Q3 2023 Cloudflare Inc Earnings Call
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You bet.
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I would now like to turn the conference over to Mr. Phil Winslow, Vice President of strategic Finance Treasury and Investor Relations you may begin Sir.
Thank you for joining us today to discuss cloud player its financial results for the third quarter of 2023 with me on the call. We have Matthew Prince co founder and CEO, Michelle <unk> co founder President and COO and Thomas Seifert CFO.
Everyone should have access to our earnings announcement this announcement as well as our supplemental financial information may be found on our Investor Relations website.
As a reminder, we will be making forward looking statements during today's discussion, including but not limited to our customers vendors partners operations and future financial performance, our anticipated product launches and the timing and market potential of those products.
Our anticipated future financial and operating performance and our expectations regarding future macroeconomic conditions.
Statements and other comments are not guarantees of future performance and are subject to risks and uncertainties muscle which is beyond our control.
Our actual results may differ significantly from those projected or suggested in any.
<unk> 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.
Otherwise noted all numbers, we talked 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 Web site.
For historical periods, a GAAP to non-GAAP reconciliation can be found in the supplemental financial information referenced a few months ago.
We would also like to inform you that we will be participating in the RBC capital markets Global T. Inte conference on November 14, and the Wells Fargo TMT Summit on November 28.
Now I'd like to turn the call over to Patrick.
Thank you Phil we had another strong quarter in spite of an increasingly uncertain world in Q3, we achieved revenue of $335 6 million up 32% year over year. We added 206, new large customers does the past more than $100000 per year and now have 2558.
Large customers up 34% year over year looking at even larger customers. We added a record number of net new customers year over year spending more than 500000 and $1 million per year with cloud Flair, our dollar based net retention ticked up 1% to 116%.
We see this as a lagging indicator and expect that it will take some time for the go to market improvements, we're seeing across our team to be fully reflected.
During the quarter, we continued to refine these go to market strategies, our pipeline close rates held steady our salesforce productivity remained constant and linearity was similar to Q2 I think that we have been able to hold things steady, while making significant organizational changes and improvements across our sales and marketing.
The organization is very encouraging.
Beyond that we're beginning to see positive early signs from the sales team members. We brought on over the six months to replace Underperformers during the quarter. The pipeline generated by this new cohort was one six times higher than those brought on at the same time a year earlier. These new account executives achieve more than 130 <unk>.
Their activity goals for the quarter, that's great news and we're thrilled to have them onboard and while they're still ramping I'm encouraged by the performance and that we've been able to revamp as much of our sales team that we have without significant disruption.
Our gross margin was 78, 7% still well above our target range of $75 to 77% and up from 77, 7% last quarter. We delivered an operating profit of $42 5 million, our fifth consecutive record quarter for the company. This represents an operating margin of <unk>.
12, 7%.
Operating profit increased nearly three times year over year, underscoring our commitment to operating efficiency and productivity.
We continued to generate positive free cash flow in Q3, we generated $34 $9 million during the quarter, representing a free cash flow margin of 10, 4%. This is a business that can generate significant cash in 2023, we expect we will generate more than $100 million in free cash flow well ahead of our original goal when we started the year.
And a direct result of improved execution across our entire business.
In Q3, we celebrated our 13th anniversary of cloud players launch at time, we call birthday week, we officially entered our teenage years and like many kids it took us a while to fully understand and articulate the category we belong to the day before our 13th birthday, we announced to the world that we realized what we are.
Activity cloud connectivity means we measure ourselves by connecting people and things together cloud means the batteries are included it scales with you. It's programmable has consistent security built in it is intelligent and learns from your usage and others to optimize for outcomes better than you could on your own.
Our connectivity cloud is worth contracting against some of the other first generation clouds. The hyperscale public clouds are in many ways the opposite they optimized for hoarding your data locking it in making it difficult to move their captivity clouds, while they may be great for some things their full potential as the only truly unlocked.
Customers when combined with the connectivity cloud that lets you mix and match the best of each of their features SaaS.
That's what we hear from customers that they are multi cloud, where they want to be or not and that's what they really need is a connectivity cloud to hook all their systems together in a fast secure reliable way.
The messaging of the connectivity cloud is resonating with customers and helping them understand the full extent of what cloud players able to deliver for them. We are not any one of our individual features or even if some of them. We are a cloud that helps you get the most out of connectivity and customers love that and are leaning into it.
Speaking of customers, we've had some great customer wins in the quarter I'd like to highlight.
Our U S government cabinet level agency within the executive branch signed a one year $2 million contract copywriters, replacing three point solution vendors, including a 20 year old incumbent solution.
We're providing a unified application security for 600 U S government applications. They were drawn to cloud players modern architecture right of innovation robust network and ability to reduce complexity by consolidating multiple point solutions into a single pane of glass.
Another U S government agency signed a one year $510000 contract for <unk> Zero Trust solutions, including access Gateway browser isolation and data loss prevention. We were selected over first generation Zero trust competitors due to our ability to consolidate numerous products across both application security and zero trust onto it.
<unk> platform.
Our federal business has grown significantly over the last year and we believe these deals are just the tip of the iceberg with both of these customers, which we expect can expand significantly.
