Q2 2023 Cloudflare Inc Earnings Call
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So I say that is nobody Matthew Prince co founder and CEO , Michelle that one co founder President and CLO and Thomas Seifert CFO by now 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 well.
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, our anticipated product launches and timing and market potential of those products are.
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.
Our 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 risks and uncertainties that could impact our future operating results and financial condition. Please see our filings with the SEC as well as in today's earnings press release.
Unless otherwise noted all numbers, we talk about today other than revenue will be on an adjusted non-GAAP basis.
You may find a reconciliation of GAAP to non-GAAP financial measures that are included in our earnings release on our Investor Relations website for.
For historical periods, a GAAP to non-GAAP reconciliation can be found in the supplemental financial information referenced a few moments ago.
We would also like to inform you that we will be participating in Staples Tech Executive Summit on August 29, and the Goldman Sachs Community and Technology Conference on September six.
Now I'd like to turn the call over to Matthew.
Thank you Bill we had a strong quarter in spite of continued macroeconomic uncertainty in Q2, we achieved revenue of $308 5 million up 32% year over year.
Added 196, new large customers those the past more than $100000 per year, and now have 2352 large customers up 34% year over year.
Our focus on go to market improvements is already paying off.
We saw sales cycles increased 20% in Q1 disciplined around deal had them returned to levels closer to what we saw last year.
All our customers and prospects continue to be very careful around there. It spans our improved execution led to a record quarter in new ACD bookings, Mike talking to customers is that while the macro environment is still challenging it has stabilized and for the first time in several quarters sentiment among it buyers.
Does not appear to be getting worse, our dollar based net retention ticked down to 115% down 2% quarter over quarter.
Base net retention is a lagging indicator so it will be slower drove flat. The go to market improvements. We are seeing it's also important to note that we did not see any new competitive pressure or churn throughout the quarter. Instead, the lower dollar based net retention is due to slower expansion from some of our existing customers we expect.
Our focus on go to market operational excellence, we will improve this metric over time.
Our gross margin held stable at 77, 7% still above our long term target of 75% to 77% and in line with 77, 8% last quarter, we delivered an operating profit of $23 million, our fourth consecutive quarter with a record operating profit we also meaning.
We outperformed on free cash flow generating $20 million during the quarter, which represents a free cash flow margin of six 5%.
Proud that our team has proven we can not only execute good times, but also be disciplined and deliver operational improvements while we're in more challenging times.
We continue to see very strong pipeline growth Q2 was another record for new pipeline generation as we discussed last quarter. We made significant changes in our sales team to proactively address underperformance that went very well both qualitatively and quantitatively our top performance are invigorated we saw.
Improvement in the average account executive productivity at the same time, we've implemented robust onboarding enablement and training programs combined with the record number of applicants were seeing for sales role. This makes for the right formula to build a world class sales organization and our team is armed with great products to sell last quarter alone.
Forrester recognized area, one or E mail security product as a leader IDC recognized as the leader for two reports in Zero Trust and network edge security as a service and we were the only new vendor recognized by Gartner for secure service edge.
Our developer platform cloud Furloughed workers continues its explosive growth, we reached 10 million active workers applications in Q2 of 250% since December and 490% year over year.
Our two continues to grow and now stores over 13, petabyte, the customer data up 85% quarter over quarter, we had 44000 distinct paying customers with our two subscription and brand name customers are beginning to adopt it as their primary object storage solution.
It seems like a good segue into some other customer wins in the quarter.
One of the fastest growing generative AI companies expanded their relationship with class, they're signing a one year $1 $7 million contract less than a year. After first starting to use our platform.
Like many AI companies in the space, it's customer relies on a multi cloud architecture for training and processing requests.
Our two less and unlock the best prices and performance across multiple cloud providers in their words quote we see cloud as a strategic foundational glue across all our services.
There continues to be our best strategic partner of all partners.
It's great to hear from any customers, but especially fun coming from a company that's doing such cutting edge work. These days feel like membership and the CEO club, it's predicated on saying AI as many times as possible on your earnings call script I have to confess I still find it a bit awkward when we first pitch cloud player debenture capital back in 2010 at.
One point I described it as the first AI powered security company for the cloud the iron roles around the table were so intense that I'm still a bit scarred, but more than a decade. Later here, we are and by our estimates cloud players. The most commonly used cloud provider across the leading AI startups.
Our two to help arbitrage lowest GPU cost to train their models. They are using our security tools themselves powered by AI or what our team would prefer to Paul machine learning to protect their own AI system and increasingly they are using the edge of our network to perform influence.
We are continuing to invest in this area and believe that we are uniquely positioned to win the inference market, which we believe will be substantially larger than the AI training market.
In Q2, we hosted our developer week, highlighting 10 major announcements and features to extend cloud floated workers as the preeminent developer platform for the leading AI company.
Q3 will feature our annual birthday week, and we have a lot more in store to provide the picks and shovels to enable AI companies to build the future.
