Q1 2023 Cloudflare Inc Earnings Call
And I have no name you bought anything you do now on in our relationship and Trust me that he heard likes it but you don't have to say.
[music].
Please standby were about to begin.
Good afternoon, ladies and gentlemen, and welcome to the cloud flare Q1, 2023 earnings conference call.
At this time all participants are in a listen only mode and pleased to get advised that this call is being recorded after the speakers' prepared remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press star one on your telephone keypad and if he would like to withdraw your question. Please press the pound key.
Now I'd like to turn the call over to Mr. Phil Winslow, Vice President of strategic Finance Treasury and Investor Relations. Please go ahead Sir.
Thank you for joining us to discuss <unk> financial results for the first quarter of 2023 with me on the call. We have Matthew Prince co founder and CEO , Michelle as island co founder President and CLO and Thomas Seifert CFO .
I know everyone should have access to our earnings announcement this announcement as well as our supplemental financial information may be found on our Investor Relations website.
As a reminder, we will be making forward looking statements during today's discussion, including but not limited to our customers vendors and partners operations and future financial performance.
Dissipated product launches and the timing and market potential of those products, our anticipated future financial and operating performance and our expectations regarding future macroeconomic conditions. These statements and other comments are not guarantees of future performance and are subject to risks and uncertainties much of which is beyond our control or <unk>.
Actual results may differ significantly from those projected or suggested in any of our forward looking statements.
These forward looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements. After this call for a more complete discussion of the rest of uncertainties that could impact our future operating results and financial condition. So you see our filings with the SEC as well as in today's earnings press release.
Unless otherwise noted all numbers, we talked about today other than revenue will be on an adjusted non-GAAP basis, you'll find a reconciliation of GAAP to non-GAAP financial measures that are included in our earnings release on our Investor Relations website.
For historical periods, a GAAP to non-GAAP reconciliation can be found in the supplemental financial information referenced a few moments ago.
We'd also like to inform you that we will be participating in Moffett Nathan.
Youll TMT conference on May 17, and Jefferies 2023 software conference on May 31.
Now before wrapping up we are excited to host our Investor day on Thursday may the fourth which is being held in conjunction with our user conference Clarifier connect in New York City. A live webcast will also be accessible from our Investor Relations Web site.
Now with that I'd like to turn over the call to Matt.
Thank you Phil Q1 was a quarter of contrast, we achieved revenue of $292 million up 37% year over year. Our gross margin was 77, 8% again above our long term target range of 75% to 77% and up from 77 four per.
Last quarter.
During the quarter, we added 114, new large customers those that pay us more than $100000 per year and now have 2156 large customers up 40% year over year. Our dollar based net retention fell to a 117% down 5% quarter over quarter importantly, we.
We did not see elevated churn across our broad customer base. Instead, we saw slower expansion from existing customers more on that in the second.
Throughout this quarter of contrast, we thought tailwind and headwind the reacceleration of our new business pipeline. During the second half of 2022 continued again this quarter and we meaningfully exceeded our pipeline plan in the second quarter in a row our win rates against the competition remained at record high levels and renewal.
Rates were consistent with the high levels experienced of the previous four quarters those were all positive signs.
On the flip side the quarter saw new challenges macroeconomic uncertainty, which intensified over the course of Q1 with every failing bank resulted in a material lengthening of sales cycles, a significant decline in close rates, even as win rates held strong and an extreme backend weighting to the quarter to give you some sense.
Almost half the new business closed in the last two weeks of the quarter, which is very non linear for us all of these factors put pressure on the core.
Most of your mind it would be a Q1 of 2020 when businesses were paralysing, we nervous about the impact of COVID-19.
This parallel shows how with uncertainty in the economy companies are closely watching their own businesses before committing to new spending.
We continue to be a must have not a nice to have and most of the DLP expected to close that just later than we expected.
I am proud of our team's ability to sail through the rough seas that characterize Q1.
Although the current economy posted uncertainty for nearly every business in the near term as Mark Hawkins and our board likes to say when the going gets tough tough get profitable and we hired plus.
We have our hands firmly on the tail of our business and are able to adjust to rapidly evolving market condition in order to deliver operating profit of $19 4 million.
Representing a record operating margin of six 7%.
Furthermore, in spite of tougher collections in the quarter, particularly in the month of March we generated $13 $9 million of free cash flow, representing a free cash flow margin of 5%. We continue to be on track to be free cash flow positive for 2023.
As we navigate through the challenging macroeconomic sees facing our industry. This period of external uncertainty presents us with a perfect opportunity to be internally reflective identifying areas of improvement within our business and taking proactive steps to create an even more successful and productive organization.
As I take stock, we're not limited by the size of our market for our products, we're not limited by our ability to innovate we're not limited by pipeline opportunity and we're not limited by sales capacity. So what are we limited launch.
As I said last quarter, our <unk>, our new president of revenue has dug into retooling our go to market effort and identified significant opportunities to improve the efficiency and performance of our sales team.
