UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________________________________________________

FORM 10-Q

__________________________________________________

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to              

Commission file number: 001-39039

__________________________________________________

Cloudflare, Inc.

(Exact name of registrant as specified in its charter)

__________________________________________________

Delaware	27-0805829
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

101 Townsend Street

San Francisco, California 94107

(Address of principal executive offices and zip code)

(888) 993-5273

(Registrant’s telephone number, including area code)

__________________________________________________

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Trading Symbol	Name of Each Exchange on Which Registered
Class A Common Stock, $0.001 par value	NET	The New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☐
		Emerging growth company	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

As of May 5, 2020, 165,000,127 shares of the registrant's Class A common stock were outstanding and 138,657,711 shares of the registrant's Class B common stock were outstanding.

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TABLE OF CONTENTS

	PART I. FINANCIAL INFORMATION	Page
Item 1	Financial Statements (unaudited)	6
	Condensed Consolidated Balance Sheets as of March 31, 2020 and December 31, 2019	6
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2020 and 2019	7
	Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2020 and 2019	8
	Condensed Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Deficit) for the Three Months ended March 31, 2020 and 2019	9
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019	11
	Notes to Condensed Consolidated Financial Statements	12
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3	Quantitative and Qualitative Disclosures about Market Risk	50
Item 4	Controls and Procedures	51
	PART II. OTHER INFORMATION
Item 1	Legal Proceedings	52
Item 1A	Risk Factors	52
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	91
Item 6	Exhibits	93
	Signatures	95

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of these words, or other similar terms or expressions that concern our expectations, strategy, plans, or intentions.

Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

•the impact of the ongoing COVID-19 pandemic, including on our and our customers’, vendors’, and partners’ respective businesses and the markets in which we and our customers, vendors, and partners operate;

•our ability to retain and upgrade paying customers;

•our ability to attract new customers or convert free customers to paying customers;

•our future financial performance, including trends in revenue, costs of revenue, gross profit or gross margin, operating expenses, paying customers, and free cash flow;

•our ability to achieve or maintain profitability;

•the consequences we may face resulting from the activities of our customers and the actions we take in response, including associated theories of liability;

•the demand for our products or for solutions for security, performance, and reliability in general;

•possible harm caused by significant disruption of service, loss or unauthorized access to customers’ content, or the actual or perceived failure of our products to prevent security incidents;

•our ability to compete successfully in competitive markets;

•our ability to respond to rapid technological changes;

•our ability to continue to innovate and develop new products;

•our expectations and management of future growth;

•our ability to maintain existing co-location relationships, ISP partnerships, and other interconnection arrangements around the world;

•our ability to offer high-quality customer support;

•our ability to manage our global operations;

•our expectations of and ability to comply with applicable laws around the world;

•our ability to correctly estimate our tax obligations around the world;

•our ability to attract and retain key personnel and other highly qualified personnel;

•our ability to maintain our brand;

•our ability to prevent serious errors or defects across, and to otherwise maintain the uninterrupted operation of, our network;

•our ability to maintain, protect, and enhance our intellectual property; and

•our ability to successfully identify, acquire, and integrate companies and assets.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, results of operations, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Readers are urged to carefully review and consider the various disclosures made in this

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Quarterly Report on Form 10-Q and in other documents we file from time to time with the Securities and Exchange Commission (the SEC) that disclose risks and uncertainties that may affect our business. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Quarterly Report on Form 10-Q, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements.

