Encouraging Growth in Key Metrics Drives 60% Gain YTD for Cloudflare Stock

Posted on February 14, 2025June 30, 2026 by io-fund

Cloudflare’s stock rose 20% in the days following Q4 earnings with strong momentum for its Workers AI platform and accelerations in multiple key metrics, paving the way for the stock to potentially reaccelerate revenue growth while driving a shift to GAAP profitability. Management also expressed a high degree of optimism for AI inference and growth opportunities through 2025, especially for its Workers AI platform.

I break down the growth in the most important key metrics, Workers AI momentum, and commentary about AI opportunities below.

Workers Developers Grew from 2 Million to 3 Million in 2024

Cloudflare has quietly amassed a large developer base with tens of millions of developers, allowing for a rather frictionless ramp for its Workers AI platform, with 2024 seeing the platform record more than 50% growth. Workers AI positions Cloudflare to capitalize on the growing AI inference market via its unique approach that offers performance at or exceeding hyperscalers’ at a lower cost.

In Q4, management noted that active Workers developers crossed 3 million, marking a 50% growth from 2 million active developers in Q1 and 25% growth from 2.4 million developers in Q2. Since November 2023, active Workers developers have risen more than 200%.

The Workers platform essentially is Cloudflare’s moat, and what separates it from the rest of software in terms of what it can provide for AI. With Workers, Cloudflare eliminates cold starts, allowing code to be executed the moment it is received – we had explained to our premium members in 2023 that it is a “combination of competing with the hyperscalers, delivering app performance at faster speeds — while keeping prices low — that is unique to Cloudflare,” and what will help the platform drive growth down the road.

Management hammered home the significance of Workers in Q4’s earnings call, emphasizing that the “killer application for Cloudflare Workers is turning out to be AI. The model of programming is uniquely suited for building tools like AI agents, and our serverless architecture, which allows you to pay only for what you use based on CPU or GPU type, positions Workers to become the go-to platform for developers who want the best price performance for AI inference and agentic workflows.”

Cloudflare is now capitalizing on the developer moat that it has built with Workers over the past few years, as developers continue to choose the platform due to the unparalleled efficiencies and cost advantages it can offer when it comes to AI inference. Customers executing inference tasks could pay up to 250% more with hyperscalers than with Cloudflare’s pay-per-use model, per management.

Workers also saw significant deal momentum in the fourth quarter. Cloudflare reported its largest customer win in Q4, a $20 million contract with a Fortune 1000 tech firm, that includes Workers and application security, while a leading AI firm expanded with a $13.5 million deal for services including Workers, R2, and more.

What could easily be overlooked (and what arguably is very important) was management’s discussion on GPU utilization rates. Management explained that while a typical customer at a hyperscaler “is seeing sub-10% utilization across their GPUs, our peak utilization of GPUs is now around 70%,” though troughs are much lower with room to improve in 2025. What this means is that Cloudflare “can get effectively 7 times today the amount of work out of $1 of CapEx spent,” allowing them to capture the excess either in margins or pass it on to customers via lower costs. Improving troughs in utilization should theoretically lead to faster processing times and an ability to handle more requests for customers, all while doing so for cheaper and at a higher margin.

Multiple Key Metrics Support Confidence in Cloudflare’s Revenue Reacceleration

Though Workers growth and commentary on improving GPU utilization rates were quiet drivers of the report, multiple key metrics showed growth in Q4, supporting management’s confidence that the first half of 2025 would mark a turning point with the strength of its business accelerating in the second half.

Cloudflare guided for 23.7% growth in Q1 to $468-469 million in revenue, and that is currently forecast to be the bottom for the year, with revenue expected to reaccelerate to the 27% level exiting the year. All it would take is a few beat-and-raise quarters to put Cloudflare on track to surpass the 30% growth level by the end of 2025.

Revenue growth is forecast to decelerate to 23.7% in Q1 before accelerating to 27% by year-end.

Multiple key metrics showed strong growth in Q4, with a handful of analysts praising the productivity strides and strong execution on these key metrics in the quarter:

Acceleration in growth in >$1M customers
High concentration of net new adds for >$1M customers in Q4
Acceleration in paying customers
Acceleration in billings and strong Pool of Funds activity
DBNRR expanding

The I/O Fund first covered Cloudflare’s AI inference story for premium members in October 2023, recently closing the position for a gain of 97% and making multiple purchases in small and mid-cap AI beneficiaries. Learn more here.here.

Cloudflare’s Paying Customer Growth Accelerates

Cloudflare reported 173 customers in the >$1M cohort at the end of 2024, for 47% YoY growth, up from 37% growth last year. Management noted that of the 55 of the net new adds in 2024, more than half came in Q4, implying at least 28 in the quarter, and 27 combined for the other three quarters; a significant uptick.

Paying customers increased 25% YoY to 237,714 at the end of Q4, an 8-point acceleration from the start of the year. From late 2022 through 2023, growth had remained in the mid-teens, with the recent uptick in paying customers coming alongside growth in AI applications and more mainstream AI usage with numerous consumer-facing and enterprise-focused models being released. What’s impressive is that Cloudflare is matching 2022 growth rates at a nearly 100,000 larger paying customer scale. Additionally, 2 of the past 3 quarters have seen paying customers grow at 7% QoQ, suggesting that a further acceleration could be still in store.

Paying customers growth accelerated to 25% in Q4 to 237,714 forecasting strong fundamentals for Cloudflare’s stock

Cloudflare’s Billings Growth Tops 30% Again

Billings meaningfully inflected in Q4, rising nearly 32% YoY and 22% QoQ to $548 million. Growth had previously been in the low-20% range for the first three quarters of 2024. Billings likely benefited from a “notable uptick in close rates” and “an improvement in sales cycles,” with management mentioning that the majority of large customers “whose deals had slipped from Q3, reengaged and signed significant contracts in Q4.”

Cloudflare’s billings growth accelerated nearly 8 points to 32% YoY in Q4.

Pool of Funds activity was quite strong as well, with activity comparable to Q3 at around 9 percentage points; management noted that a $20 million Pool of Funds contract with a Fortune 100 tech company was the largest new customer win in company history, along with a $13.5 million deal with a leading AI firm. Pool of Funds is expected to pick up strength in the second half of the year after leading to some near-term headwinds as customers transition to these contracts.

There were other encouraging signs within ramped account executives, with management saying that they “delivered a 10 percentage point increase in ramped AEs achieving over 80% of quota compared with 2023, with most gains coming in the 125% or higher attainment cohorts.” For 2025, management is expecting YoY growth in ramped account executives to “accelerate each quarter throughout 2025, further laying the foundation for Cloudflare's next phase of growth at scale.”

DBNRR Ticks Higher to 111%

Cloudflare reported that its dollar-based net retention rate (DBNRR) ticked 1 point higher to 111%, marking the first time the metric has grown since Q3 2023. Management commented that “there can be some variability in this metric quarter-to-quarter, but we believe the recent decelerating trend in DNR is stabilizing despite continued near-term headwinds from increased traction with pool of fund contracts.”

Cloudflare’s DBNRR grew for the first time since Q3 2023 to 111%.

Cloudflare’s GPU Investments Rising

With the accelerations in billings, paying customers and strong net adds in its largest customer cohort, Cloudflare laid the foundation for increased investments to support growth through 2025. While this is likely to be slightly detrimental to margins, with management guided for an adjusted operating margin of 11.6% in Q1 versus 14.6% in Q2, it paves the way for Cloudflare to meet higher demand and reinvigorate revenue growth.

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Management said that the “accelerating shift from AI training to AI inference has given us confidence to continue to increase our investment in our GPU rollout as we provision greater capacity to support demand in 2025.” As a result, network capex is expected to be 12-13% of revenue in 2025, up from 10% in 2024.

As has been the case with hyperscalers, who had been quite vocal over the past few quarters that demand regularly outpaced GPU supply, Cloudflare signaled that its investments in GPU capacity would go towards supporting higher demand as workloads shift towards AI inference.

Cloudflare is Inching Closer to GAAP Profitability

Breaking into GAAP profitability on the bottom line is a ‘holy grail’ for cloud stocks, in part due to high SBC levels that push operating expenses above 100% of revenue. Cloudflare is inching closer to reaching GAAP profitability on the bottom, though GAAP operating income is a bit further away.

Cloudflare reported a GAAP operating loss of ($34.7 million), or a GAAP operating margin of -7.5% in Q4. Though this declined slightly from -7.2% in Q3 due to some headwinds to gross margin, it marked a 7 point improvement from the -14.4% operating margin in Q1.

Cloudflare is showing prudent cost management, bringing expenses down from 92% of revenue in Q1 to below 84% of revenue in Q4. R&D expenses ticked slightly higher sequentially in Q4, understandable given the investments Cloudflare is making in its network, while marketing expenses declined 1.4 points to 41.7% of revenue.

GAAP net margin is making strides towards positive territory, with Cloudflare benefitting from net interest income and improvements to operating margin. GAAP net margin improved from -9.4% in Q1 to -2.8% in Q4, or a loss of just ($12.8 million). This improvement comes despite SBC remaining elevated at just above 20% of revenue.

Cloudflare is currently not expected to break into GAAP profitability this year, with analysts expecting a loss each quarter of 2025. However, the improvements in operating margin from cost management efforts and a potential revenue reacceleration could shift that story. Other best of breed cloud names such as CrowdStrike and DataDog have seen strong returns after breaking into GAAP profitability on the bottom line.

Cloudflare’s Valuation Looks Elevated

Even though management is quite confident in the AI inference growth opportunities in 2025, there’s not yet tangible evidence of a reacceleration on the top-line, and Cloudflare is trading at its highest valuation in more than two years. Key metrics are showing underlying signs that support revenue reaccelerating, but the valuation amplifies risks to the downside until the acceleration story materializes.

On the top-line, Cloudflare is trading at its highest valuations since May 2022, at 28x forward revenue, above where it had previously found resistance at 22x to 23x forward revenue. This makes it one of the most expensive cloud stocks aside from Palantir, trading at a near 100% premium to DataDog and Snowflake despite all three reporting revenue growth in the high 26% to 28% range for the most recent quarter.

Source: YChartsYCharts

On a free cash flow basis, Cloudflare is the most expensive of the four here, trading at 350x free cash flow versus 250x for Palantir and 75x to 77x for Snowflake and DataDog. Free cash flow has hovered at ~10% of revenue for 2024, below Snowflake at 20% through fiscal Q3 and DataDog at 29% for 2024 due to Cloudflare’s much higher investments in its infrastructure – Cloudflare spent $185 million in 2024, versus $35 million for DataDog in 2024 and $34 million for Snowflake (through Q3).

Source: YChartsYCharts

For adjusted EPS, Cloudflare is valued at 217x forward earnings of $0.80, versus 210x for Palantir and 186x for Snowflake. This is a significant re-rating in a short period of time, with Cloudflare being valued at half of this multiple in October, at 105x forward earnings. Adjusted earnings growth is also expected to be minimal in 2025, with management guiding for barely 6% growth to $0.79 to $0.80 this year.

Source: YChartsYCharts

Conclusion

The Workers platform exhibited strong momentum through 2024 with active developers rising 50% to surpass 3 million, widening Cloudflare’s developer moat as it aims to harness growth in AI via its positioning at the edge and ability to offer high-performance, low-cost inference. A handful of key metrics inflected and accelerated in unison in Q4, a positive sign for growth heading into 2025.

Cloudflare’s management expressed confidence for 2025 on AI inference driven opportunities, with multiple key metrics suggesting that a revenue reacceleration could be in store. Given the soft Q1 and fiscal 2025 guide and elevated valuation, Cloudflare is in a spot where it has to prove that it can meaningfully inflect revenue growth based on the underlying strength in large customer deals, billings, and customer growth. We think the stock will prove this; yet we also book gains at specific price levels to reduce risk.

The I/O Fund recently entered five new small and mid-cap positions that we believe will be beneficiaries of increased AI spending after Big Tech projected capex of $320B+ for 2025. Advanced members received real-time trade alerts for each trade with entries and exits discussed Thursdays at 4:30 p.m. EST in our weekly webinars. Take advantage of our limited-time promotion for $50 off monthly Advanced plans – learn more herehere.

Damien Robbins, Equity Analyst for the I/O Fund, contributed to this analysis.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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Cloudflare Q3 24: Soft Q4 Guide as Company Transitions on Billing Terms

Posted on November 8, 2024June 30, 2026 by io-fund

Cloudflare beat on the top and bottom lines in Q3, although net retention rate softened again. The company missed on revenue expectations for Q4 with management guiding for a midpoint of $451.5 million, for growth of 24.6% compared to analyst expectations of $455.08 for growth of 25.8%. Management spoke at length about being at an inflection point for a sales organization shift, yet this felt like a speculative discussion as evidence of an inflection was not visible in the Q4 guide.

Key metrics were mixed and revenue growth is getting further away from the coveted 30% mark with a 4-point deceleration in Q4. Yet RPO and customer growth remains persistently strong.

Revenue

Cloudflare reported revenue of $430.1 million in Q3, increasing 28.2% YoY, slowing from the 30.0% YoY increase reported in Q2. Revenue growth had been expected to be steady at ~26% YoY for the next few quarters, which is quite strong for best-of-breed cloud as many >40% revenue growth cloud companies have dipped <20%.

However, Cloudflare guided to just 24.6% YoY growth in Q4, seeing revenue between $451 million and $452 million, shy of the estimate for $455.8 million. This implies a sequential deceleration of ~3.6 points.

For FY24, management slightly raised its guidance, though it seems as if the raise stemmed solely from Q3’s outperformance relative to its initial guide. Cloudflare now sees FY24 revenue of $1.661 to $1.662 billion, a raise of just $3.5 million at the midpoint from its prior view for $1.657 to $1.659 billion. Q3’s $430.1 million sum beat management’s internal guidance by ~$6.5 million, implying that it is the primary factor behind the raised guide given Q4 was a miss.