Although we have won a third of the fortune 500 as customers. If we're honest with ourselves we saw a lot of our success with our enterprise customers because of the products were so good and solve real problems that every big company faces that allowed many on our sales team to succeed largely by just taking orders when the Fisher jumping right in the boat you don't need to be a very.
Good detriment.
But at the risk of mixing watering metaphors as the tide goes out you get a cleaner view who's not wearing shorts the macroeconomic environment has gotten harder and we're seeing that some of our team our dress for work digging in with Mark we've identified more than 100 people on our sales team will consistently missed expectations simply put a.
Difficult percentage of our sales force has been repeatedly underperforming based on measurable performance target and critical Kpis.
Thats, obviously, a problem, but it's one in this environment with a particularly available and actionable solution. We are now in the process of quickly rotating out those members of our team who has been underperforming and bringing in new talent with salespeople have a proven track record of success grit and a strong cultural fit to give you some.
These 100, plus people contributed approximately 4% of annualized new business sold over the last year. So we're optimistic we can make this team upgrade without significantly impacting sales capacity.
<unk> team upgrades are always hard this is a uniquely good time for us to do that a year ago. The tech labor market was extremely price.
There is an abundance of talent eager to work at cloud in Q1, we received more than a quarter million applicants approximately 40% of which were for sales positions. That's more applications than we received in all of 2021. In addition to the volume the caliber of the applicants were receiving its higher than we've seen at any point in our history.
Especially for go to market conditions, while other companies are laying off we're going to be bringing on great people with proven track records to raise the capability of our enterprise go to market team.
We've always had a culture of high performance cloud flex however, with the value of hindsight I think we and most other businesses, it's got a bit soft during the Covid crisis around performance management that was understandable at the time at that time as Ofer will work. We do is vitally important for the healthy functioning of the Internet. The opportunity ahead of us is massive with.
<unk> people on our team who are executing everyday to realize that opportunity and we have an incredibly long line of other proven talented people looking to step in to fill the position where some of our current team aren't living up to expectations are.
Our pace of innovation is not slowing down now more than ever it's Paramount, we continue to innovate and develop unique offerings that deliver value to our customers and differentiate us from the competition. We are great at that I want every dollar we put into classes that can be more productive in driving revenue profit and shareholder value.
Innovation is a long term competitive advantage, but productivity is to taking action to address inefficiencies in our go to market organization now will enable us to better capture new opportunities and expand our customer base and do so even more productively profitably and predictably than before.
I've talked about our team that's underperforming that's only half the story our top salespeople are terrific on average the top 15% of our sellers have achieved 129% quarter over the last four quarters. They are incredibly consistent at bringing in new logos expanding current customers and delivering results.
And approximately 27% of them started within the last 18 months.
We know that if we hire the right people they can ramp quickly and be successful with a full bag of products we handle.
Alright, let me tell you about some of the deals are top performers close this quarter.
A fortune 500 media company expanded their relationship with class, they're signing a three year $840000 deal and bringing their total annual spend to $2 1 million.
A customer of our application performance and security services. Since 2017. This company expanded into our zero trust portfolio with access and browser isolation for thousands of its contractors displacing two zero trust competitors and even turning down re licenses from one of them.
Cloud flex products, not only performed better than the competition during evaluation, but we were the only company that could deliver on the complex requirements needed. This.
This contract is the only the tip of the iceberg with the customer, which plans to potentially zero trust out to all their tens of thousands of employees.
Responding to our detail our campaign, a leading E Commerce technology company in Europe expanded their relationship with clouds, they're sending a three year $780000 deal. The company is going all in on popular one gateway assets has the DLP and magic with it were drawn to cloud platform as a.
Unified pane of glass to consolidate their security modernization and network transformation needs with magic when is a key competitive differentiator versus first generation Zero Trust competitors.
Our global industrial machinery manufacturer expanded their relationship with us by signing a three year $648000 deal. The company was looking to modernize their security infrastructure and is also going all in on 501 with access Gateway area, one magic win displacing multiple competitors.
They appreciate being able to consolidate vendors reduced costs and increased flexibility with cloud platform.
A fortune 1000, SaaS company expanded their relationship with cloud player signing a three year $8 $4 million deal.
Company recognized clouds, our unique position as a neutral super cloud to manage and strengthen their application security posture and accelerated SaaS platform performance across AWS DCP in their private data center environment. Additionally, no other solution could compete with our data localization suite.
To simplify the customers' global regulatory and compliance requirements are.
A leading Iot security company expanded their relationship with US signing two three year deal for a combined $4 $2 million one for its commercial business at a fed ramp one for its government business. The company has been a cloud player customer since 2020, using core application services and cloud for a tunnel for Iot.
Devices.
Onto our pace of innovation this customer bought into the cloud for our platform vision now using over 25 products across core application services.
Aro Trust and our developer platform, including <unk>, our object store and durable object combat high egress feeds from AWS.
Plan to use <unk> fed ramp authorization to scale operations on both commercial and federal sides of their business and increase their security posture.
A fortune 1000 retailers signed up $1 $3 million 46 month contract for <unk> core application services to displace their existing vendor. They also added to the company. It's been dissatisfied with the unpredictability of their bill and bought related issues from the current vendor and wanted to switch to cloud Blair knowing.