Beyond AI Bottler Zero Trust solutions, where another big winter in Q2, a fortune 500 technology services company expanded their relationship with Plaid player spending at three year $7 $2 million contract for 25000 Zero Trust fee that brought their annual spend with us over $5 million.
First became a customer in Q3 last year using our application security products.
Month into the deployment one of their senior executives that quote bottlers like magic and brought us into an ongoing competitive zero trust proof of concepts.
Butler and gateway products were chosen over first generation Zero trust competitors due to our rate of innovation and ability to consolidate all of their security onto a single pane of glass.
One of the largest online recruiting platform expanded their relationship with cloud, they're signing a 25 month $2 $4 million contract and bringing their annual spend over $5 million with more than 90% of their employees remote they were looking for a comprehensive zero trust solution and evaluated up against every leading vendor in the market.
They decided to go all in on plasma with 15000 seats for access Gateway Kathy data loss prevention browser isolation in area one email security.
Specialty proud of how quickly we were able to onboard them less than a month to fully replace their first generation Zero Trust vendor that's awesome.
In Australia, and technology company expanded their relationship with cloud player signing a one year $2 $2 million contract, bringing their total spend with us over $5 million. This customer started out on our pay as you go plan in 2016 this quarter. They signed a zero trust deal to protect their expanding workforce Theyre also broadening their use.
The cloud folks developer platform with both <unk> and durable object.
Digging down under a leading Australian healthcare provider expanded their relationship about signing a three year $2 8 million contracts, we are replacing their hodgepodge of first generation <unk> truck vendors with 12000 feet of access gateway browser isolation cat B data loss protection in area, One E Mail security.
This is another example of a customer looking to consolidate vendors and choosing cloud flair for their holistic network security solution.
Here's another cold won a fortune 500, social network expanded their relationship with cloud player signing a three year to $4 million contract.
They initially became a customer a year ago building on top of workers and using our global network to authenticate the security of one of their messaging product.
Approach is again looking to add increased privacy onto another product with our privacy gateway solution. They view cloud as a leader in privacy based on our co development of the oblivious HCV standard and they admire is one of the only other company that truly understand scale as.
As privacy is increasingly top of mind, we believe there'll be more and more of these sort of strategically beneficial relationship.
They have only said AI 11 times, so far putting me way behind thought yet so let me end with one more AI customer win.
Another generative AI company expanded their relationship with us signing a three year $1 $3 million contract. It came to us for our developer platform signing up as a pay as you go customers because theyre developers loved us they approach us about our security need and signed a deal to use our application security and zero Trust products.
There are only a 100 seats, but they are growing like crazy and building cloud we're deep into their whole staff, whether you are a fortune 500 industrial company that used us for application security and are now hiring AI developers to use our workers platform to drive innovation across your business or your 100 person. The AI start ups that started using our <unk>.
Oliver platform and then realized you can get the same security is the biggest fortune 500 company that what's really unique about cloud player.
<unk> built the cloud that connects the world securely reliably and efficiently with that I'll turn it over to Thomas Thomas take it away.
Thank you Matthew and thanks, everyone for joining us.
During the second quarter I am pleased to share that we have seen improvements in terms of the impact from the external challenges we highlighted last quarter.
Specifically.
Somewhat elevated from historical levels sales.
Sales cycles shortened in part due to the implementation of more efficient processes and tactics.
Pipeline close rates.
We're showing improvement as we continue to refine our go to market strategies and operation.
Furthermore, we observed a notable uptick in collection some of our accounts receivable, which we believe reflects a rebound in customer confidence and financial stability.
We also continue to maintain our strong commitment to being fiscally responsible and act as good stewards of Investor capital.
We delivered our fourth consecutive quarter of record operating profit.
We also prudently allocate capital with a focus on maximizing shareholder value by taking action to retire or 2025 convertible notes during the second quarter.
Turning to revenue.
Total revenue for the second quarter increased 32% year over year to $308 5 million.
From a geographic perspective, the U S represented 53% of revenue and increased 30% year over year.
EMEA represented 27% of revenue and increased 38% year over year.
APAC represented 13% of revenue and increased 23% year over year.
We were pleased to see notable performance in the EMEA and APAC regions with both achieving record new ACB bookings in the second quarter.
The strength in APAC was primarily driven by large customer deal and we are seeing security become an even higher priority in EMEA given the geopolitical situation in the region.
Turning to our customer metrics in the second quarter, we had 174129 paying customers, representing an increase of 15% year over year.
We ended the quarter with 2352 large customers, representing an increase of 34% year over year and then the addition of 196 large customers in the quarter.
In fact, we added a record number of customers spending more than $500000.
Your life basis with global player in the second quarter was also one of our highest quarterly additions of customers spending more than $1 million annually, including our largest zero trust contract to date.
Our dollar based net retention rate was 115% during the second quarter, representing a decrease of 200 basis points sequentially.
