Cloudflare, Inc. Q3 FY2025 Earnings Call

Thank you for being here. My name is Greg, and I will be your conference operator today. I would like to welcome everyone to Cloudflare’s Q3 2025 Earnings Call. I will now turn the call over to Phil Winslow. Phil?

Thank you for joining us today to discuss Cloudflare's financial results for the third quarter of 2025. With me on the call, we have Matthew Prince, Co-Founder and CEO; Michelle Zatlyn, Co-Founder and President; 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 a 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 the timing and market potential of those products, our 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 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 RBC's Global Technology, Internet, Media and Telecommunications Conference on November 18 and Needham's 6th Annual Tech Week on November 24. Now with that, I'd like to turn the call over to Matthew.

Thank you, Phil. We had an extremely strong Q3. We achieved revenue of $562 million, up 30.7% year-over-year. Great companies innovate and execute, and I think we owe our reacceleration of revenue growth to doing both these things very well. We now have 4,009 large customers, those that pay us more than $100,000 per year, a 23% increase year-over-year. Revenue contribution from large customers grew 42% year-over-year, contributing in total 73% of our revenue during the quarter, up from 67% in the third quarter last year. Our dollar-based net retention was 119%, up 5 percentage points quarter-over-quarter. Our gross margin was 75.3%, within our long-term target range of 75% to 77%. We delivered an operating profit of $85.9 million, representing an operating margin of 15.3%, and we generated strong free cash flow of $75 million during the quarter, again exceeding expectations. Our go-to-market transformation, evolving from purely product-led growth to true enterprise sales, continues to track along. Growth in net capacity of our sales force grew at its fastest pace year-over-year in more than 2 years. Sales productivity increased year-over-year for the seventh consecutive quarter. Close rates ticked up notably both year-over-year and quarter-to-quarter. Bookings from partner-initiated opportunities doubled year-over-year. Gross retention levels increased year-over-year and quarter-to-quarter. And new pipeline attainment again exceeded our expectations. Across the company, the team is firing on all cylinders. One bit of disappointing news is that CJ Desai is going to be leaving Cloudflare. CJ called me some time ago to talk about an opportunity he's been approached to be the CEO of an exceptional public technology company. He was torn because he loved his team, the work, and the mission at Cloudflare. But since his first job in technology over 25 years ago, he dreamed one day of being the CEO of a great public company. We talked through the opportunity, his career goals, and what's great and not so great about being a public company CEO. In the end, while I'm sad to see him go, I'm excited for him to get to helm his own ship. I want to give CJ an opportunity to say something on this call, in some ways, as practice for his many earnings calls to come. CJ?

Thank you, Matthew. This was an extremely hard decision for me as I love the team and mission of Cloudflare, and I see incredible opportunities ahead. I really appreciate the support as I figured out what was right for me. This job at Cloudflare is the coolest Product & Engineering job in tech today. And I will help ensure whoever fills the seat next will be world-class. I'm incredibly bullish, as you know, on Cloudflare's future. I'll miss you all, but will always be among your biggest fans.