A leading healthcare company signed a three year $1 billion contract for <unk> Zero Trust solutions, including access Gateway browser isolation in area. One email security there are legacy vendor looking to modernize their security posture as they migrate on prem applications to the cloud.
We experienced the sophisticated email phishing attack mid process and with area. One we were able to immediately protect them.
Chose us over first generation Zero Trust solutions because of the comprehensiveness of our solution, including E Mail security the VP of technology Thats distinctly we should've partnered with Clouser earlier.
A major European consulting company signed a three year $1 $6 million contract for access and gateway, along with Magic Wan and our data localization suite.
Selected cloud player over first generation Zero trust competitors because of the breadth of our platform. The theme across these examples as customers are looking for a zero trust solution increasingly wanting to protect their entire network <unk> is the only vendor that can deliver a comprehensive network wide solution from a single vendor switching gears a bit.
A fortune 500 semiconductor company expanded their relationship to cloud player signing a three year $1 $4 million contract. The customer was looking to modernize their network security posture. They adopted our magic transit product they were able to consolidate multiple point solutions on the cloud players unified platform.
And African public utility company expanded their relationship with cloud, there's plenty for year $3 million contract. This company first approached <unk> last year facing multiple under attack situations, we onboard a customer with application security and magic transit stopping the attacks they were seeing the customers. So impressed with cloud based products and <unk>.
<unk>, that's a quadruple their utilization and added additional products, including magic firewall. The fact that cloud plus network spans the globe gives us the ability to service clients everywhere.
Another International Technology Company signed a two year $1 $8 million contract for Magic Transit and advanced application security this customer approached us in the midst of a large scale ddos attack their incumbent solutions were provided by a mix of point solutions and bundled Hyperscale cloud mitigation services.
Neither but sufficient to stay ahead of the attack in Q3, we saw a significant increase in massive ddos attacks to give you a sense. These new attacks are generating nearly as much traffic as the entire internet generates globally, but pointing it to a single Victor.
There are very few networks that can stand up to these attacks I am proud of the fact that cloud player. It's architected uniquely for this moment and as the world becomes more complicated and these attacks become more common I think more and more of the Internet will turn to us for protection.
A leading AD Tech company expanded their relationship with cloud, they're signing a one year $720000 contract. This customer came to us with a technical workers use case, they needed a platform that could help them deliver through traffic spikes up to 3 million requests per second.
Existing solutions on traditional Hyperscale public clouds were expensive to maintain and would encounter errors with even relatively low traffic spikes.
Our workers was able to support their needs without breaking a sweat.
With this win we expect they will move more of their applications to are much easier to scale platform.
A fortune 500 technology company expanded their relationship with cloud player.
One year $2 $9 million contract this customer approached us to use our connectivity cloud to help them collect AI and machine learning data from their customers, while maintaining the highest level of privacy. They view <unk> as a leader in privacy and we work closely with them to develop the solution.
This deal makes clear the importance of privacy and the likely regulatory scrutiny of AI task and highlights how cloud <unk> network, which extends into the vast majority of countries on Earth can help customers take advantage of AI, while complying with an increasingly complex regulatory environment.
We continue to accelerate our efforts in AI, we believe cloud player is the most common cloud provider used by the leading AI companies.
During our birthday celebrations in Q3, we made several announcements with companies like Nvidia, Microsoft Meta hugging faith and data bricks, we also announced workers AI to put powerful AI inference within milliseconds of every internet user.
We believe influence is the biggest opportunity in AI and inference task will largely be run on end devices and connectivity cloud like cloud player right. Now there are members of the <unk> treme traveling the world with suitcases full of Gpus installing them throughout our network, we have influenced optimize gpus running at $75.
<unk> worldwide as at the end of October and we are well on our way of hitting our goal of 100 by the end of 2023 by the end of 2024, we expect to have influence optimize gpus running in nearly every location where cloud operates worldwide, making us easily the most widely distributed cloud AI inference platform.
We've been planning for this for the last six years expecting that at some point, we'd hit the crossover where deploying influenced optimized gpus made sense to that end starting six years ago, we intentionally left one or more PCI slots in every server, we built empty when demand and the technology made sense.
We started deploying that means we can use our existing server infrastructure and just add GPU cards, allowing us to add this capability, while still staying within our forecast capex envelope.
And customers are excited in the five weeks since our AI announcements thousands of developers have leverage our new AI capabilities to build full stack AI applications on cloud network processing more than $18 million request through the new features we launched just over a month ago. The demand has exceeded our expectations and.
To accelerate increasing feedbacks since mid October we have a pipeline of customers interested in putting hundreds of billions of inference tasks on our infrastructure. Each month, it's early days, but the interest we're seeing from customers large and small over what they can build with powerful inference capability is now embedded in one of the world's largest network.
<unk> is inspiring.
They like how easy it is to use workers AI they liked how its powerful but close to their users around the world they like them more efficient and fair pricing model, our civil its implementation delivers.
And they like the flexibility of bringing their own models, we're fine tuning existing models using the tools that are included as part of workers AI. If we're right that influences the big AI opportunity and that influenced tasks that are too big and too complex to run on in devices will need to run as close to the user as possible then we.