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PART I—FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

CLOUDFLARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

(unaudited)

	March 31, 2020		December 31, 2019
Assets
Current assets:
Cash and cash equivalents	$	109,063	$	138,976
Available-for-sale securities	478,791		497,972
Accounts receivable, net	39,778		33,867
Contract assets	1,779		2,063
Prepaid expenses and other current assets	18,193		16,994
Total current assets	647,604		689,872
Property and equipment, net	100,174		101,466
Goodwill	16,399		4,083
Acquired intangible assets, net	4,900		31
Operating lease right-of-use assets	48,234		—
Deferred contract acquisition costs, noncurrent	28,171		25,184
Restricted cash	8,847		6,660
Other noncurrent assets	4,202		3,528
Total assets	$	858,531	$	830,824
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	14,301	$	11,463
Accrued expenses and other current liabilities	27,872		28,314
Operating lease liabilities	17,009		—
Liability for early exercise of unvested stock options	12,006		13,263
Deferred revenue	37,096		30,843
Total current liabilities	108,284		83,883
Build-to-suit lease financing obligation	—		10,506
Operating lease liabilities, noncurrent	33,795		—
Deferred revenue, noncurrent	996		804
Other noncurrent liabilities	9,104		9,803
Total liabilities	152,179		104,996
Commitments and contingencies (Note 7)
Stockholders’ Equity:
Class A common stock; $0.001 par value; 2,250,000 shares authorized as of March 31, 2020 and December 31, 2019; 154,622 and 87,072 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively	154		87
Class B common stock; $0.001 par value; 315,000 shares authorized as of March 31, 2020 and December 31, 2019; 148,735 and 213,101 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively	143		207
Additional paid-in capital	1,038,544		1,027,179
Accumulated deficit	(333,896)		(301,706)
Accumulated other comprehensive income	1,407		61
Total stockholders’ equity	706,352		725,828
Total liabilities and stockholders’ equity	$	858,531	$	830,824


The accompanying notes are an integral part of these condensed consolidated financial statements.

6

CLOUDFLARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended March 31,
	2020		2019
Revenue	$	91,250	$	61,727
Cost of revenue	20,821		14,360
Gross profit	70,429		47,367
Operating expenses:
Sales and marketing	46,965		30,817
Research and development	33,354		17,649
General and administrative	26,181		16,048
Total operating expenses	106,500		64,514
Loss from operations	(36,071)		(17,147)
Non-operating income:
Interest income	2,569		913
Interest expense	(67)		(273)
Other income (expense), net	485		(293)
Total non-operating income, net	2,987		347
Loss before income taxes	(33,084)		(16,800)
Provision for (benefit from) income taxes	(338)		314
Net loss	$	(32,746)	$	(17,114)
Net loss per share attributable to common stockholders, basic and diluted	$	(0.11)	$	(0.20)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted	296,077		85,078

The accompanying notes are an integral part of these condensed consolidated financial statements.

7

CLOUDFLARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2020		2019
Net loss	$	(32,746)	$	(17,114)
Other comprehensive income:
Change in unrealized gain on investments, net of tax	1,346		72
Other comprehensive income	1,346		72
Comprehensive loss	$	(31,400)	$	(17,042)

The accompanying notes are an integral part of these condensed consolidated financial statements.

8

CLOUDFLARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)

(in thousands)

(unaudited)

	Three Months Ended March 31, 2020
	Redeemable convertible preferred stock			Class A common stock			Class B common stock			Additional paid-in capital		Accumulated deficit		Accumulated other comprehensive income		Total stockholders’ equity
	Shares	Amount		Shares	Amount		Shares	Amount
Balance as of December 31, 2019	—	$	—	87,072	$	87	213,101	$	207	$	1,027,179	$	(301,706)	$	61	$	725,828
Cumulative effect adjustment from adoption of ASC 842	—	—		—	—		—	—		—		556		—		556
Issuance of common stock in connection with acquisition	—	—		107	—		—	—		1,104		—		—		1,104
Issuance of unvested restricted stock in connection with acquisition	—	—		841	—		—	—		—		—		—		—
Issuance of common stock upon exercise of stock options	—	—		—	—		1,503	1		2,674		—		—		2,675
Repurchases of unvested common stock	—	—		(29)	—		—	—		—		—		—		—
Issuance of common stock related to early exercised stock options	—	—		—	—		15	—		—		—		—		—
Vesting of shares issued upon early exercise of stock options	—	—		—	—		—	1		1,222		—		—		1,223
Issuance of common stock related to settlement of RSUs	—	—		32	—		1,123	1		(1)		—		—		—
Tax withholding on RSU settlement	—	—		(11)	—		(397)	—		(7,115)		—		—		(7,115)
Conversion of Class B to Class A common stock	—	—		66,610	67		(66,610)	(67)		—		—		—		—
Stock-based compensation	—	—		—	—		—	—		13,481		—		—		13,481
Net loss	—	—		—	—		—	—		—		(32,746)		—		(32,746)
Other comprehensive income	—	—		—	—		—	—		—		—		1,346		1,346
Balance as of March 31, 2020	—	$	—	154,622	$	154	148,735	$	143	$	1,038,544	$	(333,896)	$	1,407	$	706,352