Our universal approach to protecting all traffic and our platform ease of use were top of the industry.
A leading gaming company expanded their relationship with <unk> moving from a pay as you go customers spending $200 a month to a contracted customer spending a one year $388000 deal for our two workers in application services. The company was looking for a more scalable platform for storage and the outperformance there was.
The port there exponential growth.
Realized that by moving to <unk>, they could eliminate egress fees. They were incurring from the competitor easily integrate with S. III API and centralized management in particular, they were impressed with <unk> lower latency and better throughput as well as how are too tightly integrates with workers and our core application services.
Traction among developers continues to be strong we now have $4 nine 2 million workers applications running on our platform up 146% over the last six months 33000 paying customers have activated our too and are storing more than seven petabytes of data up 25% quarter over.
Quarter.
AI companies large and small continue to build on cloud player at a breakneck pace when we ask them why they said our neutral position rapid innovation and modern nimble development environment, one last month called Us quote <unk>.
Cloud infrastructure company built through the age of AI I'd like to bring it up.
I'm extremely excited about our upcoming announcement at developer week next month, we will announce a lot around how we support AI and make any developer more productive we are the best in the industry in innovation and we're making the changes we need to make in investing in our team to be the best in the industry its sales too.
As I step back and think about what was a challenging quarter I'm struck by our opportunity we're not limited by the market for our products. We're not limited by innovation, we're not limited by pipeline opportunity, we're not limited by our ability to recruit and we're not even limited by sales capacity. Instead, we are limited by our <unk>.
So to market performance.
Something we can fix and we are committed to turning the current macroeconomic headwinds into a catalyst for positive change in growth at cloud player by investing in our top talent.
Focusing on performance management and elevating the productivity of our team to seize the opportunity. We have ahead, which we all know is massive with that I'll turn it over to Thomas to walk through the financial Thomas take it away.
Thank you Matthew and thank you to everyone for joining us in the first quarter, we continued to witness the challenging business environment, which deteriorated significantly in March when negative headlines emerged relates to SCB, the broadening banking crisis, no worsening macroeconomic outlook.
Intensifying business uncertainty companies became increasingly cautious and more deeply scrutinize deal, which impacted numerous areas of our core business, including a material lengthening of sales cycles delays in collections and the significant back end weighting in the linearity for the quarter.
For some further context technology E Commerce and financial services, our largest end customer verticals by revenue.
Also these headwinds to revenue growth that impact your cloud player outside of our control we remain committed to controlling what we can control and that is to focus on building great products that customers need while also maintaining our strong commitment to being fiscally responsible and remaining good stewards of investors capital.
As such we delivered a record quarter in terms of operating profit and operating margin and significantly outperformed on free cash flow.
We also continue to prudently allocate capital with a focus on maximizing shareholder value.
Turning to revenue total.
Total revenue for the first quarter increased 37% year over year to $292 million.
New pipeline growth again remained strong in the first quarter exceeding our internal plan for the second consecutive quarter and continuing the trend of accelerated growth in new pipeline generation.
Third consecutive quarter.
However, the significant incremental caution exhibited by customers resulted in a pronounced decline in our close rate and then extreme backend weighting of ACB bookings during the first quarter, both which were primarily impacted by the aforementioned longer sales cycles.
Specifically, however sales cycles during the first quarter was 27% longer than the average of the previous four quarters sales.
Sales cycles increased more significantly and expansion deals with our contracted customers, which were 49% longer than the average of the previous four quarters. However, our win rates.
The competition remains high.
From a geographic perspective, the U S represented 53% of revenue and increased 37% year over year.
EMEA represented 27% of revenue an increase of 40% year over year.
<unk> represented 13% of revenue and increased 31% year over year.
Turning to our customer metrics in the first quarter, we had 168.
59, <unk> customers representing.
Representing an increase of 13% year over year.
Turning to large customers, we ended the quarter with 2156 large customers, representing an increase of 40% year over year and then the addition of 114 large customers in the quarter.
Our dollar based metric to ensure rate was 117% during the first quarter, representing a decrease of 500 basis points sequentially and a decrease of 10 percentage points year over year.
Yes.
We have not experienced elevated churn rates renewal rates in the first quarter were consistent with the levels experienced from average over the previous four quarter, which was an all time high for the company.
Similar to the fourth quarter of last year. The decline in DNR was again, primarily driven by delayed expansion with our larger customers.
Moving to gross margin first quarter gross margin was 77, 8%, representing an increase of 40 basis points sequentially and a decrease of 90 basis points year over year net.
Network Capex represented 5% of revenue in the first quarter.
Fiscal 2023, we continue to expect metric capex could be 11% to 13% of revenue.
Turning to operating expenses.
We understand that a crucial aspect of our success.
And we're being responsive to near term changes in market conditions and adjusting our operations accordingly without.
Without compromising the long term opportunity ahead of us.
Which we all know it's Matt.
We again took proactive measures during the first quarter to improve operational efficiency and effectively manage spending.
As a result of this action first quarter operating expenses as a percentage of revenue.