Thanks, CJ. I appreciate how you brought a customer-first focus to Cloudflare's already powerful innovation engine. That's made us a better company able to win bigger deals. It's now part of our DNA that you deserve credit for having helped shape. And while I'm bummed you're leaving, I'm proud that Cloudflare is a place that has trained the leaders of other great technology companies. You're our second product leader in a row to be recruited away to be CEO somewhere awesome. We can't say yet where you're going, but they're lucky to have you, and I have no doubt you'll bring some of Cloudflare's relentless culture of innovation to them. With that out of the way, let's talk about some of our wins in the quarter. A Global 2000 digital media platform expanded its relationship with Cloudflare, signing a 3-year $22.8 million pool of funds contract for application services and workers. This contract marks the culmination of a powerful comeback story. We actually lost this customer to a competitor in 2016, but the Internet and Cloudflare evolved. We earned their trust back in 2023, starting with our Zero Trust portfolio. During 8 months of testing before signing this deal, our world-class security, unmatched product breadth, and powerful Workers platform ran circles around the incumbent. But that's not the whole story. The decisive factor of the win was AI. This customer looked at the landscape and correctly identified Cloudflare as the only company building the essential platform to protect and manage content for the emerging AI-driven web. This strategic win established us as the customer's clear forward-looking partner and creates a direct on-ramp for Pay Per Crawl, which could transform Cloudflare from a vendor they pay for services into a powerful revenue generator for their business. We and they believe that this is what the future looks like. A leading European technology company expanded its relationship with Cloudflare, signing a 5-year $34.3 million contract, representing an upsell of $6.8 million for Workers platform and application services. This customer is fully redesigning their architecture to move their front end onto Workers and Durable Objects. The decision to commit to a 5-year term underscores the customer's view of Cloudflare as a critical long-term strategic partner. A rapidly growing media platform expanded its relationship with Cloudflare, signing a 3-year $15 million contract for Workers and Application Performance. This customer was experiencing significant egress fees, high latency for its global customer base, and vendor lock-in with a hyperscale public cloud provider. Moving to Cloudflare will enable data to be processed and served closer to their end users, delivering superior performance and eliminating egress fees. With our unified platform, this customer will be able to drive down their total cost of ownership by more than 30%. A Fortune 500 financial technology company expanded its relationship with Cloudflare, signing a 2-year $16.1 million pool of funds contract with an upsell of $4.6 million for application services and workers. As a textbook land-and-expand journey across 3 apps, this customer started with Cloudflare's application services in 2022, expanded with our Zero Trust platform in 2023 and has been adding a number of products from our Workers platform over the last 2 years. Another Workers deal is already underway for AI use cases. A Global 2000 European pharmaceutical company expanded its relationship with Cloudflare, signing a 3-year $12.4 million contract with an upsell of $4.5 million. This is a great example of platform adoption as the customer is utilizing products from our first 3 apps: application services, SASE, and Developer. This customer views Cloudflare as a critical strategic partner choosing to displace services from 2 hyperscale public clouds and multiple-point solution providers because according to them, 'It's so much easier to build on Cloudflare.' A U.S. cabinet-level agency expanded its relationship with Cloudflare, signing a 2-year contract exceeding $20 million for our complete FedRAMP portfolio. The agency is standardizing its network and security platform on Cloudflare, displacing over a dozen legacy point solutions and generating more than $10 million in annual cost savings. We are seeing more traction than ever before across U.S. government as it looks to modernize its digital infrastructure. A Fortune 100 financial services company signed a 3-year $4 million contract for Magic Transit and Advanced Magic Firewall. Recent outages, capacity limitations, and a lack of automation features with 2 legacy incumbents left this customer with DDoS vulnerabilities at their network layer in a time when we're seeing new record-breaking DDoS attacks every few weeks, like the nearly 30-terabit per second attack we mitigated earlier this month. Cloudflare won because our fundamental architecture advantage gives us literally 4x the capacity of all our scrubbing center-based competition combined. As the Internet gets scarier, customers are realizing Cloudflare is the only network engineered to survive. A global industrial company signed a 3-year $2.2 million contract for a complete SASE portfolio, including Access, Gateway, Browser Isolation, CASB, DLP, Magic WAN, and Magic Firewall to consolidate and modernize their security stack. We're displacing a first-generation Zero Trust vendor as well as a legacy on-premise VPN provider, which were expensive and difficult to maintain across their global operations. This customer chose Cloudflare for the operational simplicity of our unified platform that delivers both superior performance and significant cost reduction. A global web infrastructure platform expanded its relationship with Cloudflare, signing a 14-month $1.2 million contract for AI Crawl Control and Bot Management. This customer is experiencing a massive surge in AI scrapers and malicious bots hitting their origin servers, inflating costs without revenue conversion and obscuring visibility into legitimate traffic. They selected Cloudflare for our innovative best-of-class bot blocking capabilities in addition to seamless expedited deployment by our deep platform integration. We're already exploring a much larger opportunity with this customer for Pay Per Crawl. We talked last quarter about how the rise of AI would impact media companies. Cloudflare has emerged as a strategic partner to these firms as they work through what the new business model of the Internet will be. But it goes beyond just media. Businesses of all shapes will be transformed by the rise of AI. I don't think people yet appreciate how AI is another massive information consumption platform shift. Just as we moved from consuming information via a browser on a desktop to social media and then to apps on mobile devices, AI is another information consumption platform shift. It changes where and how we will consume and interact with information. With the last 3 platform shifts, the business model of the Internet remains the same: create content, generate traffic, and then sell things, subscriptions, or ads. With AI, for the first time in a long time, the fundamental business model is going to change. Human eyeball traffic is unlikely to be the currency of the Internet's future. We already can see glimpses of that future. It's represented in SciFi. When George Jetson asks his helpful robot Rosie for a recipe for cookies, the response isn't 10 blue links to hunt through; it's a recipe for cookies. Most of us are increasingly living in some version of that future now with tools like ChatGPT, and it seems inevitable that more and more commerce will be facilitated by AI-powered agents working on our behalf. As that happens, new questions will arise. What happens to small businesses? What happens to brands? Brands, of course, are just shortcuts for humans to assess quality and value. What do they mean in the world of agentic commerce? I don't know what the future business model of the Internet will look like, or who the winners and losers will be, but I do believe Cloudflare will help shape it. We estimate 80% of the leading AI companies already rely on us. A huge percentage of the Internet sits behind us. The agents of the future will inherently have to pass through our network and abide by its rules. And as they do, we will help set the protocols, guardrails, and business rules for the Agentic Internet of the future. And we'll make sure the tools to participate in that future are available to all businesses, large and small. It's what we've always done. Again, we don't know exactly what the future will look like, but I believe Cloudflare will be one of the key players helping shape it. What we are playing for is a world with as many AI companies, media companies, and businesses, large and small, competing fairly to best serve customers anywhere and everywhere they and their agents transact. I'm really excited for that future, and I'm optimistic about it. But to bring it back to the present, let me hand it off to Thomas to walk through this quarter's financials. Thomas, take it away.