The accompanying notes are an integral part of these condensed consolidated financial statements.

9

CLOUDFLARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)

(in thousands)

(unaudited)

	Three Months Ended March 31, 2019
	Redeemable convertible preferred stock			Common stock			Additional paid-in capital		Accumulated deficit		Accumulated other comprehensive income (loss)		Total stockholders’ equity (deficit)
	Shares	Amount		Shares	Amount
Balance as of December 31, 2018	165,658	$	331,521	91,542	$	85	$	82,345	$	(195,878)	$	(57)	$	(113,505)
Issuance of common stock in connection with acquisition	—	—		7	—		18		—		—		18
Issuance of common stock upon exercise of stock options	—	—		346	—		681		—		—		681
Repurchases of unvested common stock	—	—		(9)	—		—		—		—		—
Issuance of common stock related to early exercised stock options	—	—		407	—		—		—		—		—
Vesting of early exercised stock options	—	—		—	—		496		—		—		496
Stock-based compensation	—	—		—	—		1,128		—		—		1,128
Net loss	—	—		—	—		—		(17,114)		—		(17,114)
Other comprehensive income (loss)	—	—		—	—		—		—		72		72
Balance as of March 31, 2019	165,658	$	331,521	92,293	$	85	$	84,668	$	(212,992)	$	15	$	(128,224)

The accompanying notes are an integral part of these condensed consolidated financial statements.

10

CLOUDFLARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended March 31,
	2020		2019
Cash Flows From Operating Activities
Net loss	$	(32,746)	$	(17,114)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization expense	10,563		6,170
Non-cash operating lease costs	4,543		—
Amortization of deferred contract acquisition costs	3,499		2,319
Stock-based compensation expense	12,897		1,057
Net accretion of discounts and amortization of premiums on available-for-sale securities	(456)		(518)
Deferred income taxes	(117)		—
Provision for bad debt	2,209		259
Change in fair value of redeemable convertible preferred stock warrant liability	—		118
Other	(197)		4
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable, net	(8,120)		(5,616)
Contract assets	284		180
Deferred contract acquisition costs	(6,486)		(4,225)
Prepaid expenses and other current assets	(1,086)		(121)
Other noncurrent assets	(658)		(148)
Accounts payable	1,507		(2,553)
Accrued expenses and other current liabilities	40		1,022
Operating lease liabilities	(4,804)		—
Deferred revenue	6,445		7,400
Other noncurrent liabilities	(1,593)		2,076
Net cash used in operating activities	(14,276)		(9,690)
Cash Flows From Investing Activities
Purchases of property and equipment	(11,405)		(9,036)
Capitalized internal-use software	(4,922)		(3,397)
Cash paid for acquisitions, net of cash acquired	(13,639)		—
Purchases of available-for-sale securities	(110,609)		(14,856)
Sales of available-for-sale securities	—		1,978
Maturities of available-for-sale securities	131,580		40,498
Other investing activities	223		22
Net cash provided by (used in) investing activities	(8,772)		15,209
Cash Flows From Financing Activities
Proceeds from the exercise of stock options	2,675		681
Proceeds from the early exercise of stock options	32		1,638
Repurchases of unvested common stock	(70)		(4)
Payments on note payable	(200)		(90)
Proceeds from build-to-suit lease financing obligation drawdown	—		23
Payment of tax withholding obligation on RSU settlement	(7,115)		—
Net cash provided by (used in) financing activities	(4,678)		2,248
Net increase (decrease) in cash, cash equivalents, and restricted cash	(27,726)		7,767
Cash, cash equivalents, and restricted cash, beginning of period	145,636		31,426
Cash, cash equivalents, and restricted cash, end of period	$	117,910	$	39,193
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest	$	34	$	214
Cash paid for income taxes	$	163	$	299
Cash paid for operating lease liabilities	$	4,477	$	—
Supplemental Disclosure of Non-cash Investing and Financing Activities:
Stock-based compensation capitalized for software development	$	578	$	71
Accounts payable and accrued expenses related to property and equipment additions	$	4,522	$	3,493
Vesting of early exercised stock options	$	1,223	$	496
Deferred offering costs, accrued but not paid	$	—	$	475
Indemnity holdback consideration associated with business combinations	$	2,188	$	—
Issuance of common stock related to an acquisition	$	1,104	$	—
Operating lease right-of-use assets obtained in exchange for operating lease liabilities	$	2,386	$	—
Derecognition of build-to-suit lease	$	9,886	$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