Got a head start on building the preferred location for inference for the most interesting AI applications of the future.
Finally, before I turn it over to Thomas I wanted to acknowledge that we continue to live in very challenging times. The war in Ukraine continues unabated now we have a new war in the middle East after the attack by him off on Israel. We have colleagues in the region, who have been impacted directly and indirectly our thoughts are with them and while we see the <unk>.
Stating images of the kinetic war the online war is also raging.
<unk> is committed to providing our services to humanitarian and civil society organizations at no cost to ensure they can continue doing their important work for all those impacted by the increasingly hostile world we find ourselves in.
In our business, we need to stay on top of cyber security issues globally and modern warfare continues to include the cyber battlefield.
As I look back on the quarter I'd like to thank our entire team at <unk> for all your hard work innovation dedication to supporting our customers and the greater Internet.
Thank you for continuing to help build a better internet for us all and with that I'll hand, it off to Thomas Thomas take it away.
You Matthew and thank you to everyone for joining during.
During the third quarter as we continued to refine our go to market strategy and operations.
Pipeline growth rates have held steady or productivity remained consistent and linearity was similar to last quarter.
We're pleased to see significant growth with general partner <unk>.
Momentum with large customers and strength in the public sector.
Importantly, we continue to maintain our strong commitment to being fiscally responsible and act as good stewards of investors capital.
We delivered our fifth consecutive quarter of record operating profit, increasing nearly three fold year over year and significantly outperformed in free cash flow.
Turning to revenue.
Total revenue for the third quarter increased 32% year over year to $335 6 million.
From a geographic perspective, the U S represented 52% of revenue and increased 30% year over year.
EMEA represented 28% of revenue and increased 36% year over year.
APAC represented 13% of revenue and increased 27% year over year.
Turning to our customer metrics in the third quarter, we had 182000 in.
<unk> 2017 customers.
We're spending an increase of 17% year over year.
We ended the quarter with 2558 large customers representing an increase of 30 corporate print year over year, and then addition of 206 large customers in the quarter.
In fact, we added a record number of net new customers year over year spending more than $500000 and $1 million on an annualized basis with cloud player.
Our dollar based net retention rate was 116% during the third quarter, representing an increase of 100 basis points sequentially.
Also there can be some variability in this metric quarter to quarter. We continue to believe the recent decelerating trend and DNR stabilizing near these levels.
Moving to gross margin third quarter gross margin was 78, 7%.
Presenting an increase of 100 basis points sequentially, and an increase of 60 basis points year over year.
Network Capex represented 8% of revenue in the third quarter as we continue to benefit from our focus on driving greater efficiency for more infrastructure and the.
Uniqueness of our platform to onboard new work.
Despite having begun to invest an enormous opportunity in front of us with the planned rollout of GPU to more than 100 cities by the end of this year, we expect network capex to be 8% to 10% of revenue in fiscal 2023. However, we anticipate network capex to return to.
To more normalized levels over time.
Turning to operating expenses.
Third quarter operating expenses as a percentage of revenue decreased by 5% sequentially and decreased by 6% year over year to 66 footprint.
Our total number of employees increased 11% year over year, bringing our total headcount was 3529.
Quarter.
We were selective in hiring during the quarter.
To evaluate deploying AI and automation at scale to reengineer, our business processes across the company.
Early investments in these areas are already delivering encouraging returns, we will remain prudent and hiring as we continue to invest in broadening and deepening the use of AI and automation across our operations to drive higher productivity and greater efficiency.
Sales and marketing expenses were $129 million for the quarter.
Hilton marketing as a percentage of revenue decreased by 3% sequentially and decreased 38 from 41% in the same quarter last year.
Research and development expenses were $54 2 million in the quarter R&D as a percentage of revenue decreased by 1% sequentially and decreased to 16% from 18% in the same quarter last year.
General and administrative expenses were $38 $5 million for the quarter.
G&A as a percentage of revenue decreased by 2% sequentially and decreased to 11% from 13% in the same quarter last year.
Operating income was $42 5 million compared to $14 8 million in the same period last year.
Third quarter operating margin was 12, 7% an increase of 690 basis points year over year.
This highlights our ongoing focus on becoming more productive and doing more with less.
Given that operational excellence is the long term competitive advantage.
Turning to net income in the balance sheet, our net income in the quarter was $55 3 million or diluted net income per share of <unk> 16.
We ended the third quarter with $1 $6 billion in cash cash equivalents and available for sale securities.
Free cash flow was $34 $9 million in the third quarter or 10% of revenue compared to a negative $4 6 million or 2% of revenue in the same period last year.
Remaining performance obligations ARPA you came in at one 1 billion, representing an increase of 5% sequentially and 30% year over year.
Current <unk> was 75% of total <unk>.
Moving to guidance for the fourth quarter and the full year.
With broadening geopolitical uncertainty and increasingly mixed macroeconomic data points across geographies the business environment in which you operate remains challenging to predict.
And as a result, we continue to remain prudent and cautious in our outlook for the fourth quarter.
Now turning to guidance for the fourth quarter, we expect revenue in the range of 352% to $353 million.
Presenting an increase of 28% to 29% year over year.
We expect operating income in the range of $28 million to $29 million.