Thank you, Matthew, and thank you to everyone for joining us. We are pleased with our strong third quarter results that underscore how our strategy for delivering continued innovation and accelerating growth while also maintaining a relentless focus on operational excellence is working. Revenue growth accelerated for the second consecutive quarter to 31% year-over-year, providing clear evidence of the momentum building in our business. We complemented this robust growth with a highly balanced operating plan, investing significantly in our innovation pipeline and expanding our go-to-market capacity while simultaneously remaining committed to the strong unit economics of our business to drive operating leverage and deliver compounding shareholder value. Turning to revenue. Total revenue for the third quarter increased 31% year-over-year to $562 million. From a geographic perspective, the U.S. represented 50% of revenue and increased 31% year-over-year, which is up nearly 10 percentage points sequentially. Growth in the U.S. region was primarily driven by strength with partners, our workers developer platform, and large customers, including pool of funds. EMEA represented 27% of revenue and increased 26% year-over-year. APAC represented 15% of revenue and increased 43% year-over-year. Turning to our customer metrics. In the third quarter, we had approximately 296,000 paying customers, representing a record net addition of nearly 30,000 paying customers sequentially and an increase of 33% year-over-year, driven by an uptick in customers, including those graduating from the free tier to small paid accounts for developer platform products around our AI Week and birthday week. We ended the quarter with more than 4,000 large customers, representing an increase of 23% year-over-year. Revenue contribution from large customers increased to 73% of revenue during the quarter, up from 67% in the third quarter last year. We again saw particular strength in our largest customer cohorts. For the fourth consecutive quarter, we added a record number of our largest customers year-over-year, those that spend over $1 million and $5 million with Cloudflare annually. Accelerating sequential and year-over-year revenue growth from both of these cohorts served as a significant tailwind to our expansion business. As a result, our dollar-based net retention rate accelerated to 119% during the third quarter, up 5% sequentially and 9% year-over-year. Moving to gross margin. Third quarter gross margin was 75.3%, remaining within our long-term target range of 75% to 77% and representing a decrease of 100 basis points sequentially and a decrease of 350 basis points year-over-year. During the third quarter, paid versus free customer traffic again increased both year-over-year and quarter-to-quarter, resulting in a higher allocation of expenses to cost of goods sold from sales and marketing. Our Workers developer platform continues to deliver outsized growth with the world's most innovative companies increasingly adopting Workers for running AI inference tasks as well as building AI agents and full-stack applications. While the relative revenue contribution across our 4 Acts can impact near-term gross margin, the unit economic margin of our business remains very consistent. Network CapEx represented 14% of revenue in the third quarter. We expect network CapEx to be approximately 13% of revenue for full year 2025. Turning to operating expenses. Third quarter operating expenses as a percentage of revenue decreased by 4% year-over-year to 16%. Our total number of employees increased 16% year-over-year, bringing our total headcount to roughly 4,800 at the end of the quarter. Sales and marketing expenses were $201.2 million for the quarter. Sales and marketing as a percentage of revenue decreased to 36% from 37% in the same quarter last year. Research and development expenses were $82.5 million in the quarter. R&D as a percentage of revenue decreased to 15% from 16% in the same quarter last year. General and administrative expenses were $53.5 million for the quarter. G&A as a percentage of revenue remained consistent at 10% compared to the same quarter last year. Operating income was $85.9 million, an increase of 35% year-over-year compared to $63.5 million in the same period last year. Third quarter operating margin was 15.3%, an increase of 50 basis points year-over-year. Turning to net income and the balance sheet. Our net income in the quarter was $102.6 million or diluted net income per share of $0.27. Free cash flow was $75 million in the quarter or 13% of revenue compared to $45.3 million or 11% of revenue in the same period last year. We are comfortable with consensus free cash flow estimates for the fourth quarter of fiscal 2025. We ended the third quarter with $4 billion in cash, cash equivalents, and available-for-sale securities. Remaining performance obligations, or RPO, came in at $2.143 billion, representing an increase of 8% sequentially and 43% year-over-year. Current RPO was 64% of total RPO. Moving to guidance for the fourth quarter and full year 2025. For the fourth quarter, we expect revenue in the range of $588.5 million to $589.5 million, representing an increase of 28% year-over-year. We expect operating income in the range of $83 million to $84 million, and we expect an effective tax rate of 20%. We expect diluted net income per share of $0.27, assuming approximately 377 million shares outstanding. For the full year 2025, we expect revenue in the range of $2.142 billion to $2.143 billion, representing an increase of 28% year-over-year. We expect operating income for the full year in the range of $297 million to $298 million, and we expect an effective tax rate of 20%. We expect diluted net income per share over that period to be $0.91, assuming approximately 370 million shares outstanding. In closing, the strength of our third quarter results confirms that our strategy to deliver continued innovation with accelerating growth and strong unit economics is driving significant and measurable value. At the beginning of the year, we committed to reaccelerating revenue growth over the course of 2025 on the way to our goal of achieving $5 billion in annualized revenue by the fourth quarter of 2028. Our performance over the last 2 quarters demonstrates that we are effectively executing against both of these objectives. In fact, we expect to reach a $3 billion annualized revenue run rate in the fourth quarter of 2026 on our journey to $5 billion and beyond. This trajectory reinforces our conviction in our strategy and our ability to deliver exceptional long-term value for our shareholders and customers. Before opening it up for questions, I would also like to extend my personal thanks and congratulations to CJ. The processes, discipline, and leadership bench he established at Cloudflare will enable our innovation engine to continue to scale well beyond his tenure. All of us at Cloudflare wish CJ continued success in his next chapter. And with that, operator, please poll for questions.