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CLOUDFLARE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1. Organization and Basis of Presentation

Organization and Description of Business

Cloudflare, Inc. (the Company, Cloudflare, we, us, or our) has built a global cloud platform that delivers a broad range of network services to businesses of all sizes and geographies, making them more secure, enhancing the performance of their business-critical applications, and eliminating the cost and complexity of managing individual network hardware. Cloudflare provides businesses with a scalable, easy-to-use, unified control plane to deliver security, performance, and reliability across their on-premise, hybrid, cloud, and software-as-a-service (SaaS) applications. The Company was incorporated in Delaware in July 2009. The Company is headquartered in San Francisco, California.

Basis of Presentation and Principles of Consolidation

The accompanying interim condensed consolidated financial statements and accompanying notes have been prepared in conformity with accounting principles generally accepted in the United States (U.S. GAAP) and applicable regulations of the Securities and Exchange Commission (the SEC) regarding interim financial reporting, and include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The Company’s fiscal year ends on December 31.

Certain information and note disclosures normally included in the financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the applicable required disclosures and regulations of the SEC. Therefore, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Initial Public Offering

In September 2019, the Company completed an Initial Public Offering (IPO) in which it issued and sold 40,250,000 shares of Class A common stock, which included 5,250,000 shares sold pursuant to the exercise by the underwriters of an option to purchase additional shares, at the public offering price of $15.00 per share. The Company received net proceeds of $565.0 million from sales of its shares in the IPO, after deducting underwriting discounts and commissions and offering costs. Upon completion of the IPO, 31,381,152 shares of redeemable convertible preferred stock were automatically converted into an equal number of shares of Class A common stock, 134,276,690 shares of redeemable convertible preferred stock were automatically converted into an equal number of shares of Class B common stock, outstanding warrants to purchase shares of redeemable convertible preferred stock were automatically converted into outstanding warrants to purchase shares of Class B common stock, and 15,198,587 shares of Class B common stock held by former employees were automatically converted into an equal number of shares of Class A common stock.