Consistent sequentially and decreased 5% year over year to 71%.
Our total number of employees increased 23% year over year, bringing our total headcount to approximately 3390 at the end of the quarter.
We will continue to pace hiring for the year based on market conditions.
Sales and marketing expenses were $120 6 million for the quarter.
Sales and marketing as a percentage of revenue increased by 1% sequentially and remained consistent at 42% compared to the same quarter last year.
Research and development expenses were $51 $3 million in the quarter R&D as a percentage of revenue remained consistent sequentially and decreased to 18% from 19% in the same quarter last year.
General and administrative expenses were $34 6 million for the quarter G&A as a percentage of revenue remained consistent sequentially and decreased 12% from 15% in the same quarter last year.
Operating income was $19 4 million.
Compared to an operating income of $4 9 million in the same period last year.
First quarter operating margin was six 7% an increase of 440 basis points year over year.
These results highlight the efficiency and elasticity of our business model, which remain key elements of drug for their success.
Turning to net income in the balance sheet.
Our net income in the quarter were $27 2 million or a diluted net income per share of <unk>.
During the first quarter, we initiated a tax planning strategies, and we were able to successfully reduce cash taxes related to beat and other taxes.
As a result.
<unk> expense for the quarter was $3 9 million.
We ended the first quarter was $1 7 billion incentives cash equivalents and available for sale Securities free.
Free cash flow was $13 9 million for the first quarter or 5% of revenue compared to negative $64 4 million.
30% of revenue in the same period last year.
Remaining performance obligations or RPE, okay $959 million.
Representing an increase of 6% sequentially and 39% year over year.
<unk> was 75% of total IPO.
Before moving to guidance for the second quarter and full year I would like to begin with our expectations and the provisions we have factored into guidance.
Last quarter, we highlighted our expectation for sales cycles to continue to lengthen for both the first quarter and full year 2023.
However, the level of elongation experienced in the first quarter was unprecedented in parts of the past hour forecast entering the year pressuring revenue growth.
As a result for the second quarter. Despite the continued reacceleration of new pipeline generation and our high win rates against the competition, we've assumed sales cycle to remain at elevated levels experienced during the first quarter.
Therefore also assume close rates remain at continued low levels from.
From a linearity perspective, we've assumed a 10.
Your back end weighting of ACB booked and have therefore incorporate minimal in period revenue recognition for the second quarter.
Also we believe the currently depressed close rates and elongated sales cycles are temporary in nature, we cannot predict when the increasing caution as exhibited by the customers during the first quarter, we will recover.
Such that we are pursuing these headwinds, which indentified in the month of March will persist through the end of the fiscal year.
Now turning to guidance.
For the second quarter, we expect revenue in the range of 300 clients to $306 million.
Representing an increase of 30% year over year.
We expect operating income in the range of $14 million to $15 million and we expect diluted net income per share of 7% to eight.
Assuming approximately 345 million common shares outstanding.
Two our aforementioned tax planning strategy, we expect an effective tax rate of 6%.
For the full year 2023, we expect revenue in the range of $1, two 8 billion to $1 284 billion.
Representing an increase of 31% year over year at the midpoint.
Operating income for the full year in the range of $73 million to $77 million.
And we expect diluted net income per share over that period and the range of 34 to 35.
Assuming approximately 345 million common shares outstanding.
We expect an effective tax rate of 9% for 2023.
After having achieved positive free cash flow in the second half of last year and again during the first quarter of this year, we continue to anticipate being free cash flow positive for the full year 2023.
For modeling purposes, we expect free cash flow to trend upward on an ongoing basis, but anticipate near term variability in our free cash flow generation for the second quarter anticipated to be lower than the first quarter shifted the timing of capital expenditures and other payable.
In closing we are.
Remain confident and the enormous opportunity ahead of us as well as <unk> and durability of our operating model.
We are focused on becoming even more efficient more productive not sure during the currency challenging macroeconomic backdrop, but also because operational efficiencies as a long term competitive disadvantage.
I also like to thank our employees for their continued dedication to our mission customers and partners and with that we'd like to open it up for questions. Operator, Please poll for questions.
Thank you Mr Secor, ladies and gentlemen at this time any questions. Please press star one and if you find your question has already been addressed you can remove yourself from the queue by pressing the pound key.
This afternoon to Sterling auty of market maintenance.
Yeah. Thanks, Hi, guys I think the big question is around the guidance I think coming out of last quarter. The perception was that the guidance was actually aggressive and you kind of alluded to the close rates that you had factored in now with the changes that you've seen and especially in light of the sales changes youre looking.
To make what are the elements that investors can look to to see the confidence in being able to deliver on the revised outlook.
Yes, maybe I'll get started here remember when we gave guidance.
During the last quarter, we actually try to another.
The first and second quarters are more challenging.
In the later half of the year.
Looked at close rates and assume that.
What we see in the third and fourth quarter of last year.
Elongation would continue but.
The deteriorating environment surprises us.
We saw sales cycles.
Really.
Elongate, our beyond our own forecast and up to 27% on average and then the expansion business before.
Close to 50% so those firm material differences.