Margins

Cloudflare reported strong adjusted operating margin of 14.8%, which led to raising its adjusted operating margin guide for FY24 to 13.3%, up from last quarter’s FY24 guide of 11.9%. GAAP operating and net margins continue to make slow progress towards positive territory due to high stock-based compensation of 20.5%.

GAAP gross margin was 77.7%, down slightly from 77.8% in Q2 but up 1 point from 76.7% in the year ago quarter. Adjusted gross margin was 78.8%, down from 79.0% in Q2 but up slightly from 78.7% in the year ago quarter.
GAAP operating margin was (7.2%), improving from (8.7%) in Q2 and (11.7%) in the year ago quarter. Adjusted operating margin was 14.8% in Q3, well above the 11.9% guided and improving from 14.2% in Q2 and 12.7% in the year ago quarter.
For Q4, management guided adjusted operating margin of 11.9%.
For FY24, management guided for adjusted operating margin of 13.3%, a strong increase from 9.8% at the beginning of FY24 and its previous guide for 11.9% given in Q2. The increased guide is driven by Q2 and Q3’s outperformance, with both quarters seeing adjusted operating margin >14%.
GAAP net margin was (3.6%), improving slightly from (3.8%) in Q2 and (7%) in the year ago quarter. Adjusted net margin was 16.9%, falling from 17.3% in Q2 but up slightly from 16.5% in the year ago quarter.

EPS

For fiscal year 2024, Cloudflare is expected to report EPS growth of 51% YoY to $0.74. Cloudflare beat slightly on EPS in Q3, while guiding for flat QoQ growth for adjusted EPS for Q4.

Cloudflare is close to GAAP profitability yet it’s not clear given stock-based compensation when the company will tip over the edge. The stated in the investor’s presentation the long-term goal is a 20% adjusted operating margin, which implies GAAP profitability would be narrow, yet achievable. Notably, there is no firm date being provided.

GAAP EPS was ($0.04), flat QoQ and up from ($0.07) last year.
Adjusted EPS was $0.20, beating estimates and Cloudflare’s guide for $0.18. This was also flat QoQ and up 25% YoY.
For Q4, management guided for adjusted EPS of $0.18. For FY24, based on the slight beat in Q3, management raised its adjusted EPS guide to $0.74, up from its previous view for $0.70 to $0.71. This represents YoY growth of 51%.

Cash and Balance Sheet

Cash flow generation remained steady in the quarter as cash flow margins expanded sequentially.

Operating cash flow was $104.7 million in Q3, for a 20% margin. This improved from a 19% margin in both Q1 and Q2.
Free cash flow was $43.7 million, for an 11% margin, an improvement from 10% in Q2 and 9% in Q1. The company stated its goal is a 25% FCF margin.
Cash and available-for-sale securities totaled $1.824 billion while convertible notes totaled $1.286 billion.

Cloudflare’s free cash flow is especially impressive given the company has to build a bigger network and invest in GPUs for edge AI.

“Network CapEx represented 10% of revenue in the third quarter. During the quarter, we saw a notable shift in customer conversations and buying behavior from AI training to AI inference, including our first multimillion dollar workers AI contract.

This gives us confidence to continue to increase our investment in higher-end GPUs as well as the breadth of our GPU rollout as we provision greater capacity to support demand in 2025. As. A result, we continue to expect network CapEx to increase again in the fourth quarter to reach 10% to 12% of revenue for the full year 2024.”

Key Metrics:

RPO

RPO came in at $1.53 billion for growth of 39% year-over-year and up 6% sequentially. This is higher than the year ago quarter when RPO was at 30% YoY and up 5% sequentially.

Compared to last quarter, RPO reported growth of 37% year-over-year and 6% QoQ, for 69% of total RPO, which means this was technically a stronger quarter on this key metric.

DBNRR

Cloudflare’s DBNRR dropped again in Q3, falling to 110%, compared to 112% in Q2 and 115% in Q1. Throughout 2023, DBNRR hovered around 115% and higher, so the decline over the past two quarters is important to watch. This quarter, management reiterated the decline is being driven by slower net expansion in the larger customer cohorts as they move to “pool of funds” contracts, which shifts billings from annual contracts to pool of funds accounts that are on a monthly basis for three or more years (for larger customers).

Per management again this quarter:

“Our dollar-based net retention was 110%, down 2 percentage points quarter-over-quarter. While customer churn remains consistently low, our shift to more pool of funds deals with our largest customers, which represented nearly 10% of new ACV booked in the quarter, up from 1% a year ago has put downward pressure on dollar-based net retention and change the shape of revenue recognition in the short term.

Over the long term, however, we believe pool of fund deals are very positive for the business as they represent our largest customers making a broad commitment to Cloudflare's overall platform.”

Customers

Paying customers increased 22% YoY to 221,540, accelerating from 21% in Q2 and 17% in Q1. Management stated on the call they count 35% of the Fortune 500 as customers.

For customers with >$100K ARR, growth decelerated 2 points sequentially to 28% YoY to 3,265 customers. This cohort accounted for 67% of revenue in Q3, flat with Q2 but up from 65% last year. Management pointed out that the 28% resulted in a record addition 219 large customers, referring to the growth remaining high even on a larger base of customers.

Billings

Despite other metrics such as >$100K ARR customers and DBNRR decelerating, Billings accelerated sequentially in Q3. Billings increased 24% YoY to $447.3 million, a 1-point acceleration from 23% growth last quarter.

Earnings Call:

Net Retention Rate; New Sales Org

The tone on the earnings call was more of a “wait and see” tone about the new sales organization reaching an inflection point. On one hand, we are seeing strong total customer growth and billings inflect. Yet, on the other hand, Cloudflare is asking investors to place their trust in the company on the “pool of funds” deals that are causing a rapidly decelerating net retention rate.

What investors should keep in mind is that management is foreshadowing the mixed key metrics could last for a few quarters as current customers shift to the new billing terms: “As we mentioned last quarter, we expect new customers to contribute a higher percentage of our overall year-over-year revenue growth for the next several quarters.”

There was also a note that larger deals were pushed back, yet the miss in Q4 doesn’t inspire confidence they were pushed back only by a quarter: “However, some larger deals slipped out of the quarter in the U.S. in particular, during what was a transitional period under new sales leadership in that region. These deals are still active in our pipeline with many having already closed this quarter.”

The company discussed being at an inflection point, yet as an investor, I prefer more evidence of this with revenue growth inflecting, as well (which did not happen): “All the changes in our sales force may have impacted the short-term cadence of some larger deal cycles. What stood out to me is that the third quarter felt like we hit the inflection point in the rebuild of our go-to-market team.”

However, when pressed, management remained confident it was truly an inflection point. My best guess is the inflection will catch up to revenue perhaps by Q2 given the note it’s a few quarters out.

Timothy Horan Oppenheimer & Co. Inc.

There's a lot of moving parts, obviously, with the sales productivity and limited capacity there in the pooling. Can you maybe talk about the timing of when revenue growth can accelerate again. Do you think the fourth quarter around 25% guide, is that the bottom? Or do you think it's still a few more quarters out? And related to this, can you update us on what you think the timing of for the $5 billion revenue target that you have? And I had a quick product follow-up.

Thomas Seifert CFO

Yes. Thank you for the question. As we said before, for us, in our subscription business model, revenue is very much a lagging metric. Sales capacities is a product of the amount of headcount we have and the productivity progress they are making, this translates into pipeline and sales prospects, turns into ACV and then ACV is recognized ratably over the lifetime of the contract as revenue. So it's very much a lagging indicator. And as we said before, models like this, there are slow on their way down, but they're also slowing their way up.

But the important part is, as you heard in Matthew's prepared remarks that we think we have reached this key inflection point with net sales capacity now, which is the leading growth indicator have been patent. So from there on, we expect sales activity translating the ACV moving forward and going up. And you see this already in those parts of the world where this conversion and transition has happened successfully. Revenue was up 38% already in APAC, and it was up 1% in Europe, which is our highest productivity region has been over the last several quarters. So we think we have bottomed out from a net sales capacity perspective, and move forward from there.”

Capex Spending and Edge AI

Cloudflare has offered visibility in capex spending plans as it builds out GPU-powered edge servers for AI inferencing purposes. This involves large orders of GPUs, to which Cloudflare made it quite clear they are able to work with any hardware on the market and at a high utilization rate.

Given Cloudflare may one day become a leading AI stock, discussions around the AI market are provided for future reference as we along, especially given there is no official AI revenue number being reported by Cloudflare today.

Per the company, there has been progress: “During the quarter, we saw a notable shift in customer conversations and buying behavior from AI training to AI inference, including our first multimillion dollar workers AI contract.”

Notably, there was not an update to the Workers key metric of 2.4 million developers this quarter.

The discussions around one of Cloudflare’s key value propositions was the following:

“And in order to support that, we have made the investments to increase not only just the number, but also the power of the GPUs that we're deploying around the world. What I think is unique about Cloudflare is 2 things. One, we are actually able to deliver inference incredibly close to where anyone is on earth because we've deployed the inference capabilities across at this point, nearly all of our network.

But in addition to that, we've actually done the work to get higher utilization out of those same GPU resources where what we see when we survey customers that are trying to manage this themselves, through hyperscale public cloud is that they're getting utilization rates that are sort of in the 5% to 10% range of the resources that they're buying.

We're able to deliver much higher utilization. And in the process of that, that means that we can actually pass on the effective savings to our customers. So they not only save in not having to maintain their own team to manage these virtual machines and containers, but they also save because we can just do more with the same GPU resources that are being deployed.”

Conclusion:

Cloudflare is among the highest in terms of valuations for best-of-breed stocks at a 19.7 forward PS. Although this was a decent report with no major red flags, this valuation is not where I’d be buying the stock given the report was not a knockout. The question being considered is if we should close the position since odds are quite high we will get the stock lower.

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Cloudflare Q3 Earnings Preview: All eyes on the guide

Posted on November 7, 2024June 30, 2026 by io-fund

Cloudflare will release its Q3 results on November 07th. Analysts expect revenue to grow 26.4% YoY to $424.12 million and adjusted EPS to grow 14.2% YoY to $0.18.

During Q2 results, management increased the FY revenue guide to $1.658 billion at the mid-point from $1.65 billion, representing YoY growth of 27.9%. The FY2024 adjusted operating margin guide was raised to 11.9% from 9.8%, up from 9.4% in 2023.

There was a survey published by Wells Fargo that stated Cloudflare is taking more market share from cybersecurity vendors. The downside is the report also stated Q3 was the weakest environment they’ve seen in three years. We need an earnings report to confirm the results of the survey, yet it’s encouraging to see NET is stronger than its peers in a spending environment that is largely outside of the company’s control.

Regarding AI, Cloudflare is uniquely positioned to capture inference at the edge. The company has grown developers on the Workers platform from 2 million to 2.4 million, for 20% QoQ growth. Companies with decent sized developer moats (Nvidia, Apple, etc) have a developer following in the 3 to 4 million range. Given the majority of the AI market is focused on training large language models at the moment, inference needs time, but there are early signs of which companies will succeed as AI matures.

Revenue

The company’s revenue is expected to grow steadily at around 26% in the next few quarters. The growth is quite strong for best-of-breed cloud as many >40% revenue growth cloud companies have dipped <20% in recent years in what has been a seismic shift in cloud. Our firm was early to report on this shift for our members. Yet, Cloudflare is one of the very few that have sustained strong growth levels.

Q2 revenue grew by 30% YoY to $401 million. Management guide for Q3 is $423 million to $424 million, representing a 26.2% year-over-year growth at the midpoint.
Analysts expect Q3 revenue to grow 26.4% YoY to $424.12 million and 25.8% YoY to $455.80 million in Q4.

Last quarter, management increased FY2024 revenue guide to $1.658 billion at the midpoint from $1.65 billion, representing 27.9% YoY growth.
Analysts expect revenue to remain steady over the next three years at 28% growth, 27.1% growth and 27.8% growth YoY through 2027.

Margins

Cloudflare showed strong improvement in operating margin and net margin in Q2. It also significantly increased the full-year adjusted operating margin guide from 9.8% to 11.9%.

Q2 gross margin was 77.8% compared to 75.6% in the same period last year. Adjusted gross margin was 79% compared to 77.7% in the same period last year.
Operating margin was (-8.7%) compared to (-18.2%) in the same period last year. Adjusted operating margin also significantly improved to 14.2% from 6.6% in the same period last year. The operating expenses were reduced due to focus on higher productivity and better efficiency in the operations.
Management’s adjusted operating income guide for next quarter is $50.5 million at the midpoint or 11.9% of revenue compared to $42.5 million or 12.7% of revenue in the same period last year.
The difference between the GAAP and non-GAAP operating margin is due to stock-based compensation which was $86 million in Q2 or 21.4% of revenue. The high level of stock-based compensation reflects what the competitive cloud industry must do to retain talent.
During Q2 results, management had increased the FY 2024 adjusted operating income guide from the range $160 million-$164 million or 9.8% of revenue at the mid-point to $196 million-$198 million or 11.9% of revenue at the midpoint. By doing the math, the Q4 adjusted operating income guide comes to $47.1 million or 10.4% of revenue.
Q2 adjusted net income was $69.5 million or 17.3% of revenue compared to $33.7 million or 10.9% of revenue in the same period last year.

EPS

Analysts have increased adjusted EPS estimates after the company raised the FY 2024 guidance to $0.70 to $0.71 from the earlier guide of $0.60 to $0.61. Management Q3 adjusted EPS guide is $0.18.

Analysts expect Q3 adjusted EPS to grow 14.2% YoY to $0.18 and 15.4% YoY to $0.17 for Q4.
Analysts expect strong growth with 2024 adjusted EPS to grow 46.1% YoY, followed by 20.5% in 2025, and 28% in 2026.

Cash Flow and Balance Sheet

The company’s cash flows are improving. Management has reiterated they expect full year free cash flow in the range of $160 million to $164 million. This is a significant improvement from the $119.5 million free cash flow in 2023 and also suggests an acceleration in the second half with estimated free cash flow of $88.1 million.