Importantly renewal rates in the second quarter were consistent with the quarterly average in 2022, which was an all time high for the company.
Instead similar to the last two quarters the decline in DNR was again, primarily driven by slower expansion in our larger customer cohort.
We calculate DNR by comparing the on the license revenue from paying customers four quarters prior to the annualized revenue from the same set of customers in the most recent quarter.
As a result, this will be a lagging indicator floats less underlying.
Underlying business trends.
Based on our visibility, we believe the deceleration and DNR nearing a bottom.
Moving to gross margin.
Second quarter gross margin was 77, 7%, representing a decrease of 10 basis points sequentially and a decrease of 120 basis points year over year.
Network Capex represented 11% of revenue in the second quarter of.
Fiscal 2023, we now expect network capex could be 10% to 12% of revenue.
This scoring the scalability and efficiency of our network, even as we onboard new workloads, including AI.
Turning to the operating expenses.
Second quarter operating expenses as a percentage of revenue remained consistent sequentially and decreased by 8% year over year to 71%.
Our total number of employees increased 11% year over year, bringing our total head count to 3389 at the end of the quarter.
During the second quarter, we addressed consistently low performing sales capacity with a focus on upgrading our customer facing talent to improve growth increase productivity and drive long term success.
We will continue hiring for the year based on market conditions and remain committed to raising the bar on your higher additions given cullender opportunities available in the market.
Sales and marketing expenses were $125 4 million for the quarter sales and marketing as a percentage of revenue decreased by 1% sequentially and decreased to 41% from 44% in the same quarter last year.
Research and development expenses were $53 million in the quarter R&D as a percentage of revenue decreased by 1% sequentially and decrease of 17% from 20% in the same quarter last year.
G&A expenses were $41 million for the quarter G&A as a percentage of revenue increased 1% sequentially and decreased to 13 from 15% in the same quarter last year.
Operating income was $23 million compared to an operating loss of $891000 from the same period last year.
Second quarter operating margin was six 6% an increase of 700 basis points year over year.
These are folks highlight our continued focus on becoming more efficient and more productive not truck during the currently uncertain macroeconomic backdrop, but also because of operational efficiencies our long term competitive disadvantage.
Turning to net income in the balance sheet, our net income in the quarter were $33 7 million or diluted net income per share of <unk> 10.
We ended the second quarter with $1 $6 billion in cash.
Cash cash equivalents and available for sale Securities.
Cash flow of $20 million in the second quarter or 6% of revenue compared to negative $4 4 million or 2% of revenue in the same period last year.
Remaining performance obligations or <unk> came in at $1 billion.
Representing an increase of 8% sequentially and 36% year over year.
Current <unk> are 75% of total <unk>.
Before moving to guidance for the third quarter and full year I would like to begin with our expectations and the progression we have factored into this outlook.
Despite being encouraged by the forward progress we delivered during the second quarter in terms of shortening sales cycles and improving close rates mixed macroeconomic data points serves as a reminder, that we are operating in the business environment.
So showing signs of stabilization continues to be challenging to predict.
As a result, we remain prudent and cautious in our outlook for the second half of the year and we are fully committed to continuing to adapt our tactics and strategy.
Funds that these external Barry.
Now turning to guidance for the third quarter, we expect revenue in the range of $330 million to $331 million.
Representing an increase of 30% year over year.
We expect operating income in the range of $20 million to $21 million.
And we expect diluted net income per share of <unk> 10.
Assuming approximately 347 million shares outstanding.
We expect an effective tax rate of 11%.
For the full year 2023, we expect revenue in the range of $1 283 billion to $1 287 billion.
Representing an increase of 32% year over year.
Operating income for the full year in the range of $81 million to $85 million.
And we expect diluted net income per share over that period to be 37.
Assuming approximately 345 million 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 both the first and second quarters of this year, we anticipate generating significant free cash flow for the full year 2023.
For modeling purposes, we continue to expect free cash flow to trend upward on an ongoing basis, but anticipate variability in our free cash flow generation quarter to quarter.
In closing our team remains committed to driving operational excellence, ensuring long term growth and delivering significant shareholder value.
I'd like to thank our employees for their continued dedication to our mission customers and partners and to our shareholders. We create new value. Your continued support and with that I'd like to open it up for questions. Operator, Please poll for questions.
Thank you.
As a reminder, if you would like to ask a question. Please press Star then the number one on your telephone keypad.
If you would like to withdraw your question Press Star one a second time.
Pardon me, we ask that you. Please limit yourself to one question and one follow up question and we will pause for just a moment to compile the Q&A roster.
And we will take our first question from Shaul Eyal with TD Cowen Your line is open.
Thank you.
Good afternoon, guys congrats on the results and the outlook.
Matthew can you talk about some of your displacement activity this quarter and maybe my second part of the question will be do you see AI is accelerating your displacements and win rates. Thank you.
