Q2 2022 Cloudflare Inc Earnings Call
Hi, Matt.
Yeah.
Yeah.
Yeah.
Oh no.
And now.
Oh no.
Sure.
So what day.
Okay.
Good afternoon, My name is Emma and I will be your conference operator today.
At this time I would like to welcome everyone to the clubs Flair second quarter 2022 earnings call.
All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
If you would like to ask a question. During this time simply press star followed by the number one on your telephone keypad if.
If you would like to withdraw your question again press the star one thank you.
Jason Nolan V. P of Investor Relations you May begin your conference.
Yeah.
Thank you for joining us to discuss financial results for the second quarter 2022.
On the call, we have Matthew Prince co founder and CEO , Michelle that one co founder President CLO and Thomas Seifert CFO by now everyone should have access to our earnings announcement.
As well as our supplemental financial information may be found in 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.
As anticipated future revenue financial performance operating performance non-GAAP .
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.
Customers and large customers.
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 challenging general economic condition, including inflation rising interest rates and other impacts of the ongoing COVID-19, pandemic and Russia, Ukraine conflict.
Our actual results may differ significantly from those projected or suggested in any forward looking statements.
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.
Current and prior period financials discussed are reflected under ASC 606.
May find a reconciliation of GAAP to non-GAAP financial measures in our earnings release on our Investor Relations website.
For historical periods, the GAAP to non-GAAP reconciliation can be found in the supplemental financial information referenced a few moments ago.
We would also like to tell you that we will be participating in the Stifel Turnkey Executive Summit on August 30, the Deutsche Bank Technology Conference on September one and.
Piper Sandler Frontiers conference on September 13.
Now I'd like to turn the call over to Matthew.
Thank you Jason.
Even with the increased economic uncertainty, we had a very strong quarter in Q2, we achieved revenue of $234 million up 54% year over year, we added a record 212, new large customers paying us more than $100000 per year and now have 1000.
749 customers over the threshold.
These large customers now represent 60% of our revenue up from 50% six quarters ago.
This trend illustrates our large established enterprises increasingly form the foundation of complex business in fact to date, 29% of the Fortune 1000 are already paying classic customers nearly threefold increase over when we went public less than three years ago.
Our dollar based net retention remained strong at 126% down 1% over last quarter, while there may be some noise in that number from quarter to quarter, we won't be satisfied until it's above 130% as best of breed among the companies we consider peers. Our gross margin remained strong at 78, 9%.
90 basis points year over year, and still over our long term target of $75 to 77%.
Our operating margin was right at breakeven, which continues to be our plan. So long as we can deliver strong growth.
I'm watching closely is our free cash flow margin it showed significant improvement quarter over quarter, and we continue to forecast it will be positive in the second half of the year.
On our last earnings call I got a lot of raised eyebrows for many of you. When I said Q1 of 2022 would prove to be the hardest quarter for our industry since Q1 of 2020.
It didn't make me, particularly popular around the CEO club, where the first rule of recession is not to talk about recession. However.
Currency has always been one of <unk> core values.
Call it like I see it in that spirit, let me share some more details of what we saw and are seeing in.
In Q1, our pipeline generation slowed sales cycles extend that customers take longer to pay their bills. We watch those metrics closely throughout Q2 and saw them all at least stabilized theyre, not where we'd throw up rate yet, but the metrics are trending in the right direction given our visibility early in the economic downturn, we rapidly adjusted.
Our go to market message, we shifted our messaging to focus on ROI, helping customers save money and consolidated spend from multiple point solution vendors behind cloud flex broad platform.
Messages about saving money and using fewer vendors didn't particularly resonated year ago, but they do today.
Having a broad platform to solve so many customers' problems while at the same time saving the money as a superpower in times like these.
As I look at our wins in the first half of the year I believe it's fair to say that it is harder today than it was a year ago to sign up a new customer, but it's gotten easier to talk to our broad set of existing customers about doing more with us.
And customers are leaning forward to hear about how we can save them money reduce their it complexity, all while increasing their security performance and reliability.
I'm not a member of the National Board of economic advisers, So I'm not the person to say, whether we're in a recession or not how bad it may be or how quickly we may rebound.
I am the CEO of <unk> and while our business remains strong I believe this is the time for prudent and cautious.
Metaphor I've been using with our team has talked about the different conditions, you may face driving a car on the road.
A year ago, we can see per mile and the road was clear so it made sense to open up the throttle today, we find ourselves in what my grandmother used to call. It to leapfrog. The road ahead is less certain so it makes sense to keep our hands on the wheel our eyes on the road and let up a bit on the accelerator.
Whether we're in one or not recession stock. They heard everyone. No company is recession proof, but some are more recession resilient and others.
Things I know are universally true no matter, how bad the concession made yet companies aren't going to abandon the internet and not going to give up on the cloud and go back to on premise boxes and package software hackers aren't going to stop hacking and cyber security will remain a must have not a nice to have and we're already.
Already seeing evidence of all of this with our gross renewal rate in every region for the first half of the year hitting all time highs since we went public.
Not recession proof, but I wouldn't trade places with any other CEO right now.
Personally if I think back my career has been defined by recession I think a lot of peoples are.
Recessions have always been hard, but theyre also formative moments to focus and ultimately improve.
In 2000, as the first dot com bubble burst the law firm I was supposed to go workforce that they didn't need any more securities lawyers, but they could probably find a spot for me and their bankruptcy practice.
