare shirts.
I think I don't I don't want to handicap, how likely it is to win that contract, but they werent wearing the shirts about any other competitors and so I think the goodwill that we've built.
In the developer community continues to pay dividends not only in kind of our low end business, but that it's also in our high end in large customer business as well.
Super Thank you.
Your next question comes from the line of Joel Fishbein from Suntrust. Your line is open.
Good afternoon, and again congrats on a great work you ended the year comments I just have one for you.
Can you please remind us how.
Core of the.
The trial.
Allocated.
Sales and marketing line.
Quantify that.
This quarter.
Yes, I, Ken and I think there are two angles. So that veteran one is a true accounting question.
The second angle if it's more performance question. So let me address both so from an accounting perspective, we account for the cost of our free customers and sales and marketing and not in cost of revenue because there is no revenue with those customers and if one free customer becomes a paying customer than the cost of supporting that customer moved to the cost of revenue.
However, if we were to reallocate the cost of all of our free customers into cost of revenue, our gross margin would still be well above 70% and it would be well above 70% in Q4, well above 70% for the whole fiscal year 19 by let by 70% whether you look at it on that.
GAAP or on a non-GAAP basis, so that the performance is not accounting results. It's the result of a truly differentiated architecture, we talked about this.
Standard off the shelf hardware, one homogeneous software that allows us to run all products on all service and all the patients and with that we can manage demand, we can manage capacity and cost across our global network and that is what truly differentiates us from.
Single point solution providers or provide us that need more than one network or heterogeneous networks to provide there the breadth of products. We provide so we can understand that some of our competitor the struggled with the performance, but it's truly a technical.
For our architecture differentiation that not where we where we account for our cost of free customers.
Thank you could you just one quick follow up in terms of the conversion is there any metrics that you can provide relative conversion.
Free to paid.
We will we address.
How about to take a written check on this we will reassess the discussion when we when we report on Q1 and talk about revenue.
Base KP eyes, and high definition is going to change and then propane.
Provide you with a part of historical numbers I think that would be the right point to pick up that discussion.
Sounds great. Thank you so much.
Thanks, Joel again, a few would like to ask your question. Please press Star then the number one on your telephone keypad. Your next question comes from the line of Jim's fresh from Piper similar to your line is open.
Hey, guys congrats on the quarter.
I just want to go back to a question asked here a little bit.
The reason that dollar base renewal rate starts to inflect higher is really just because the enterprise business continues to become a larger part and we're talking about renewal rate.
Probably above 120%.
So James can be I, Miss just kind of key piece of that would you might just repeating repeating the question quickly.
Yes, you guys were talking about having dollar based renewal rates slowly increase is a large part of that just because we're moving more towards an enterprise mix over time, where usually across the space dollar based renewal rates are north of 120%.
Yes, so I think that outlets. So first of all thanks. Thanks for that thanks for adding coverage and we're happy to have you following us along and so I think that we have we've always seen cloud players business as one continuous funnel.
And and so we see a customer the signs up as a free customer as someone who who we hope to be able to drive business across across the entire.
The entire.
Space and so as a result, we've not broken out dollar based that retention just on our large customers or otherwise we think it's appropriate to reported the way that we think of it internally and so it is correct to say that because we have such a diverse mix of customers youre going to see higher.
Churn rates as higher absolute churn rates, among small businesses, because they're more likely to go out of business or the other things happen with them and so I think that we are some of the improvement that we anticipate and dollar based sent retention definitely comes from a mix shift as we as we shift to more.
And more large customers, but I think it also comes from our increased ability to sell more products to customers, who whoever they are and to improve even at that low and how we how we are able to keep those customers and have them have the maintained so I think we as as Thomas said, we do see this has allowed.
Lagging indicator, but that that the evidenced that we're seeing is that customers are we are landing with customers in one place and then being able to expand them overtime and that's going to help our dollar based sent retention over time as well as the mix shift to larger customers.