Unaudited Interim Condensed Consolidated Financial Information

The accompanying interim condensed consolidated balance sheet as of March 31, 2020, the condensed consolidated statements of operations and of comprehensive loss for the three months ended March 31, 2020 and 2019, the condensed consolidated statements of cash flows for the three months ended March 31, 2020 and 2019, the condensed consolidated statements of redeemable convertible preferred stock and stockholders’ equity (deficit) for the three months ended March 31, 2020 and 2019, and the related footnote disclosures are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. GAAP. In management’s opinion, the unaudited interim condensed consolidated financial statements include all adjustments necessary to state fairly the Company’s financial position as of March 31, 2020, its results of operations for the three months ended March 31, 2020 and 2019, and its cash flows for the three months ended March 31, 2020 and 2019. The results for the three months ended March 31, 2020 are not necessarily indicative of the results expected for the full year ending December 31, 2020 or any future period. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the

12

related notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the condensed consolidated financial statements and accompanying notes to the condensed consolidated financial statements. Such estimates include, but are not limited to, allowance for doubtful accounts, deferred contract acquisitions costs, the period of benefit generated from the Company’s deferred contract acquisition costs, the capitalization and estimated useful life of internal-use software, the assessment of recoverability of intangible assets and their estimated useful lives, useful lives of property and equipment, the valuation and recognition of stock-based compensation expense, uncertain tax positions, and the recognition and measurement of current and deferred income tax assets and liabilities. Management bases these estimates and assumptions on historical experience and on various other assumptions that management believes to be reasonable. Due to the COVID-19 pandemic, there is ongoing uncertainty and significant disruption in the global economy and financial markets. The Company is not aware of any specific event or circumstance that would require an update to its estimates or assumptions or a revision of the carrying value of its assets or liabilities as of May 8, 2020, the date of issuance of this Quarterly Report on Form 10-Q. These estimates and assumptions may change in the future, however, as new events occur and additional information is obtained. Actual results could differ materially from these estimates.

Note 2. Summary of Significant Accounting Policies

Significant Accounting Policies

The Company's significant accounting policies are discussed in the "Notes to Consolidated Financial Statements, Note 2. Summary of Significant Accounting Policies" in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019. There have been no significant changes to these policies that have had a material impact on the Company's condensed consolidated financial statements and related notes, except as noted below.

Operating Leases

The Company enters into operating lease arrangements for real estate assets related to office space and for co-location assets related to space and equipment located in co-location facilities. The Company determines if an arrangement contains a lease at its inception by assessing whether there is an identified asset and whether the arrangement conveys the right to control the use of the identified asset in exchange for consideration. Operating leases are included in operating lease right-of-use assets, operating lease liabilities, and operating lease liabilities, noncurrent in the Company's condensed consolidated balance sheets. Right-of-use assets represent the Company's right to use an underlying asset for the lease term and lease liabilities represent the Company's obligation to make payments arising from the lease. The Company's operating lease arrangements contain both lease and non-lease components. Operating lease right-of-use assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Lease payments consist of the fixed payments under the arrangement, less any lease incentives such as tenant improvement allowances. Variable lease costs, such as lease payments that depend on an index or a rate, are expensed as incurred and not included within the calculation of right-of-use assets and lease liabilities. At inception of an arrangement, the Company allocates the consideration to the lease and non-lease components and recognizes a right-of-use asset and corresponding lease liability for each lease component. As the implicit rate of the Company's leases is not determinable, the Company uses an incremental borrowing rate (IBR) based on the information available at the lease commencement date in determining the present value of lease payments. The lease expense is recognized on a straight-line basis over the lease term.

The Company generally uses the base, non-cancelable lease term when recognizing the right-of-use assets and lease liabilities, unless it is reasonably certain that a renewal or termination option will be exercised. Leases with a term of twelve months or less are not recognized on the consolidated balance sheets. The Company recognizes lease expense for these leases on a straight-line basis over the term of the lease.