That time to reflect on why they are watching companies that flowed with what I wanted to do with the rest of my life and pivoted to become an entrepreneur.
14 years ago in 2008 at the onset of the last global recession, Google pulled their full time offers for all of their summer insurance, which included my co founder at Plaid flare Michelle's Atlas.
If that hadn't happened plaza would've never been born.
At the same time.
Learned what a margin call wideband deeply embarrassingly literally had to borrow money from my mom to pay my rent.
What I got an extremely personal lesson on the importance of free cash flow and it's why I am ensuring right now in this uncertain time, the cloud players prioritizing being free cash flow positive.
Tough times forced you to reevaluate everything you've done and become better it's why the best companies come out of a tough time, even stronger than they went in may.
Maybe it's a bit masochistic, but I'm looking forward to have plateau. It gets even better during some of the tough times for the global economy that seem likely ahead and then the wheel eyes on the road letting up a bit on the accelerator.
With that background and to avoid being too much of a plumber, let's talk about some great customer wins in the quarter.
Fortune 500 retailer in Europe signed a $1 million three year deal for multiple cloud their products. They wanted to reduce their operational complexity by replacing a number of point solutions with cloud pledged broad platform. We became that web application firewall content delivery network management system and a number of other application protection services, which are easy to map.
<unk> platform, having proven success protecting their infrastructure, we're now talking to them at adding expanding <unk> zero trust provider chip.
A fortune 500 energy company signed a $784000 three year deal.
Had been using these scalar cloud.
Cloud player solutions easier to use more performance and integrated across their full security control plane.
As I said last quarter, we like our win rates when we go head to head with scalar and Palo Alto networks, because our product is better and can scale to meet the needs of complex organizations like this one.
While we are still relatively new to the zero Trust space, we're going head to head against them more and more off yet.
Yet another fortune 500, industrial company funded $1 $3 million five year upsell agreement. This customer first adopted cloud player in Q1 of 2022 and is already seeing ways. They can use more of our platform. Whats also notable is this is an example of us increasingly working with channel partners. We believe channel sales are especially important.
In the Zero Trust based and in Q2, we successfully signed up have the scale or top channel partners as new cloud with our partners.
State of Arizona expanded their use of our platform signing a $770000 one year expansion deal.
Arizona has been a long time, but their customer and continues to expand the use of our platform as we launch new products.
Remember their first <unk> with us from several years back with specified the address and method of shipping of our products as if we are a heartbeat that.
We shipped them T shirts, not hardware and they've continued to grow without ever sets.
One of the world's largest advertising conglomerate signed a $1 $7 billion one year deal. They originally came to us last quarter under attack that originated out of Russia being the power of our platform. This quarter. They expanded their engagement. This was yet another competitive aircraft deal against other leading zero trust vendors like we're hearing over and over again.
This customer chose <unk> because of the strength of our broad platform and our ease of use and the work that they are head of cloud with cloud Blair everything works there are no issues.
One of the largest online recruiting firms signed at $5 $5 million three year deal. They were an extremely technical buyer, who put our entire platform through its paces in the yen. They demonstrated for themselves that we were by far the best of breed. This is also an example of how increasingly we're seeing executives bring cloud flair to their new workplaces in this.
The buyer newest from its previous position and it was our champion when he moved job and was promoted in his words, you don't get fired for buying platform.
Workers continues to gain traction among developers last earnings call I talked about the importance of building workers into other platform as the best shortcut. The developer adoption in Q2, we signed deals with one of the largest E. Commerce platform one of the fastest growing web development platform and a next generation database platform embedded workers as a server.
As a preferred development environment.
These deals represent hundreds of thousands of dollars in guaranteed revenue with upside as usage grows but more importantly, we believe they are the fastest path to catalyzing, a robust ecosystem around plateau workers and exposing its power to the broad community of developers.
Another interesting thing of note in the quarter as we're increasingly seeing other security companies adopting cloud player as the best of breed solution.
Credibly affirming when your peers choose your product a public security compliance vendor, a leading endpoint security provider and one of the largest data security vendors all signed multi year contracts each worth more than $700000, even our direct competitors often used cloud cyber ddos mitigation and other services, where we are the clear leader.
This recognition by our peers of our best of breed products continues to validate why im confident they will continue to grow even stronger through the tough economic times that may be ahead.
One last thing in the spirit of transparency before I turn it over to Tom We had a bug in our billing system related to how we expire unused credits for pay as you go customers before we went public for good accounting reasons, we put in place a policy, where we expired unused credits after three years that system triggered for the first time earlier this year. Unfortunately, a bug.
Unit cost our systems to report a spike in total paying customer last quarter. The revenue involved is not material less than $160000 that caused that to over report the number of paying customers last quarter. The correct numbers are 148184 in Q1 and 151803 in <unk>.
Q2.
Our pay as you go business is only 11% of our revenue today, but we believe it's important to continue to invest in order to serve the entire market and protect our flight.
And then burst by the mistake and we fixed the bug and put in place checks designed to catch any similar areas in the future I don't like it when we make mistakes.
It's important we'd be transparent and own them when we do which is why I insisted on addressing this today. It also leaves more fun topics, where Thomas with that I'll hand, it off to Thomas will walk through the financial Thomas take it away.
Thank you Matthew and thank you to everyone for joining us.