We expect an effective tax rate of 7%.
We expect diluted net income per share of <unk>, assuming approximately 354 million shares outstanding.
Please note that our share count guidance now includes dilution from our convertible senior notes for approximately $6 8 million share.
Given the cloud clear chief the level of profitability, whereby these securities are no longer be anti dilutive.
For the full year 2023, we expect revenue in the range of $1 6 billion to $1 287 billion.
Representing an increase of 32% year over year.
We expect operating income for the full year in the range of $110 million to $111 million and.
And we expect diluted net income per share over that period to be 45% to 46%, assuming approximately 350 million shares outstanding.
We expect an effective tax rate of 8% for 2023.
After having achieved significant pre cash flow in the first three quarters of the year, we expect to generate over $100 million in free cash flow for the full year 2023.
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 dedication of our ambition as well as our customers for trusting us to help them for some of the hardest problems they face when modernizing and transforming their businesses 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 one on your telephone keypad and please limit yourself to one channel one follow up.
Your first question comes from the line of Matt Hedberg from RBC capital markets. Please go ahead.
Great. Thanks for taking my questions guys. Congrats on the results Matthew for you.
A lot of exciting news at birthday week.
Including Workers' AI and everything else that you guys announced I guess broadly speaking.
Given the focus on it.
And all the investments this year or next year, how should we expect to see some of the monetization benefits of generative AI customer spend is that something that you'd be able to quantify at some point or what are some of the bread crumbs that we should watch for success there.
Yes, Thanks, Pat I think that there are a couple of different areas, where we're monetizing.
And that's that's starting to show up in the results and then there are a couple of areas, where I think there is a law.
Longer time horizon, and we're really optimizing for adoption I think the place where we've been positively surprised is with our our two product <unk> is our object store.
And critically it allows customers to be multi cloud and to easily move data to wherever they are the resources that they need without charging them, an egret tax like like some of the other traditional hyperscale public clouds do that's the place where a lot of the growth that we're seeing.
It's coming from AI companies. They love the fact that they can take their data and their training sets and move it to wherever their gpus that are available around the world and that's that's driving and I think as we see more.
More and more usage of that Thats driving revenue.
For us that we're realizing today and I think that will be something that will we will go forward into into the quarters to come I think that some of the areas around in France.
Early days, but I think that you I think you would be likely to hear us start talking about larger customers that are moving significant workloads over to the AI space.
I think that the individual developers will be we're really going to optimizing that space for adoption and building out an ecosystem, but as you can hear us on earnings calls.
Talk about how people have really moved.
Workloads and we've got customers in the pipeline that are talking about moving billions of it inference events per month to a network. That's when that starts to turn into real revenue for us and I think it's early days. So we don't know exactly what the timeframe on that will be but the conversations we're having are very exciting and it's a space that.
And that definitely bullish on.
Super Super exciting and then maybe Thomas for you.
We still have Q4 to close out here and you didn't really talk about next year, but given some of the uncertainty out. There you guys are still delivering good results are there any building blocks that you would share as we start to think about our fine tune our calendar 'twenty for either growth or profitability estimates.
While we wont talk too much about 24 on this earnings call that you might expect there will be time for that on our next earnings call, but I think it's important in mind to keep in mind that we've been talking about cascading. The impacts are in terms of the progress we make.
And when it hits our books right. It's all about closing pipeline first and we have seen strength there in the third quarter continued in the fourth quarter, how this turns into ATB.
Uncertainty and once it hits the ACB it'll take.
Turn off Paul.
Fourth quarter report shows up into revenue.
It's been good progress, especially at the beginning of this cascade.
And as we move through that that waterfall of progress you will see a response showing up in our numbers and next year.
Thank you very much.
Your next question comes from the line of Brent <unk> steel.
Please go ahead.
Matthew you've highlighted sales efficiency as one of the top goals for this year I think Thomas mentioned.
It was it was staying consistent or maybe you had mentioned this in linearity was pretty steady I guess, you mentioned some of the sales improvements but kind of.
Where do you where do you stand in terms of your overall game plan on the on the go to market. How far are you through this this process in kind of what's left is there an easy way to.
To frame this this move.
Yes, so we've talked about how.
On previous calls, we really looked across our go to market functions and recognize that.
There was there was an opportunity for us to improve and what I'm proud of is is that we havent waffled on that on that path. We havent. We havent changed course, we haven't had significant.
Disruption or distraction as we've as we've gone through that and I think that the caliber and quality of the people that we're bringing on to those go to market teams. The early indications are and again there is still ramping but the early indications are that they're doing a significantly stronger job.
Rob and they're delivering.
<unk> results. So that's a process and it takes it takes time to to work through that but I think that we're seeing positive indication I think we're being we don't want to lose our marbles and and and and be too aggressive, but we're being very disciplined.
One of the things that I remember.
Always talked about is how we've had a business where we invest behind the demand that we see and I think the same thing is true in the go to market side, where we're seeing that the increased rigor and increased discipline has early signs of paying off and if that continues and we get more <unk>.
Points, along the way then that's a place where we'll be able to invest with again, new leadership in place and and and new training and enablement for our sales team and again.