Yes, all I really appreciate the question.
We've had a lot of noise on the line from that from the operator, so hopefully hopefully we can get good things muted apologies for that.
So I think that when we look at displacement. It really is across three different parts of our business. So the first area is our traditional and application security business and in that space. We continue to place displace a number of traditional hardware vendors to people, who are providing web application firewall load balancers.
Providing various services that people had in those in those areas. We also see point cloud solutions that are doing just one of those things gained displaced by us where we can very much pick up a significant amount of their business and that that's been the case for quite some time the.
The second part of our business, which is our zero Trust business.
First is sort of the front door of your business. The second is kind of the backlog of business Zero Trust business is about protecting employees and data in that case, where more and more going head to head with the other first generation Zero Trust providers. So the Zee scalar is Palo Alto networks, Cisco and <unk> of the World and again, we really like our win.
In this space and a number of examples that I cited.
Specifically either in competitive solutions, there or in some cases, where we're actually doing takeouts people, who had made bets on the first generation of zero trust providers and wanted to upgrade to us for better ROI on much better user experience much faster more performance network and I think that.
That's one of the areas that I'm. The most excited about the third area is really our workers business, which our developer platform and in that play in that space.
It really depends on what's going on and increasingly we're doing takeouts from object store, where people are moving data off of more traditional object stores onto our two which is our object store.
A lot of times, we're also just moving individual applications or individual functions to us and so it's not a complete displacement oftentimes people will use us alongside our more traditional hyperscale public cloud.
But we can see that.
Working together in the AI space in.
In particular, I think that again, it's such a new space.
Now that we're displacing people as much as we're just helping AI company get what they need and the two big areas around that our first route first around training, where GPU scarcity is significant and the cost with the traditional hyperscale public clouds are moving data to wherever there is cheap GPU capacity or even available GPU.
<unk> makes it cost prohibitive and so our too because we don't charge for <unk> has been just a real boon for a lot of AI companies to be able to adopt.
They can find the cheapest GPU at any moment.
Again, its been an area, where a lot of that growth has come from and then increasingly we think that the inference market is really going to be fought between two areas. One is going to be on your device itself. If you have a driverless car you don't want when a ball is bouncing down the street and the Kid is chasing after it for that that decision on whether or not to put on.
The brakes to have to go out to the network that you want that to living in the car itself and so a lot of inference and model you run on devices, but we think if theyre not all run on devices. If they have they are too large because they need too much capacity out from either a GPU or memory or network access space in those cases, its going to make sense.
To run it in the network itself and then that cloud is uniquely positioned to win in that inference market for those models that make sense not to run on the device themselves. The more complicated model that makes sense to run in.
At the edge of the network and that's exactly what we're starting to see from more and more of these really innovative AI startups.
Got it. Thank you so much good job.
And we will take our next question from Matt Hedberg with RBC capital markets. Your line is open.
Great. Thanks for taking my question guys.
Thomas I had a question for you obviously good results this quarter and there was a lot of optimism.
In your portion of the prepared remarks.
You talked about.
Sort of like better better better win rates shorter deal cycles et cetera.
When I look, though at sort of the sequential growth for Q3 Q4, it's a bit higher than what we saw in the first half.
Just what are some of those main factors that are giving you sort of increased optimism for the second half and does guidance assume the macro stay constant or maybe even improve a little bit.
Well, thank you Matt.
We saw the FERC data points that what you call it.
Let me be a bit more optimistic we think we still think we need to apply a good portion of caution.
Outlook, one data point doesn't really make a trend at this point, we do not assume that the macroeconomic environment improves.
Improving significantly we still see significant mixed macroeconomic data points that we factored into our guidance and then therefore.
To date, as we said prudent and cautious not over interpreting from one data point.
Got it that's helpful. Maybe just a quick follow up.
So double clicking on the strength you saw this quarter there was a lot of conversations about shorter sales cycles better win rates.
Just any quantifiable benefit from your new CRM Mark.
As he is he's come on board in May be improved.
The sales focus.
And we're making good progress both in terms of restructuring our our team.
Terms of adapting our tactics and strategies, how we move.
Market, but you have to remind remember that's bringing on new people arent takes ramp time.
A little bit shorter in the Midmarket.
Sure.
A little bit longer in the enterprise segment, we have not seen most of those improvements yet and we do not expect to see them over.
The course of the remainder of this year, so we're making really good progress but.
We have been cautious in terms of what we have factored in the guidance that we've given for the second half.
Thanks, guys.
And we will take our next question from Trevor Walsh with JMP Securities. Your line is open.
Great. Thanks, you for taking my question, maybe Matthew just for you first a lot of the comments around AI seems to focus more around the developer piece and worker, specifically, which you can add that your part of your act III.
Does that become more something accelerated into more of an act two for that part of the platform can you just maybe talk a little bit about kind of the.
Changes in other gain months from that perspective.
Sure. Thanks Trevor.
I think that I mean.