Another strong quarter driven by strength in our large customers.
A record number of large customer additions as we continue to build our expansion engine.
Our success in the first half of this year reflects the investments in our innovation and large enterprise go to market initiatives as well as the benefits of operating a durable subscription based revenue model.
Turning to revenue.
<unk> revenue for the second quarter increased 54% year over year to $234 5 million.
The growth in revenue was driven by strong adoption of our product portfolio and continued traction with our enterprise customer base.
Area, one the email security company, we acquired in April contributed less than 1% of revenue.
From a geographic perspective, we saw continued strength in both the U S and internationally.
<unk> represented 53% of revenue and increased 55% year over year.
EMEA represented 26% of revenue and increased 54% year over year.
APAC represented 14% of revenue and increased 43% year over year.
We are pleased to see growth continue to accelerate in APAC.
Turning to our customer metrics in the second quarter, we had 151800 repaying customers.
Representing an increase of 20% year over year.
We saw a higher level of churn due in part to a pay as you go customers shifting down to our free customer tier.
As our business continues to move up market. The total revenue contribution from our <unk> business, which largely reflects SMB continues to decline.
Presenting a 11% of revenue in the second quarter down from 14% in 2021.
Close at our Investor day in May.
Turning to large customers, we ended the quarter with 1749 large customers, representing an increase of 61% year over year.
And the record addition of 212 large customers in the quarter.
We were pleased to see large customer revenue contribution increased again sequentially.
Continue to move upmarket shipping products in future.
Great.
This is reflected in our large customer cohorts consistently increasing size and revenue contribution.
Significant expansion from our large customers contributed to a dollar based net retention of 126%.
Representing a decrease of 100 basis points sequentially, and an increase of 200 basis points year over year.
While we expect DNR to continue to trend upward overtime, we expect some variability quarter to quarter.
Moving to gross margin second quarter gross margin was 78, 9% representing an increase of 20 basis points sequentially network Capex represented 13% of revenue in the second quarter.
We continue to expect some level of quarter to quarter variability given strategic purchase decisions and continue to expect network capex to be 12% to 14% of revenue for fiscal 2022.
Turning to operating expenses second quarter operating expenses as a percentage of revenue increased 3% sequentially and decreased 2% year over year to 79% we had another strong hiring quarter.
Our total number of employees increased 49% year over year, bringing our total number of employees to approximately 3060 at the end of the quarter.
As we look forward into the second half of 2022, we plan to slow that velocity of hiring given global macroeconomic uncertainty. We also see an opportunity to raise the bar on new higher additions given dislocations in the market.
Sales and marketing expenses were $103 9 million for the quarter, Jonathan marketing as a percentage of revenue increased 2% sequentially and decreased to <unk> 44 from 45% in the same quarter last year.
Research and development expenses were $46 $2 million from the quarter.
R&D as a percentage of revenue increased 1% sequentially and stayed flat from 20% in the same quarter last year.
General and administrative expenses were $35 8 million for the quarter.
<unk> as a percentage of revenue stayed flat sequentially and decreased to 15 from 16% in the same quarter last year.
Operating loss was $891000 compared to an operating loss of $4 million from the same period last year.
Second quarter operating margin was negative, 0.4%, improving 220 basis points year over year.
Log for our acquisition and continued investment in area. One we would have been operating profit positive.
Turning to net income in the balance sheet.
Net income in the quarter was $312000 or net income per share of zero cents.
Tax expense for the quarter was $793000.
We ended the second quarter with $1 $6 billion in cash cash equivalents and available for sale Securities free.
Free cash flow was negative $4 4 million in the second quarter or 2% of revenue compared to negative $9 8 million or 6% of revenue in the same period last year.
Operating cash flow was $38 3 million in the second quarter or 16% of revenue compared to $7 5 million or 5% of revenue in the same period last year.
We will be diligent in balancing operational discipline moving forward.
Have a heightened focus on free cash flow, while maintaining profitability at or near breakeven with continued investment to address the enormous opportunity in front of us.
As mentioned in prior quarters, we continue to expect to return to positive free cash flow in the second half of 2022.
Remaining performance obligations, our Po came in at $760 million reps.
Representing an increase of 10% sequentially and 57% year over year current <unk> was 76% of total RPM.
Before we move to guidance for the third quarter and full year I would like to provide additional color on our expectations.
The uncertainty in the macroeconomic environment.
Similar to the early days of Covid, we performed rigorous analysis to understand that.
Risks and opportunities in the current environment, however, by Covid, particularly affected a narrow set of industry. The current challenges impact our broader set of verticals, which is why we believe it's important for us to be more prudent in this quarters guidance.
Headwinds from foreign exchange have also accelerated with our product portfolio are priced in U S dollars, our products are becoming more expensive internationally.
And while we haven't seen a material change in our customers' behavior to date, we are seeing elongated sales cycles at the high end of our business.
In a sense of the increasingly cautious environment factored this into our outlook.
For the third quarter, we expect revenue in the range of $250 million to $251 million.
Representing an increase of 45% to 46% year over year.
We expect operating income in the range of zero to $1 million, we expect net income per share.
Even to one.
Assuming approximately 342 million common shares outstanding.
We expect a tax expense of $1 9 million.
For the full year 2022, we expect revenue in the range of 968 $972 million.
Representing an increase of 47% to 48% year over year.