Q2 operating cash flow was $74.8 million or 19% of revenue compared to $64.45 million or 21% of revenue in the same period last year.
Q2 free cash flow was $38.3 million or 10% of revenue compared to $19.97 million or 6% of revenue in the same period last year.
Network capex was 6% of revenue in Q2. Management expects network capex to reach 10% to 12% of FY 2024 revenue in the 2H of the year as the company is rolling out GPUs in every location. We see setting these expectations while ultimately increasing cash flows as a positive.
The company had cash and available-for-sale securities of $1.757 billion and debt of $1.285 billion compared to $1.716 billion and $1.284 billion in Q1.

Key Metrics

Remaining Performance Obligations (RPO) Accel’d QoQ

RPO increased 6% sequentially and 37% YoY to $1.42 billion although it was a deceleration from 40% growth in Q1. The current RPO was 69% of total RPO.

Billings

The company primarily focuses on RPO as a more comprehensive measure of its business. We track billings since they are reported for other cybersecurity stocks. Billings grew by 23% YoY and 9% QoQ to $421.7 million, a slight deceleration from 24% growth in Q1.

DBNRR

DBNRR was 112% in Q2, a 3-percentage point deceleration from 115% in Q1. The CEO stated the decline was driven by slower net expansion in the larger customer cohorts and an increase in “pool of funds” contracts. The pool of funds contracts is a transition in billing from annual contracts to pool of funds accounts that are on a monthly basis for three or more years. The pool of funds accounts are unique to the largest customers (for example, 4 of the top 10 customers are this account type) that use many products across the entire Cloudflare platform. These are considered larger platform deals that are paid on a monthly basis in a multi-year contract rather than an annual contract on one product. This is shifting how DBNRR and RPO are reported since revenue is recognized as the customer consumes the service.

Customers and Workers AI platform

Paying customers grew by 21% YoY to 210,166 and accelerated from 17% in Q1. For customers with an ARR of >$100K, Cloudflare reported 30% YoY growth to 3,046. This customer cohort contributed 67% of revenue, flat with Q1 yet up from 64% in the year ago quarter.

Cloudflare Worker Applications grew from 2M developers to 2.4M developers in four months, per the CEO’s opening remarks. The Workers AI Platform developer accounts grew 67% QoQ and inference requests grew 700% QoQ.

Other key point to watch

Customer Wins

Wells Fargo noted that the Q3 security reseller survey was the weakest in the last three years. However, Cloudflare’s survey results showed a strong uptick. “Cloudflare's (NET) results significantly up ticked to +31% net (-9% last qtr), as resellers noted strong overall demand trends for the full suite, including SASE, CDN, and cloud security.” This data point is not meant to make an earnings call, rather we will look for management to confirm the results of Q3.

Management mentioned in the last earnings call that the go-to-market initiatives are reaping rewards. The company also delivered another quarter of double-digit year-over-year increase in sales productivity during the second quarter, and saw an uptick in close rates, and an improved sales cycle.

The management also announced several large customer wins, and the notable one was the land & expand customer, who was a free customer: “A leading Australian technology company expanded their relationship with Cloudflare, signing a two-year $17.5 million contract, $7.2 million of which is expansion. They started with Cloudflare back in 2016 as a free customer and today use nearly all our products spanning use cases as diverse as remote application access, worker serverless development and bot management.”

Another prominent U.S. university signed a five-year $5.7 million contract. With Cloudflare, they were “able to replace multiple legacy vendors with a unified platform and cloud-first architecture.”

Valuation

Cloudflare is trading at a P/S ratio of 20.04 and a fwd P/S ratio of 18.06 and is trading below its five-year average P/S ratio of 32.67. Cloud has seen a re-rating, so the multi-year averages are not reliable in the current macro backdrop.

Conclusion

Given CrowdStrike has stumbled recently, Cloudflare has emerged as the leading best-of-breed cybersecurity stock. Although not GAAP profitable yet, the company saw a slim (3.8%) net margin in the last quarter, which puts GAAP profitability on the horizon. In the meantime, the company is improving its margins and cash flows, putting investor concerns to rest about capex, and is quietly sitting on one of the biggest developer ecosystems in the market with a fairly frictionless path to onboard the Workers AI platform once the inference market takes off.

We continue to watch Cloudflare’s report with anticipation as the company is firing on many cylinders. We are participating in the event Cloudflare beats, and we also have a trading plan in mind should we be able to get shares lower.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Recommended Reading:

CrowdStrike Q1: The Strongest Best-of-Breed Cloud and Cyber Stock in the Market

Posted on June 5, 2024June 30, 2026 by io-fund

As we near the end of the Q1 earnings season with a few reports left to go, there is no denying what is the strongest cloud stock and cybersecurity stock in the market. Every single cloud and cybersecurity report this quarter has carried a line item or two of disappointment. CrowdStrike shrugged off the cloud woes and is continuing to set itself apart in a meaningful way.

The company delivered a strong quarter as it beat on both the top and bottom line, and increased its full-year revenue guide. Net new ARR growth was far ahead of management’s expectation from last quarter. Cash flows rose to new records, and module adoption rates increased sequentially. However, operating margins took a step backward, as operating expenses increased 13.5% QoQ, driven by a more than 20% QoQ increase in sales and marketing spend.

Consolidation was the primary theme on the call as it led to the beat/raise that other cloud companies, almost without exception, have been unable to deliver. CFO Burt Podbere said the quarter was characterized by “strong execution and platform adoption as customers increasingly consolidate on the Falcon platform.”

CEO George Kurtz elaborated on the consolidation in the earnings call, and reiterated that the company is still “firmly on the path to $10 billion in ending ARR.” This would be up from $3.65 billion in ARR today. The timeline is a bit unclear as to when this will be achieved, but the vision that management has for where the company could go certainly doesn’t hurt to hear.

The high-profile exclusivity deal with AWS for Falcon and a deal with Google Cloud were announced in May, and were also a focus of the opening remarks and Q&A.

For additional reading on CrowdStrike, please read “CrowdStrike: Steady Growth, Strong Bottom Line” with information on its full product suite and also CrowdStrike Q4: RPO Surges, Net New ARR Impresses with more information on why AI revenue won’t be easy to detect.CrowdStrike: Steady Growth, Strong Bottom Line” with information on its full product suite and also CrowdStrike Q4: RPO Surges, Net New ARR Impresses with more information on why AI revenue won’t be easy to detect.

Revenue and EPS:

CrowdStrike reported 33% revenue growth in Q1, a slight QoQ acceleration, though revenue growth is expected to continue decelerating through the rest of the year.

CrowdStrike reported revenue of $921 million in Q1, representing YoY growth of 33% and beating estimates by $16 million. This marked a 40 bp acceleration in YoY revenue growth from 32.6% last quarter.
Adjusted EPS was $0.94, increasing 63% YoY and beating estimates by $0.04. GAAP EPS was $0.18, compared to $0.00 in the same quarter last year.
For Q2, CrowdStrike guided for revenue of $958.3 to $961.2 million, for YoY growth of 31.2% at midpoint. This was slightly above the consensus estimate for $956.3 million in the upcoming quarter.
CrowdStrike guided for adjusted EPS of $0.98 to $0.99 in Q2, an increase of 33.1% YoY at midpoint.
CrowdStrike increased its full-year revenue guide, now seeing FY25 revenue between $3.976 billion and $4.01 billion, compared to its prior view for $3.925 billion to $3.989 billion. Adjusted EPS guide was increased to $3.93 to $4.03, versus a prior view for $3.77 to $3.97. The boost adds confidence to management’s view that operating leverage will be felt more heavily in the back half of the year.

Margins:

While GAAP gross margin remained flat, CrowdStrike felt some margin pressures down the line on a sequential basis, as operating expenditures ramped higher in the first quarter. This pushed both GAAP and adjusted operating margins lower sequentially.

GAAP Gross margin in Q1 was 75.6%, staying flat YoY. Adjusted gross margin was 78.3%, a 30 bp expansion from 78% in the year ago quarter.
GAAP operating margin was 0.8%, for a third straight quarter of positive GAAP operating margin; this compares to 3.5% last quarter and (2.8%) in the year ago quarter. Adjusted operating margin was 22%, compared to 25% last quarter and 17% in the year ago quarter.
GAAP net margin was 4.6%, down from 6.4% last quarter but up from 0.1% in the year ago quarter. Adjusted net margin was 25%, down from 28% last quarter but up from 20% in the year ago quarter.

Cash and Debt:

Cash flows have been strong for CrowdStrike, and the company reported record cash flows this quarter.

Operating cash flow was $383.2 million, increasing more than 27% YoY, for a margin of 42%.
Free cash flow reached a record $322.5 million, rising nearly 42% YoY for a 35% margin.
CrowdStrike reported cash and equivalents of $3.702 billion.
Debt totaled $742.9 million.

Key Metrics:

ARR:

ARR increased 33% YoY to $3.65 billion, a 1 percentage point deceleration from Q4.

Net New ARR:

CrowdStrike had guided for Q1’s net new ARR to increase “at least double digits up to the low teens,” yet it easily surpassed this guide as it reported 22% YoY growth in net new ARR to $211.7 million.

CrowdStrike has notched three consecutive quarters with net new ARR growth >10%, with two straight quarters above 20% growth. This is a notable shift in the trends that we have seen recently in net new ARR.

Given that this is one of the most tracked metrics for the company, maintaining strong growth in net new ARR in the double digits reflects positively on business momentum as we progress through 2024 and entering 2025. Management noted that while they “did not specifically guide to net new ARR, our net new ARR year-over-year growth assumptions for the second quarter of the fiscal year are at least double digits, up to the low teensour net new ARR year-over-year growth assumptions for the second quarter of the fiscal year are at least double digits, up to the low teens,” implying that we may see a deceleration in Q2 relative to Q1.

Module Adoption:

Customers adopting 5+, 6+, or 7+ modules all increased sequentially, and one of the highlights here was that deals involving 8+ modules nearly doubled YoY — CrowdStrike reported that these large deals increased 95% this quarter. In addition, CrowdStrike noted that the number of deals involving cloud, identity, or next-gen SIEM more than doubled YoY in Q1.

RPO:

RPO was $4.7 billion in Q1, accelerating to 42% YoY growth from 35% last quarter, though on a QoQ basis, growth was minimal, at just 2% QoQ from $4.6 billion in Q4.

Earnings Call:

Consolidation = CrowdStrike is a Fierce Competitor

Consolidation on Falcon was one of the core topics of the Q1 earnings call, with CrowdStrike touting strong initial momentum for Falcon Flex. Analysts pressed management about their long-term $10 billion ARR target, as well as the recent AWS exclusivity deal and generative AI slowing down other software deals.

CEO George Kurtz discussed how consolidation is one of CrowdStrike’s strengths: the “foundational theme underpinning CrowdStrike's results is the power of the Falcon platform to consolidate cybersecurity at scale. This is coupled with the market's unequivocal desire for a single AI-powered software platform consolidator. We're landing with more modules than ever before. The number of deals involving cloud, identity or Falcon Next-Gen SIEM modules more than doubled year-over-year, and we're closing some of our largest deals ever.foundational theme underpinning CrowdStrike's results is the power of the Falcon platform to consolidate cybersecurity at scale. This is coupled with the market's unequivocal desire for a single AI-powered software platform consolidator. We're landing with more modules than ever before. The number of deals involving cloud, identity or Falcon Next-Gen SIEM modules more than doubled year-over-year, and we're closing some of our largest deals ever.

We're consistently hearing that customers want to partner with us as they consolidate, standardizing their cybersecurity future on the Falcon platform and investing their trust in CrowdStrike as cybersecurity’s North Star. Let me explain why.

We built the right architecture from the start, the industry's lightest weight, easiest to install sensor embedded with AI, no system reboot required a single AI native platform console, not disparate stitch together or siloed multi-platforms. … The Falcon platform's differentiated architecture creates a technological competitive moat around our ability to be cybersecurity's premier platform consolidator. … And now with Charlotte AI, customers are experiencing more platform utility at faster speeds, shrinking hours of their security workdays into minutes… The Falcon platform's differentiated architecture creates a technological competitive moat around our ability to be cybersecurity's premier platform consolidator. … And now with Charlotte AI, customers are experiencing more platform utility at faster speeds, shrinking hours of their security workdays into minutes.” This consolidation “delivers extreme cost savings, [meaning] the more modules customers adopt, the more cost savings they realize,” up to $6 for every $1 invested in the Falcon platform.

Building on the consolidation point was some interesting commentary from management about its subscription model, Falcon Flex, which also underpinned the recent AWS deal. Management said that “in the 3 quarters since we've built the Falcon Flex program, the customers who have subscribed to this new licensing model represent over $500 million in deal value, growing our share of customer wallet while consolidating and simplifying their security.” CFO Burt Podbere added more color on Falcon Flex, saying that the “Falcon platform's unique ability to consolidate multiple vendors along with the early success of our Falcon Flex program drove bigger consolidation deals in the quarter.” the early success of our Falcon Flex program drove bigger consolidation deals in the quarter.” It also was noted that Falcon Flex aided in CrowdStrike reaching “record levels of pipeline for the year.”

Exclusivity Deal with AWS:

CrowdStrike’s recent deal with AWS as its exclusive cloud security provider was underpinned by Falcon Flex, and Barclays analyst Saket Kalia questioned management about the deal, asking how the relationship with AWS was expanded and how it sets CrowdStrike apart in cloud security.

CEO George Kurtz responded, saying it is “really reflective of what we’ve built” in terms of the scope of the platform, spanning agent and agentless, code to cloud solutions, and the “technical advantages that our offerings have for our customers. When you look at someone like AWS, they’re obviously looking for the best cloud technology in the market, and we believe we have it, and it’s fantastic to be able to expand our relationship there. This is also a Falcon Flex deal, again reflective of the fact that customers want to do more with us, they want to buy more, and we’re giving them the opportunity to do this.”

The Impact of Generative AI

Analysts were also curious as to how generative AI was impacting the customer journey.