I think it's early still but I think that we have good indication and I'm proud of the fact that we did this so far without significant disruption or distraction within our business.
Thanks.
Your next question comes from the line of Joel.
Paul Fishbein from <unk> Securities. Please go ahead.
Thanks for taking my question Thomas one for you. It's a good segue from the last question.
Clearly outperforming on the gross margin on the operating margin side.
And frankly cash flow just how are you going to continue to balance profitability and investment in some of these high growth areas that Matthew outlined.
Just love some color there thanks.
Yes, just following up on one more Matthew I.
I think we have the business.
It's really about instrument that you could see this now managing ourselves through quite some macroeconomic turbulence.
So the business is well instrumented business model is built in a way that allows us to visibility when demand picks up and we have been.
We will invest behind the demand.
We have also realized that there is significant.
Scalability and efficiency in the business model.
You are what had been showing up.
The financial numbers.
A couple of quarters really well, so I think the combination of visibility into the system.
Picking up or not.
Instrumented business and there are a lot of elasticity and how we move forward keeps us confident that we.
Theyre, hence term under Raptor and can control their ramp up.
<unk>.
Thank you.
Your next question comes from the line of Andrew Nowinski from Wells Fargo. Please go ahead.
Great. Thank you congrats on another amazing quarter High then please accept my thoughts and prayers for your employees that are affected by the terrorist attack in Israel.
So I wanted to ask you guys about the.
The workers AI offering that you launched I think it's really interesting I was wondering what the early feedback is on it and particularly the vector database component.
And whether the staggered rollout of the Gpus as a potential gating factor as people kind of wait.
Maybe to deploy that at scale or wait for the rollout of the Nvidia Gpus before rolling it out at scale.
Yes, Andy Thanks. Thanks for the question again, it's an area that we're extremely excited about.
I am proud of the fact that our team has been able to get it rolled out as quickly as they have or we thought it was an ambitious goal to be at 100 cities by the end of the year. The fact that we're in now over 75.
And that we've been able to deliver that while still staying very disciplined around capex is important and we're not seeing that people are waiting for things to be to be everywhere for MTBE and testing I do think that as we are going into various geographies around the world. It creates a.
We'll differentiation with us we're hearing, especially in markets outside of the United States, how they have salt left behind in.
In the in the AI space and an increasingly I think as Youre seeing with the executive order on AI with some of the European regulation on AI being able to keep AI. Local is we think going to be something thats, a real a real differentiation for us the vector database I think that's actually a good question.
To ask about and sort of got lost in some of the other other stories, but I think some of the more.
Sort of people who are paying attention.
Within the AI space recognize how how important that is being able to fine tune your models and have a database. That's built on top of the existing <unk> infrastructure that we have.
Is it something that.
Not only allows us to do inference, but actually allows us to do.
Fine tuning as well, which gives us sort of.
Two of the three major legs of the of the AI stool and and.
That's sort of my my Sneaky feature that I think is going to be pretty disruptive because you can use our vector database, whether you're using the rest of cloud players AI systems. It becomes a really great.
Function for.
AI users, who are wanting to do fine tuning and that combined with the locality that we can deliver.
With the workers AI system in inference.
Scattered around the entire world allows us to do something that is truly a complete AI ecosystem.
And that again, the AI developers that are paying attention asked the same question, which is that is Wow. How did you. How did you guys add at a vector database and the good news is again all of these things are built on a lot of the primitives that we had before we did have to go out and build something new we could put gpus and our existing servers, we could build vector is.
Vector database on top of our two and some of the other primitives that we had out there and and we could learn from the huge number of AI startups that are already using cloud player in terms of what tools they needed in their toolkit and that's what our team is delivering.
That's great. Thanks, Matt keep up the good math to keep up the good work.
Your next question comes from the line of Hamed <unk> from Morgan Stanley. Please go ahead.
Hey, good evening. Thank you for taking my question.
And congrats on a solid result in what's been a pretty tough environment.
Matthew.
You talked a lot about that.
And for an opportunity and a lot of great color. There could you just maybe level set and remind us of all the different sort of vectors for potential monetization over time talked about are too.
Potentially the vector database angle as well, but any others that we should consider and then maybe a follow up for Thomas.
A lot of this is sort of price on a more consumption basis. So.
As the demand starts to ramp should we start to see that more in a real time fashion as it relates to your revenue. Thank you.
Yes, I'll start and then and then Thomas Ken can add add to it I think there are three different areas in which we can see growth in delivery from from AI that the one where we.
We've seen it now for at least last 18 months.
Is just in our traditional products using cloud players security services to protect AI systems is absolutely critical and as you go to some of the leading.
AI platforms that are out there youll, often see cloud plus logo, our brick using AI systems ourselves actually to check to make sure youre at human being check to make sure that youre not a.
Threads before before letting you answer that I think is is just our bread and butter and what we can deliver very efficiently. The second area is with things like our two and charging for storage and again, that's going to be.
Storing the models storing the training sets for those models.
Using the fine tuning data with our two and vector is to be able to process. Those models and again that that's going to be much more bucket as you set a consumption based.
Approach and then the third way is that we're charging for inference and what I think is unique about us is because at core klesla is incredibly good as a routing and scheduling engine.