And our first question today comes from Matt Hedberg with RBC Capital Markets.

Congrats on the results. And CJ, we look forward to hearing about your future role. Matthew, there were a lot of strong metrics this quarter, but 43% RPO growth that accelerated. I think that was the highest RPO growth that you guys have reported since 2022, certainly stood out. I'm wondering if you could provide a bit deeper dive into what drove that acceleration this quarter.

Yes. I'll start, and I think Thomas can probably add to it as well. I think we try to be a place that says what we do and do what we say. And so I think the real thing that's happening is we are transforming from being a product-led growth company to being a true enterprise sales company. So you're seeing the average tickets tick up. You're seeing the large deals tick up. And that's driving just success in taking what have always been exceptional products and getting them in the hands of customers. And so I think our sales team deserves a lot of credit for really just driving great execution.

What I would add is that the RPO growth points to primarily two drivers: customer quality and platform expansion. We are seeing exceptional strength with our large customer cohorts, specifically those that spend more than $1 million or $5 million with us, both of which delivered record growth this quarter. Additionally, there is increased consumption among our large pool of fund customers, demonstrating the growing strategic importance of our platform for large enterprises globally. Furthermore, our Workers platform, including Workers AI, is proving to be a significant new avenue for long-term commitment and growth.

That's great. Actually, could I double-click just Thomas, you mentioned the pool of funds, and I know you mentioned in your prepared remarks. But specifically, like how is that showing up in the results? You introduced that several, I think, years ago at this point now. But how is that driving some of this as well?

The share of pool of funds deal this quarter was again up. It's now low double digits of total ACV. And we are seeing now across our pool of funds contracts an extremely balanced consumption of these contracts. On average, we're slightly ahead, and that delivered a strong performance in the quarter. So if you have a platform like ours with more than 55 revenue-contributing products now, you need a vehicle that allows frictionless adoption and consumption of these products. And I think the sales team and the organization at Cloudflare has become quite good at deploying these contracts and driving consumptions with customers.