Q, Matt Hedberg (RBC): “In the spirit of a customer's overall GenAI journey, one of the things we're hearing is that, that could potentially slow down deal cycles for the broader software landscape. I'm wondering, as your customers adopt your AI platform, maybe more specifically Charlotte AI, are they seeing faster time to production for GenAI application? In other words, does it speed up a customer's GenAI journey?”

A, CEO George Kurtz: “Yes. I think what we're seeing is that customers are really embracing the fact that we can reduce their operational workload for their stock analysts. We can take hours of mundane front work and turn it into minutes. And not only answer questions with the collective wisdom and knowledge that CrowdStrike has developed over the many years, but also drive automation. We talked about the Falcon Fusion or technology built in. So when they look at what we've built and how we can save time and how we can drive AI automation into an AI-native SoC, I think this is really important for them.”

Double-Clicking on the $10B ARR Target:

While generative AI is likely aiding growth via significant reductions in operational workload, there was no specific commentary as to the revenue impacts from genAI products. However, management’s confidence in its $10 billion ARR target was scrutinized.

Q, Fatima Boolani (Citi): “what do you feel like will help your relative velocity in attaining that [$10 billion ARR]. So frankly, what would have to go really right for that outcome to be realized within 3 years versus 5 years, appreciating that you haven't put a time frame on it.”

A, CEO George Kurtz: “When we look at our ability to consolidate, and I talked about in the call, Falcon Flex, I think is a game changer for a lot of customers, buying more, buying bigger, leveraging the platform and you see velocity of adoption using Falcon Flex. So really excited about that and what it's going to mean for CrowdStrike.

The second piece again, as I talked about in my prepared remarks is, that Next-Gen SIEM is natively built in. So rather than sending data out somewhere else and paying for the transport costs and all the complexity around that, the bulk of the use cases and the data that's generated that goes into a SIEM is already in the platform of choice for customers, and we see that being a meaningful opportunity for us to massive market opportunity.”

While Kurtz primarily focused on the product opportunities from Falcon Flex and SIEM, CFO Burt Podbere explained CrowdStrike’s target in terms of its TAM: “We talked about cloud being around in that same time frame, $2.5 billion to $3 billion. We talked about identity being $1 billion to $1.5 billion. We talked about Next-Gen SIEM being $1 billion to $1.5 billion. So you start adding up those numbers and you get more and more confidence in terms of being able to attain that number. That's how we think about it internally.”cloud being around in that same time frame, $2.5 billion to $3 billion. We talked about identity being $1 billion to $1.5 billion. We talked about Next-Gen SIEM being $1 billion to $1.5 billion. So you start adding up those numbers and you get more and more confidence in terms of being able to attain that number. That's how we think about it internally.”

Essentially, cloud is expected to remain the largest overall driver in dollar terms, but SIEM and identity are expected to quickly catch up to the billion-dollar range – Next-Gen SIEM and identity ARR surpassed $450 million in ARR combined last quarter, and Podbere’s comments point to both combining to a $3 billion opportunity, or nearly 6x growth over the next 5 to 7 years. He also noted that CrowdStrike grew its headcount 15% YoY in Q1 to support its trajectory to the $10 billion – this was a likely culprit of the increased operating expenses in Q1 and subsequent QoQ margin weakness.

Conclusion

CrowdStrike delivered a strong quarter, reporting a rare QoQ revenue growth acceleration for Q1 in what has unfolded as a difficult quarter for cloud stocks. Margins dipped down the line, though key metrics, particularly net new ARR, remained strong. CrowdStrike also boosted its full-year revenue and adjusted EPS guide, as it continues to sign larger deals, benefitting from the strength of its Falcon platform. It is not only the excellence of this report that stands out, yet the also the weakness of CrowdStrike’s peers. As you can imagine, we are currently looking to add to our position. Our goal is to buy at lower levels (worth a shot), or if price does not cooperate, we will buy on a breakout.

Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.

Recommended Reading:

ServiceNow Overview: Key Metrics are Strong

Posted on April 24, 2024June 30, 2026 by io-fund

ServiceNow’s upcoming earnings report is of high interest to us. There are many key metrics to highlight, including the company’s ability to re-accelerate subscription revenues to 27% YoY in the previous quarter, up from 22% a year ago. RPO also accelerated nicely to 29% YoY growth up from 22% in the year ago quarter. Net New ACV (NNACV) was up 33% YoY compared to 30% in the year ago quarter with the number of transactions over $1M in NNACV more than doubling QoQ from 83 to 168 transactions.

The CFO stated that the company’s generative AI product, Now Assist, contributed to the recent raise for FY2024 guidance of $165 million. However, gen AI’s contribution is very new and not too impactful yet, per management.

ServiceNow is the rare cloud company that is GAAP profitable and has a strong free cash flow margin of 30% for FY2023.

This report dives deeper into the elements that underpin ServiceNow’s optimism, including an examination of its financial health, strategic initiatives, and the anticipated impact of its AI-driven products on the market.

Key Points:

Q4 2023 Revenue Performance: ServiceNow reported a 25.62% increase in Q4 revenue, reaching $2.44 billion. QoQ growth improved by 6.6%, with expected Q1 revenue of $2.59 billion, marking a 23.5% year-over-year increase.
Robust Subscription Growth: ServiceNow's subscription revenues reached $2.37 billion, growing 27% YoY and exceeding revenue guidance of $2.32 billion and growth of 24.75% at the mid-point and $2.32 billion, while professional services declined by 10% YoY in Q4 and 18% for the year.
Expansion and Strategic Alliances: ServiceNow enhanced its OT management capabilities with acquisitions of 4Industry and Smart Daily Management, collaborated with Hugging Face and NVIDIA on the StarCoder2 LLM, expanded its partnership with NVIDIA for telco-specific AI solutions, deepened its alliance with EY for AI compliance, and launched new payment and AI-powered solutions through strategic alliances with Visa and AWS.
Mixed Margin Performance: ServiceNow experienced mixed margins year-over-year, with improvements in operating and net margins, while gross and subscription margins saw slight declines.
Operational Efficiency and Investment Strategy: The company is raising its full-year operating margin target from 28% to 29% due to continued operational efficiencies. Investments are focused on innovation in AI, particularly Gen AI, with significant hiring in R&D to drive these initiatives.
Strong Growth Outlook with GenAI Focus: According to management, the newly launched Gen AI product, Now Assist is contributing to the company’s largest net new ACV. This segment saw 168 deals greater than $1 million, up 33% YoY.
Strategic Gains Across Segments: Despite challenges in the market environment, ServiceNow closed numerous large deals globally, including a record number of new $1 million+ deals and major wins in the public sector such as with the US Army and Australian Department of Defense.

Revenue and Earnings:

ServiceNow reported fiscal Q4 revenue of $2.44 billion for an increase of 25.62% YoY. This is a 6.6% improvement QoQ from $2.29 billion in revenue. The growth rate was 24.96% in the September quarter, and thus, December marked a slight acceleration. In terms of being seasonal or not, this did not occur last year, rather the December 2022 quarter decelerated by 90 basis points in growth rate.

ServiceNow is expected to see slightly slower growth next quarter at 23.5% for revenue of $2.59 billion. For the full year, analysts are expecting growth of 21.4% for revenue of $10.89 billion.

The performance in Q4 was packed with milestones for ServiceNow, spanning the full breadth of their portfolio. Each of their workflow businesses, technology, customer, and creator, are over $1 billion in annual contract value (ACV). And the company has 11 individual product lines with north of $250 million in ACV.

ServiceNow ended Q4 with 1,897 customers paying over $1 million in ACV adding 108 customers compared to the prior quarter. This is the addition in $1M customers in the past five quarters.

The company closed 168 deals greater than $1 million in net new ACV (NNACV) in the quarter, a 33% increase year-over-year, that includes five deals over $10 million. Interestingly, this was over 100% growth QoQ.

For the full year 2023, ServiceNow saw an approximate 30% increase in deals greater than $1 million in net new ACV.

Despite this, total ACV only increased 15% in Q4 2023 compared to the prior year period. This is down from 17% growth in the previous quarter and down from 22% in the year ago quarter.

Remaining Performance Obligations (RPO) and current Remaining Performance Obligations (cRPO) are two popular metrics to track for ServiceNow.

RPO ended the quarter at approximately $18 billion representing an acceleration to 29% YoY. This compares to growth of 26% in the previous quarter and compared to growth of 22% in the year ago quarter.

cRPO was $8.6 billion, representing 24% YoY which was down from 27% in the previous quarter although was up from 22% in the year ago quarter.

Gen AI products, via Now Assist, drove the largest net new ACV contribution for the first full quarter of any of ServiceNow’s new product family releases ever, including the original Pro SKU.

ServiceNow topped analyst estimates on both the top line and bottom line. Analysts were expecting GAAP EPS of $1.43, non-GAAP EPS at $2.78 and revenue of $2.4B, while the company reported GAAP EPS at $1.46, non-GAAP EPS at $3.11and revenue at $2.44B. Even though the company’s earnings growth is expected to slow in 2024, management is still anticipating solid double-digit growth for the year.

Revenue Segments:

In Q4, subscription revenues were $2.37 billion, growing 27% YoY, exceeding the high end of the company’s guidance. ServiceNow closed out 2023 with $8.68 billion in subscription revenues, also representing 27% growth compared to fiscal 2022 subscription revenues. The CFO Gina Mastantuono had this to add on subscription revenues, “All organic at a scale that hasn't been accomplished by any other enterprise software company.”

Professional services and other revenues were $72 million for Q4, a (-10%) decrease YoY. For the full year of fiscal 2023, professional services and other revenues amounted to $291 million, representing an (-18%) decline YoY.

With regards to ServiceNow’s total addressable market (TAM), the CFO commented on a major milestone: “For the first time in a decade, IT services will become bigger than communication services in 2024. Gartner estimates that by 2027, nearly all of the growth in worldwide IT spending will come from software and IT services. And when you drill deeper into the Gartner forecast between 2023 and 2027, $3 trillion will be spent on AI.” This speaks to size and growth of the total addressable market for ServiceNow.

Margins:

Margins were mixed YoY as the company's focus on low-margin AI products is evident in its financial outcomes. Operating margin and net margin improved, while gross margin and subscription margin declined slightly YoY.

Non-GAAP subscription gross margin dipped to 84% in Q4 2023, flat QoQ but a decrease from 86% in Q4 2022. The company expects this margin to improve slightly to 84.5% in 2024, reflecting investments in data centers and emerging growth opportunities, partially offset by a change in useful life in data center equipment from four to five years. ServiceNow is also raising its full year non-GAAP operating margin target from 28% to 29% driven by continued operational expenses efficiencies.

Margins were a topic in the conference call with one analyst congratulating the company on the performance in 2023, with the CFO adding the expectation those margins will continue to expand in 2024.

Cash Flow:

Operating cash flow of $1.61 billion in fiscal Q4 represented a margin of 66%. Free cash flow of $1.34 billion represented a FCF margin of 55%.

There is $8.1 billion in cash and investments on the balance sheet and $1.49 billion in debt. Debt has remained constant since Q4 2022 with no amounts due in the next twelve months.

ServiceNow announced that the company repurchased 400,000 shares of its common stock for $256 million as part of its share repurchase program.

Earnings Call:

ServiceNow is expecting strong growth yet again in 2024 with GenAI being a central part of the bullish view for the stock. Analysts had a lot of questions on the topic.

GenAI

ServiceNow’s new Gen AI product, Now Assist, was stated to have “drove the largest net new ACV contribution for our first full quarter of any of our new product family releases ever.” Therefore, it’s not surprising to see it as a key topic during the Q&A.

And despite the very strong performance in Q4 and fiscal year 2023, it brought out a few interesting takes from management, specifically on the environment they face as we head into 2024.

Here is what the CEO stated when asked about the Gen AI product driving the largest net new ACV contribution:

“What's really happening and I can say this after 186 CEO meetings in the last six months, the CEOs are now getting very involved with the Gen AI revolution. They realize there has to be architectural adjustments to their environment and the manner in which they manage their data and the platforms they're beholden to actually take advantage of Gen AI.

And if you think about the half a century mess that exists out there with legacy systems, in many cases, multiples of the same system, we have one unifying force in these conversations, which is the Now platform because we cooperate with the complexity of this landscape without putting people in a position to rip and replace […]

As I said, that SKU has outsold any other new introduction we put into the marketplace. So, there's a real appetite to invest in Gen AI, and there's no price sensitivity around it because the business cases are so unbelievable. I mean if you're improving productivity, 40%, 50%, it just sells itself.”

Overall, this is an encouraging note on the sales environment along with the potential of the Gen AI segment for ServiceNow. It’s not a huge revenue driver at the moment, but the trajectory means it could become a key driver of growth in 2024 and beyond.

Here’s what Gina had to add about Gen AI during the call.

I get the question often, do we see the adoption curve to be steeper for our Pro Plus than our Pro. Certainly, in the first full quarter of launch, it absolutely has shown that.

That being said, it's very early days. And so from a revenue contribution perspective, it's not going to be huge, but it's certainly helped when I thought about my guide for 2024 and that increase of $165 million at the midpoint, right? So Gen AI, early days, but the adoption curve so far is steeper than the original Pro. We will keep an eye on it.but it's certainly helped when I thought about my guide for 2024 and that increase of $165 million at the midpoint, right? So Gen AI, early days, but the adoption curve so far is steeper than the original Pro. We will keep an eye on it.

Net New ACV

ServiceNow’s new logo count continued to accelerate in Q4, with a record 10 new customers signing deals over $1 million in NNACV, including a $10 million win with a very large global financial services firm, which is their largest new customer logo in history.

Chipotle, Air France, TIAA, NTT, Data Group Corporation, and Busch are some of the brands that are utilizing ServiceNow to enhance their operations.

Additionally, in Q4 ServiceNow built on a record Q3 with the public sector, with key wins including in the United States Army, US Postal Service, and Australian Department of Defense Digital Delivery Group.

During the call, one analyst wanted more details on the drivers of the momentum in ACV.