And that's how we're able to deliver.
The very high gross margins that we have compared with.
Some others in the space is that we just get a much higher degree of utilization and we pass that on to our customers and in this case the way that we're charging for our Gpus is termed by the industry of the server lists method of charging and what that means is we only charge you for when you're actually running an inference task.
And then we're able to schedule that very effectively across our entire platform and we think that that.
That's going to.
B.
Various.
As disruptive in this space as some of the things that we've done with workers have been.
And the traditional.
Space and Thats that something that is very attractive to AI developer. So I think those are the three ways that we see as monetization around this one is our traditional security products second is around storage.
Either training SaaS or models themselves or or the refining and fine tuning model systems or then the third is actually charging for what is effectively the compute capacity and doing that in a way that is again very disruptive compared with some of the other.
Providers that are in the space and we can we can often decreased peoples inference task costs pretty substantially while that's still being a very high margin business for us. So.
We're excited.
Coming back to your second question so today.
The shelf variable revenue.
Our overall revenue is very very low.
The ramp of the.
Service and products that match future pension would increase this share.
We've seen some of the strength actually in the third quarter from a revenue perspective already coming from variable revenue. So this is one data point, but not enough to make a good correlation of our trend.
With the highest share of variable.
With products and services that are priced variable you would see more.
You did impact on revenue for sure, but we don't have enough data yet to see how this will play out but the first time.
These are encouraging.
Thank you.
Your next question comes from the line of James Fish from Piper Sandler. Please go ahead.
Hey, guys. Thanks for the question you guys have talked a lot about AI here, but where are we with getting more shots on goal with more of a wave two products in network security in particular away.
Additionally, Thomas more for you while customers were good the dollars out of just we're a little bit lower than what we've seen in past few past few quarters.
Is that just being a reduction in contract durations, given the macro or what other aspects are impacting this and I'm sorry, if I missed this did you give an RPI number this quarter.
Yeah, Jim So I'll take the first step and then hand it off to Thomas for for the second I think we're seeing real strength around the network security.
And in our Zero Trust products, we've been recognized as leaders in those spaces by by a number of the key analysts that that's driven up the amount of interest the pipeline for those products is extremely strong and what we're seeing is that <unk>.
Increasingly customers want it.
Especially in the sort of making every dollar go further increasingly they want to say I don't just want to protect.
The back door of my business I want to protect the front door of the back door the side door and all of the doors in the business and so we are the one vendor that is able to give people that vendor consolidation that single pane of glass and I think that that comes through and a lot of the customer examples in stories that we've seen it so.
What we're seeing more and more is people want to buy the entire cloud platform they want to protect their entire business.
With that and Thats driving more interest in both our network security as well as our zero Trust products.
Yeah.
For the third quarter.
$1 billion, and 83 million and Thats part of my script.
Expansion is getting better.
<unk> ticked up one percentage point stabilizing I think thats, what we have been talking about in the previous.
Earnings call that we see bottoming out.
I would still say that it's easier to have new logo acquisition.
To expand with existing customers.
The trend we have seen that this might be impact that timing wise a budget wise by by current macro concerns I think still holds true it has not changed materially from the third quarter from the second quarter.
Awesome. Thanks, guys.
Your next question comes from the line of Ashwin, Rick Chris Sorry from Baird. Please go ahead.
Yeah. Thanks for taking my question congrats on the solid execution I'd, just like to switch gears, a little bit to Ddos.
So my two I mean of course cloud flares, a unique approach to to Ddos pricing definitely the first problem from the competition and sort of tying the price to the size of the attack you have opted for more customer centric approach. So just curious in today's elevated ddos landscape.
We're seeing that this flexibility kind of appreciated by customers and not being charged based on the scale of the attack is that becoming a key driver far stronger share gains and then I have a quick follow up for Tom.
Yeah. So so first of all.
The world is getting a lot more complicated and we're seeing.
Even nation state actors turning to Ddos attacks to disrupt.
The services around the world.
A new attack vector, which our team alongside Google and AWS.
Helped discover and announced this last quarter.
Generating attacks that are.
I mean literally almost doubling the total volume of traffic on the entire internet when when they are when theyre doing going forward and.
The nature of how we're able to stop those attacks in the architecture of how we're able to stop those attacks is very unique.
Two cloud side, and we're seeing even some of the large hyperscale public clouds that have their own <unk>.
Limited Ddos mitigation services point customers to us because we're the best in the world at assets and I think that that's.
That's a real differentiator for us the pricing also is important and what's unique is because every single server that is part of <unk> network can run every single service as we stop these massive attacks not only are we.
Again, better able to to technically.
Stop them, but we are then.
Able to do it without changing our underlying pricing because it doesn't drive up what our costs are early on we said that we should pass that advantage onto our customers and so we created pricing that was as you said very customer centric.
Appreciated by the market I think more and more people are leaning in on on Ddos and using us for that and what we're seeing is that then we can use that as sort of the milk in the grocery store, where we can sell other products across our suite and just like I said before customers.
Just want to protect the front door. They don't know what you want to protect the backdoor they want to protect all of the parts of our business and so we're seeing that having.
Collective solutions from a platform that can solve Ddos zero Trust WAF.