Business Combinations

The Company includes the results of operations of the businesses that the Company acquires from the date of acquisition. The fair value of the assets acquired and liabilities assumed is based on their estimated fair values as of

13

the respective date of acquisition. The excess purchase price over the fair value of the net assets acquired and liabilities assumed is recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed requires significant judgment and estimates including the selection of valuation methodologies, future expected cash flows, discount rates, and useful lives. The Company’s estimates of fair value are based on assumptions believed to be reasonable, but which are inherently uncertain and, as a result, actual results may differ from estimates. During the measurement period, not to exceed one year from the date of acquisition, the Company may record adjustments to the assets acquired and liabilities assumed with a corresponding offset to goodwill. At the conclusion of the measurement period, or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are reflected in the condensed consolidated statements of operations.

When the Company issues payments or grants of equity to selling stockholders in connection with an acquisition, the Company evaluates whether the payments or awards are compensatory. This evaluation includes whether cash payments or stock award vesting is contingent on the continued employment of the selling stockholder beyond the acquisition date. If continued employment is required for the cash to be paid or stock awards to vest, the award is treated as compensation for post-acquisition services and is recognized as compensation expense.

Transaction costs associated with business combinations are expensed as incurred and are included in general and administrative expense in the Company’s condensed consolidated statements of operations.

Recent Accounting Pronouncements

Recently Adopted Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and since that date, has issued several ASUs to further clarify certain aspects of ASU 2016-02 and provide entities with practical expedients that may be elected upon adoption. The Company adopted the new standard beginning January 1, 2020 using the modified retrospective approach, electing the optional transition approach of not adjusting the comparative period financial statements for the impact of adoption. The Company elected the package of practical expedients permitted under the transition guidance, which allows the Company to carryforward its historical lease classification, its assessment on whether a contract is or contains a lease, and its initial direct costs for any leases that existed prior to adoption of the new standard. In addition, the Company elected not to recognize lease liabilities and related right-of-use assets for leases that, at the lease commencement date, have a lease term of 12 months or less. Adoption of the new standard on January 1, 2020 resulted in the recognition of $50.0 million of operating lease right-of-use assets and $52.8 million of total operating lease liabilities on the Company's condensed consolidated balance sheets. As part of the adoption, the Company also derecognized deferred rent of $2.8 million, primarily consisting of the noncurrent portion, net build-to-suit assets of $9.9 million, the build-to-suit lease financing obligation of $10.5 million, and recorded a cumulative-effect adjustment of $0.6 million to accumulated deficit as of January 1, 2020. Refer to Note 6 to these condensed consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments. This ASU changes the methodology for measuring credit losses and requires the establishment of an allowance for estimated credit losses on financial assets, including trade and other receivables, at each reporting date. The Company adopted ASU 2016-13 effective January 1, 2020, noting no material impact on the Company’s condensed consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (ASC 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement. This guidance provides that implementation costs be evaluated for capitalization using the same criteria as that used for internal-use software development costs, with amortization expense being recorded in the same income statement expense line as the hosted service costs and over the expected term of the hosting arrangement. For public business entities, it is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. For all other entities, it is effective for fiscal years beginning after December 15, 2020, and interim periods beginning after December 15, 2021. Early adoption of the amendments in this update is permitted, including adoption in any interim period, for all entities. The Company early adopted ASU 2018-15 effective January 1, 2020, noting no material impact on the Company’s condensed consolidated financial statements.

In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This ASU revises, and staggers, the effective dates for various major updates that have been issued since 2014 to alleviate the burden on both larger public companies as well as

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private companies, smaller public companies, not-for-profit organizations, and employee benefit plans. The Company adopted ASU 2019-10 effective January 1, 2020, noting no material impact on the Company’s condensed consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes (ASC Topic 740). This ASU simplifies accounting for income taxes by removing certain exceptions to the general principles and amending existing guidance to improve consistent application. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. The Company adopted ASU 2019-12 effective January 1, 2020, noting no material impact on the Company’s condensed consolidated financial statements.

Recently Issued Accounting Pronouncements

There have been no recent accounting pronouncements since the filing of the Company's Annual Report on Form 10-K for the year ended December 31, 2019, that may have a material impact on the Company's condensed consolidated financial statements.