Bill McDermott:

Just a couple of statistics on the customer workflows, 18 of our top 20 deals, what we're seeing is there's a tremendous opportunity to really take ServiceNow and squarely place it on the Customer Relationship Management category.

When you think about front, mid and back office and the fact that we can align all three of those things, and nobody has to lose for us to win. We could fill in all the blanks for what the current participants don't do, especially with their integration problems. It's just a fantastic opportunity for our customers.

And I think it's important to note, when I gave the Field Service Management example, our net new ACV in Field Service Management, specifically was up over 50% and year-over-year.

So, I think it's important to recognize that we have a whole list of new logos in this space. And employee workflows, nine of our top 20 deals and was kind of interesting. Every single CEO now is looking to make the people packed far more productive than it is and with natural language to have your employees seek the data and the information they want and have it reported back to them in just a very nice paragraph of content and data so they can do their jobs better, is kind of like in the no-brainer category.

RPO and cRPO

RPO and cRPO are key indicators of growth and future projections for ServiceNow. Analysts were zeroing in on what the upside is for the current quarter, Q1 2024, and how much is due to Gen AI adoption.

Gina Mastantuono:

So, we beat our Q4 cRPO growth guidance by 200 basis points as you know. And I would say it's driven probably half and half by net new ACV outperformance and certainly, Gen AI is in there, but it's not all Gen AI.

So, our core business is also doing well. And then we also did see higher early renewals than we had assumed in our guidance. And I would say it's about half and half of the total beat.

Government:

The government is a very strong potential growth area for ServiceNow. A few analysts wanted more details.

They asked about cyclical spending at the public sector and what their AI adoption cadence is going to look like.

Here’s Bill’s take:

Our federal business is really outstanding. And for the benefit of our shareholders, I think that there's a tremendous opportunity to replicate what we're doing in the United States federal and many other governments around the world. That is clearly an ambition that we have, and we have many use cases and many references to back that up.

Recent AI Announcements:

On March 18, 2024, ServiceNow announced it has signed an agreement to acquire 4Industry, a Netherlands‑based partner whose manufacturing technology application is built on the Now Platform, and has completed the acquisition of Smart Daily Management, a connected digital worker application from EY. Together, the deals augment ServiceNow’s existing operational technology (OT) management capabilities, adding Connected Worker solutions and enhancing expertise across key industrial markets such as manufacturing, energy and transport & logistics.

On February 28, 2024, ServiceNow, Hugging Face, and NVIDIA, announced the release of StarCoder2, a family of open‑access large language models (LLMs) for code generation that sets new standards for performance, transparency, and cost‑effectiveness.

On February 26, 2024, ServiceNow and NVIDIA announced that they are broadening their relationship with the introduction of telco‑specific generative AI solutions to elevate service experiences.

On January 24, 2024, ServiceNow announced a broader strategic alliance with EY to empower responsible AI use for enterprise customers, deliver unified solutions for AI compliance and governance, and bring AI‑enhanced experiences to EY employees and clients with ServiceNow Now Assist.

Additionally, ServiceNow and Visa announced a five‑year strategic alliance to transform payment services experiences. The initial phase includes the launch of ServiceNow Disputes Management, Built with Visa–– a single, connected solution for disputes resolution.

ServiceNow also announced a five‑year Strategic Collaboration Agreement with Amazon Web Services (AWS) to offer the ServiceNow Platform and full suite of solutions in the AWS Marketplace. The two companies will also co‑develop and launch industry‑specific, AI powered applications.

Conclusion:

The key metrics on ServiceNow help to create a picture that something special is going on at this company compared to many cloud peers. As with nearly every stock in the market right now, investors must contend with valuations. This is one thing if you’ve owned a stock for some time and are sitting on gains, but is a bigger risk if you’re wanting to enter now for the initial entry. We’d like to keep ServiceNow in our pipeline to buy at lower levels, while also keeping an eye on the upcoming earnings report to see if any new information changes that decision. As always, each investor must determine their own unique risk profile for themselves. For our purposes, we view ServiceNow as fairly valued at 17 PS ratio compared to a 17 PS ratio 5-year median and 15.5 PS ratio 3-year median. The bottom line is only recently GAAP profitable and trades at a 88.6 PE Ratio compared to 5-year median of 1826 (noisy signal). Price to free cash flow is at 56 compared to a 5-year median of 52.6. Therefore, for our purposes, it makes sense to try and get the stock lower since the probability it can stretch higher (and sustain a higher valuation) is low.

Chad Shoop, Equity Analyst for the I/O Fund, contributed to this analysis

Recommended Reading:

Cloud Earnings Review: AI a key driver for growth

Posted on March 25, 2024June 30, 2026 by io-fund

Every quarter, we provide an overview of the cloud sector including hyperscalers and best-of-breed companies. We had discussed in our last analysis that the hyperscalers are showing signs of stabilization. In a further positive development, the hyperscalers growth accelerated in the recent quarter, helped by a much-needed boost from AI.

Below, we look at best-of-breed companies that are expected to decline sequentially by 4 points, the same deceleration we noticed in Q3 to Q4. This is an improvement from an 11 point decline in Q1-Q2 of last year. We also discuss various financial metrics that can help determine which cloud companies will continue to lead.

Tracking the Cloud ETFs YTD performance, SKYY beat the QQQ (tracks the Nasdaq-100 Index) by one percentage point and other ETFs are trailing with WCLD with (1.37%) return and CLOU with (4.06%) YTD returns.

Big Tech is the Best Proxy for Cloud

Big Tech Companies are more insulated than Best-of-Breed cloud and offer a 360-degree view of how the cloud industry is faring. The Big 3 cloud providers are the best proxy since they account for 67% of the cloud market. They also represent the layer in the tech stack that tends to be the most resilient in terms of churn. The switching costs are quite high for cloud IaaS services.

Microsoft Azure had the fastest growth of 30% among the Big 3 and all the three companies showed an acceleration that was helped by AI revenue. Microsoft Azure Q4 growth rate and AWS accelerated by 1%, while Google Cloud accelerated by 4%. This is an improvement from the trend in the previous quarter when we noted, “Microsoft Azure’s Q3 growth rate was the outlier among the Big 3 as its growth rate accelerated by 3%, while AWS remained steady albeit at a slower growth rate, and Google Cloud decelerated by 6%. The steep deceleration in Google Cloud was a negative surprise as analysts were expecting it to grow 26% compared to the actual 22%.”

According to Synergy Research Group the combined Q4 YoY growth of the Big 3 cloud providers marked the highest growth compared to the previous three quarters and also the largest sequential increase ever. “The year-on-year growth rate was 20% in Q4, markedly higher than the previous three quarters. Notably, the market grew by $5.6 billion from Q3. That is by far the largest quarter-on-quarter increase ever achieved.”

Microsoft

Microsoft Azure grew 30% YoY and 28% in constant currency, including a 6% incremental contribution from AI.
Growth accelerated from 29% in the previous quarter and was slightly down from 31% in the same period last year.
The company’s CFO, Amy Hood, said Azure growth will remain stable in the next quarter. “In Azure, we expect Q3 revenue growth in constant currency to remain stable to our stronger-than-expected Q2 results. Growth will be driven by our Azure consumption business with continued strong contribution from AI.”Growth will be driven by our Azure consumption business with continued strong contribution from AI.”

AI’s impact on Azure was notable: Microsoft said that Azure’s 30% growth stemmed from “strong demand for our consumption-based services including 6 points from our AI services.” This 6-point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4. While that may seem small, it is significant considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate.

Microsoft’s earnings call reflected growing AI optimism, with strong key metrics for its AI offerings across its product suite. Satya Nadella also signaled in the earnings call Q&A that optimization is over for now on traditional workloads, which is positive. “I'll call it, optimization only and no new workloads start, that I think has ended at this point. So what you're seeing is much more of that continuous cycle by customers, both whether it comes to AI or whether it comes to the traditional workloads.”

AWS

AWS revenue grew by 13% YoY to $24.2 billion and is now approaching a $100 billion annualized run rate.
Growth accelerated by one percentage point from 12% in the last quarter yet was lower than the 20% in the same period last year.

The company’s CEO, Andy Jassy, sounded very optimistic in the earnings call on the prospects of AI. “Gen AI is and will continue to be an area of pervasive focus and investment across Amazon, primarily because there are a few initiatives, if any, that give us the chance to reinvent so many of our customer experiences and processes, and we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years.”we believe it will ultimately drive tens of billions of dollars of revenue for Amazon over the next several years.”

The company’s CFO pointed out that optimizations are slowing. “Similar to what we shared last quarter, we continue to see the diminishing impact of cost optimizations. And as these optimization slow down, we're seeing more companies turning their attention to newer initiatives and reaccelerating existing migrations.”

Google Cloud

Google Cloud revenue grew by 26% YoY to $9.2 billion, helped by the increasing contribution from AI, beating the estimates of $8.94 billion.
Even though the growth is lower when compared to the 32% growth in the same period last year, it has accelerated from 22% in the previous quarter.
The strong growth in the quarter also helped the company narrow the gap to 4 percentage points with Microsoft Azure’s leading growth of 30% compared to 7 percentage points in the previous quarter.

In the earnings call, CFO Ruth Porat said, “The Cloud team is intensely focused on bringing the benefits of Gemini, our industry-leading AI technology, to enterprises and governments globally, and we are gratified with the level of engagement. The strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area.” The company launched Gemini in December and offers three versions: Gemini Ultra, Gemini Pro, and Gemini Nano.

The company’s CEO Sundar Pichai also echoed the thoughts of Microsoft and Amazon’s management on cost optimizations reducing, saying “the cost optimizations in many parts are something we have mostly worked through.”

Best of Breed

We took a sample of the top-ranking cloud stocks on revenue growth, free cash flow, adjusted operating margin, and valuations.

Best-of-breed cloud companies are expected to decline sequentially by 4-points; from 5% QoQ growth last year to the expected 1% QoQ this year. This is the same as we noticed in Q3 to Q4, wherein it showed an improvement from a decline of 11 points in Q1 to Q2 of last year.

However, on a percentage basis, the recent QoQ/YoY deceleration is 72% compared to the 47% decline in Q3 to Q4 estimates and slightly better than the 83% decline in the same period last year.

All the best-of-breed cloud companies showed a deceleration similar to the trend seen in our previous analysis. CrowdStrike has the lowest deceleration, from 9% last year to 7% expected this year. Bill Holdings has the highest deceleration, from 5% growth last year to (4%) this year. In our previous analysis, Bill Holdings had the lowest deceleration.

Earnings Beats

Bill Holdings led with a revenue beat of 6.8%. The company’s revenue grew by 22% YoY to $318.5 million. The core revenue, which includes subscription and transaction fees, grew by 19% YoY to $275 million. Management highlighted the better-than-expected standalone total payment volume (TPV) growth of 10%. However, they are still cautious on macro, “It's too early to call a trough in B2B spend, and we expect the current interest rate environment will continue to depress overall spend growth.” The management guide for the next quarter is $299 million to $309 million, representing a YoY growth of 11.5% at the midpoint.

MongoDB’s revenue exceeded analyst expectations by 5.2%. The company’s revenue grew by 27% YoY to $458 million. However, the stock sold off post earnings as the FY guidance missed estimates. Management FY revenue guide was $1.9 billion to $1.93 billion below the estimates of $2.03 billion. The adjusted EPS guide was $2.27 to $2.49, far below the estimates of $3.22.

HashiCorp’s revenue grew by 15% YoY to $155.8 million, beating estimates by 4.3%. Management revenue guide for the next quarter is $152 million to $154 million, representing a YOY growth of 10.9% at the midpoint. The management highlighted in the earnings call that they are targeting 20% growth sometime in FY2026. Per CFO, “And then what follows is basically progressive improvement on the growth rate until it reaches 20% in the fiscal 2026 period, not that fiscal '26 will be 20%, just to be clear. So what we're signaling is that — the fourth quarter was a great quarter, and we feel like the optimization cycle is abating. There are signs of positive activity. We're not out of the woods.”we feel like the optimization cycle is abating. There are signs of positive activity. We're not out of the woods.”

HashiCorp’s adjusted EPS came at $0.05 compared to ($0.07) in the same period last year, beating estimates by 501%. This was the second consecutive non-GAAP profitability for the company. Snowflake’s adjusted EPS grew by 150% YoY to $0.35, beating estimates by 98%. MongoDB ranked third with a beat of 82.6% and its adjusted EPS grew by 50.9% YoY to $0.86.

Bottom Line and Free Cash Flow

GAAP profitability is another crucial metric to monitor closely, especially with macroeconomic uncertainty. Most of the names listed in the chart below are unprofitable on a GAAP basis because they pay high stock-based compensation.

This is one of the more important metrics that separates the winners from the laggards. For example, CrowdStrike recently achieved the feat of four consecutive quarters of GAAP profits and a full year in GAAP profits. The stock has been up 140% in the past year.

Bill Holdings has improved its operating margin to (13%) from (43%) in the same period last year. CrowdStrike has improved to 4% from (10%) in the same period last year. Zscaler reported (9%) compared to (17%) last year.

ServiceNow has the highest free cash flow margin of 55%, up from 52% in the same period last year. Snowflake ranks second with a free cash flow margin of 42% and Datadog ranks third with a free cash flow margin of 34%.

Valuations

CrowdStrike has the highest forward P/S ratio of 19.5 among the best-of-breed cloud stocks. It is followed by Cloudflare at 19.3 and Datadog at 15.5.

Ranking based on revenue estimates change for next quarter.

GitLab’s revenue estimates have been revised by 2.5% and Zscaler ranks second with a positive revision of 1%. MongoDB had a negative revision of (2.1%) after the company’s FY guidance came in below analyst expectations.

Ranking based on adjusted EPS estimates change for the next quarter.

Zscaler had the highest adjusted EPS revision of 10.5% among the best-of-breed cloud stocks. It is followed by CrowdStrike at 8.3% and Snowflake at 0.8%.