The other thing that I'd add is I think where we saw downward pressure on things like dollar-based net retention as we rolled out pool of funds. As those pools are now getting consumed, you can see our dollar-based net retention is ticking back up. And so I think pool funds will show up in RPO, pool of funds as it initially puts downward pressure on things like dollar-based net retention, but you can see that, that's now ticking up again. And so just to reiterate what Thomas said, these are an indication of customers trusting us as a strategic vendor, making larger, bigger bets on us, and it is an undoubtedly positive sign for us as a strategic vendor to more and more large customers.

And our next question comes from the line of Adam Borg with Stifel.

Maybe for Matthew, on the sales productivity gains, it's been great to see that continue. Are we at a point now where these gains are beginning to flatten out? Or is there still room for this to continue to trend higher in the coming quarters?

I believe that productivity will keep increasing in the upcoming quarters. The quality of the team we're bringing on board and their capability to secure larger deals contribute significantly to the enhanced productivity of the sales team. We see potential for further growth. Additionally, starting last quarter, we've seen an improvement in the ramped rep capacity. We've successfully navigated a period of restructuring the sales team, and now we are seeing the positive outcomes from those changes.

That's great to hear. And maybe just as my follow-up, it was really interesting to see a few weeks back the integration with Oracle OCI that was announced. Maybe talk a little bit about what advantages does it provide to those OCI customers?

Yes. So we're really excited to work with Oracle. They've been a terrific partner for us over the years. They evaluated Cloudflare's products and realized that we were really the best of breed for what they could offer to their customers. And so Cloudflare will be natively available within Oracle's OCI platform, including across hybrid, multi-cloud, and OCI hosted workloads, which gives us access to a large pool of customers and gives Oracle's customers access to Cloudflare's world-class tools. I think one of the things that we're particularly aligned on is that we and Oracle both see the future as a multi-cloud future, where customers are going to have many different cloud providers. And what they need is one consistent interface where they can apply security rules and have consistent network performance. And Cloudflare is the best in the world at doing that. And so I think the fact that we have been able to work with Oracle, integrate our products directly into Oracle and Oracle's customers are going to be able to enjoy the benefits of that. That's great for us, but it's also great for Oracle, and we're excited to have them as an even more deeply integrated partner.

And our next question comes from the line of Gabriela Borges with Goldman Sachs.

Congrats on the quarter. Matthew and Thomas, I wanted to revisit your comment from earlier in the year about doubling your network capacity this year. So my question is, do you think that you're capacity constrained in Workers? To what extent are the capacity decisions that you're making this year essentially dictating a range of outcomes on what Workers revenue could be next year? And I know you have some really interesting thoughts on fungibility of workloads between CPUs, older gen GPUs, and newer gen GPUs. So I would love to hear your comments there as well.

Sure. I don't think we're capacity constrained because of somewhat the nature of how we've architected Cloudflare and the philosophy of how we make CapEx and network investments. We always have tried to invest behind demand, not ahead of demand. And the thing that allows us to do that is that what we are selling is not a particular box in a particular place or a fraction of a particular box in a particular place. What we're selling is the ability to get work done across our network. And so Cloudflare itself is effectively a giant scheduler where we can move workloads to wherever we have capacity anywhere in the world. And the nature of the network is that it's always somewhere, it's the middle of the night and there's always excess capacity there. Now that's not ideal, but the good news is that for some of our smaller customers or low-end customers or free customers, we can move them to places across the network that have that free capacity, still gives them great performance. but then reserve the capacity that we have as close as possible to our largest customers. As we see that growth, that then means that we can invest behind it and be able to just make sure that we're getting the most utilization possible. The other thing that I think is unique about us is that certainly versus the hyperscalers, the primary business of the hyperscaler is to essentially rent you a server or a fraction of a server, and they try to effectively get whatever they pay for the server back 5x over the life of the server. That's their business. Whereas we're about, again, getting work done for our customers. We're selling something different, which is a sort of level of abstraction up from that. What that means is that we believe it's our job, not our customers' job to make the utilization rates as high as possible, make our systems as efficient as possible. And so it's been remarkable to see over the last 15 years, how our team has been able to squeeze as much as possible out of the CPU capacity that we have, where we can run that CPU capacity at 70% to 80% utilization and get more out of every CapEx dollar we spend. But what's fascinating is we're sort of speed running the last 15 years now with GPUs, where we're figuring out how to make GPUs multi-tenant, how to make them load and unload models more quickly and driving the utilization of GPUs up substantially. And so that is still well below what we have with CPUs, but we see no reason that we can't get GPUs also up to that 70%, 80% utilization. And that, again, just means that every CapEx dollar that we spend, both can be behind the demand that we see and then secondly, that we'll get more out of it, more effective value out of it for the services that we're delivering our customers versus some of the legacy hyperscaler models.

