Cloudflare, Inc. (NET) Earnings Call Transcript & Summary

All right. Fantastic. I will go ahead and kick us off here on stage. Thomas Seifert, CFO of Cloudflare. Really grateful to you joining us multiple years in a row. Thank you for taking the time.

I'm aging, yes.

So I comment, I love that. I get to ask you this question because you're going to give me the most conservative possible response.

The most thoughtful.

Most thoughtful -- most balanced. We have a debate with investors on this concept of the inference economy which is the idea that, look, we're so early in agents and agentic capabilities that the best part of whatever product cycle is tied to agentic inference is still ahead of us. Now you're already putting up 36% growth at the very beginning of this product cycle. So if we would extrapolate out and say, look, the best part of Cloudflare's growth opportunity tied to workers, tied to SASE, tied to Act 4, it's still ahead of you. That would suggest directionally that the best part of your growth story is also still ahead of you. So talk to us a little bit about the framing there. Why would that not be true or what would we need to see to feel even better than it is going to be true?

Here, we -- one of our founders, Michelle, will make fun of her. Because every year, when we have kickoff for the year and talk about the targets for what is to come and how we approach the year, she says, we are only getting started. Now this is our eighth year as a public company. So the beginning of the year, she said at the eighth time, and I truly think that what she just said is true. When we think about our life in Act, Act 1, Act 2 at Act 3, Workers, Workers AI, we'll talk about it, Act 4, content protection, how we monetize it. We still -- we think that, that opportunity is dwarf -- is going to dwarf what is already behind this. Last year, we were sitting here, and agentic AI was still far away. The step-up of the LLM only came in November, and we were primarily concerned about convincing you all that our sales execution was on track. That productivity was coming that we felt comfortable investing in sales capacity, and that was driving the early steps of acceleration in growth in a quite significant way. Now I think we are what you described in the -- in this paradigm shift of what an agentic AI world is going to do to us. And we find ourselves at a point where the network, the architecture, the biggest competitive moat of Cloudflare, the network itself seems to be designed for what is going to come and support what agentic AI workflows are looking for, super low latency, secure sandboxes to execute code and so on. So what you look for are the signs that signal this early -- the early innings sign because of the architecture of the network and the benefits, developers are flocking to Cloudflare. So that is an early sign that I think is signaling this dramatic shift. Developer account was up 2 million developers quarter-over-quarter alone. You see that the acceleration of revenue is now happening in what we call variable revenue, right? So consumption-based revenue. Another big shift, I think, in the agentic world is that we move and disrupt SaaS from a seat-based metric into highly variable consumption-driven revenue. That is where we see acceleration. We're at a point now where pretty much all the large names of AI native companies, whether it's Lovable, Sigma, Anthropic, OpenAI, building on Workers on top of the network. And in one of the stats we gave at Investor Day was that we think about 80% of the significant AI enterprise infrastructure is a customer of Cloudflare. So all the signs you want to see. And there's one trend that I think is signaling what is going to come when we talk about Act 4. There was this vertical that we always were highly underrepresented, it was content creators. Media was always a vertical that was revenue weak at Cloudflare because there was not a lot of value for us, just moving pipes from one place to another, and they are now shifting towards Cloudflare to start to protect and make their content that they create scarce in order to generate leverage. So I think there are so many structural signs that signal what is coming. And that is, to be very honest, what gave us the confidence at Investor Day to raise our North Star, right? We said for many years now, 40% was our North Star, we shifted that to 50%. We'll exit this year with significant momentum in that direction. And I think there's clearly a world, and that is what we also said beyond '27 where we will live in a world beyond the Rule of 50. And that will be the result of acceleration Act 3 and Act 4.

Let me pick up on the network architecture comment that you just made. Many investors in the room will spend time at the hyperscalers. Hyperscalers will invest hundreds of billions in the CapEx guidance to be able to support training clusters, but also inference clusters and there's some debate around mix between training and inference that we'll leave aside for now. The interesting thing about Cloudflare is you were not investing hundreds of billions of dollars and yet you have this product cycle and compute tied to inference in the -- at the edge. So maybe square that cycle for us.

Well, a big part, I think, is already what you mentioned. When the CapEx was started, we said training is not our world, at least not at this point in time, not for the super large models, things might change as models get smaller and maybe run even more on-premise, on enterprises, on open models. Our world is inference. Inference is an interesting, interesting world, right? When we talk about AI, it's in the larger extent the GPU-driven discussion. There was a very interesting part at Investor Day in Rita's presentation on how important CPU capacity is in order to orchestrate agentic AI workflows. Where does the data come from? Instruction, what needs to get computed? What API needs to get access? That is our world. That is what Cloudflare's network is today already. A reason why our gross margins used to be so high and still are high, because we really understand well how workloads get scheduled. That allows us really to take that strength into this AI world of inference where we think GPU is important, but the demand curve is really bending when it comes to CPU and memory capacity, and that's where we excel. In this world of inference, I think an important advantage for us is that we do not have to provision ahead of demand, right? Two years ago, when we started work on Workers AI, I mean, there were so many questions. When will we see revenue? What is the pricing? And we always said, it's not what's important. What is important is to get as many developers on the platform. We need -- we want to understand the variety of inference workloads because that is what we need to optimize, right? We need to understand what hardware stack we have to put in place and learn how to schedule AI workloads in a way that gets us to utilization that is similar to our Act 1 and Act 2 products. That work is now paying off, right? We have made a tremendous progress on how we schedule inference workloads on CPU capacity, it doesn't mean, we don't need GPU capacity, we deployed GPU capacity pretty much in all of our PoPs in all of our data centers. But that is the strength we built from based on the fact that this investment can follow a demand signal, and we do not need to provision ahead of it. It also means, that doesn't mean that our CapEx will stay low. CapEx can go up but it will go up in conjunction with me telling you that revenue is going to come up, too. So we are quite comfortable that the CapEx efficiency is going to hold for a while.