The assumptions we had at the beginning.
Of this year.
I think we took this into account in the guidance now carefully also assuming that the linearity deterioration we've seen in the first quarter.
Continue for the second quarter, specifically, we presumed Archie any revenue right.
A recognition from in quarter ACB generation. So this I think is prudent in light of what we have seen you heard from Matthew that.
Salespeople that are impacted by this pressure contributed very little in terms of overall ATV generation to the current.
So we think.
There is more upside.
In this transition and there is some price in terms of top performance and.
Positive impact on sales capacity moving forward.
The good thing to point out again that the.
The improvement in pipeline that we have now seen over consecutive quarters has continued in the first quarter. So as Matthew mentioned smarter.
The limitation of opportunity.
We've seen sales cycles extend but not pipeline slowing down towards that Joan.
Very encouraging sign but I think.
The results are prudently now reflected in the guidance and the deterioration we've seen in the.
The first quarter, especially from a clinical perspective material impact on how we think about there.
The rest of the year.
Understood and maybe one quick follow up from Matthew can you just characterize for us the traction in the AI opportunity in particular to give US. One example, but when you look at it as a whole how you're seeing it track and what should we think about the expansion opportunities from that customer base through the rest of the year.
Yes Sterling.
The AI is something that that I think surprised us last quarter in terms of the positive impact and that continues to.
To surprise us we've seen the revenue that's coming from AI companies just quarter over quarter.
<unk> has substantial growth north of 20% quarter over quarter growth from from from the largest AI companies.
That that use us and it's not just one or two but from large to small what we're hearing from AI companies is that as they look to who theyre going to use for their infrastructure and they can start with a clean slate. They cloud player is a part of that and that we're helping them go fast.
Pete.
Get the most efficiency be able to protect themselves from some of the significant cyber security and fraud risks that they face and that continues to be something that that is is delivering really positive results for us I think youre going to see.
During our developer week.
Next month in May.
Highlight some of these these customer stories and highlight ways that AI companies are using cloud flare in order to push that that innovation forward. So I think that that is has continued to be a real positive for us and that that has only accelerated from even Q4.
Great. Thank you.
Thank you and ladies and gentlemen, just a reminder, we do ask that you. Please limit yourself to one question and one follow up question.
Now to Thomas lately of Keybanc.
Hey, guys. It sounds like you with Keybanc. Thanks for taking the question here it sounds like.
Yes, there is a lot of pent up demand.
No gross churn and pipeline, making new records.
Maybe it's for Matthew you talk about these are these are critical needs in terms of access and security and not so much a nice to have but what are these customers explaining to you that way.
Waiting on maybe looking for some indicators in terms of like how long this pause.
We'll kind of take a thought Matthew that would be my first question.
Yes.
I think that.
Everyone continues to communicate to us that that they are.
They want to continue to invest with US I think what we're seeing from ITT organization.
Is that Theyre, all looking very critically at their budgets and asking themselves what projects can.
Can they delay versus what projects do they have to have to invest and so we continue to see when companies are under duress when they're under attack that those deals are closing extremely quickly.
But some of the times, where people are initiating a new large project.
Moving to zero Trust environment.
Or something else that would be that would be a larger initiative.
That the sales cycles on on those projects are extending.
Beyond where they were before I think one of the things Thats unique about cloud flare is even with the extended sales cycles.
Those cycles tend to on average be significantly faster than the peers in our industry and so back in.
Early 2022, we were among the first to call the slowdown in the economy, because we could see that sales cycle slowdown that they picked back up but then again are slowing down right. Now I think we tend to see that earlier than some of our peers.
And I think that.
One of the things that has always characterize how we think about our business is real prudence as we as we look forward. So no one is telling us that that projects are getting.
We are getting cancelled any significant in any significant way that people are saying budgets are tight we are being more cautious and that is taking our sales cycles to be longer.
Dan.
Then we have historically seen and longer even than the elevation that we saw through the back half of 2022. So we're trying to be very prudent about how we think about this but customers continue to tell us they are not switching to another competitor theyre not we haven't seen any elevation.
In loss rates to the competition quite the opposite that people are saying, we want to invest with you. We're just being cautious with our it spend and thats thats, causing everyone to measure twice before they cut once.
Alright, that's helpful that there maybe as a follow up perfect segue actually to the.
The Conservative Ness of this got it sounds like it's increasingly conservative I love to hear maybe from Thomas in terms of maybe any indications of what.
Are you seeing from from numbers coming in in April .
From the end of March.
Just kind of trying to gauge in terms of.
When we could even yes.
Back to the 130% long term dubner would be would be helpful that Thomas.
So are we.
The early indication on the second quarter do not indicate a material change in either to the negative turn more to the positive. So we are cruising along.
But no indication that it gets materially better.
No indications that it's deteriorating market.
Okay. Okay. Thank you.
Thank you the next now to Brent Thill at Jefferies.
Good afternoon, Matthew just on the sales side when you think about.
What's happening with the new head of revenue and ultimately kind of the what happens when you change out.
I guess, how confident are you that.
There isn't a longer transition.