We expect operating income for the full year in the range of 7 million to $11 million. We expect net income per share over that period and the range of three to four.
Assuming approximately 343 million common shares outstanding.
We expect a tax expense of $6 4 million.
We are fortunate to be uniquely positioned as the provider of mission critical services to all customers and while there are challenges in the economy. We remain excited about the <unk> and plentiful.
To think that closely employees for their continued dedication and resiliency in delivering exceptional service to our customers partners and communities and with that I'd like to open it up for questions. Operator, please pull for questions.
Thank you.
As a reminder, if you would like to ask a question Press Star then the number one on your telephone keypad.
Today that you limit yourself to one question and one follow up thank you.
Your first question comes from the line of Matt Hedberg with RBC capital markets.
Your line is now open.
Great. Thank you very much for the question and congrats on the results in a tough environment.
Maybe Thomas for you Matthew had a lot of helpful commentary as we said I think we appreciate the candor.
You mentioned longer sales cycles, but you're still increased your full year guide by $13 million of more than $7 million Q2 beat can you talk a little bit more about specifically, how you thought about levels embedding levels of conservatism and are you assuming things kind of stay the same or maybe you can just gets worse from here.
Okay.
Yes.
We looked at a lot of different factors impacting guidance. This year and you picked up some already so we continue to see elongated sales cycles at the high end of our of our business that especially in the hopper.
Bucket.
We expect that to continue.
So also on that our our European business.
What's the second best.
Best performing region this quarter than we've seen at TG aviation performance, especially in Europe over the first and second quarter. So we expect that the trend for sure not to improve.
You also see.
Cross the board I think that companies are.
Becoming more cautious in how they approach.
The business and things are just kind of twice.
In order to make sure that.
That's helpful only be done ones. So we have not factored in our guidance.
Things would improve from from.
From Geos.
From here on moving forward.
And.
Performed rigorous analysis across verticals across various regions and customer cohorts and Thats why youll see a more prudent and more cautious.
Guide four for the third quarter and the end of the year.
Got it that makes sense and then maybe just one for Matthew.
Yes.
The wins that you called out and workers are exciting.
I guess I'm wondering.
Is there is there an opportunity maybe more challenged economic times for customers to start to use it.
Workers, and even more creative and maybe cost effective high ROI ways than they would have otherwise done. So like you said the road was kind of clear ahead, and no clouds or fog in front of us.
Yes, I think one of the really powerful things about workers is it efficiency.
And so a workload and equivalent work load running on workers versus running on any of the sort of traditional public clouds, AWS or Google cloud or Microsoft Azure.
Is typically significantly less expensive to run and the technical work in order to make that happen as part of the magic.
Of what workers deliveries and so we are definitely seeing.
Especially in.
Either new startups or people, who are really realizing that they've got to make money go further.
The days of just wildly spending on your cloud Bill I think are behind us and there are many different ways, both with workers as well as just some of our standard products that if you put us in front of your typical public cloud, we can often save you quite a bit of money and so again I think that that was a message that didn't.
Really resonate very much a year ago, where everyone was just seemed like money was free and and people were throwing it at any problem that was out there, but I think in these particular environments, where people are trying to figure out how to stretch your dollar even further workers and cloud players platform as a whole is very.
Effective at helping people save money.
Super helpful. Thanks, guys.
Your next question comes from the line of James Fish with Piper Sandler Your line is now open.
Hey, guys. Thanks for the questions.
Yes.
Intra quarter was an interesting release from you guys that you talked about the club car one partner program and Matthew in your prepared remarks, you mentioned, taking some of your competitors top.
Top channel partners.
Can you go over some of the details that you expect in terms of how this program is going to work for you guys is are solely focused on security and how this is going to impact your indirect indirect mix and profitability over the next couple of years.
Yes.
I think that.
From the early days of cloud layer, we explored.
Various partner programs and the challenge was that for a lot of our early products.
Five minute sign up.
And and they just worked out of the box and so there wasn't a lot of value to add as a value added reseller and so while we had.
I'd call fairly standard success for the SaaS industry.
And working with partners I don't think our products really facilitated.
Getting the most out of the partner ecosystem and especially.
If all our partner is as is an order taker then that's not not a lot of value I think a handful of things have happened one is that our products have gotten more complicated and the ability to customize them in various ways had become much richer. So for example with workers.
What we're seeing from a partner like IBM is that they can actually develop their own intellectual property for a particular industry vertical deploy that on workers and then sell that same IP over and over again, that's great for them. It really drives their services revenue and it's great for us because it means that we are.
We're getting more leverage and what we're able to deliver them through partners. The second thing is that I think we saw with Zee scalar.
Their success with a handful of partners in selling the zero Trust products was really successful with those products take more work to actually implement and deploy within an organization thats not a five minute setup and so in that case, that's an area, where we are able to work with partners and in particular.
We're very much following the playbook and when we talk to the partners that are selling zero Trust services. They all want to have more solutions in their basket to be able to bring to customers because in a lot of cases that kind of previous zero trust solution either suffered.
From a lack of ability to scale real performance bottlenecks.
Having the total global coverage that global companies need and cloud Larry addresses all of those things extremely well. So I think that that's an opportunity for us in terms of profitability I think the good news is that these more complex products.
Tend to actually be the highest margin products that we have and so as we were designing the program. We thought that we could have it be bulk margin accretive to cloud player while also still being very attractive.