Right limiting bot management access control and how that all behind one single pane of glass is a very very very compelling offerings or somewhat starkly. If you look at some of the other zero trust vendors that are out there they are actually cloud with our customers using our ddos mitigation products because we are the best in the world in the world at them.
Great.
Super helpful. Just a quick follow up on what you said around zero Trust.
I agree your margin really allows you to kind of disrupt the market kind of enabling you to use pricing as a competitive advantage in and of course, we'll discuss the ddos pricing on zero Trust.
When you are bundling around around <unk>.
Just curious like it still seems like you guys are.
So pricing kind of similarly, uniquely worse as a market more attractively.
Just curious.
Are you thinking about kind of what's also going for like PMM optimum pricing.
Given where the market is given the strength of the demand.
And also try to push forward on the margin front is that a lever that you guys are thinking through.
I think that we can use price.
There is a as a weapon to wind business, we have tended not to see that theres a lot of price sensitivity.
There and so we're not we're not going to we're not going to just push that if we don't have to I think that the place that is more attractive is actually in how we create platforms, where you can have a complete network security solution.
And it's also really powerful that we can run our zero trust products at extremely extremely high margins for us actually the same reasons as as the Ddos mitigation products. We if you take all of the other zero trust vendors that are out there and add up.
While their traffic, we could add them all to cloud players network.
Without significantly increasing our underlying.
Cogs.
Delivering that traffic and so thats that gives us an advantage over time and we do believe that whoever has the lowest cost of servicing tends to win over the long term and that is something that is very difficult for any of our competitors in that space to match.
Got it makes sense so for household thanks a lot.
Your next question comes from the line of Alex Henderson from Needham and company. Please go ahead.
Great. Thank you so much.
Matt you guys continue to Amaze me.
In the ability to anticipate things.
567 years before they happen I think about the micro thriving.
Micro services in your server list platform as an example, and now you're talking about having lots of slots open for insulin say six years ahead of schedule.
It's pretty amazing.
Prescient.
I was hoping you could talk a little bit about the uniqueness of the platform as we move into the world driven by an prints AI.
It's pretty clear to me that the combination of the workers platform combined with the location of your edge.
Bind with all of the other elements of the service platform at the edge is your unique positioning, particularly with the <unk> two and the vectors stuff that you've announced so is there anybody else.
Has.
In our reasonable positioning to compete with you in that context.
As unique as you look to me.
In this competitive landscape.
Thanks for the thanks for the kudos.
And I.
I think we we sometimes are we sometimes are a little bit early and sometimes.
And for people, who are paying close attention almost three years ago, we actually did that announcement with Nvidia.
That was a trial balloon kind of in the space to see how much demand there was and at the time.
Wasn't a ton of demand.
But we can see how our models are improving in France is improving we knew that this was something which was coming.
And so we learned from that that first thing I think we built a really strong relationship with the Nvidia team in part because of that and some of the work that we've done with them in the networking space.
But I think that that we try to learn and stay and buy ourselves the flexibility over time to be able to to be able to deliver in this space I don't know of anybody else that has an architecture like ours, where we.
Made the hard decision early on to say every machine everywhere can run every task.
We don't have dedicated scrubbing centers. So that we don't have dedicated regions for one service or another.
It has required us to invent a lot of technology and.
And build a lot of intellectual property around that that technology and just just a lot of knowhow in running a network like that it is harder upfront to build it that way, but it results in a much higher level of efficiency a much higher level of <unk>.
Much faster pace of innovation.
And we're able to capitalize on that.
Today, and so I think it.
It would require a complete re architecture.
<unk> from any of the providers that we know in order to be able to do what we've done.
In this space and I think it's again part of the secret to our continued pace of innovation and again really proud of our team and everything that they've done to be able to deliver it.
One last question along the same lines if I could the.
Imprints AI market, how much of that do you expect to be at the edge and how much.
Do you expect within inference that might be in more centralized.
Or regionalized locations.
Yes, I mean, my my thesis around this is that.
Probably the most inference tasks will be run directly on your device. So on your on your Apple device on your Samsung device on your LG device.
Whatever that that is.
But ideally you're going to want to have it. So that you can seamlessly handoff, whether youre using a low power device that.
That needs to optimize for battery life for needs to optimize for the lowest build of materials or you're trying to run a task, which is so big and powerful that youre going to have to hand that off to a device nearby and so you want the rails between those things to be as seamless and efficient as possible and from.
A user's experience you're going to want that to be transparent to them and so I think the most powerful devices out there.
There are going to get more and more powerful with the models that are running on them.
Less powerful devices devices that.
Again have to have weeks of battery life, but still need to be smart.
Or the most interesting models that are bigger and can do more interesting things I think it's going to naturally makes sense for that inference to be actually running as close as possible to the end user I don't see a ton of reasons why you would run in <unk> back in some centralized location I think that that is going to have a.
<unk> penalty in doing that I think it's going to have a regulatory penalty in doing that I think it's going to also have actually a cost disadvantage in sending it back to a central location and so as we build this out and we give people the tools to be able to run those sophisticated models as yet I think it's a two horse.