Highlights and Lowlights in Q4

CrowdStrike reported the fourth consecutive quarter of GAAP profits and the first full year of GAAP profits. The turnaround in GAAP profitability is most impressive compared to its cloud peers. The company’s key metrics are also accelerating. Notably, the net new ARR accelerated by 14% to 27% growth in the recent quarter from 13% in Q3. The company is in a unique position by combining cybersecurity with AI in a single platform with a data-centric architecture. Our complete post-earnings analysis is here.

Cloudflare beat revenue estimates by 2.7% and adjusted EPS by 26.3%. The company’s adjusted operating margin grew by 500 bps to 11% in the recent quarter. The free cash flow margin improved by 200 bps to 14%. CEO and co-founder Matthew Prince said in the earnings call, “The machine that underlies Cloudflare is firing efficiently on all cylinders, and we've been able to execute even as the macro environment remains choppy.” Key metrics accelerated, RPO accelerated to $1.245 billion, up 37% YoY compared to 30% YoY growth last quarter. We have discussed the company further in our post-earnings analysis here.

Zscaler beat revenue estimates by 3.6% and adjusted EPS estimates by 31%. On the macro, the company’s CFO said in the earnings call, “We believe we are still operating in a challenging macroenvironment and customers continue to scrutinize large deals.” Despite the beat and raise, the stock sold off post-earnings since the company guided for a (7%) sequential decline in calculated billings, suggesting further deceleration in this key metric to the low-20% range. We have discussed the company further in our cybersecurity analysis here.

Conclusion

The hyperscalers growth accelerated with a boost from AI. Cloud optimizations are reducing, which is positive. However, the macro conditions are still challenging. We will continue to look for outliers in the cloud category as we move into next quarter’s earnings season. We added CrowdStrike and Cloudflare to our portfolio partly informed by scans such as these, which revealed bottom line strength coupled with strong growth. We also use these overviews to keep an eye on valuation, of which cloud stocks are particularly sensitive to in this environment with very few successfully trading over 20 Fwd P/S since Q4 of 2021.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Recommended Reading:

Cloud Earnings Review: AI a key driver for growth

Posted on March 25, 2024June 30, 2026 by io-fund

Big Tech is the Best Proxy for Cloud

Microsoft

Microsoft Azure grew 30% YoY and 28% in constant currency, including a 6% incremental contribution from AI.
Growth accelerated from 29% in the previous quarter and was slightly down from 31% in the same period last year.
The company’s CFO, Amy Hood, said Azure growth will remain stable in the next quarter. “In Azure, we expect Q3 revenue growth in constant currency to remain stable to our stronger-than-expected Q2 results. Growth will be driven by our Azure consumption business with continued strong contribution from AI.”Growth will be driven by our Azure consumption business with continued strong contribution from AI.”

AWS

AWS revenue grew by 13% YoY to $24.2 billion and is now approaching a $100 billion annualized run rate.
Growth accelerated by one percentage point from 12% in the last quarter yet was lower than the 20% in the same period last year.

Google Cloud

Google Cloud revenue grew by 26% YoY to $9.2 billion, helped by the increasing contribution from AI, beating the estimates of $8.94 billion.
Even though the growth is lower when compared to the 32% growth in the same period last year, it has accelerated from 22% in the previous quarter.
The strong growth in the quarter also helped the company narrow the gap to 4 percentage points with Microsoft Azure’s leading growth of 30% compared to 7 percentage points in the previous quarter.

Best of Breed

We took a sample of the top-ranking cloud stocks on revenue growth, free cash flow, adjusted operating margin, and valuations.

However, on a percentage basis, the recent QoQ/YoY deceleration is 72% compared to the 47% decline in Q3 to Q4 estimates and slightly better than the 83% decline in the same period last year.

Earnings Beats

Bottom Line and Free Cash Flow

Valuations

CrowdStrike has the highest forward P/S ratio of 19.5 among the best-of-breed cloud stocks. It is followed by Cloudflare at 19.3 and Datadog at 15.5.

Ranking based on revenue estimates change for next quarter.

Ranking based on adjusted EPS estimates change for the next quarter.

Zscaler had the highest adjusted EPS revision of 10.5% among the best-of-breed cloud stocks. It is followed by CrowdStrike at 8.3% and Snowflake at 0.8%.

Highlights and Lowlights in Q4

Conclusion

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Recommended Reading:

CrowdStrike Q4: RPO Surges, Net New ARR Impresses, GAAP Margins Strengthening

Posted on March 6, 2024June 30, 2026 by io-fund

CrowdStrike reported a new record for net new ARR in Q4, far surpassing the record it set in the previous quarter, and GAAP margins continued to strengthen. Net new ARR accelerated significantly in the quarter to 27% growth, which is a 14-point acceleration from 13% growth in Q3. This is up from 2% growth for net new ARR in the year ago quarter. The turnaround in this particular key metric is notable, especially compared to other cloud stocks whose key metrics are decelerating. ARR increased 34% to $3.44 billion, which was down 1 percent from 35% growth last quarter.

For FY25, CrowdStrike’s guide was marginally above consensus, yet the market is clearly pleased with the continued expansion in operating and net margins. The turnaround on net new ARR is notable, yet the turnaround on GAAP profitability is what is most impressive compared to its cloud peers, especially considering the far majority of cloud stocks are years away from GAAP profitability (if they ever get there). We covered this in-depth here.

Revenue and EPS:

Q4 revenue was $845.3 million, beating estimates by $5.3 million, representing YoY growth of 33%. This is down from 36% growth in the previous quarter.
Q1 revenue was guided between $902.2 million to $905.8 million, representing YoY growth of 30%.
FY24 revenue was $3.06 billion, an increase of 36% YoY.
FY25 revenue was guided at $3.925 billion to $3.99 billion, slightly ahead of consensus for $3.94 billion and representing YoY growth of approximately 29% at midpoint.
Q4 adjusted EPS was $0.95, beating estimates by $0.13 and representing YoY growth of 102%. GAAP EPS was $0.22, compared to ($0.20) in the year ago quarter.
FY24 adjusted EPS was $3.09, an increase of 101% YoY. GAAP EPS was $0.37, compared to ($0.79) in FY23.
The bottom line is expected to grow steadily over the next two fiscal years, suggesting that GAAP profitability is permanent. With that said, analyst consensus for next quarter of $0.82 is lower than Q4’s EPS of $0.95. It’s likely we see upward revisions to Q1’s EPS over the next few days, although management guided for an adjusted operating margin that is four points lower QoQ than the current quarter.

Margins:

Margins strengthened across the board – driven by four quarters of GAAP gross margin at 75% and GAAP subscription margin at 78%. For the full year, CrowdStrike nearly broke even from operations, reporting just a ($2 million) loss from operations, or a (0%) margin, an 800 bp improvement from FY23. CrowdStrike also reported its first full year with GAAP net profitability, reporting a 2.9% net margin, compared to an (8.2%) margin in FY23.

Q4 saw net margin more than double sequentially, from 3% in Q3 to 6.4% in Q4, as net income surged 101% QoQ to $53.7 million – this means that CrowdStrike generated 60% of its GAAP net income in Q4 alone.

Q4 GAAP gross margin was 75.3%, compared to 72% in the year ago quarter.
Q4 GAAP operating margin was 3.5%, the second straight quarter with a positive margin and an increase from 0.3% in the previous quarter.
o To further illustrate CrowdStrike’s margin expansion, GAAP operating income was $30 million this quarter compared to (-$61.5) million in the year ago quarter. This is up from $3.2 million last quarter.
o CrowdStrike’s adjusted operating income was $213.1 million for a margin of 25%. The company is guiding for a lower margin next quarter of 21%.
Q4 GAAP net margin was 6.4%, the fourth consecutive quarter with a positive margin and an increase from 3% in the previous quarter.

Stock based compensation was 20.9% of revenue compared to 20.3% of revenue in the previous quarter for a total of $176.3 million.

Fiscal Year 2024 Margins:

FY24 GAAP gross margin was 75%, compared to 73% in FY23.
FY24 GAAP operating margin was (0%), compared to (8%) in FY23.
FY24 GAAP net margin was 2.9%, compared to (8.2%) in FY23.

For FY2025, the CFO provided the following color: “As a result of increased hiring in the first half of the year, changes to the timing of our merit cycle and the timing of certain marketing programs, we expect operating leverage to be more weighted to the back half of FY '25.”

Cash and Debt:

CrowdStrike is known for its strong cash flow margins and this quarter was no exception. The company raised its FY2025 free cash flow target by 1-point at the midpoint. Per the CFO: “Next, we are raising our free cash flow target for FY '25 from between 30% and 32% to between 31% and 33% of revenue.”

Q4 operating cash flow was $347 million, representing a 41% margin. Free cash flow in the quarter was $283 million, a 33.5% margin.
FY24 operating cash flow was $1.16 billion for a margin of 38%. Free cash flow was $938.2 million for a margin of 30.7%.
Cash, equivalents and short-term investments totaled $3.47 billion.
Debt totaled $742.5 million.

Key Metrics:

CrowdStrike added a record $281.9 million in net new ARR in Q4, far surpassing its previous net new ARR record of $223 million set just in Q3. Net new ARR increased 27% in Q4, a 14 percentage point acceleration from just 13% growth in Q3.

According to the CFO: “while we do not specifically guide to ending or net new ARR, given the incredible performance of Q4, I will share our currerpnt seasonality assumptions with respect to net new ARR in Q1, which calls for Q1 net new ARR year-over-year growth to be at least double digits up to the low teens.” The CFO is tempering expectations that 27% is not realistic for next quarter, but strong growth is still achievable.

ARR of $3.44 billion was up 34% YoY compared to ARR of $3.15 billion and growth of 35% in the previous quarter. Management has stated: “We continue to aggressively invest in our innovation engine and flank the company to achieve its vision of reaching $10 billion in ARR over the next 5 to 7 years.” That would imply about 200% growth in 5-7 years. The growth of deals with total value exceeding $1 million accelerated to “over 30%” this quarter for 250 customers.

Deferred revenue of $3.05 billion was up from $2.36 billion in the year ago quarter. The sequential increase from $2.5 billion suggests that billings are strong. Billings for this quarter comes to $1.36 billion, up 65% QoQ and up 39% YoY. There was mention on the call that total billings outgrew short-term billings, which translates to customers committing for longer contracts. Management likes to remind analysts that ARR is a better measure of their business, even during quarters when deferred revenue and billings are strong.

Similar to deferred revenue, RPO reported an astonishing surge that points toward CrowdStrike being resilient compared to its peers. RPO was up 35% YoY and up 24% QoQ to $4.6 billion. This is the highest QoQ growth we’ve seen the company report since tracking this metric over the past 11 quarters. Compare the 24% QoQ growth to only 3% QoQ growth last quarter.

Subscription revenue of $795.9 million increased 33% compared to 34% last quarter. Professional Services grew 26.3% for revenue of $49.4 million.

Customers with multiple modules increased 1% across the board, including in the 7+ module cohort, 6+ module cohort, and 5+ module cohort.

Dollar based net retention was 119%, same as last quarter. The company offered visibility (finally) into the quarterly DBNRR over the past year of “Net retention was 119% in Q3, 119% in Q2 and 122% in Q1.” These numbers had been left vague before. It’s softening a bit and 120% is the benchmark CrowdStrike has stated they want to achieve.

Earnings Call:

Data-Centric Architecture in a Single Platform:

The predominant question in the Q&A is why is CrowdStrike resilient when peers are not. As you’re likely aware, Palo Alto Network, Fortinet and Zscaler saw turbulence following their earnings reports. Overall, the CEO and management team focused on why a platform is important instead of a fragmented approach to acquisitions from “multi-platform hardware vendors [that] evangelize their stitched together patchwork of point products, masquerading as thinly veiled piecemeal platforms.” Wow, those are strong words. CrowdStrike is not shy about naming the companies they are taking business from. In this call, it was Azure Sentinel, Splunk and Palo Alto Networks. Later on, there was a quote that I think best juxtaposes the differences between the piecemeal platforms and what CrowdStrike is offering:

“So when we think about architecture, architecture does matter and really what we've created is a very data-centric architecture that allows us to get data at scale into our platform, leverage our AI and then create the outcomes. It's that collect once, use many. We have a single platform. Our competitors have many other platforms as they call them. We have a single agent. Our competitors have 5, 6, 7, 8 agents depending on the competitors.

So when we look at our architecture, it was really designed from the beginning to solve the problems of today and the future problems. And the result of that is ease of use, the outcome that a customer is looking for, stopping breaches and lowering the cost, and future proofing what they want. I've — in a prior life, I've been involved in companies that acquired a lot of products. And I can tell you, it is near impossible to stitch all this stuff together, particularly at the agent level unless you're very diligent about it.

This was further quantified in the opening remarks when it was stated that a recent IDC platform is “showcasing $6 of return for every dollar invested in the Falcon platform.”

We first covered the impact AI can have on lower costs in previous free analysis here and a deep dive on CrowdStrike here.

AI Revenue Won’t be Easy to Detect

It’s important to drop a note that many companies can break out AI revenue, whereas CrowdStrike’s data-driven AI features are inherent to the platform. Therefore, I don’t believe it’s possible to have a separate AI segment the same way other companies offer.

The previous deep dive on CrowdStrike stated the following:

“The statement that CrowdStrike’s data is more valuable is based on the vast number of threats their platform has already detected. Essentially, the argument is that their XDR platform is better than competitors, and therefore, their data is better than competitors, which results in smarter and more accurate AI output. Here is how management spoke about it: “we actually have a very well-defined training set that's annotated based upon all the threat hunting that we've done over the last 10 years.”

Automation reduces the number of false positives. Instead of getting every piece of telemetry that requires the security team to investigate, AI-assisted endpoint detection and response solutions eliminates the noise so that the security team is only responding to those that have the potential to be critical. Fundamentally, cybersecurity is a data problem. CrowdStrike’s Falcon platform ingests, correlates, and queries petabytes of structured and unstructured data from ever-expanding disparate external and internal sources in real-time. It builds rich context and delivers greater visibility by constructing a dynamic representation of data across an organization. As a result, the company’s AI models are often highly accurate in triggering a response.