The additional point I would make is in addition to what Matthew said is that the supply chain within Cloudflare is so optimized to a large degree because we use off-the-shelf equipment and parts that we can deploy hardware, especially in Tier 1 cities and generate revenue even before we start to pay for the equipment. So not only do we have the flexibility that Matthew described really well at length, our reaction time to deploy hardware where we need it is really, really fast.

That makes sense. The follow-up is on competition for Cloudflare in the enterprise for securing those inference workloads and winning those inference workloads in particular. Matthew, I would love to hear you comment on how do you think competition is evolving in the enterprise as you build out some of the breadth and depth of your functionality? And on the flip side, are you seeing anything new from newer platforms, newer cloud platforms that are AI native or inference focused?

I think that the primary competition for inference workloads continues to be the hyperscalers. And it continues to be the model of do you want to do this work yourself and have to optimize yourself or do you want to hand it off to Cloudflare. And I think in the cases where we're in the conversation, we're able to show that there's just a much better TCO, total cost of ownership, a much lower cost, and much better performance when we manage that for you. And so there's kind of a standard way people do things, which is the hyperscaler way. We're having to teach them that there is a different way that's out there. But the primary competition still comes from the hyperscalers. And I think that we are finding, though, that once somebody learns that there's a better way, Cloudflare is very, very sticky, and we keep those customers over the long term.

And our next question comes from the line of Shaul Eyal with TD Cowen.

Congrats on the quarterly results. So many new product announcements in recent weeks during Cloudflare Connect and Birthday Week. Specifically, Matthew, I wanted to ask about NET Dollar. We have received many questions about this product. It could become a meaningful long-term growth driver. How should we think about the regulatory framework around it? And what has been maybe the early reception kind of out there? And maybe along these lines, my follow-up will be maybe a word about AI gatekeeper. I know you started discussing it more vocally last quarter. Lots has changed over the past few months. You've indicated some initial activity, some contract wins around the guardrails from publishers and AI companies. So can you talk to us about what has changed in recent months? And is there anyone else out there emerging with a similar offering?

So let's begin with NET Dollar. As we have engaged with AI companies, merchants, media companies, and the broader range of the Internet, we realized that as we enter an era of agentic commerce, we will need a specific currency for transactions between agents. This is the foundation of our NET Dollar project. We are unlikely to tackle this entirely on our own due to various regulatory issues, but there are numerous opportunities. For instance, Stephanie Cohen on our team understands the complexities of the financial services sector, and we are approaching this with care. We believe we can implement a solution that both promotes agent-to-agent commerce and aligns with regulatory standards in the U.S. and globally. However, this is just one of our initiatives in this space. We aspire to serve as the universal translator of AI, compatible with protocols like MCP, Anthropic, Google, and Microsoft's versions, with Cloudflare supporting all of them. Besides the enthusiasm surrounding NET Dollar, I am also excited about our collaborations with Coinbase on X402, as well as with Visa, Mastercard, and American Express to enable agent-to-agent payments. Cloudflare aims to facilitate connections across the network, regardless of the context. While we see potential advantages in NET Dollar, we want to ensure we support all options, catering to customers, merchants, and media companies of all sizes. This approach is unique, reflecting our commitment to multi-cloud solutions. We recognize that there will be various payment methods and agentic protocols, and many AI companies will collaborate with diverse media and businesses to create a smoother, AI-driven commerce future. We envision ourselves at the core of this evolution. Regarding your question about gatekeeping, we have a product called AI Gateway, but I understand you are inquiring about how we assist media companies in developing future business models. We are witnessing positive results in this area, with a strong number of media companies signing up and reporting improvements in their deals with AI companies. While we will face competition, our substantial investment in public policy has positioned us as thought leaders on the future business models of the Internet. This expertise has opened dialogues not just with traditional media but also with banks, which are experiencing declines in research payments due to AI advancements. This situation is prompting discussions with financial services. Brands are expressing concerns about their identity in the future of agentic commerce, as are small businesses. My passion lies in ensuring that everyone has an equitable opportunity to participate in this new paradigm. Therefore, we will continue to provide our tools to all, regardless of size.

And our next question comes from the line of Fatima Boolani.