You see the potential partners that are bringing that to market and so I think that this is an area that we're watching very carefully I think its part that is we're going to continue to invest in actually is also one of the hidden benefits of us acquiring area. One is they had a lot more experience with the <unk>.
And with partners and so working with the team there to really design that program has been has been great and the reception from partners has been has been terrific. So I think it's a it's a win win for us and for our partners.
Very helpful. Matthew.
Last one for me is the big government quarter coming up here and obviously you guys have the system integrator relationship I guess, what are you seeing on the government agency side and that fed ramp program. Thanks, guys.
Yeah I appreciate I appreciate it.
We are.
It's like being in line that the DMV.
That we pulled our number and are just waiting for it to come up for us to get our fed ramp certification and so we expect that we will have very positive news for that next next quarter, but we're basically at number one number 84, and it's showing number 80 83 on the on the.
White, a red number accounting board at the Dnb, So that's positive.
We see across the board not just with federal but the example that I gave in the state of Arizona, We're seeing a lot more people adopt.
Lastly, our services in that in that government space and so I think that that continues to be a place where we have very strong relationships.
And as we continue to get the various certification will allow us to go even faster.
Okay.
Your next question comes from the line of Alex Henderson with Needham <unk> Co. Your line is now open.
Great. Thank you very much.
I was hoping you could talk a little bit about the.
The context of the commentary around economic conditions. This is pretty obvious.
The entire planet the economies globally are decelerating and particularly Europe is under a lot of.
Yes, but.
Your initial comments was that you saw that start to really manifest in.
<unk> and that has actually improved somewhat or at least stabilized in <unk>.
Yet you sound a lot more cautious on year.
<unk> process, and so forth and I'm wondering if.
If there is a little bit of a.
Disconnect between those two.
None of those two it doesn't sound like your business has rolled it all and sequentially got worse or more.
But on the other.
Side of the coin you sounded like you are being much more conservative in your outlook. So could you parse between those two a little bit.
Yes, Alex I think that.
Okay.
What we see is that the environment has gotten harder and I think we saw the first signals of that actually going back to December of 2021, and they really started to manifest in various ways slowdown of pipeline slowdown.
Of customers paying their bills.
In Q1 of this year and we talked about that on the last quarter.
Earnings call and I think some people.
We're questioning why why we would do that.
What I think we've been able to do though because we saw that we acknowledge that.
We didn't we didn't pretend like everything was was normal was really adjust to take advantage of the.
The situation and so I think one of the real powers of cloud <unk> business is the diversity of our customer sets both on a geography.
And also industry basis that diversity of our products.
And that allows us to have multiple levers to be able to continue to deliver even when when the times get tough and I think if you go back to the co bid quarters and that was definitely a time, where we had to adjust how we went to market. What we did what types of customer.
We focused on we really transitioned from being a business driven primarily from getting new logos to one that developed a real expertise in how to go to our existing customers and sell them more and I think there are a lot of analogies that are similar to the sort of adjustments that we've made that allowed us to.
<unk>.
A quarter like this but make no mistake.
We're still we're still in what my grandmother would call truly fog, we've still got to go out and do the work every day.
Filling up the wheel Barrow with new leads.
Sifting through it to look for what's what's what's going to be the most promising and then being able to and being able to deliver but what I like about our business is again, a diversity across customer types customer sizes products ways that we can go to market and I think our team has done a good job of adapting to what is a much more difficult.
<unk> today than it was a year ago.
Thanks Jay.
So maybe you wanted to.
Maybe one additional point I pointed that out in my script, but and I didn't mention it in the in the previous answer.
What we do feel.
Also currency headwinds, especially in Europe . So you can if the economic activity for us in terms of deal volume.
What would be the same we see the headwinds from a currency perspective in Europe , but also in other parts of the World Japan for example, we need to digest.
Yes.
It actually leads me to the second question I wanted to ask is the European environment is particularly onerous.
20% currency translation headwinds in EMEA or inflation rising interest rates bank or the bank of the ink.
England just range rates half percent today in fact.
Given that environment.
They are struggling with huge price increases, particularly on systems in local.
Plus the currency translation and their budgets are fairly flat now my understanding is there seems to be a.
A separation between companies that are selling relatively low priced high value technologies and companies that are selling high ticket.
Technologies can you talk about whether you are.
<unk> low price.
And the.
The fact that your lower ticket upfront.
Gives you a big advantage in that geography, because of that characteristic and whether youre seeing more pressure on the higher value higher bigger ticket.
Transactions, because I think ultimately that seems to be the divining rod between who wins or loses in in Europe .
Well I think it is certainly a benefit that our products are mission critical but.
Even then.
The high end.
In figure ACB deals that position takes longer that's where you see the elongated sales cycles.
Factoring in our favor is the gross margin has gone up their strong points of the business model.
We deployed that weapon, you always talked a bit about it as a strategic weapon when it makes sense so that doesn't mean.
Price cutting.
Try to be strategic and accommodating where we think it makes sense to both business relationship in business.
But we are using our margin to accommodate for that without any doubt.
Great. Thank you very much.
Your next.
Question comes from the line of Shaul Eyal with Cowen. Your line is now open.
Thank you good afternoon guys congrats.
Set of results.
Matthew This first question for you so thoughtful discussion.