You said something interesting there, which is the training opportunity may change as models get smaller or not quite the training opportunity, but there is a scenario where the industry evolves and if we're training smaller models, maybe Cloudflare has a role in that. Maybe just elaborate on that on what you mean...

I don't want to go too far there and get ahead of my skis. But what I think is that how you optimize -- smaller models and open models will put pressure or pricing pressure on tokens. And how you cope with that from a revenue perspective, right? In order to get throughput up, so you can have -- you optimize revenue in a different way. I think it's going to be really interesting, and I think this is our playground. So it will play -- it will be another vector that will play to our strengths, whether that is inference or early training adoption of models to enterprise-specific use cases. On enterprise-specific data, maybe even on-premise in order to make sure that the data leakage is contained.

We're actually hearing more about this idea that enterprises could bring more compute on-premise. So maybe pick up the thread there. What do you think the opportunity is for Cloudflare, whether it's on the sovereign SASE side or more on the on-premise compute side?

Well, we were just debating on centralized large data centers versus a highly decentralized network. That is what we are, right? We drove data sovereignty and data privacy products from a very different perspective before AI was even a topic. Those products are now are the basis of making sure that either critical infrastructure customers -- sovereign nation customers, federal business in parts of -- in friendly parts of the world can contain their data privacy and data sovereignty risk. We are built for that. You literally can wrap something around a byte of data. You're a citizen of Zurich and your credit card can only move between those 2 cantons, and can only be on a data center of that security level. That is what the network was built for, and that's why we think this will be another growth vector that will play well for us.

Absolutely. Okay. I want to ask you about Act 4. And if I think about some of the products that you've announced around identity payments gateway, one of the comments that Matthew has made is, look, one of the reasons this has become important to Cloudflare is because the existing payments network don't give you the throughput that you would need to support agentic transactions at scale. I would otherwise have been skeptical about Cloudflare's ability to build all of these pieces of infrastructure, but for the fact that you've done bold things with your architecture before and you have Stephanie Cohen driving some of this for you. So talk to us a little bit about what the building blocks are to be able to actually realize the vision on agentic payments, agentic transactions, Pay Per Crawl, Act 4.

Let's start with Pay Per Crawl, right? This is how it all started when we saw that crawl rates and links were completely diverging and content creators lost an opportunity to monetize the content that they created. These were the early innings of Act 4. And we started with established products like bot mitigation of our tool in order to give content creators a tool to make their content scare and put them in a position to negotiate for people paying for crawling their content. This is how it all gets started. There are 2 sides of the situation. Meanwhile, we are working on both sides. You probably saw our announcement -- research announcement with OpenAI to index what we have -- today, LLMs crawl literally every page that is important every minute because they don't know what changed, right? And you don't want to miss that an important football player dropped out of the game 2 minutes before it starts, but this costs significant of money, bandwidth that ultimately stayed by the content creators. So more than 20% of the [ bet ] is behind us, we can signal what changes. We know what changes. We know what has refreshed and that is valuable knowledge for the LLMs that they are ready to pay for because it contains the complexity of what they need to do. It reduces the cost and it makes our friendly ecosystem. So significant progress. Now we talk about how we monetize transactions. And when 20% of the [ bet is ] or more is behind on our network when all these agentic AI agents and workflows go to our network, we are in the flow of what commercial transactions are going to come and you want to be a part of it. So we announced a couple of products that our first step in that direction. We announced what we call monetization gateways, so content providers can literally sell what they have. We introduced Cloudflare Wallets, which allows you and your agents to have autonomous transactions. We announced identity tools, and there's more to come. The big lift to be honest, is still in front of us because Matthew, I think, gave some stats on the last earnings call, we had of how many, 10,000 transactions per second, a significant payment provider today is able to handle that is literally in the 10,000s of transactions. We think we need to be in the millions or tens of millions of transactions in small value, high volume on our network, another -- and we are quite excited about that. There's significant effort going in that direction together with partners. Literally every credit card, every large fintech company is part of this effort. So we think that is why it all accumulates to Act 4 being probably the biggest opportunity that is still in front of us and it's going to dwarf whatever we have done so far.

Say more about the heavy lifting to realize the vision. You mentioned -- do you already have the ability to do the throughput at the hundreds to thousands, millions?

We are not at the millions yet. This is work in progress. There's engineering -- significant engineering effort going in that direction, yes.

What about from a partnership and an ecosystem standpoint?

All the partnerships announced. There's Visa and there's Mastercard, there's American Express, there's PayPal, there's Coinbase. So it's a large set of partners that need to come together, but will provide the infrastructure in order to enable that, yes.

When is the right time for us to get excited about seeing it in the numbers?

Well, remember, it's about building a durable business model, right? So we pace our time in light of the opportunity. We cannot take this lightly, processing millions of transactions per second that will be a responsibility and obligation. We want to make sure that the tech is ready for it. And there's still so much earlier stuff that needs to happen that gets us excited when we talk about Act 3. So I think that acceleration is coming, and we're in a good track.

This is a little bit of a framework monetization question for you. So when I think payments, I think, 275 basis points as a take rate. This is a little bit interesting because I guess you could do it as a take rate model. You could do it as a per transaction model. What are some of the things going through your head?