Erase that it's going to be the phone and end device manufacturers that are that are going to get better and better and better over time, and then it's going to be the connectivity clouds like a cloud flare that are going to deliver on on those models that can run on the end device itself.
Super Thank you so much.
Your next question comes from the line of Mark Murphy from J P. Morgan. Please go ahead.
Thank you Matthew you have so many products that can help companies reduce the egress fees and all the other charges that are running up in their hyperscale are built.
And I was.
Thinking of Super Sleeper and Sippy in hyperdrive in some of the other products could you comment on the demand patterns, there and just.
Just whether you are benefiting from some of those optimization efforts out. There then I have a quick follow up.
Yes, I think that that's I mean, everyone today.
He is looking at their cloud Bill and saying how can we how can we make this go down how can we get more with every dollar that is being spent and as companies do that theyre realizing that one.
The best way to.
Not get just completely gouged by whoever your cloud provider is is not be completely dependent on them and have the ability to negotiate and move data and workloads from one provider to another and so enabling that multi cloud universe is just fundamental to how we think about what we're doing.
And then second to finding those places where.
You might be more locked in today and finding ways to release that that lock in and I think that's fundamentally what we're doing at cloud player as I talked about in the beginning.
The Hyperscale public clouds, the key kpis that they pay attention to is how much of a customer's data or are they holding on their systems do they hold captive, whereas the cloud players what we pay the most attention to is how much connectivity can we deliver how many things can we make it easy to move that data between.
And I think that fundamental difference, it's not so much that we're trying to compete directly with the clouds, but but over time, what we really want to do is enable customers to be able to get the best out of AWS, and Google and Microsoft and Oracle and IBM and Alibaba and Tencent.
And b that fabric that connects them all together and I think more and more customers are seeing the power of that their multi cloud whether they want to be or not and we are the consistent control plane that can sit between all of those things help them reduce their cost of them reduce lock in and really have a much more competitive cloud ecosystem overtime.
Thank you so much for that I really appreciate it and just as a follow up is there any rough math on the number of Gpus, you're loading into <unk>.
Suitcases two to install over the next 12 months and.
Should we assume that those are or that those can be some of the lower end gpus for inference, saying, they're they're they're not the ultra expensive high end ones.
I think what we.
We hear from customers is that they don't want to have to think about what GPU is is the right GPU.
For them and so we will have a mix of gpus today, where standardized around Nvidia, but where we are good friends with the folks at AMD and Intel and Qualcomm, We're all doing interesting things in different models from what we've seen perform differently on different types of of Gpus that are out there.
And so I think youll find every flavor under the Sun.
From from expensive to achieve <unk>.
Delivered across across the network, but what we're really trying to optimize for is looking at the models that are being run and then giving people the right tools that they need in a way that can give them. The best performance on not just our speed basis, but also on our cost and efficiency basis, and thats going to be.
Diversity across across that ecosystem, and and and we are good at being able to scale up our capacity as we have demand and investing behind the demand and and I think that this is going to be another area, where we demonstrate that.
Thank you very much.
Our final question comes from the line of Trevor Walsh from JMP Securities. Please go ahead.
Great. Thanks for squeezing me in here at the end Matthew I just wanted to piggyback, maybe how some of your last comments there on that final question than just the ones you had in your in your prepared remarks around the category classification of the connectivity cloud.
That makes total sense to me in terms of the strategic more CIL lens as far as kind of the benefits of being handed that connective tissue and kind of savings around our two kind of all of the things, but as you go and talk to see so that and especially within the context of your act too.
Product or products that you have zero trust and otherwise does that messaging and need to change a little bit or do you think they view it in the same way because I think they're kind of.
Obviously, the audiences and the kind of the overall value prop might be similar but different in some respects and just maybe help us understand how much that CSO respond or are in fact responding to that same connectivity cloud messaging. Thanks.
Yes, I think we.
We have been strong with sito's for some some time and they know us and they know the value that that we can deliver I think what we're trying to make sure that we have can have a strategic conversation with the CIO is in any and the cfos that are out there and say here's how we can.
Liver value help you consolidate vendors and give you one consistent control plane.
That is that has that incredible ROI to it. So I think we're I think we're we don't want to rest on our laurels. We've been very very strong with practitioners. We have been very strong in the security come in the security community, but we want to make sure that we can have that strategic conversation we had.
A record number of of.
Customers that.
Signed up with over $1 billion, a year with US we had a record number of the crops into that $5 million a year with us. This last quarter and those are those are conversations that have to be had.
The CFO even even in.
Even in large companies the CFO is going to be involved in signing 5 million dollar deals.
And so I think that the messaging is the right time and it reflects that we are talking to higher and higher levels within the organization and we are being seen much more of a strategic partner within within those companies.
That's great I appreciate it.
Yeah.
Thank you.
I will turn the call over to Matthew Prince for closing remarks.
I appreciate everyone at cloud player all of our customers partners and helping us navigate what is an increasingly complicated world. Our thoughts are with all of the people around the world that are being affected by war, we're continuing to deliver our services and stand up for the Internet and even in these incredibly complicated times.
The work that classic does is important in making sure. The internet can continue to thrive. Thank you all we will see you back here next quarter.
This concludes today's conference call. Thank you for your participation and you may now disconnect.
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