In the quarter, maybe some chatter around your crypto exposure potentially implications may be good opportunity here to address cloud exposure, maybe your current thinking on this vertical given the changing dynamics, we've seen in recent months.
Okay sure.
I think that we.
We have customers that are in that space, including a number of the large exchanges, but I don't think that there are any of them.
That would that would crack being a top 10 customer and I think as a whole I don't know the exact exposure Thomas may be able to to add to it but I will say that it's not significant enough that it has been brought up as a as a big risk items internally, so I think that.
We have always had.
I personally.
Have never.
There's a lot of religion around.
But the crypto space, where people are either pipe really pro crypto or hopefully against crypto I feel like I'm, the only kind of agnostic on crypto, where I don't think we have that heavily on it.
But at the same time.
We've definitely made sure that if if if if.
There are things that emerge from it.
That we're in a position to take advantage of those.
That has not been at.
A meaningful headwind to us.
Yes, and maybe some color our exposure to crypto was less than.
Single mid single digits and percent of revenue up 5% for the second quarter.
Not a big and interesting part in terms of there.
The size and the amount of customers, but not a big exposure to revenue.
Understood and then tell us maybe one one for you.
Question on elongated sales cycle I know, it's a bit tricky.
First from customer to customer, but maybe can you generalize for us.
How long how much how many cycles being Allen data are we talking two weeks.
A week or more.
More than that.
How should we be thinking about it.
The world elongated as a very very general.
Term.
Well.
I'd say for the main part of our business, we are still far below 90 days from a cyclical.
Cycle perspective, so when we talk about <unk>.
<unk> sales cycles within the upper end of our cohorts, where you look at.
The bucket 500000 per million <unk>.
Where its moving out but there it's moving out by weeks not by days.
Understood very helpful. Thank you so much.
We ask that analysts limit themselves to one question. So we may get to everybody today. Thank you.
Your next question comes from the line of the chemo from Ronnie with Citi. Your line is now open.
Hey, good afternoon, and thank you so much for taking my questions.
And Matthew or Thomas jump ball for either one of you.
About the shift to pay as you go customers. Some of your observations on commentary around elongated deal cycles that you just addressed.
Im curious if you can just sort of take a step back and bifurcate for us how new logo land purchasing and procurement behavior has changed versus expansion or installed base expansion customer behavior has changed over the last three months and maybe if you can help contextualize this or put this on.
Through the lens of your product pillars.
Whether there is more or less.
You said your slower adoption of certain pillars versus others and certainly against the hardware supply chain constraint backdrop that we're in right now.
Sure so.
As I said in the prepared remarks.
I think that it has gotten harder to sign up a new logo.
Since the beginning of the year.
But but it's actually gotten easier to talk to our existing customers about using more of their platform more of our platforms in order to solve the problems that they that they have.
And so I think that that where we benefit is because we have such a broad product portfolio that allows us even in these times, we're signing up new logos as hard we can go to our existing customers and have a conversation about how we can simplify their it stack, how we can save them money.
How we can make them more secure and and I think that that's that's.
That's attractive so we're still signing up plenty of new logos.
But I think that is.
On balance it has definitely gotten harder to sign up new logos and it has gotten easier to have conversations about expanding usage of our platform and especially adopting different products that are part of our platform in terms of what products.
R R.
How the how the mix of products is changing I think security continues to be top of mind.
I think that there was real kind.
Kind of concern around when the Russian invasion.
Ukraine happened that there would be a tax that went out.
From Russia in retaliation against Western companies that actually did not materialize in Q1, the way I think a lot of people thought it would but we started to see more of that.
Start to materialize in Q2, it's still.
I wouldn't call it a trend yet but.
But we're seeing more companies come under attack and turning to us win when that happens and so I think this is an environment, where security products do very well and and across our security portfolio, we're seeing strength.
Thank you so much.
Your next question comes from the line of Joel Fishbein with Trust. Your line is now open.
Thank you for taking my question.
Matthew at Analyst Day, you talked about X in these large markets that clouds there to go after notwithstanding the.
Macro environment current macro environment is there anything that has changed in your philosophy about these big markets and maybe you can just give us an update on <unk>.
These acts are large markets and where you are positioned maybe specifically around <unk> and the big data that you have going on right now thank you.
Yes so.
Yeah.
We think of cloud flare as stacking mulch.
Multiple.
Adoption S curves one behind another and so our first act.
How do we protect.
The the infrastructure of customers around the world and it's it is it is incredible to see how we've been able to.
Do that.
Successfully where today more than 20%.
Of all websites use our our infrastructure.
We'll continue to sell those products, but I think that where we are earlier in that S curve is.
As with our zero trust products, and where we're able to go to all of those people, who die adopted our application security products and now say Hey, we can help you with zero trust as well and I think that that is the Big Act that were focusing on right now act three for us, which I think will really start to hit in a material.
Real way around revenue.
Three.
Three to five years.
It's really around workers.
And I think we have been very pleasantly surprised how that adoption has happened faster and sooner and earlier than we expected.
<unk>, two which is our object store and our S. Three Amazon S III competitor.
Went into public beta last quarter, and we expect that it will go into GAA right at the end of Q3, and so I think that thats an opportunity for us to do more.
And we will continue we continue to invest in it and again, we think that the real durable nature of cloud Blair is that we're able to continue to stack. These acts one behind another behind it.
Great. Thank you.