Note 3. Revenue

        Revenue Recognition

In accordance with ASC 606, revenue is recognized when a customer obtains control of promised services. The amount of revenue recognized reflects the consideration that the Company expects to be entitled to receive in exchange for these services. To achieve this standard, the Company applies the following five steps:

1. Identify the contract with a customer

The Company considers the terms and conditions of the contracts and its customary business practices in identifying its contracts under ASC 606. The Company determines it has a contract with a customer when the contract is approved, the Company can identify each party’s rights regarding the services to be transferred, the Company can identify the payment terms, the Company has determined that collectibility is probable, and the contract has commercial substance. The Company applies judgment in determining that collectibility is probable, which is based on a variety of factors, including the customer’s historical payment experience or, in the case of a new customer, credit and financial information relevant to the customer.

2. Identify the performance obligations in the contract

Performance obligations promised in a contract are identified based on the services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available to the Company, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. The Company’s performance obligation primarily consists of subscription and support services, as they are provided over the same service period.

3. Determine the transaction price

The transaction price is determined based on the consideration to which the Company expects to be entitled in exchange for transferring services to the customer. Usage-based variable consideration is recognized in the period it is incurred. None of the Company’s contracts contain a significant financing component.

4. Allocate the transaction price to performance obligations in the contract

The subscription and support services in the Company’s contracts are considered a single performance obligation, and thus the entire transaction price is allocated to the single performance obligation.

5. Recognize revenue when or as the Company satisfies a performance obligation

Revenue is recognized at the time the related performance obligation is satisfied by transferring the service to a customer. Revenue is recognized when control of the services is transferred to the Company’s customers, in an

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amount that reflects the consideration that the Company expects to be entitled to receive in exchange for those services.

The Company generates sales directly through its sales team and through its channel partners. Revenue from sales to channel partners are recorded once all revenue recognition criteria above are met. Channel partners generally receive an order from an end-customer prior to placing an order with the Company. Payment from channel partners is not contingent on the partner’s collection from end-customers. The Company has determined that it is acting as an agent in these arrangements and records this revenue on a net basis.

Subscription and Support Revenue

The Company generates revenue primarily from sales to its customers of subscriptions to access its platform, together with related support services. Arrangements with customers generally do not provide the customer with the right to take possession of the Company’s software operating its global cloud platform at any time. Instead, customers are granted continuous access to the Company’s global cloud platform over the contractual period. Access to the Company’s platform and products is considered a monthly series comprising one performance obligation. A time-elapsed output method is used to measure progress because the Company transfers control evenly over the contractual period. Accordingly, the fixed consideration related to subscription and support revenue is generally recognized on a straight-line basis over the contract term beginning on the date that the Company’s service is made available to the customer. Usage-based consideration is primarily related to fees charged for the Company’s customer’s use of excess bandwidth when accessing the Company’s platform in a given period and is recognized as revenue in the period in which the usage occurs.

The typical subscription and support term for the Company’s contracted customers, which consist of customers that enter into contracts for the Company's Enterprise subscription plan (and which the Company previously referred to as enterprise customers), is one year and subscription and support term lengths range from one to three years. Most of the Company’s contracts with contracted customers are non-cancelable over the contractual term. Customers typically have the right to terminate their contracts for cause if the Company fails to perform in accordance with the contractual terms. For the Company’s pay-as-you-go customers, which consist of customers that sign up for the Company's Pro or Business subscription plans through the Company's website (and which the Company previously referred to as self-serve customers), subscription and support terms are typically monthly.

Variable Consideration

If the Company’s services do not meet certain service level commitments, its customers are entitled to receive service credits, and in certain cases, refunds, each representing a form of variable consideration. Revenue from sales is recorded at the net sales price, which is the transaction price, and includes estimates of these forms of variable consideration to the extent that a significant reversal of cumulative revenue will not occur in a future period. The Company has historically not experienced any incidents that had a material impact on its consolidated financial statements. Accordingly, any estimated refunds related to these agreements in the condensed consolidated financial statements are not material during the periods presented. Usage-based consideration is primarily related to fees charged for the Company’s customer’s use of excess bandwidth when accessing the Company’s platform in a given period and is recognized as revenue in the period in which the usage occurs.