The the order of the act.
Is.
Is is pretty.
I'd still say act one is is application security <unk> Zero Trust Enactory is as workers.
I would say that we have been very pleasantly surprised at how quickly the workers' platform.
Taking off but we are not at this time optimizing that platform for how can we bring.
As many dollars out of it is possible, we think that studying developer platforms across history. What we've seen is what you really needed the adoption and so what I'm encouraged by is that every single day when new companies are starting when new trends take off like like I had that people are.
Turning to this and I think.
I don't think that this is a flash in the Pan this event.
<unk> kind of.
New new wardrobe that that is going to look good for a little while but but quickly fade. This is something that is real and we're seeing that more and more companies more and more experienced developers are turning to the workers' platform in order to be able to deliver something that they can't get from the traditional.
Scale public clouds and so.
I think that any great.
Great.
Work of.
Fiction or otherwise.
Some.
The excitement often comes in the later chapters and so I don't want to diminish it by saying that the tax rate, but I think theres a huge opportunity there, but I also don't want to lose the fact that we had many customers. This year really dive into our act II products and we're making.
Credible gains in that in that space as well. So I think we've got a really exciting secondhand third act.
Awesome. Thanks, Matt I appreciate the color, maybe just a quick follow up for Thomas.
196 large customers that you added in the quarter could you maybe provide a little bit of color around are those current customers crossing into that threshold or.
Or is there a preponderance or even like an even split of new customers. Just landing that size can you just give us maybe a general sense of kind of where where where that pool of customers is coming from.
In the past it was pretty even.
50, 50 between new customer sign on on the <unk> expansion.
I would say.
Last quarter specifically.
Probably a larger share of new customers signing up right beyond the million dollar range. So it shifted slightly away from expansion into new new logo sign on.
Awesome, great. Thanks, again for taking the questions.
And we will take our next question from Jonathan Ho with William Blair. Your line is open.
Good afternoon. This is general wanting more for Jonathan Thanks for taking my question.
Like to get some clarification, if I could on <unk>.
I understand your net retention rate.
Understood you correctly, you had indicated in your prepared remarks.
Attention right.
As a lagging indicator that should should benefit from.
Go to market and sales replacement initiatives and such.
But then I believe you also said that it was impacted by and large by the largest customer cohorts.
Wouldn't expect large customers to be quite as impacted.
I wouldn't think.
That large customers would be impacted so much by.
Your sales or go to market because there are existing customers are our most a lot of them would be could you help me.
Understand.
How that would impact our retention rate and what kind of some of the moving parts are there.
Alright, just to make sure the extension rates stayed high.
Expansion in the large customer cohort.
What's a little bit lagging that is look we already saw.
So in the prior quarter.
Close to one of the reasons for my previous answer that the large customer.
Growth was pretty much coming more biased towards new logos than it was coming from an expansion expansion.
In my prepared remarks, it's caused a lagging indicator.
Because it's pretty much a look back to the four prior quarters that is what you compare senior finance or any movement, we see in an existing quarter.
We will take time to show up in <unk>.
We see we think we are seeing broadening.
Of the DNR development. So we are quite hopeful we'll move that upwards to wear and beyond where we where we came from but because we are so conservative in how we measure DNR, it's an all in across all customer cohorts.
It's very much a lagging indicator so so.
It would take a while before all the improvement that we are initiating and getting expansion going again will show up in Vietnam.
Yes.
Okay. Thank you and if I could just ask you mentioned that some of these initiatives you wouldn't expect.
To see.
The new sales folks and whatnot being fully productive through the end of the year.
It makes sense can you talk about your progress on the implementation of the sales processes.
Kind of a win win.
You might think you're halfway done fully done at what point in time and have you identified further process improvements since our last talked a quarter ago. Thank you.
Yes, so I'll take that I think that market is doing a really great job look.
Looking across the organization I think one of the things that we really highlighted last quarter was that we had some underperformance across the org.
And we address that what I was.
Over the course of the last three months, it's kept very careful.
My fingers on the pulse of the organization met with a ton of our team and what I'm hearing from the team is that they are super invigorated. They appreciate the additional training and enablement that we've that we've implemented and that we're seeing our sales team get the tools that they need in order to make sure that they can.
Clothes, great deal and we again have very strong pipeline and I think that what youll see is that.
That gets reflected as we have those new reps that are coming on as we do more enablement with our existing reps and.
And that I think is something that is very bullish for what what we have going forward.
Yeah.
Thank you.
We will take our next question from Brent Thill with Jefferies. Your line is open.
Good afternoon, Matt.
If you take your Crystal ball at ball out in the second half of the year I'm. Just curious if you feel things are starting to slowly improve it seems like a lot of your security peers are starting to see some decay and perhaps you're gaining some share here relative to your architecture and platform I'm curious.
You can kind of maybe stitch the back half together.
And how you're seeing it a 40000 foot deal.
Yes.