On the existing team whats, giving you that view that.
This current team is kind of in place you've got the right fit and this is maybe more internal execution than external forces.
Well I think that I think it's a combination of both of those those things. If we're honest I think that the fact that the macro economy has gotten harder.
<unk> some of the weaknesses in some of the sellers on our team win when things were.
Cruising along in 2021.
You didn't you didn't have to be really disciplined seller in order to be successful at cloud player and.
And I think that that combined with.
Some of the.
What happened during Covid combined with our hesitancy in terms of.
What the opportunity costs were in terms of replacing people win that.
The tech employment market.
Was was overheating all combined to have a get to a place where we just had a number of people on our team who weren't performing and I think mark has.
Done an incredible job.
At really identifying specifically who those people are.
And starting the process of moving those those people off what I see though is that if you look at our top sellers.
They are enjoying incredible success and we're the lowest performing sellers.
Decelerate it substantially.
During the macroeconomic slowdown.
Top sellers on our team has seen around a 1% decrease in their productivity and so what that indicates to me is that with new leaders like mark for onboard and some of the lieutenants that he is bringing on.
And the incredible talent, which is applying to cloud where again a quarter million people apply to work for us in Q1, I don't know of any other SaaS company that is seeing that volume of talent.
That is out there people want to come work for us the people who are successful at cloud player.
Can be extremely productive and Kevin can do well themselves as sellers and I think mark is bringing a focus and a discipline, which is going to pay off.
Thing Thats I think very encouraging is as we look at the people that we can replace.
That that debt.
They are contributing such a small percentage in terms of our capacity that we actually think that this will any any type of change like this obviously has is something that we want to do various humanely and we want to be.
We are very thoughtful about taking care of the team that we have but we think that as we transition that team out.
We're going to not only increase the performance of our high performers, but bring on new performers that give us much higher performing capacity and Mark I think is doing an incredible job at not only identifying who asked to be moved out but boy when I talk to the people that we're hiring to replace those people.
Just get incredibly excited by what they are able to deliver to us.
And just a quick follow up for Tom It looks like if im looking at this right. The number of net new enterprise accounts was the lowest you've seen in two years at a 114 sequentially. So I guess it seems like you saw it across both enterprise and SMB is kind of a way to frame. It that you didn't there wasn't one sector that stays stronger.
I think that that Regis correct.
Great. Thank you.
Thank you the next now to Matt Hedberg of RBC capital markets.
Great. Thanks for taking my questions, maybe a follow up to that last question from Brent.
Comment on the pay as you go side of your business is that being impacted by the macro sort of more or less the same as the enterprise.
I think that what we're seeing is again weakness across across the entire space payments ago remember is a relatively small percentage of our overall business.
Then 15% of revenue so it doesn't move the needle one direction or another but we definitely are seeing that there is a lower rate of upgrade.
But at the same time, we are not.
Not seeing that there is a lower rate of downgrade what I am excited by is the developer traction.
That we're seeing across our business. The fact that we're closing in on 5 million applications running across across the platform.
The majority of those are coming from pay as you go developers and and that continues to be a pipeline, where we where we see lots of success. We also have examples like the one that cited in the prepared remarks, where we had a customer that was paying us $200 a month.
<unk> that we identify.
Worked with and were able to upgrade to a enterprise customer spending hundreds of thousands of dollars a year with us. So pay as you go continues to pay lots of dividends, but I think that the same.
<unk>, where people are are just watching their budgets are much more carefully.
Shows up.
Our cross across the entire space and that.
We don't see a significant difference.
At the at the low end of our business versus versus the high end of the business.
Got it thanks, and then Thomas.
With the reduced 'twenty three outlook.
31, 5% I think at the midpoint.
Below sort of the implied five year $5 billion target that you guys talked about a couple of quarters ago.
Just any thoughts on does this environment change your thought process on getting to that $5 billion in five years or maybe.
Just some updated thoughts on that.
Yes sure.
Matthew rightfully pointed out that the market is not living it's limiting the opportunity.
Limiting up there is.
Some headwinds now there will be temporary in nature, but they don't.
Don't take away from the enormous opportunity in front of us so it doesn't change our thinking around this.
This journey is going to take us.
Thank you very much.
Thank you the next now to Keith Weiss of Morgan Stanley .
Makes sense. Thank you guys for taking the question.
Hi.
A little dense here, but I'm not quite getting what happened in the quarter.
I think to like some of the explanation that you guys are giving.
Banking crisis was in the let.
Let me take the first two weeks of March.
Guys tend to have a pretty linear business. So I would've expected the comment would be we only closed like 15% of our business in the last two weeks if that was what the impact was and then like with the salespeople if they hadn't been productive for awhile Theres lessening really incremental there.
As had been.
Matthew you called out a weaker macro last year and you were one of the earlier ones to say hey, listen it is in a great environment out there, but you guys were able to operate really effectively all throughout 2022, and you bring to market a really good ROI focus and it really good cost value proposition like I don't quite get what change.
In Q1, and the timeframe in which it changed.
Yes, Keith I think that.
As we've put a floodlight on it the biggest thing that changes sales cycle length and.
