Stock price plummets after earnings! Cloudflare (NET.US) AI efficiency fails to meet market's high growth expectations: layoffs of 20%, Q2 revenue guidance slightly below expectations.

Cloudflare, a cloud network security and internet connectivity service company, announced its first quarter financial report for the 2026 fiscal year. On one hand, revenue, profit, and full-year guidance all exceeded Wall Street's expectations; on the other hand, the second quarter revenue guidance fell "just short" of expectations and the company announced layoffs of over 1,100 employees, leading to a 19% drop in the stock price after hours. The company's stock price had previously risen by 30% year-to-date and doubled over the past 52 weeks. Simultaneously with the financial report, co-founder and CEO Matthew Prince proclaimed that AI is driving a fundamental platform reconstruction of the internet and labeled it as "Cloudflare's biggest tailwind in history." However, Wall Street apparently did not buy into this narrative. Q1 Performance Analysis: Exceeding Expectations Across the Board In the first quarter ending March 31, Cloudflare nearly hit or exceeded analysts' expectations on all key performance indicators. Revenue reached $639.8 million, a 34% year-over-year increase, surpassing LSEG's consensus expectation of $621.9 million. The U.S., EMEA, and APAC regions all achieved synchronized growth of 34%, 31%, and 34%, respectively. In terms of profitability, adjusted earnings per share (EPS) were $0.25, which was about 9% higher than analysts' expected $0.23. GAAP net loss was $22.9 million ($0.07 per share), significantly narrower than the loss of $38.45 million ($0.11 per share) from the same period last year. Operating quality was also notably strong: adjusted operating profit reached $73.1 million, with an operating margin of 11.4%, both significantly higher than the $56 million from the same period last year. Free cash flow was $84.1 million, representing 13% of revenue, a substantial increase from the $52.9 million from the same period last year. In terms of customer structure, growth in large customers was robust. The number of large customers contributing over $100,000 annually reached 4,416, a 25% year-over-year growth, accounting for 72% of total revenue. Transactions over $1 million grew by 73% year-over-year, while customers over $5 million increased by 50%, reaching historically high levels. Remaining performance obligations (RPO) reached $2.543 billion, a 36% year-over-year increase, with current RPO accounting for 64% of the total, a 34% increase year-over-year, providing visible support for future revenue conversion. The overall customer retention rate reached the highest level in four years. Internal data shows that partner channel revenue accounted for 30% of the total, and the Act Two product series (Cloudflare's core product line for expanding zero trust security and network services) is accelerating penetration through a consultative sales channel. Q2 and Full-Year Guidance: Low Tolerance for Misses in High Expectations Cloudflare provided second quarter revenue guidance of $664 million to $665 million, with an adjusted EPS of $0.27. While the EPS guidance was in line with market expectations, the midpoint of the revenue guidance at $664.5 million was slightly below LSEG's consensus of $665.3 million a difference of only about $8 million, less than 0.12% of the midpoint of the guidance. On an annual basis, Cloudflare raised its revenue guidance from $2.785 billion to $2.795 billion to $2.805 billion to $2.813 billion, with the midpoint of $2.809 billion higher than the market's expectation of $2.79 billion; the adjusted EPS guidance was raised significantly from $1.11 to $1.12 to $1.19 to $1.20, well above the expected $1.13. With a full-year outlook that was raised across the board and a second quarter guidance that only slightly missed expectations, Wall Street's core anxiety about Cloudflare is reflected: in a market environment where AI is already fully priced and may even have a bubble, investors are highly sensitive and intolerant to even the slightest signals of short-term slowdown. As multiple analysts pointed out, "Due to the Q1 performance exceeding expectations, investors were expecting a more optimistic outlook for Q2, and the relatively conservative guidance was interpreted by the market as a signal of short-term growth slowdown." Layoff Plan: Deep Restructuring Under the AI Narrative The layoff announcement that accompanied the financial report was undoubtedly the most significant catalyst for the stock price plunge. Cloudflare announced a global reduction of approximately 20% of its employees, over 1,100 people, affecting all its functional departments and regions. By the end of 2025, the total number of full-time employees in the company will be 5,156. In an internal memo to employees, Prince and co-founder Michelle Zatlyn emphasized that the layoffs were not about cost-cutting, but rather a strategic personnel adjustment based on the fundamental change in working methods driven by AI. Data shows that over the past three months, internal AI usage at Cloudflare has increased by over 600%, with employees in engineering, finance, marketing, human resources, and other departments running thousands of AI conversational agents daily to complete tasks. 