What Cloudflare (NET) Said on Its Q3 Earnings Call

Key Points

• Revenue rose 39% year over year to $782.5 million, with growth supported by large customers and developer-platform demand. Cloudflare forecast fourth-quarter revenue of $845 million to $846 million and said it expects to reach GAAP profitability that quarter, ahead of its prior timeline.
• Large customers made up 75% of revenue, and dollar-based net retention increased to 122%. Cloudflare added 308 customers spending more than $100,000 annually and surpassed 10 million active developers.
• Adjusted operating margin expanded to 17.5%, while gross margin declined to 72.4%, within the company’s long-term target range. Management cited demand for AI-development services and security products as growth drivers, while noting that newer “Act 4” offerings have begun generating revenue.

Cloudflare NYSE: NET reported third-quarter revenue of $782.5 million, up 39% from a year earlier, as growth in its developer platform and spending by large customers helped drive what management described as its strongest quarter as a public company.

The company also forecast fourth-quarter revenue of $845 million to $846 million and said it expects to achieve profitability under generally accepted accounting principles, or GAAP, in the quarter. That would be earlier than its prior goal of reaching the milestone by 2028 at the latest.

Co-founder and CEO Matthew Prince said Cloudflare posted its fastest revenue growth in nearly four years while achieving its highest operating margin. The company’s financial figures other than revenue were adjusted, non-GAAP measures unless otherwise noted.

Large customers and consumption drive growth

Cloudflare added 308 large customers during the quarter and nearly 1,000 over the past year, ending the period with approximately 5,000 customers paying more than $100,000 annually. Large customers accounted for 75% of revenue, up from 73% a year earlier.

Dollar-based net retention, a measure of spending by existing customers, rose to 122% from 120% in the prior quarter and 119% a year earlier. CFO Thomas Seifert said the company’s largest customers were growing the fastest, while “pool of funds” contracts were making it easier for customers to expand their use of Cloudflare products.

Cloudflare added more than 158,000 paying customers during the quarter, nearly double the previous record of more than 80,000 in the second quarter, Prince said. The company also surpassed 10 million active developers on its platform, up from 7 million in the prior quarter.

Seifert said variable revenue was the primary contributor to the quarter’s upside. Customers across a broad group were either joining pool of funds arrangements or using their commitments faster than expected and renewing earlier, often with larger commitments, he said.

Among the deals Prince highlighted were a one-year, $11 million Workers Developer Platform agreement with an unnamed AI company and a 13-month, $15.5 million Magic Transit contract with an unnamed Fortune 100 cloud infrastructure provider. A U.S. federal department also signed a five-year, $10.3 million contract for Cloudflare’s secure access service edge, or SASE, products, he said.

Profitability improves as gross margin declines

Adjusted operating income rose 60% to $137.1 million, with operating margin expanding to 17.5% from 15.3% a year earlier. Adjusted net income was $143.7 million, or 38 cents per diluted share. Free cash flow increased to $82.1 million from $75 million, although it declined as a share of revenue to 10% from 13%.

Gross margin fell to 72.4%, down 2.9 percentage points year over year, but remained within Cloudflare’s long-term target range of 70% to 77%. Seifert said the Workers platform carries lower gross margins than some other products but has significantly lower costs to book sales. He added that engineering work to improve compute efficiency could provide further benefits.

Remaining performance obligations, a measure of contracted future revenue, rose 34% year over year to $2.877 billion. Current RPO, representing 65% of the total, increased 37%.

AI services and security demand

Prince attributed the company’s momentum partly to demand for its developer platform as businesses build AI agents, as well as to concern about newly discovered security vulnerabilities. He said growth was broad-based across industries, rather than concentrated among AI companies.

Cloudflare recorded its first revenue in the quarter from what it calls “Act 4” products, which aim to support new internet business models. Prince said one existing service helps OpenAI identify when web pages have changed, allowing it to crawl more efficiently. He also discussed potential future micropayments for agent access to content.

Prince said he could not predict when those newer models would become major revenue sources, but suggested they could become Cloudflare’s largest business over a 10-year horizon.

Outlook and sales leadership

For the full year, Cloudflare forecast revenue of $2.963 billion to $2.964 billion, representing 37% growth. It projected adjusted operating income of $462 million to $463 million and adjusted diluted earnings of $1.35 per share. For the fourth quarter, it expects adjusted operating income of $156 million to $157 million and adjusted diluted earnings of 43 cents per share.

Cloudflare also named Christian Smith president of revenue, succeeding Mark Anderson, who plans to retire at year-end. Prince said Anderson will remain an adviser for at least the next year. Smith said his immediate priorities include strengthening sales execution and accelerating enterprise growth.

Discussing a restructuring earlier in the year, Prince said Cloudflare had reduced some management roles while shifting hiring toward employees who build and sell products. He said the company expects to end the year with more employees than it had before the layoffs.

About Cloudflare (NYSE:NET)

Cloudflare, Inc provides cloud-based services that help businesses and other organizations protect, connect and improve the performance of websites, applications and networks. Its global network delivers services including content delivery, domain name system management, and protection against distributed denial-of-service attacks and other cyber threats.

The company also offers web application security, bot management and Zero Trust services for securing access to applications and internal networks.

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