I don't know how accurate my Crystal ball is but but I think that I wouldn't say that it feels like things are are improving it feels like things are plateauing.
Q1 was really hard.
The fact that we had in one quarter sales cycles increase 20% was was.
A very big and and frightening.
Our current and I think we were pretty early in earnings season call of that that there was a real concern across it buyers, but that got reflected by many companies.
Came after us what we saw in Q2 was that sales cycles returned back.
To be more in line with what we were seeing last year in 2000.
Slide 22 is still elevated.
Yeah.
In the several years prior to that so.
It feels like to me that we're in for a grind.
And not the clubs are in particular, but across the entire economy and that that grind as is.
He is going to be hard, but I think it is actually serving us quite well, because it's forcing us towards operational excellence.
And across our entire team people are digging and theyre working hard and they're making sure that every processes as sufficient as possible and I think that youre right. One of the things that is unique about us versus a number of others is as we look at our products that we've been able to achieve very high gross margins I think that's the best one of the best.
<unk>, we haven't really differentiated platform and as customers are looking for ways to consolidate their vendors to find how to get more ROI out of everything they're doing they are turning to us and our team is ready and we have the right products and so I think the grind. That's ahead is actually something that.
I was going to be hard, but it's something that I think I'm looking forward to and we are going to become a better company as a result of it.
Thank you.
And we will take our next question from Keith Weiss with Morgan Stanley . Your line is open.
Excellent. Thank you guys for taking the question and definitely glad to hear things are stabilizing.
I wanted to dig into the comment that you need.
Put in the press release on the conference call about.
Workers and cloud player being a really good platform for inference.
Can you talk to us about sort of the underlying technical y.
Why do you think.
It's still pretty early days with these technologies and we're also trying to figure out what kind of how influenced plays out over time. So I think your view would be helpful to the overall kind of industry conversation as well as the cloud payer conversation on why you guys are well positioned and then the follow up is for Thomas.
Yes.
Whenever we hear entrance.
We're thinking that this is a GPU intensive and compute intensive type stuff and typically lower gross margin. It sounds like youre pretty comfortable that this isn't impacting gross margins in the near term is that just because it's still relatively early days in relatively small volumes or should we be thinking that this could as this ramp this could potentially have.
Bigger gross margin impact over time.
Thank you.
So Keith I appreciate all the questions that they are really really important to understand the advantages.
We have in this space. So so first of all what are the.
The challenges with within France, and I think there are really two.
<unk> seems like a bigger deal and it's probably actually not as big a deal than the other.
Doesn't seem like it's a big a deal but it is a really big deal and in both I think that they shape. How we think the inference market is going to work out. So the one that it feels like it's a bigger deal is around performance, which is that if you're playing with the various generative AI.
Company is if you are trying to do something that's that wait time between when you submit Aquarius and when you get back a response.
That is going to become a bigger and bigger differentiator between different AI platforms, and so anything that you can do in order to make that performance as fast as possible is advantageous in one of the ways to do that is to move the actual inference as close as possible to the person who's requesting and so again, we think that inference will primarily be done on.
Device or very close to where the end user is inside the network. We won't get again the ball is bouncing across the street you want that influence that to be done on the device on the driverless car itself. So we won't win every influence task, but there will be a lot that makes sense to be running in the network.
Where we have again almost infinite.
<unk> network capacity, almost infinite storage and memory and very very significant CPU and GPU, our resources to be able to run those those imprints tasks that I actually think will be the lesser of the two advantages for us the larger one which again doesn't feel like it's a bigger deal, but we're already seeing it play out some of the <unk>.
<unk> efforts that are happening around the world is that a lot of times for the inference tasks.
The data there is very private and people and governments want that to stay as close to the actual end user as possible. So we've already seen action in Italy that has restricted the use of certain AI tools, because it send data out of the country.
Cloud player can uniquely do because we're positioned across more than 250 cities worldwide. When the vast majority of countries worldwide. So we can actually process that information locally. So again, we think that on device or very close to where the user is on cloud florist network is going to be the place where in France.
Take place I'll tell you a quick stab at your second question as well and then hand, it off to Thomas for anything, but he would add.
I think the thing that gives you an extra like one clarification.
<unk>.
Worldview.
It sounds like you think we're going to see more kind of smaller open source and distribution of a lot of very small model versus like a world view that everything is going to come up into a big GPT Orlando model over time is that correct.
Not necessarily but but we run enough capacity.
Capacity out at the edge of our network that we can run fairly large I mean, very very very large models.
Out at at our network and what I think is a little bit confusing as most of you know.
If you are trying to do the training of the models than having the absolute latest greatest GPU. The H 100 from Nvidia right now.
There's a lot of constraint in getting those those chips, but theres actually a sweet spot for inference tasks, which isn't necessarily at the absolute cutting edge of all of.
The models and so popular is not the right place to actually process. The two.
Training of.