97% of engineers are already using AI coding tools in their daily work. "With AI and conversational agents becoming core parts of our workforce, Cloudflare's way of working has fundamentally changed. Because of this, we are consciously designing the company's structure to supercharge the value we deliver to customers," Prince stated in the memo. "This was not an easy decision, but it is the right decision there are roles in the company that are no longer needed for our future." In terms of restructuring costs, the company expects to incur about $140 million to $150 million in related expenses, with approximately $105 million to $110 million in cash, and non-cash stock compensation costs of about $35 million to $40 million. Most of the expenses will be recognized in the second quarter, and the overall restructuring is expected to be substantially completed by the end of the third quarter. Regarding compensation for laid-off employees, Cloudflare made a sincere arrangement: employees will receive full base salary until the end of 2026, with health benefits for U.S. employees continuing until the end of the year, and equity ownership extending until August 15, with employees who have not met the one-year vesting period being exempt from cliff vesting. This round of layoffs also makes Cloudflare the latest technology company, following Block (formerly Square), to undergo organization restructuring driven by AI. In recent years, companies such as PayPal, Coinbase, and Freshworks have also highlighted AI as a key factor in their layoffs and personnel reorganizations. Market Reaction and Interpretation In a situation of high expectations, the market gave a clear and harsh ruling on this "mixed bag" financial report. After the report was released, the stock price dropped to around $208 in after-hours trading, a decrease of about 19%. Analysts and commentators generally believe that the weak Q2 guidance combined with the large-scale layoffs triggered panic selling in the market. Analyst John Butler, who had issued a warning before the financial report, indicated that rising costs associated with AI tools could drag down Cloudflare's revenue growth. In the financial report, the adjusted gross margin rate declined from the level a year ago to 72.8% (below the market's expected 75.1%), a decrease of 210 basis points compared to the previous quarter and 130 basis points year-over-year, confirming this concern. The company attributed this to changes in the mix of paid and free traffic, as well as the increased proportion of developer platform products with temporarily lower gross margins. At a deeper level, the market's intense reaction reveals the core contradiction in the current AI valuation narrative: under the grand narrative of AI being seen as the company's greatest tailwind in history, investors' patience is wearing thin they not only demand to see revenue growth brought about by AI, but also demand to see actual cost efficiency and profit conversion, rather than a "efficiency restructuring" achieved through large-scale layoffs. Competitive pressure in the industry cannot be overlooked. Akamai announced a Q1 revenue of $1.074 billion on the same day, and disclosed an agreement with a leading U.S. edge AI model provider for an 7-year cloud infrastructure agreement worth $1.8 billion; Fastly reported a record $173 million in first quarter revenue the day before, with a 47% year-over-year increase in security business revenue. Cloudflare is not the sole beneficiary in the AI race, and the competitive landscape is rapidly heating up. For Cloudflare, the next few quarters will be a critical test. The company must prove: firstly, that AI is not just a grand "tailwind" narrative, but can actually accelerated revenue and improved gross margins; secondly, that the organizational restructuring plan driven by layoffs can truly bring about structural improvements in operational efficiency, rather than just one-time cost reductions. Following the financial report, Goldman Sachs Group, Inc. downgraded its rating from "Buy" to "Neutral" and lowered its target price from $380 to $285. Their core concern lies in potential profit margin drag from slowing demand from enterprise customers and changes in product portfolio. Prince described AI as the biggest opportunity in Cloudflare's history now, he needs to prove to Wall Street that his judgment is correct.