However, in the earnings report this quarter, the CEO stated a few new things that investors should see creates a more all-encompassing AI platform:

“We collect trillions of threat signals daily creating one of the world's largest and fastest-growing cyber threat data set. From day 1, we've been an AI company, training the industry's most effective and accurate AI models to prevent attacks based upon our data moat.”

Falcon for IT:

On the same note that AI is not a separate revenue segment for CrowdStrike, there are additional ways CrowdStrike plans to leverage its “AI-native” platform. One of the more popular hybrid use case is called Falcon for IT, which allows IT teams to leverage AI and automation to query the IT systems and servers. This is useful for things like fleet management, compliance, and performance monitoring. By using generative AI, IT Teams can query assets for unauthorized software, outdated machines, patch status and also schedule queries to detect anomalies.

I’m highlighting this as a segue into the broader idea that AI and automation is likely to have a large impact on CrowdStrike (and perhaps more immediate) compared to other cloud stocks on the market.

This was the CEO’s commentary on the call:

“Customers are looking for a better solution in this area. And one of the things that we found is that the security team has been solving a lot of IT problems and challenges for IT for a long time, and we really needed to carve out a home for IT. So when you look at some of our competitors in that market, it's — obviously, it's a pretty big market, but having a single agent and the ability to actually solve IT problems, which many of our customers were doing already, is fantastic.

So again, early days, but the feedback and the interest is off the charts for Falcon for IT, and it goes to the heart of how we built the platform. To collect data, it doesn't have to be security data. It can be almost any data related to either our agent first-party data or now third-party data we can ingest. And that solves many use cases beyond what we originally came to market with. So I think the sky is the limit there.”

FY2025 Net New ARR Commentary

Since ARR and net new ARR is what moves the stock, I wanted to include what the CFO stated in terms of FY2025. It’s very vague but sounds positive in terms of net new ARR building from Q1 and beyond.

Question
Matthew Hedberg (Analyst)

I'll offer my congrats as well, guys. Burt, your new ARR commentary was helpful for Q1. I'm curious, this time last year, I believe you talked about flat net new ARR growth for fiscal '24. And obviously, I think you guys did about 6% this year. Any just sort of like directional guardrails you give us from a full year perspective in terms of just thinking about it from a net new perspective?

Answer
Burt Podbere

So with respect to ARR, obviously, we don't guide to it. But we have talked about in the past where we've started the year in Q1 and build from there. And that's kind of really all I can really comment on ARR. You can kind of infer where we're going with our guide. And — but at the end of the day, our guide — the methodology has remained consistent, and that's how we think about it.

Conclusion:

CrowdStrike’s post-earnings reaction is as much about CrowdStrike as it is about the weakness of its peers. The excellent timing of the increasing GAAP profitability merging with accelerating key metrics is something we are not likely to see in any other best-of-breed cloud company this earnings season.

The market is anxious to find AI winners early-on. By combining cybersecurity with AI in a single platform with a data-centric architecture, CrowdStrike is emerging as one of the few cloud companies that has resiliency and the AI “it” factor. We continue to believe that 20 Forward P/S is the ceiling for cloud stocks, yet we also continue to believe that CrowdStrike is the leader in the cloud category. For reasons quite apparent this evening, CRWD is one of two that we are interested in owning now and into the foreseeable future out of the dozens and dozens of cloud stocks on the market.

Note: We have updated the analysis on 03/06 with the following: Billings for this quarter comes to $1.36 billion, up 65% QoQ and up 39% YoY.

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Cloudflare Q4: Key Metrics Accelerate

Posted on February 9, 2024June 30, 2026 by io-fund

Cloudflare beat on both revenue and EPS figures in what management dubbed an “exceptionally strong” Q4. Revenue growth held steady at the 32% range in the quarter, and while cash flow generation was superb, GAAP profitability remains elusive with little change to the bottom line.

Under the hood, the key metrics shined by accelerating where it matters most – RPO, Paying Customers, Annual Contract Value and Customers Paying over $100K.

Revenue and EPS:

Cloudflare has been able to slightly accelerate revenue in the last two quarters, yet the guide implies that management is not confident revenue will sustain in the >30% growth range. Cloudflare’s price action tends to be strong because although the cloud stock has decelerated on a YoY basis from 42% growth, its peers have decelerated much further. As a general rule, the further away a cloud stock is from the 20% growth mark, the better. Cloudflare is comfortably above this.

Revenue:

Revenue in Q4 was $362.5 million, beating estimates of $353 million and representing YoY growth of 32%.
Cloudflare accelerated in the September quarter to 32.2% from the June quarter at 31.54%. Although minimal, it’s one of the few best of breeds that has done so.
Next quarter management is guiding for revenue to be $373 million at midpoint, implying YoY growth of 28.5%. Therefore, the thin acceleration we saw in the previous two quarters may not hold.
For FY23, revenue totaled $1.297 billion, increasing 33% YoY from $975.2 million. For FY24, management guided revenues to be $1.65 billion at midpoint, implying YoY growth of 27.3%.

EPS:

Adjusted EPS was $0.15, beating estimates of $0.12 and representing YoY growth of 150%. GAAP EPS was ($0.08), beating estimates of ($0.11).
For FY23, non-GAAP EPS was $0.49, increasing 277% YoY. GAAP EPS was ($0.55), a minor improvement from ($0.59) in FY22.

Margins:

While Cloudflare was able to demonstrate strong improvement in adjusted (non-GAAP) margins in Q4 and for FY23, GAAP margins were little changed down the line, highlighting the headwinds created by elevated levels of SBC on a path to GAAP profitability. Stock based compensation is 21.3% of revenue, or $77.3 million in the most recent quarter, which is in line with previous quarters.

Adjusted operating profit increased to $39.8 million, up 2.5X from $16.9 million in the year ago quarter. However, next quarter adjusted operating profit is expected to be between $34 to $35 million, so this is something to watch.

GAAP gross margin for Q4 expanded 30 bp QoQ and 170 bp YoY to 77%. Non-GAAP gross margin expanded 20 bp QoQ and 150 bp YoY to 78.9%.
GAAP operating margin in Q4 was (-11.8%) compared to (-11.7%) last quarter and compared to (-18.5%) in the year ago quarter. Non-GAAP operating margin was 11.0% compared to 12.7% last quarter and compared to 6.1% in the year ago quarter. The lack of margin expansion QoQ is a weakness to this report and something to watch.

GAAP net margin was (7.7%), down 70 bp QoQ but up 900 bp YoY.

On an annual basis, the adjusted operating margins have expanded nicely with Cloudflare having a flat adjusted operating margin in mid-2022 to having mid-single digit adjusted operating margins to now having high-single digit adjusted operating margins. The market has reacted favorably to Cloudflare becoming profitable on an adjusted basis.

For FY23, GAAP gross margin was 76.3%, a 20 bp YoY improvement. Non-GAAP gross margin improved 10 bp YoY to 78.3%
GAAP operating margin was (14.3%), a 630 bp YoY improvement. Non-GAAP operating margin was 9.4%, a 670 bp YoY improvement, up from 3.7% in FY2022. The company had $122M in adjusted operating profit.
GAAP net margin was (14.2%), a 560 bp YoY improvement. Non-GAAP net margin was 13.1%, a 950 bp YoY improvement.

For FY2024, management stated that both cash flow and operating profit will be lower in the first half and higher in the second half. Management guided for operating profit of $154 to $158 million.

Though operating and free cash flow margins improved quite dramatically YoY, GAAP operating and net margins barely budged, with SBC weighing down on strong growth in gross profit.

Cloudflare reported nearly 35% YoY growth in gross profit to $279.2 million in Q4, though operating income improved less than 16% YoY to ($42.8 million). This partly stemmed from high SBC, at $77.3 million, or 21.3% of revenue, in Q4.

Total operating expenses were 115% of gross profit in Q4, down from over 124% in the year ago quarter. For the full year, that ratio was nearly 119%, compared to 127% in FY22. While Cloudflare is making progress in reducing spend, it will struggle to become GAAP profitable without cost cuts so long as it maintains SBC at or above 20% of revenue. Operating expenses are growing nearly 8 points slower than revenue, at around 25% in Q4, but again, this growth rate must moderate significantly should revenue growth decelerate to below 30%, as guided for FY24.

Cash and Debt:

Cloudflare’s cash flow generation was remarkably strong, with operating cash flow more than doubling YoY with free cash flow turning sharply positive. The consistent and strong cash flow is key to Cloudflare’s positive price action. The company reported record FCF in Q4 of $50.7 million.

Operating cash flow was $85.4 million in Q4, or 23.6% of revenue up from 20% in the September quarter yet down from 28% of revenue in the year ago quarter.
For FY23, operating cash flow increased 106% YoY to $254.4 million, or 19.6% of revenue.
Free cash flow was $50.7 million in Q4, or 14% of revenue and is up from 12% of revenue in the year ago quarter. For FY23, free cash flow was $119.5 million, up from negative free cash flow of (-$39.8 million) in FY22.
One of the differences between operating cash flow and free cash flow is network capex. This is a primary reason why FCF can be minimal at times. Network capex was 8% in the most recent quarter and was lower than 10% in the same quarter last year due to greater efficiency from its infrastructure. Network CapEx is expected to be 10% to 12% of revenue in 2024, including the additional investment due to the AI opportunity.
Cash, equivalents and short-term investments totaled $1.673 billion.
Convertible debt totaled $1.283 billion.

Key Metrics Accelerate:

Per management: “We blew away our previous record for new ACV [annual contract value] booked in the quarter. In Q4, new ACV booked grew nearly 40% year-over-year, making it not only our record in absolute ACV but also the fastest percentage growth we've seen since 2021.”

Paying customers increased 17% YoY to 189.8K, a third-straight quarter with customer growth accelerating after slowing to just 13% growth in Q1.increased 17% YoY to 189.8K, a third-straight quarter with customer growth accelerating after slowing to just 13% growth in Q1. Growth in customers with >$100K ARR accelerated 1 point to 35% in Q4, reaching 2,756, and accounting for 66% of revenue, up from 63% in the year ago quarter.

Per management on the call: “We saw particular strength in our largest customers with a record number of net new customers spending more than both $0.5 million a year and $1 million a year on an annualized basis. We signed our largest new logo with an expected total contract value over $30 million and our largest customer renewal with a total contract value of $60 million.”

Customers paying over $500,000 totaled 346, up 56% YoY.
Customers paying over $1 million totaled 118 customers, up 39% YoY.
Revenue from large customers increased to 66% of revenue, up from 63% in the year ago quarter.
For FY2023, revenue from large customers represented 64% of total revenue compared to 61% in 2022 and 54% in 2021.

Deferred revenue of $347.6 million is up 11% QoQ from $311.5 million in the previous quarter and is up 50.8% YoY from $230.4 million in the year ago quarter.

RPO accelerated to $1.245B, up 37% YoY compared to 30% YoY growth last quarter. The QoQ RPO growth of 15% is the highest for at least two years (we began tracking Cloudflare closely in Q4 2021).

DBNRR was 115% in Q4, a 1 point sequential decline. This needs to be watched as we move along. Management stated last quarter when DBNRR was 116%: “We continue to believe the recent decelerating trend in DNR stabilizing near these levels.”

Geographically, revenue growth surged in EMEA, while revenue growth in the US remained steady QoQ at 29.8% to $188.1 million. EMEA revenue increased 38.2% YoY to $101.2 million, an acceleration from the 36% growth rate recorded in the region in Q3.

Additional Earnings Call Commentary

Mark Anderson, the former CEO of Alteryx and former President of Palo Alto Networks, is joining Cloudflare as President of Revenue. In the opening comments, there was also mention of a 3-year contract with the U.S. Department of Commerce worth $33 million. Plus, a leading technology company signed a 3-year $66 million contract for Cloudflare’s Zero Trust products.

In 2023, Cloudflare deployed GPUs in 120 cities and has plans deploy inference-specific GPUs in nearly every city of their global network to be within milliseconds of every device connected to the internet. As stated in a previous write-up, this will be important for the edge network. Per management: “from our launch in September to the month of December, the average number of daily workers' AI request increased 9x.”

Notably, the outperformance this quarter was driven by Cloudflare’s Zero Trust and SASE security products with AI not yet materially impacting revenue. When an analyst asked why Cloudflare is showing so much strength in Zero Trust, the CEO replied: “And what we find is when we're in the consideration set, we're just a next-generation platform, and we're faster, we're more secure, we're more reliable, and we're a better solution for a lot of vendors. And so not only are we winning the greenfield opportunities, but we're increasingly winning opportunities from first-generation Zero Trust vendors where their customers aren't satisfied with the solutions they have and they're moving fully to us.”

More on AI Inference at the Edge:

Although AI is not materially impacting revenue right now, it inevitably will in the next couple of years. This company is well positioned for AI inference at the edge, which we’ve covered in a deep dive here. Part of this is building out GPU capacity which is why capex will increase to 10%-12%.

Here was a good question to help timing for Cloudflare’s AI potential.

Question
Timothy Horan (Analysts)

Related to the previous question. Can you maybe update us on your best guess on timing when the Workers platform, starts to drive some material revenue when it starts to move the needle? And maybe the same thing for AI. I know you said kind of not this year. And what do you think for both these platforms, what does this mean for overall growth rates for the company?

Answer
Matthew Prince (Executives)

Yes. I think what has been interesting has been that Workers is a big piece of a lot of the deals that we see. So it's still in somewhere around 20% of the large deals that we closed, have some workers component to it. And that's held actually fairly steady, but those deals are continued to go up and up. So it depends on how — we don't break out the various pieces of Cloudflare because we think that the platform functions very well as one unified platform.

And we close more deals because we have workers involved. But a lot of times, that includes our reverse proxy security services oftentimes includes our Zero Trust security services. And what we really want to be is not a one-trick pony for any one of our customers. We want to actually have multiple different things that they rely on and be that strategic vendor that provides a broad set of solutions to them. So I think it's already materially driving new business and large deals.