Matthew, I wanted to ask you about the AI native ecosystem. It is embryonic, but on an absolute tear, there's so much capital flowing into the space, and you have taken a very active interest in bringing these AI natives onto the Workers and Workers AI platform. So what I wanted to ask you specifically was, can you help us think about the AI native exposure that you have today in the business? Anything that we should worry about from a concentration standpoint at this present time? And then maybe at a higher level, some of the engagement that you are seeing from a pool of funds perspective, how much of that is drawing in more AI-native eyeballs specifically because of the differentiation that you provide from an architectural standpoint at the edge for AI inference?

Yes. While we are excited about AI and AI inference, it currently represents a small part of our overall revenue. It is growing quickly, but I don't perceive any significant concentration risk at the moment. Interestingly, the initial interest from AI native companies often revolves around our security products rather than the inference products. This is because the cost associated with AI can be high for every query, making it essential to prevent fraudulent queries in order to maintain cost-effective operations. We estimate that around 80% of AI companies utilize our services in some capacity, primarily for securing our core products. However, we are working on encouraging more of them to adopt our inference products as well. When it comes to our competitive advantages, being close to users significantly reduces latency. In situations involving human-computer interaction, especially with applications that feel dynamic and interactive, every millisecond is crucial. If the experience slows down, it disrupts the perceived engagement, particularly in voice communication and other interactions that require a natural flow. We are well-prepared for this. Additionally, we assume the responsibility of driving utilization, which enables us to outperform most customers operating independently. This often results in better performance and lower operational costs, positioning us favorably within the market. I anticipate fluctuations in AI over the next few months and years, but it is evident that AI has transformative potential. Many inference tasks will run locally on devices like handsets or driverless cars, but when that is not possible, the next best option is to run them on the network. Cloudflare is currently the only network that can provide this capability globally, which will continue to enable us to handle workloads effectively, regardless of the broader trends in AI.

One comment I want to make just to make sure we have no misunderstanding. When we say de minimis, we mean that no customer is bigger than 2% of revenue.

And our next question comes from the line of Mark Murphy with JPMorgan.

So Matthew, we noticed that Cloudflare is upgrading its security to be quantum-safe so that data stays protected even when quantum computers eventually arrive, whenever that's going to be. I'm wondering if you can just describe the work you're doing? And do you think this is more of a long-term science project that won't matter for, say, 5 to 10 years? Or do you think it's something that could have some implications in the medium term? And then I have a quick follow-up.

I have mixed feelings about quantum technology. While some people believe it will drastically change everything and create major issues, I don’t share that view. I see quantum as changing certain aspects, potentially leading to more efficient package delivery and fewer flight delays. It may create challenges for some older cryptography methods, but those are manageable. Cloudflare's unique strength lies in our ability to utilize our scale in content delivery to find effective solutions. We have previously partnered with Google, leveraging their reach with Chrome browsers to develop future-proof cryptography that will withstand the advancements in quantum computing. We’ve collaborated to provide data to the Internet Engineering Task Force and NIST to help standardize new protocols, which we’ve implemented across our entire network at no cost to all customers, ensuring that everyone has access to high-security standards. As people upgrade their devices, all modern browsers will support post-quantum cryptography. Taking these steps now is vital, even if we don't currently have quantum computers capable of breaking cryptography. The main concern lies in the risk of data being stored; if significant Internet data is acquired and kept, it could later be decrypted. While this may not affect most of our customers, as their credit card information changes after several years, it is crucial for certain clients, such as U.S. government agencies. We aim to implement solutions that are fast and battery-efficient on devices. By partnering with organizations like Google, we can conduct real-world tests to ensure our approach is feasible and cost-effective. I believe this is not just a science project but a forward-thinking initiative, exemplifying how Cloudflare strives to fulfill its mission of improving the Internet.

Yes, that is pretty fascinating. Just as a very quick follow-up. You mentioned egress fees I think last call and again, this call, I should say, the elimination of egress fees. It feels like you're winning some real business that's partly tied to that. Can you just touch on the economics that that would unlock for the customer by removing those fees?

Egress fees are the costs charged by hyperscalers every time your data exits their systems. These fees have been notoriously high, creating significant leverage points because, at scale, bandwidth becomes very affordable and nearly free. Even though costs for hyperscalers' bandwidth have consistently decreased, they have not shared these savings with customers. They prefer to retain customers' data. We believe customers should have the freedom to move their data wherever they choose, supporting a multi-cloud approach. Products like R2, our object store, enable customers to manage their data, allowing for easier movement across networks without incurring high costs. We aim to ensure customers can use any combination of clouds that suits their needs while Cloudflare serves as the network that integrates these services, providing safe, secure, efficient, reliable, and fast access.