A model that makes much more sense to do in a in a more traditional centralized data center model much like much of that traditional hyper scale public clouds.
In those cases, you have to have the latest greatest gpus, but when youre doing in France again, a lot of that is going to run on your device.
And a lot of that is also going to run inside the network and we are going to be able to with a much lower capex spend leverage the edge of our network in order to be able to do that processing extremely efficiently and maybe we don't need the <unk> hundreds maybe we can live within a 100 or whatever it again at <unk>.
<unk> or two behind but that that's also the difference between training and inference inference doesn't need necessarily the latest greatest GPU does that does that make sense.
Yes Super helpful. Thank you.
Sure.
What I would add is you know.
I always remind people to truly understand the competitive mode of cloud player and the efficiency of the business model you have to start with our network and how it can be targeted using off the shelf hardware completely and be creative in how much junior software stack that allows you to run every product every service.
Locations are now massive globally distributed network that is not only efficiently designed to heart to handle large volumes of data, but also large volumes of similar payments request.
That makes it already today very well suited for insurance costs, which.
By nature, often walk through processing.
Requests simultaneously so.
And it requires less computational power trading.
Trading model. So I think the architecture of the network itself puts us in that.
It's a really advantageous position and Thats why we are so confident that the business model is going to hold and that's one of the reasons why we're able to it you can get.
Capex ratio down for the year. Despite the fact that AI workloads are are putting are being put more and more on our network. So youre really.
Let me go back and really understand the accretion the architecture of the network itself.
You'll find the answer there.
Excellent Super interesting guys. Thank you.
And we will take our next question from Andrew Nowinski with Wells Fargo. Your line is open.
Okay.
Okay. Thank you and congrats on another great quarter.
Wanted to shift gears and ask about zero Trust is there any more details you could provide on that record zero Trust contracts, you talked about and whether that was the displacement of another vendor and maybe why they selected software and then I have a quick follow up thank you.
Sure I think that in almost all of the zero Trust deals that we see we are at least in competition with some of the first generation Zero Trust vendors.
Ian.
And many of them.
They are there is an incumbent vendor and we are displacing them usually when that happens.
The usability of the of the existing Zero Trust vendor has been has been really bad.
It's crazy that with some of the leading zero trust vendors. If you try to use your laptop when youre on a United Airlines Wi.
Wi Fi flight that they're captive portal on United Airlines doesn't work, that's obviously unaccepted, maybe that was acceptable and the pandemic when no. One is traveling but now that people are traveling.
That's something that just doesn't doesn't hold up anymore and so I think the thing that has been an advantage of cloud player is that because we almost think of ourselves at times as a consumer company and we have a zero trust product that you can download to your phone right now in use it's one dot one dot one dot one that is running on so many.
Devices and as we work with device manufacturers to actually build our network directly into their applications those things give us the visibility to be able to focus on performance to be able to focus on end user experience and to be able to directly replace oftentimes what have been there.
Sort of first generation Zero trust vendors that frankly don't have the same user experience and the same performance and so and so in many of these cases and all of the cases at least competing with the other more traditional zero trust vendors and in many cases now we're displacing them.
That's great. Thank you Matthew.
And then as a follow up I think most people assume that Microsoft's new interim solutions will be targeted at the SMB sector at the lower end of the market, but that is a market that I think caused where it can also serve so I'm just wondering what youre seeing in terms of competition with the new interim solutions.
Yes, that's what my sense is of how Microsoft is thinking about this and in fact I guess.
Long been a really great partner of ours and.
Specifically.
And even their announcements of this.
We looked for ways to.
I highlight that the part of the market.
The SMB market, but we're not we're not satisfied just winning the F&B market, we're winning some of the largest enterprises and I think the biggest enterprises that have the most interest here and so I think Microsoft has been a great partner to clubs there were directly integrated into their edge browser.
The network that we have delivered them very unique.
<unk>, but we also respect them as a competitor and.
I think what we have is an advantage is that network a network that they use themselves.
But it's something where over time I think their entry into the market is just validated the market its defined it and we look forward to competing.
Competing in the places that we do in cooperating in any other places, where we don't and what we see is that what customers really want is a network provider that can protect your front door and your back door customers really understand is that there's a reason that we have account.
Accountants, and auditors and that those are separate things and.
What customers really want is they want a solution that works across not just one vendor's products, but the entire it stack and I think thats, what we see time and time again as the reason why customers are selecting selecting cloud players Zero Trust solutions.
That's great. Thank you very much.
Yeah.
And we will take our next question from Mark Murphy with JP Morgan Your line is open.
Thank you and I'll add my congrats.
Matthew can you elaborate on your vision for how cloud player can protect companies from leaking sensitive data out in.
Yes, maybe having some of that land inside of generative AI model, what kind of opportunity do you see.
Since that traffic to Microsoft in open AI is so tremendous in that area and you have the partnerships. There that you've mentioned is there a role you can play directly to try to help control that some of the data flows in that Azure open AI service.