But as the Workers platform, I think the AI space, I think a lot of the money, which is being spent on AI right now, especially with some of the hyperscale public cloud, a lot of that is for training of models that is not — we are not the right place to actually do model training. But as that transitions over time and people start to figure out how can you take those — the models that you've built and turn them into real products. I think that's where you'll start to see a much more significant share of — you'll start to see revenue that is showing up that is meaningful to us. In terms of delivering the value in the AI space.

But I think it's — we're still so early. And I think that the thing to track is less about us. It's more about how long does it take product managers and engineers to really figure out how to harness these new tools into — and providing customer value. I think we've seen a ton of — I mean, the challenging thing with AI is, it is really easy to make a demo, but it's very hard to make a product. There's a ton of value that will be created here, but I think it's going to still take some time. And I think it's going to be up to some things that are somewhat out of our control. But I can't imagine being better positioned than we are.

Macro Remains a Headwind:

Given the strong price action, I want to highlight that management is still not fully confident in the macro environment:

Matthew Hedberg

Great color. If I can ask one follow-up to Thomas. Your guide for '24 revenue, I think calls for about 600 basis points of deceleration. Obviously, you talked about a lot of positive sequentially, but also some of the caution that you still have about the macro. Just wondering if you could unpack a little bit more some of the assumptions there. I think you noted maybe NRR might be nearing a bottom. But just what's built into that in terms of like logo adds, maybe an improvement in NRR, but just sort of unpack that a little bit more.

Answer
Thomas Seifert

Yes. Obviously, we had a very good fourth quarter with a lot of good data points, pointing in the right direction. The improvement that Matthew was talking about on the go-to-market side. Not only in terms of productivity, but pipeline improved, the deal size has improved and linearity went better. We also saw their best quarter-over-quarter improvement from an RPO perspective. This is all pointing in the right direction.

But we still have to cope with the fact that one data point alone is hard to change your prediction and your trajectory. So we are still cautious that everything else that is going on. Matthew mentioned in his part that the big scenes that we saw last year from a macroeconomic perspective, skittishness of buyers and budget releases is continuing. And I think this informed our view for the year. And obviously, we'll adjust our strategy and approach to the year as we have — unless we collect more data points. But it served us well over the last 4 years as a public company, to look really hard at the data we have and draw the right conclusions from it. And I hope that '24 will get us to the same outcome

FY2024 Revenue Growth Helped by Government Deals:

Following a question about the U.S. Dept of Commerce deal, the CEO stated the following about the public sector:

“I think that our federal business as well as our SLED business, state local education, and our global government business has all been real signs of strength. And I think that, that, in part, is because of the fact that the world is getting scarier and we're seeing more attacks […] More than half of the world's population will vote in 2023 in elections. And so I think the fact that we've been leaders in protecting elections and making sure that elections are run without cybersecurity being part of the story has gotten us in the conversation in a lot of places around the world. […] So I would expect that, that business continues to be strong throughout 2024.

Your second question is kind of the flip side of that, which is I think that the macro continues to be challenging. There are two hot wars going on right now. I think we are not out of the woods economically in terms of getting totally ahead of inflation. Again, I think in the U.S., that looks better than some of the other places in the world. There's a lot of ways that you can imagine the world continues to get more complicated. And I think IT buyers need to be skittish. Q4 definitely felt like people were starting to make decisions, and they were starting to say that there are certain things that are must-have versus nice-to-have. And I think we continue to be sorted into the must-have bucket.”

Conclusion:

Cloudflare’s price action today was certainly welcomed, and not all that surprising given the Big 3 is accelerating on cloud. There’s bound to be some cloud stocks that beat this quarter if the bellwethers are showing a rebound of sorts. Cloudflare provided hints in the last earnings report that it was a solid choice compared to its peers.

We are especially excited for Cloudflare’s potential in the future (next 1-2 years), as the CEO pointed out that most AI spend is on training, yet they are well positioned for when the focus is on inference and the edge. We see this stock as a winner in the next phase for AI, which we detailed in our most recent webinar and in our deep-dive here.

This 20%-ish move will put Cloudflare at or just above that resistance level of 20 Fwd P/S for cloud valuations. What cloud investors need to see in the (very) near term (next 1-3 months) is if cloud can push past the 20 Forward P/S resistance it’s been hitting since the FED lowered rates OR will cloud resume a more blow-off top valuation of 40 Forward P/S which we saw for about 1-2 years in 2020-2021. There is risk in both scenarios so each investor will need to decide for themselves how to handle cloud positions now that cloud stocks are reaching that resistance. There is no easy answer – yes, these are great stocks, quality companies, that will do well long-term — but they are also pricey right now. We will keep you up to date on our real-time decisions via text alerts.

Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.

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Microsoft Fiscal Q2: Cloud Leads the Way

Posted on January 31, 2024June 30, 2026 by io-fund

Microsoft beat on both the top and bottom lines with margins above guided levels, with Azure growth accelerating sequentially once more. Revenue growth of 17.7% reached the highest level in two years, driven by the cloud. Microsoft continues to demonstrate increased operating leverage even as it works to quickly build and scale its AI infrastructure to capture growth across the stack.

Fiscal Q2 revenue beat estimates by $890M, with the beat primarily coming from Intelligent Cloud. Microsoft reported 20% growth in Intelligent Cloud to $25.9 billion, ahead of its guide for 17-18% growth to $25.1 billion to $25.4 billion. Azure growth was 30%, a 200 bp QoQ acceleration on strong demand for consumption-based services.

AI’s impact on Azure was notable: Microsoft said that Azure’s 30% growth stemmed from “strong demand for our consumption-based services including 6 points from our AI services.” This 6 point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4. While that may seem small, it is significant considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate.

While Microsoft was optimistic about its Copilot AI subscription offerings, it did not divulge any material numbers about adoption rates. Microsoft said it has more than 400 million 365 Commercial customer seats and 78.4 million 365 Consumer subscribers, giving a nearly ~480 million customer base to target. Assuming just a 2% adoption rate across both Commercial and Consumer by the end of the fiscal year, Copilot would already be surpassing a $3 billion annual run rate.

CEO Satya Nadella said that Microsoft now has moved from “talking about AI to applying AI at scale by infusing AI across every layer of our tech stack.” Azure has been one of the first growth outlets, in part due to its tie in with OpenAI, with Copilot subscriptions for enterprises and consumers one of the next outlets. It’s this wide-ranging suite of AI services and ability to capture AI growth at multiple parts of the stack that sets Microsoft apart from the rest of Big Tech.

Revenue and EPS:

Microsoft reported a fiscal Q2 growth rate of 17.7% YoY for revenue of $62.02 billion, versus expectations for 15.9% growth on revenue of $61.1 billion. This was Microsoft’s highest growth rate since fiscal Q3 2022.
This beat flowed through to the bottom line, with EPS of $2.93 versus expectations for $2.77. This represented 33% YoY growth, the highest growth rate in more than 2 years.
Microsoft guided for $60 billion to $61 billion in revenue, for YoY growth of 13.4% to 15.3%.

Segment Revenue:

Productivity and Business revenue was $19.2 billion, up 13% YoY, driven by 17% growth in Office 365 Commercial. Growth came in 150 bp ahead of the midpoint of the guided range for 11-12% growth.
Intelligent Cloud revenue was $25.9B, up 20% YoY, driven by strong demand for consumption based services and Azure. This was a 100 bp acceleration from last quarter and a 500 bp acceleration from 15% two quarters ago.
More Personal Computing revenue was $16.9 billion, up 19% YoY. Windows revenue increased 9% with OEM revenue growth of 11%, while devices revenue decreased (9%).

Guidance on Segment Revenue:

Productivity and Business revenue guided to decelerate ~185 bp QoQ at midpoint for growth of 10.3% to 12% YoY.
Intelligent Cloud revenue guided to decelerate ~185 bp QoQ at midpoint for growth of 17.3% to 19% YoY.
More Personal Computing revenue guided to decelerate 700 bp QoQ at midpoint for growth of 10.5% to 13.5% YoY.

Margins:

Margins were ahead of expectations across the board, with Intelligent Cloud continuing to show improvement in operating margin. We previously discussed after fiscal Q1’s earnings in October that Microsoft can drive operating leverage from AI, and Q2’s results further confirm this thesis – Microsoft boosted its operating margin forecast, saying operating margins would increase 100 to 200 bp YoY after calling for flat margins last quarter.

Operating margin for Q2 was 43.6%, 120 bp ahead of guidance for 42.4% and up 490 bp YoY. For the first half of fiscal 2024, operating margin was 45.4%. Microsoft’s guide of 100 to 200 bp expansion implies full-year operating margin between 42.8% to 43.8%, with next quarter’s guide for 42.9%.

We previously discussed how there may be more room for operating margin expansion in Intelligent Cloud as Microsoft continues to stay disciplined with OpEx with implementing the AI transition with Azure. Intelligent Cloud’s operating margin was 48.1% in fiscal Q2, up from 41.4% in the year ago quarter but down from 48.4% in fiscal Q1. Microsoft’s increased operating margin forecast suggests that Microsoft may capitalize on AI growth in the cloud and drive higher margins for both Azure and 365 over the next two quarters.

Gross margin of 68.4% was up from 66.9% in the year ago quarter. The guide for next quarter is approximately 69%.
Operating margin was 43.6%, up from 38.7% in the year ago quarter. Operating margin is guided for 42.9% next quarter, based on the midpoint of provided ranges, implying a slight sequential decrease.
Net margin was 35.3%, up from 31.1% in the year ago quarter.
Productivity and Business operating margin was 53.4%, down 20 bp QoQ but expanding 520 bp YoY.
Intelligent Cloud operating margin was 48.1%, down 30 bp QoQ but expanding 670 bp YoY due to strength in Azure. IC operating income rose 40% YoY to $12.46 billion.
More Personal Computing operating margin was 25.4%, down 1250 bp QoQ due to a 38% increase in operating expenses primarily from the Activision acquisition.

Cash Flows:

Operating cash flow was $18.9 billion, up 69% YoY on strong cloud billings and collections, versus a lower comparable quarter last year.

Free cash flow was $9.1 billion, up 86% YoY, with the high growth rate again coming against a weak comparable quarter.

Key Metrics:

Bookings increased 17% YoY and 9% on a constant currency basis, up from 14% in Q1. This was driven by strength in long-term Azure contracts and “strong execution across our core annuity sales motions, including healthy renewals.”

Azure AI customers totaled more than 53,000, with one-third of these being new customers over the past twelve months. This implies customer growth rate of approximately 50% YoY. In addition, more than half of the Fortune 500 are using Azure OpenAI Services, highlighting the strength of Microsoft’s AI offerings.

GitHub Copilot’s paying subscribers surpassed 1.3 million, meaning the offering has surpassed $150 million ARR at a $10/month price. Paid subscribers rose ~30% QoQ from 1 million last quarter, and are up nearly 90% in just two quarters.

Earnings Call:

Microsoft’s earnings call reflected the optimism the company has for its AI offerings as well as the strong momentum and adoption of said offerings, though Microsoft offered little concrete statistics around its newest Copilot subscriptions for 365 customers.

We have said previously that Copilot 365 is one of the more crucial growth trajectories to watch as we move into calendar year 2024. Microsoft explained that its internal research and external studies have shown “as much as 70% improvement in productivity, using generative AI for specific work tasks. And overall early Copilot for Microsoft 365 users were 29% faster in a series of tasks like searching, writing, and summarizing.” These productivity gains are leading to strong adoption of Copilot: Microsoft said that “two months in, we have seen faster adoption than either our E3 or E5 suites.”

Cloud and Azure’s strength was evident throughout the call. CFO Amy Hood noted that “demand for our Microsoft cloud offerings, including AI services drove better-than-expected growth and large long-term Azure contracts.” In addition, “Microsoft 365 suite strength contributed to ARPU expansion for our office commercial business.”

For Azure specifically, management said that “customers continue to choose Azure to simplify and accelerate their cloud migrations. Overall, we are seeing larger and more strategic Azure deals with an increase in the number of $1 billion-plus Azure commitments.”

One of the most important comments of the call was in regards to Azure’s 30% growth. Management said that both “AI and non-AI Azure services drove our outperformance” in the quarter. For Q3, Azure’s growth is expected to remain stable QoQ, driven by consumption-based services “with continued strong contribution from AI.” Reading between the lines here suggests that cloud optimization trends are ending, with comments of stable growth leaning more towards possible acceleration rather than deceleration.

Nadella further hammered that point home in the Q&A, saying that he believes that the “period of massive optimization only and no new workloads start, that I think has ended at this point. So what you're seeing is much more of that continuous cycles by customers, both whether it comes to AI or whether it comes to the traditional workloads.”

Elevated demand for AI services was a common theme, from Azure’s 6 point growth to GitHub to Power Platform. Management said that “GitHub revenue accelerated to over 40% year-over-year, driven by all-up platform growth and adoption of GitHub Copilot, the world's most widely deployed AI developer tool.” GitHub Copilot subscribers rose 30% QoQ and nearly 90% from ~700,000 in fiscal Q4. For Power Platform, Microsoft said that “more than 230,000 organizations have already used AI capabilities in Power Platform, up over 80% quarter-over-quarter.”

Microsoft’s earnings call reflected growing AI optimism, with strong key metrics for its AI offerings across its product suite. Microsoft is hinting at cloud optimization trends fading away, with high demand for AI services in Azure adding 6 points to growth while non-AI services contributed to outperformance.

Conclusion

Microsoft is at the front of Big Tech’s AI revolution on the software side, and this is unlikely to change given the company’s key advantage in targeting 400 million enterprise seats. Revenue growth has accelerated significantly over the past four quarters, from 2% growth to 17.7% growth, driving 33% EPS growth this quarter. Microsoft is proving that its substantial investments in AI infrastructure and its wide-ranging AI suite is paying off on growth for both the top and bottom line.

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