Disaggregation of Revenue

Subscription and support revenue is recognized over time and accounted for substantially all of the Company’s revenue for the three months ended March 31, 2020 and 2019.

The following table summarizes the revenue by region based on the billing address of customers who have contracted to use the Company’s global cloud platform:

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	Three Months Ended March 31,
	2020				2019
	(in thousands)
	Amount		Percentage of Revenue		Amount		Percentage of Revenue
United States	$	44,215	48	%	$	30,739	50	%
Europe, Middle East, and Africa	23,106		26	%	14,626		24	%
Asia Pacific	17,604		19	%	12,179		20	%
Other	6,325		7	%	4,183		6	%
Total	$	91,250	100	%	$	61,727	100	%

The following table summarizes the revenue from contracts by type of customer:

	Three Months Ended March 31,
	2020				2019
	(in thousands)
	Amount		Percentage of Revenue		Amount		Percentage of Revenue
Channel partners	$	9,159	10	%	$	6,196	10	%
Direct customers	82,091		90	%	55,531		90	%
Total	$	91,250	100	%	$	61,727	100	%

Contract Balances

Contract liabilities consist of deferred revenue and include payments received in advance of performance under the contract. Such amounts are recognized as revenue over the contractual period. For the three months ended March 31, 2020 and 2019, the Company recognized revenue of $20.2 million and $11.5 million, respectively, that was included in the corresponding contract liability balance at the beginning of the periods presented.

The Company receives payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. Standard payment terms are due upon receipt. Contract assets include amounts related to the Company’s contractual right to consideration for both completed and partially completed performance obligations that have not been invoiced.

Costs to Obtain and Fulfill a Contract

The Company capitalizes sales commission and associated payroll taxes paid to internal sales personnel that are incremental to the acquisition of channel partner and direct customer contracts. These costs are recorded as deferred contract acquisition costs on the condensed consolidated balance sheets. The Company determines whether costs should be deferred based on its sales compensation plans, if the commissions are in fact incremental and would not have occurred absent the customer contract.

Sales commissions for renewal of a contract are not considered commensurate with the commissions paid for the acquisition of the initial contract. Commissions paid upon the initial acquisition of a contract are amortized over an estimated period of benefit of three years while commissions paid for renewal contracts are amortized over the contractual term of the renewals. Amortization of deferred contract acquisition costs is recognized on a straight-line basis commensurate with the pattern of revenue recognition and included in sales and marketing expense in the condensed consolidated statements of operations. The Company determines the period of benefit for commissions paid for the acquisition of the initial contract by taking into consideration the expected subscription term and expected renewals of its customer contracts, the duration of its relationships with its customers, customer retention data, its technology development lifecycle, and other factors. The Company periodically reviews the carrying amount of deferred contract acquisition costs to determine whether events or changes in circumstances have occurred that could impact the period of benefit of these deferred costs. The Company did not recognize any impairment losses of deferred contract acquisition costs during the periods presented.

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The following table summarizes the activity of the deferred contract acquisition costs:

	Three Months Ended March 31,
	2020		2019
	(in thousands)
Beginning balance	$	25,184	$	15,940
Capitalization of contract acquisition costs	6,486		4,225
Amortization of deferred contract acquisition costs	(3,499)		(2,319)
Ending balance	$	28,171	$	17,846

Remaining Performance Obligations

As of March 31, 2020, the aggregate amount of the transaction price allocated to remaining performance obligations was $233.0 million. As of March 31, 2020, the Company expected to recognize 82% of its remaining performance obligations as revenue over the next 12 months and