Yes, I think that this is an area that.
We really listened to what customers' concerns were.
And built a product that specifically addresses the concern that that youre highlighting because it's one that is on the mind of just about every.
Hi.
GC and see so it's out there and that is that whether they are telling their employers are not.
The best data that almost half.
Of workers at and knowledge industry companies are using AI in one way or another in their jobs and the risk. It with AI is that if you send a piece of information up to one of these models. It gets incorporated in the same way that if your two year old here is a bad word.
It's really hard to get them to unlearn that that thing and so the key is really making sure that the data doesn't actually leave and so what we've created is leveraging our existing data loss protection products, the DLP products and making them specific to tag data in such a way.
Did you can say here's a piece of information maybe it's from our marketing website I am totally fine with that going out to the public.
Juror in executing that zero trust and out to the public AI.
Vendors and being able to train on that in fact, it's great. If they are trained on my my marketing messages here's another piece of information, which is much more sensitive where maybe I am going to restrict that specifically to my own internal or sandbox solutions.
Are the AI training models for that and then maybe there is something else.
That sort of Cliche example, the secret Formula Coca Cola or.
Maybe what all of your internal pay.
Or maybe that you don't ever want to get out to anything and so we've used our DLP solutions in order to specifically address the concern that <unk> in general counsels have about data leaking out what we think that that can do is over time add not only those controls, but then start to add things like this.
<unk> has a certain value so I'm going to send that to maybe GPT three five rather than GPT four to save money on that and so we think that because of the position. We're in because so much of the AI universe relies on us that it puts us in a great position to not only provide the security to the AI companies, but also.
Secured you anyone who is using AI in their business and so we can benefit from both sides of the equation.
Thank you it's extremely helpful.
Yeah.
And we will take our final question from Alex Henderson with Needham Your line is open.
Great. Thanks, so much.
I was hoping you could talk a little bit about the <unk>.
Fairly massive change in tone.
The <unk> call and the current call which highlights.
Yes.
An improvement in <unk>.
Pretty much every metric.
Track.
And.
Specifically, maybe call out some of the differences between various geographies.
Whether the improvement was in large enterprise was also in the mid market and the SMB market.
Can you give us some granularity as to where that tone is changing.
Lee.
You called out the Euro what are your advanced bellwethers over the last year, and if youre seeing that changing.
An inflection and tone.
I would love to know where it's coming from.
Yes, Alex I'll start and then Thomas will have some more I think that.
I think that Q1 was scary.
Because having a 20% increase in your sales cycle in a single quarter and we've seen we've seen sort of it or something around that around 20% of an increase but over the entire course of 2022 and so when that then spiked.
In Q1, what we didn't know was whether that was was going to it whether we were going to be another 20% longer in sales cycles.
In Q2, and thankfully that's not what happened it came back down.
But again I wouldn't say that it's come back down to a point, where we feel super optimistic.
About about the macro I think the macro is still very hard in the next period of time is going to be a grind.
But it is we didn't have the same.
Just explosive expansion in sales cycles that I think we and a lot of other peers in the industry saw in in Q1, and so I think thats, where that has been that's what led to the conservatism that we had in Q1 and I think that that return.
Turning to something which again, it's still elevated but not.
But it's back to what we were seeing in Q.
More around what we're seeing in Q4.
That is I think that's the primary driver at least from my perspective in terms of in terms of what.
It may be is what you put it as a more optimistic tone.
Any sense of specifically any verticals or any categories or geographies.
Alrighty.
Size business.
Yes.
That changed most dramatically.
So let me give you some more color.
We saw refill forward improvement we talked about this we also saw a lot of inconsistency in this.
And the environment that makes it much harder to predict what the second half it's under Perry.
APAC was very promising.
Before we saw a lot of very large deals, especially coming from APAC.
The European business with very much security, driven and very encouraging progress.
But very specific to.
Geopolitical situation.
Europe is in.
And then the Americas rebel more muted in general.
We felt very specific performance really good performance in the Middle East, but also in South America, North America with appropriate more muted than anything else.
Vertical buys.
There's not a lot to talk about it but it's very consistent performance I would say that's not one vertical that I would pick out in time.
Overall underperformance.
Great. Thank you so much.
Yeah.
Ladies and gentlemen, I would now like to turn the conference back to Matthew Prince for closing remark.
I just wanted to take a second to thank everyone at cloud flare up again.
As the macro environment continues to be challenging I am proud of how our team has stepped up and executed towards operational excellence.
Everyone is working incredibly hard to help live up to our mission of helping build a better internet. So thank you to all of the clouds, our employees to all of our customers and all of the investors and we really appreciate everything that you're doing for us.
Yeah.
And ladies and gentlemen, this concludes today's call and we thank you for your participation you may now disconnect.
And all of the investors and we really appreciate everything that you're doing for us.
Yeah.
And ladies and gentlemen, this concludes.