And our next question comes from the line of Jackson Ader with KeyBanc Capital Markets.

The first one, Matthew, certainly losing CJ is a real loss, even if it is a great opportunity. And I'm just curious, whether you feel comfortable with the bench that he leaves behind and how you kind of ensure maybe that he either is or will be replaceable?

Yes. First of all, CJ is fantastic, and while we can’t discuss his future, his new company is fortunate to have him. Although we're disappointed about his departure, I'm incredibly proud and excited for him, as this has been a long-term goal for his career. I'm glad he's heading to what I believe is an exceptional technology firm. The good news for us is that when CJ joined, he didn’t implement many changes or hire extensively; he recognized our engineering team's existing talent, highlighting the exceptional engineers and product leaders we have. What they needed was someone to concentrate on customer focus, and CJ really instilled that customer obsession within our product and engineering teams, which will be lasting. I don’t believe there’s a significant risk of key people leaving just because CJ is moving on; they joined Cloudflare, not just for CJ. He was an asset to Cloudflare, but our team remains strong. Now that we’ve addressed the news, I genuinely think this is one of the most thrilling roles for any product or engineering leader in the tech world. You get to help shape the future and define the future business models of the Internet, which is incredibly exciting. While CJ is unique, I’m confident we’ll find another world-class leader to step in.

Okay. That makes sense. And then a real quick follow-up. Matthew, you mentioned earlier the move from a product-led growth company to more of an enterprise company. The other side of that coin is now seasonality matters, right? We're heading into a fourth quarter. If you're selling more enterprises, that makes December all that much more important than prior December. So I'm curious about how the pipeline has built through the year and what you're kind of expecting as you're going into a more enterprise-ready fourth quarter than is typical for Cloudflare.

Let me get started, and Matthew can jump in. We gave the guidance we gave for the fourth quarter in light of what we are seeing. So we are very encouraged by the pipeline buildup for the fourth quarter, but guidance and foreshadowing what is going to come is more than just pipeline. We look at sales productivity. We look at the net sales capacity we add. We look at the motion and velocity in the developer business and all the indicators that we are currently seeing are reflected in how we guide for the quarter. So pipeline is encouraging, but there are more factors contributing to the picture we have of what is in front of us. And you heard from both of us that we are quite optimistic in how we look at the future.

Yes, we have experienced some level of seasonality for quite some time. Historically, Q4 tends to perform better than the earlier quarters. After reviewing the pipeline, we feel very confident about the coverage we have for Q4. This is all part of our evolution toward becoming a true enterprise sales company.

And our final question today comes from the line of Mike Cikos with Needham.

Matthew, first for you. I just wanted to see, can you please provide an update on the trends you're seeing in the SASE market specifically? Would just love to get an update on traction you're seeing out there as well as how the competitive landscape is changing, if at all, from where we were a couple of months ago.

Yes. I mean I think our SASE product when we're in consideration is performing extremely well. We don't see significant changes in the competitive landscape. We think we are very competitive. I think the biggest change for us has been just a kind of the proverbial forehead slapping moment of just looking at Netskope's S1, seeing that 95% of their sales are through channel, seeing the same thing for a while, we thought that, that was sort of an aberration for Zscaler and realizing the way that you sell these products is through partners. And so we are doubling down on that. You see that we're seeing a significant uptick in the partner-led opportunities. We have always, I think, had good kind of willingness to partner, but we haven't always made it as easy as possible to partner with us. I think we're cleaning that up and doing a good job getting that in shape. And that, I think, will be the big unlock for those products to be able to be sold. And those are critically important products for us because their gross margins are so high. And so as we're seeing strength in parts of our business like Workers, the best way to balance that out is also to sell SASE as well because, again, it's something that has just extraordinarily high gross margins to it. Whereas products like Workers, the gross margins are good and will get better and better over time. But because they are newer products, they're not as optimized in that space. So I think this is a really opportune time, and I'm excited about sort of the partner-first strategy, especially with our SASE products.

And with that, I will now turn the call back over to CEO and Co-Founder, Matthew Prince, for closing comments. Matthew?

I just want to thank our entire team for an incredible quarter. It takes a ton of effort of people executing, of people innovating, and us being able to deliver results like this. Thank you so much and we'll see you back here again next quarter.

Thanks, Matthew. And that concludes today's conference call. You may now disconnect. Have a great day, everyone.