More than 25%.
And so that pushed back.
A lot of what was happening.
In the quarter, we would typically see about half of our business closed in the last month of the quarter I think the fact that you had the uncertainty around around the bank and again it wasn't just customers of FCB of credit Suisse, but it was it was entire.
Faith spaces, where purchasing departments really said.
I mean, they've got they've got very nervous regardless of who they were they were banking with <unk> and we just saw more companies pushed pause on that that pushed a lot of our business into the last half of March and that pushed.
Pushed some of our business.
Outside of.
The closing within the quarter and so what we don't know is whether March is the new reality.
In which case again, I think we want to be very prudent as how we think about the business.
Going forward or if the world was snap back.
Fairly quickly the early reads that we're seeing are not that where again it doesn't feel like it's getting significantly worse, but we don't also see things getting significantly better.
That that.
As we sort of shown a floodlight on what was it that.
That changed what changed is a material change in the length of the sales cycles with.
The win rates didn't change, but the close rates debt.
Okay.
You had mentioned that you saw that in both small customers and large customers was there any product families that sustained better or worse than others was there any variance on that side.
Any question.
I think we continue to have extremely fast close rate.
When someone is under duress.
So when they when they when they when they see that there is a problem and they need to and they need to address it I think.
That doesn't change quarter over quarter for I think obvious reasons, we were able to respond very quickly in some of the offline we bring them back online in those deals close in after in a matter of hours.
That things.
Other things that showed a lot of promise in the quarter, where things like our two where we're increasingly seeing large customers bring over larger and larger datasets, but across the board.
We are seeing that anything that requires sort of a larger commitment customers were again.
Measuring twice before they cut one and and everyday.
<unk> increase in sales cycles, what I think is different about us in a lot of other companies is that we see things faster because even even with the 25% increase in sales cycles, we're still significantly faster sales cycles than most other SaaS companies and so I think we see things earlier.
And what we don't know again is that they are radical change too.
How procurement departments are thinking about it spending that is what we are trying to be prudent around when we think about guidance.
Or is it something that was just a short term effect of sort of the.
<unk>.
In March around around the.
The banking sector.
And I think that the net this quarter. This next quarter will prove out which direction that goes but we want to be extremely prudent and cautious as we think about things going forward.
Got it that's very helpful. I appreciate you walking through that.
Thank you we'll go next to James Fish with Piper Sandler.
Hey, guys.
On gross margins here are holding above your long term average as well.
And Matthew you actually just talked about the fact that the larger commitments taking longer is there a thought process here can you maybe just try to get that land a little bit smaller and maybe.
Offer higher discounts kind of near term to try to land smaller deals here.
I think we're.
I think that's always been part of our playbook and.
And I think that what we are what we are able to do because of the broad set of products that we have.
Is is fine lots of different ways into a customers.
Account and and so that that is I think a.
That's something that we're able to do and I think we can maintain.
Gross margins that are within our 75% to 77% target range I think it's a mistake for us to dramatically take that gross margin rate down.
Over time, but but I think that we can actually.
Bundle and discount and go after even small deals.
Because of the margin profiles that we have.
And then use.
The engineering that we have in order to deliver still the gross margins that we expect so we're not changing what our gross margin targets are we are.
We're not losing deals on price.
I am and and we are and where we've been able to continue to be.
Be extremely competitive and deliver an extremely high ROI, while also delivering.
Software gross margins.
Makes sense and Thomas I appreciate all the details around sales cycles lengthening.
But on the close rates.
To think about the magnitude difference youre seeing here and how much worse could could it get for you guys.
Is this kind of the bottom potentially close rates that you are assuming or another.
Another step lower from here thanks, guys.
Yeah.
We don't want to say we are prudent about.
When we talk about our or guidance I think we tried to be prudent for this quarter and.
We've tried to take into account what we have seen in the first quarter and we're thoughtful around how we build kind of improvement or non improvement in those variable savings. So we won't be there the non linearity we saw in the quarter was significant we have not.
Incorporate any any significant improvement.
As I said in this towards the second quarter, we have not assumed any significant revenue recognition from ACB.
During the second quarter.
Thoughtful about how we have looked at the outlook.
Yes.
Just wanted to reiterate what metrics. When you started this year, we were starting to talk from our perspective at that point. We sit there is there is the guidance for the first quarter, especially it is probably more challenging than for the remainder of the year.
I think how we framed it.
If you look at the first quarter.
We came into range of our guidance.
Slightly off the midpoint and primarily because of the non linearity.
The offset of the first quarter, what impacted the forward looking guidance that elongation of sales cycles.
John .
So you push a waiver from the ECB.
Further out.
And we looked at that way and we have not assumed that.
It's going to pull any significantly over the course of the year. So I thought we have been thoughtful about what we took the guidance together.
Yeah.
Thank you we'll go next to Joel Fishbein at Truest.
Thanks for taking my questions Matthew just one for you and really appreciate the color on the changes youre, making in go to market efficiency, but I wanted to ask about some of the partnerships that you've established with some of the global size like Accenture and shields up and see if <unk> seen any change in that in that go to market and maybe just give us an update.