Okay.
Your next question comes from the line of Hamzah firewalls.
<unk> with Morgan Stanley . Your line is now open.
Hi, guys. Thank you for taking my questions Matthew maybe a question on the security angle for you.
<unk> talked a lot about having larger platform conversations with your existing customers can you comment on when you talk to Cio's. He says that these customers what is their willingness to really wanted to transform and modernize their existing security architectures versus perhaps continuing to refresh their existing on premise data.
Yes, I mean, I think Morgan Stanley is a great cloud with our customer and we have we have.
Terrific relationship with with the CIO team over there and it's and it's definitely an organization that has been willing to embrace.
Change and and we I think that that's that's a big big piece and I think thats. Most organizations today understand that they have to make that change and they are very willing to have that conversation I think the thing that has changed to some extent.
Even those organizations that thought they could continue to invest in on premise hardware are finding the current situation very difficult, where if you wanted to get a new firewall today. The lead times can be nine months before you get it and at the same time the firewall vendors.
We are raising their prices and so I think that youll.
Lot of.
In the in the results a lot of that sort of RP O.
That that you saw in the traditional firewall vendors with people basically holding their place in line, but it's not a way to make customers happy telling them they have to pay more.
And then delaying when when the product is going to be there. So even for some of the organization that traditionally have that we don't believe in the cloud or we don't believe in and moving in this direction I think that that June is starting to change and it's becoming very much. The minority opinion that you can solve these problems.
With on premise hardware.
Thank you.
Your next question comes from the line of Adam Borg with Stifel. Your line is now open.
Hey, guys and thanks, a lot for taking the question maybe.
Maybe just for Thomas I think you talked to the script about.
Being more judicious in selling hiring in the back half of the year and maybe hoping you could talk a little bit more about which areas are still prioritizing hiring and which ones you are kind of slowing a bit more thanks. So much.
Yes, so we grew quite a bit employee head count wise in the second quarter. We said, we would take the velocity down quite a bit.
We still prioritize go to market.
Opening open positions and protect hurting people moving into the second half so the slowdown in G&A.
And some of their R&D functions, but go to market.
It's still going to continue.
To hire.
Super clear thanks, so much.
Your next question comes from the line of Andrew Nowinski with Wells Fargo. Your line is now open.
Great. Thank you maybe just a follow up question on the operating income for the year your loss.
In Q2 is actually better than your guidance I think you just said you're slowing slowing hiring in the second half of the year. So I assume the reason you lowered your operating income for the full year fiscal 'twenty. Two is due to the <unk> acquisition on it. So could you just pull that out maybe tell us what your organic.
Revenue and operating income would have been.
Outside of that acquisition.
Yes, I don't want to get more its much more specific than that.
The color we gave on our in our script, but it has to wait a couple of moving parts.
Without the continued investment in area. One we would have been operating margin positive.
Lean more and Theyre seeing them.
Single digit mid digit million.
Our range for.
For the second quarter.
And I assume the operating guidance for the year would have gone up in absence of that acquisition.
We gave guidance.
For the quarter that took into account a lot of variables.
According to parcel out what the specific impact.
One would have been if we hadn't done that.
That acquisition.
The guidance is a holistic picture on many things that move you should take it as that.
Understood. Thanks.
Your next question comes from the line of Trevor Walsh with JMP Securities. Your line is now open.
Great. Thanks again for taking my question Matthew maybe quick one for you on your comments around DBS you mentioned your aspirational goal of 130%.
What do you think is how do you get there kind of a function kind of where youre at now based on macroeconomics.
Just what's going on in terms of budgets or is there something internally that you guys are looking to maybe change <unk> kind of refocus efforts on in order to drive that number up thanks.
Yes, I think that it really is for us about how we bundle products together.
Today, 29% of the Fortune 1000 are already cloud where customers.
If you fast forward with that.
I think that that is a very significant percentage of the fortune 1000 customers and so what we really want to focus on is how do we get them to use more of our platform and what I think is unique about cloud player is we've already got the products in place where we can have those.
Those customers are.
Adopt our more and more of our platform. There is not a single customer that uses every single feature of cloud platform today in terms of a contracted customer and so I think that's where we really see that growing and I think that's a very healthy way to expand spend with customers to become more and more critical.
What we want to be is the network that the fortune 1000 rely bonds for connecting to the Internet.
Making sure that they're secure making sure that their employees have the best experience possible and making sure that no matter what happens they are always going to be online.
Great. Thanks, a lot.
Your next question comes from the line of James Breen with William Blair. Your line is now open.
Thanks for taking the question can you just talk a little bit about capex is up a bit this quarter.
A little bit higher than the guidance for the year the range for the year and how you think about that spending going forward and maybe some of the puts and takes on cash flow relative to topline growth.
Areas, where you can generate cash without too greatly impacted the top line. Thanks.
Maybe I could start it on Capex I mean, we are going to stay within the range that we guided for the year.
We said before you will see variability quarter to quarter, just in terms of how we purchase where we see opportunity to Poland and spend.
And make sure that we maneuver our so smartly around the supply chain disruptions youll see that this is pretty much driving the variability quarter to quarter, but we will stay within.
The range, we guided for the year.
Our free cash flow perspective.
We said we have a.
A lot of levers at hand.
One of the biggest levers is.
<unk>.
Moving to annual billing for our large customers we are.