Got it thanks for all those details and then Thomas one for you is there anyway to quantify the 75, new enterprise adds this quarter in terms of what was brand new to the cloud software platform versus how much were paid prior paying customers Im sorry, if I Miss in the if it was in the script before I'm kind of jumping between calls.
Yes, we gave some color on the script, but no problem so about half over the year for the quarter, it's a bit war.
Granular, but over the year half of the ads are.
So with that we expended and half of it as a new customers that start at north of $100000 of annualized fillings.
Thank you congrats again.
Operator can we're almost a time can we take questions from just one more analyst plus absolutely. Your final question comes from the line of Amit Daryanani.
My apologies for meat dairy on omni from Evercore ISI. Your line is open.
Perfect. Thanks, a lot of snuck in under the line there.
I guess, maybe to stop with I was hoping you could just touch on the as to acquisition and maybe talk about what's the revenue your Tam opportunity does that bring for you over time I doubted broaden the revenues with it initially at least and is this something that came about as you went to market with platform for teams as a piece those perhaps missing there or what led to the deal in the first place.
Yes, so as to.
Was pre revenue they have about nine full time employees. So it's not not a big team.
To add I think that we're always looking around at companies that have.
Interesting technologies.
And and we had heard as we were talking to potential customers and and existing customers of cloud server teams there was interest around.
The browser isolation space there are a handful of companies that are they have different technologies out there and and we looked at all of them about whether there was an opportunity for us to partner with them potentially acquire them or maybe it was something that we would build ourselves and when we were largely that the technology that was there I attended.
To break a lot of the internet tended to slow things down and that seem very.
And it seemed very not cloud flurry.
And so I remember when I first our corporate development team had had been introduced to ask to up in Kirkland, Washington, and and I was I was super skeptical about whether it would be something that was interesting and they said just play with the demo and I wrote back and I was I said there must be something.
With the demo, it's not slowing the internet down at all and they said no no thats because they've just built a better way of doing this and so we spent time with them. Initially looked at if there was a way that we could partner with them and I think that over the time of getting to know them. They just they felt very much like an extension of our team at.
And and we made the determination that it was that it was.
I, great fit for us to be able to acquire them I think our bias on M&A is still away from it I think that internally developed systems make a lot more sense and I think we've seen other company is in the cloud space try to cobble together acquisitions.
Of entire product lines, and and have them see their margin suffer as a result.
But we will continue to look and when we do find teams that have really differentiated products or technology.
One of the one of the benefits of being public as we have more capability to do acquisitions like this.
He asked to is is working hard to integrate their technology into the edge of our network again, there is no new hardware the has to be deployed it just gets deployed across our existing network, we anticipate that will have.
It is something in the sort of second half of this year, but I wouldn't anticipate significant revenue or probably any revenue from us to this year and in terms of the Tam I am I am I'm bullish, but but but I think it's a little too early to put a specific number on it.
Fair enough. That's really helpful. I guess would just follow up Thomas when I look at the calendar 20 revenue guide of about 37 personal so revenue growth.
Is the way to think about what are you embedding here in terms of either customer addition growth or customer count growth with customers over 100000 billing because it doesn't seem like you expect your dollar based net retention ratio to improve in a material we at least in 2000.
Well, we always said that DNR is a lagging indicator it will pick up over time, but it will not explode. So you it will follow.
The the development of business. So if it's.
If you get the impression that it picks up only slowly over the course of the yen that would be the right thing to take away from our guidance.
In the momentum really continues to come across the Vectrus. We have discussed already for for 19, we will see expansion in our core business, we will expand existing customers and we will significantly grow or new customer footprint. We also continue to invest.
Heavily in outside of North America with opening new offices in Europe, and Asia that is going to help us.
Tokyo and France.
Specifically, so it will be consistent across the broad funding of customers and businesses we have.
Yes.
Thanks Summit.
Yes.
Hi.
Great question at this time I turn the call back over to the presenters.
Thank you everyone for joining the call we're really proud of what we have.
Don in in Q4 and that team has all hard at work.
Out there building, great products and selling them and I look forward to talking to you all next quarter.
Thank you everyone for joining today. This concludes todays conference call you may now disconnect.
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