On how those are factoring.
I think that we're still in the early days.
Of that but but encouraging.
We were able to win a federal deal, which continues to expand and partnership with with Accenture.
And that has given them confidence to take us to market.
And a number of other partnership and global global deal.
That market has been great in terms of bringing a real focus on partnerships and thinking about what are the parts of the market that we want to serve directly versus part of the parts of the market that we want to serve with with partners and I think as we have these early wins.
That begets our ability.
To win more with the <unk>.
Large global systems integrators.
And other large large partners.
They're seeing the same thing that we are when we talk when I talk to them. They are seeing very much a conservatism around.
It spend.
That I think is less pronounced.
In the security space and so I think that there is more willingness and eagerness to work with us, but when we talk to.
The systems integrators.
And in.
And other large partners, especially at the high end of the market.
I think that.
They are reflecting the same the same sort of conservatism of measure measure multiple times before you cut that theyre seeing from from their customers and I think that it continues to be a large opportunity and something that especially in zero Trust and workers were saying that we can we can deliver more with.
Them.
But.
I think that that is a place where we've actually seen.
Got it.
Shops look at ways of making sure that they are being as optimal as as possible.
Thanks, just as a quick follow up.
The.
Deal sizes, they are generally bigger than your normal size since you're landing.
I'd like to be larger organizations with these partners.
Yes, they tend to be tend to be.
Larger than the average deal, but we land $10 million plus deals on our own.
As well I think over time Youll see us again work more closely with those size.
Other partners to deliver.
Some of the larger deals and make sure that we can make inroads into into into more accounts and use them as a way to help integrate larger solutions together so.
I think it's something that is a priority for us I think we have the early wins.
But now we need to continue to scale those programs.
Gotcha. Thank you so much.
Thank you and we'll take our final question today from Mark Murphy of Jpmorgan.
Thank you very much Thomas where bookings more heavily impacted on the CDN side.
Side of the business or the security side or perhaps elsewhere.
Alright.
We never talk about TD at match.
I would say I come back to work.
Customers are.
Difficult situations.
Under duress onboard pumps those products tend to be security product.
The statement of product wise as to security products, we are doing better than the application services.
Okay understood and then Matthew when you.
When you look back on it and I think Brent asked about this a bit earlier, but the Tianjin head of sales position last November .
The goal is to introduce more rigor and discipline I think you acknowledged at the time that those changes can take time.
I'm curious to what extent you might have actually seen disruptions.
From sales org changes, whether it be account mapping or territory assignments or commission structures or anything along those lines, which.
You could look at it and say well this might actually stabilize a little later in the year.
Yes.
Yeah.
I understand that.
That that that that that would be handy, if we could point to that.
I don't think that Thats, what what we're seeing right now I think that the.
That that we've actually seen our top sellers be more productive I think that that.
<unk>.
The changes that Mark is putting in place really are starting with these changes now.
And in that that obviously does introduce uncertainty we think we have our handle around that I think we've planned that extremely well and again I think that.
As we look out at the caliber and quality of the people, who we can bring on board and how we can invest in our top performers day.
Just getting on.
Our sales performance to look much more like a normal distribution than what today is much more of a bimodal distribution.
Is it is it is an extremely.
<unk> way for us to Reaccelerate the growth that we have and so.
The changes that Mark is making are the right changes.
Our team.
Highest performing individual contributors and managers on our team are leaning forward and E. Mailing me everyday about how great. It is to have an additional amount of rigor and discipline.
There are there may be bumps along the road these transitions do take time.
We are on the right path Mark is the right person across our team the feedback that we're getting is extremely positive and again, we're not limited by the market for our products. We're not limited by innovation, we're not limited by pipeline, we're not even limited really by sale.
<unk> capacity, even as we transition people off of our team and so that gives me a lot of confidence going forward.
That while we will continue to see pressure from the macroeconomic conditions.
Over over the next year.
I am.
I really am excited.
Sure.
We have our sales engine match, our innovation engine.
What we're going to be able to deliver as a company.
Thank you very much.
Thank you and ladies and gentlemen that is all the time, we have for your questions. This afternoon I would like to turn the conference back over to Mr. Prince for any closing comments.
Thank you so much really appreciate everybody tuning in for the call. This has definitely been a quarter of contrast, but it is an incredible opportunity for us to continue to make cloud flare a better company I. Appreciate all of the hard work from all of our team we are excited.
For the quarter ahead, I hope to see many of you at our Investor day on May four and make sure to tune in the following week. The developer week. There are a number of incredible announcements coming thank you so much.
Thank you Mr. Prince ladies and gentlemen that will conclude the costly or Q1 2023 earnings call again, we'd like to thank you all so much for joining us and wish you all a great evening Goodbye.
[music].
Yes.
Yes.
[music].
Okay.
Okay.
Okay.
Yes.
Thank you.
Right.
Thank you.
Yes.
Yes.
So Alaska.
Thank you.
<unk>.
Okay.
Yes.
Yes.
Thank you.
Sure.
Sure.
Yes.
[music].
Alright.
Yes.