From a company history perspective coming from from a pay as you go business, where people give us credit card even at the beginning of the second quarter.
The majority of our revenue plus months building. So we've made great strides towards that direction of annual billing.
A lot of opportunities still in front of us. So I would say is the biggest lever.
But we run a pretty holistic.
Cash conversion.
Across the company that looks into literally anything that can positively impact free cash flow generation and it's a cross functional project.
And we're making good progress and you saw that already reflected in the second quarter numbers.
Okay.
Great. Thanks.
Your next question comes from the line of Gray Powell with BT AIG. Your line is now open.
Alright, great.
Thanks for taking the question and congratulations for the.
On the strong results.
So yes, Matt you called out the Fortune 500.
Energy company, where you're replacing these scalar and then you talked about some other similar wins.
I'll make sure I have it correct you are those mainly on the <unk> side with cloud for access.
Or were there some gateway wins as well.
Then maybe you can just drill into that a little bit more and talk about like why you wanted or is it more on price technology or a combination of both.
Yeah. So when we when we sell our zero Trust solutions, we really believe that.
The pieces all fit together.
Together and and so those are tipped.
Typically when sometimes somebody will just what will just.
Adopt one portion of the solution, but we really like to sell that holistic solution and see how all of the pieces fit together in terms of where we win.
I think what we hear from the space is that.
Our products are significantly more performance.
We have a much more holistic solution, where we can.
<unk> protect mobile devices in a way that a lot of the other providers can't we can work across the geographies.
When I was this time last year traveling in Africa, using our products they worked great.
Whereas most most people in this space don't have that broad of a of a network.
It can deliver that and I think that we're just able to scale much more significantly we have literally two orders of magnitude more capacity.
To be able to handle the forward proxy traffic across us than any of the other providers in the space and I think that that's.
That's why.
<unk> been able we've been able to.
Displayed.
Some companies that have used that have tried to adopt the scalar and found it less.
Less user friendly and that generated a lot of support tickets.
But that's really not our focus our focus is going after all of the on premise.
Firewalls and hardware and VPN that exist in the universe and so I think they can be successful and we can be successful, but I think we have a better product and and over time I think that will help us help us win.
Understood.
Thank you very much.
And then can we take a question from one more analyst. Please of course. Your final question today comes from the line of Brent Thill with Jefferies. Your line is now open.
Matthew on area, one I know, it's early but can you give us an update of what youre seeing there and I guess again on the last question can I squeeze one and at the end.
The area one tech is amazing.
The product.
We're seeing really great wins from from very large customers and we think of that product as being a gateway to help with people on their zero Trust journey. If you think about E mail the nature of it and Numerate.
The employee directory oven organization and it very much then helps us sell the others Zero Trust products.
That we have and so that conversation is going well. It is also a conversation that is going well in terms of talking to our existing customers. It turns out everybody has got a phishing problem.
It is for most of our customers one click to sign up and test.
There are not area. One can can result in that and so we are seeing mill.
Million plus wins that close.
And oftentimes in a matter of days or short number of weeks, which is which is just because because we can just prove how successful that is I think beyond that everyone has helped us in a number of other ways. One as I mentioned earlier is that they they had a much more sophisticated channel program, which is now help.
<unk> developed our channel program, and I think where we're really thankful for that team being on board and then the third which I think youll hear us talk about more going forward is that they have a really world class threat intelligence team and that I think will turn into more products.
Across across our entire platform and because because and because as because I like your brand I'll. Let you have one more question.
I appreciate that.
You've had the crystal ball and everyone. Appreciate your candor and I think you were the first one to come out and say hey, things are filling a little different than they felt it was just trying to understand when you look at the perspective of what's happening now.
You mentioned things have stabilized.
Want to make sure we understand from your perspective, it hasn't gotten worse.
Come in that you are.
The stabilization trend that Youre seeing have you seen that extending into July and in the rest of the summer whats your sense of kind of the trajectory from where where things came in and where you're at now.
Yes, you got me in trouble with a lot of my peers at your at your conference where I.
I said that the economy was was.
It is not as rosy as as people think and I think you've heard a lot of those folks echo those comments now in Q2.
Let me be clear I think that the economy is still in really rough shape and I don't know.
I'm not a member of that.
I'm not an economist, but from what we hear from customers customers are really still suffering and in the economy I wouldn't say that the economy itself has stabilized what I would say is we have had the flexibility in our business to be able to adapt to a.
Difficult environment.
That environment continues to be difficult and I think it will be difficult at least through the rest of the year.
But being able to deliver products that deliver real value have an incredible ROI can save customers money and are must haves not nice to haves puts us in an incredibly powerful position and as I said in the prepared remarks, I would not trade places with any other CEO .
Thank you.
This.
Our Q&A portion of the call, Matt Matthew Prince I'll turn the call back to you.
So I'd like to first of all thank a bunch of the students from the Berklee School of music to let us use some of their new and original songs offer the hold music going going in so I hope for those of you who tuned in the call. Early are you appreciated that I also wanted to thank the analysts are actually asking Thomas some questions. This time, usually I could get out of the question. Thanks.
Our team and all of our customers, we've got our hands on the wheel horizon. The road and we'll see you all back here next quarter.
This concludes today's conference call. Thank you for attending you may now disconnect.
Okay.
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Amy.
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Good morning.
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<unk>.
Okay.
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[music].