Cloudflare: Revenue Accelerates to >30%, Key Metrics Strengthen

Posted on November 28, 2025June 30, 2026 by io-fund

Cloudflare’s fundamental profile strengthened in Q3 with the company reporting its fastest revenue growth rate in seven quarters, returning to >30% YoY territory, while a majority of key metrics all accelerated in unison.

Outside of the financials, Cloudflare remains very well positioned for AI inference, though inference does not yet contribute meaningfully to revenue. Discussion on GPU utilization rates was fruitful and highlighted how Cloudflare can remain in near lock-step with demand while avoiding capacity constraints and with relatively low capex.

Management also believes that versus the hyperscalers, they have a strong TCO advantage when it comes to inference, and in the future, the network will be one of the best places to run inference requests. Cloudflare also shed more light on Act 4, its Pay Per Crawl feature, which will enable creators to be monetized for AI data scraping, and while it is quite early, it is aiming to solve a quickly emerging pain point.

Material Evidence of Revenue Reacceleration, Driven by US and Enterprise Clients

Cloudflare reported its largest beat since Q1 2022, reporting revenue of $562.0 million in Q3, 3.1% ahead of estimates as growth accelerated nearly three points to 30.7%. On a QoQ basis, revenue accelerated to 9.7% from 6.9% last quarter.

The US is emerging as a primary driver for this reacceleration, with growth rebounding 10 points sequentially, from 21.7% YoY in Q2 to 31.5% YoY in Q3. US revenue jumped 12.2% QoQ versus a 7.2% QoQ increase in Q2.

Additionally, Cloudflare’s enterprise cohort, or customers contributing >$100K ARR (and likely primarily US-based) are another key factor behind the reacceleration. >$100K ARR customers drove 73% of revenue in Q3, or ~$410 million, rising 42% YoY and 13% QoQ. This was a sharp 12 point acceleration in YoY growth from 30% in Q1, to the fastest growth since Q1 2023, while QoQ growth was the highest since Q2 2022 at 13%.

Q3 also marked Cloudflare’s first >30% growth quarter in the past five and its fastest revenue growth in the last seven quarters. This is the first step in confirming a sustained revenue acceleration, yet the more important piece is showing that >30% growth can actually be sustained for multiple quarters.

For Q4, Cloudflare guided for revenue of $588.5 to $589.5 million, a slight deceleration to 28% on the topline. This was ahead of estimates for $580.8 million. Interestingly, consensus estimates, just one day following earnings, moved from $589 million to $617 million, suggesting analysts are increasingly optimistic on the company’s ability to sustain this revenue acceleration, supported by strong key metrics.

For FY25, Cloudflare boosted its revenue guidance to $2.142 to $2.143 billion, a $28 million increase from its prior guide. This points to YoY growth of 28.3%, a slight deceleration from 28.8% growth in FY24.

Key Metrics Strengthen, Aided by Enterprise Transition

Despite a lack of meaningful AI contribution, other key metrics strengthened significantly in Q3 and support this material reacceleration story. Cloudflare cited its shift from a product-led, SMB-focused company to an enterprise sales company as a primary driver behind the improvement in key metrics.

There are a few reasons that this focus on enterprise clientele is important for Cloudflare’s growth story, with the simplest being that visible acceleration of enterprise customer revenue in Q3 translated to the material topline reacceleration. Enterprise customers are also likely to expand much quicker than SMBs – for example, Cloudflare noted that accelerating QoQ and YoY growth in its >$1M and >$5M customer cohorts acted as a significant tailwind to DBNRR, which rose five points sequentially to 119%, the highest since Q4 2022.

This DBNRR expansion is also linked to Cloudflare’s Pool of Funds billing approach, which provides a seamless vector for large customers to explore adoption of Cloudflare’s 55 products under a single contract, and allocate funds to different products based on consumption. While management explained that the rollout initially created some downward pressure on DBNRR, consumption of these deals acted as a tailwind to DBNRR this quarter. CFO Thomas Seifert added that POF is “now low double-digits of ACV” and gaining share in the quarter.

Enterprise traction is also showing up in RPO, which accelerated four points to 43% YoY to $2.14 billion; on the other hand, current RPO decelerated three points to 30% YoY and accounted for 64% of RPO.

Management explained that this RPO acceleration “points to primarily 2 drivers, the customer quality and the platform expansion. We are seeing exceptional strength with our large customer cohorts, specifically those that spend more than $1 million or $5 million with us, both delivered record growth this quarter. And in addition to that strength is increased consumption of our large Pool of Fund customers, demonstrating I think, the increasing strategic importance of our platform for those large enterprises globally. And in addition to that, our Workers platform, the developer platform, including Workers AI, is just providing to be a significant new vector for long-term commitment and with that growth.”

Moving forward, it will be important to see consistent strength in both DBNRR and RPO as further evidence that Cloudflare’s large customers can continue to support >30% revenue growth.

Bringing GPU Utilization up to 70-80%

GPU utilization can easily be overlooked, but arguably it is one of the most important discussions for Cloudflare, as its value proposition is inherently tied to executing workloads for customers quickly, efficiently, and with a strong TCO advantage.

Management provided a more extensive discussion on utilization than they have in recent quarters, hinting that they can potentially improve utilization rates further and quickly bring more capacity online to meet demand without becoming capacity constrained.

From our free newsletter in February 2025 recapping Q4 results, Encouraging Growth in Key Metrics Drives 60% Gain YTD for Cloudflare Stock, we pointed out that Cloudflare was seeing peak GPU utilization around 70% with room to improve through the year. Now, in October, CEO Matthew Prince slightly raised this, saying that they are leaning heavily on their experience of running CPUs at 70-80% utilization and aiming to have GPUs match that level. This ties in to Cloudflare’s architectural differences compared to the hyperscalers, with Cloudflare’s main goal being improving utilization to serve more workload requests and the hyperscalers’ goal of making as much money from renting GPUs:

“The other thing that I think is unique about us is that certainly versus the hyperscalers, the primary business of the hyperscaler is to essentially rent you a server or a fraction of a server, and they try to effectively get whatever they pay for the server back 5x over the life of the server. That's their business. Whereas we're about, again, getting work done for our customers. We're selling something different, which is a sort of level of abstraction up from that. What that means is that we believe it's our job, not our customers' job to make the utilization rates as high as possible, make our systems as efficient as possible.

And so it's been remarkable to see over the last 15 years, how our team has been able to squeeze as much as possible out of the CPU capacity that we have, where we can run that CPU capacity at 70% to 80% utilization and get more out of every CapEx dollar we spend. But what's fascinating is we're sort of speed running the last 15 years now with GPUs, where we're figuring out how to make GPUs multi-tenant, how to make them load and unload models more quickly and driving the utilization of GPUs up substantially. And so that is still well below what we have with CPUs, but we see no reason that we can't get GPUs also up to that 70%, 80% utilization.”

Continuing to bring peak utilization rates higher and improving troughs 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.

A core advantage Cloudflare has is its serverless architecture spanning >13,000 networks globally with 449 Tbps of network capacity (up from 348 Tbps in January), letting the company shift workloads anywhere in the world where it has excess capacity. Prince says that while it is not always ideal, Cloudflare can move its smaller, free or low-end customers “to places across the network that have that free capacity, still give them a great performance. but then reserve the capacity that we have as close as possible to our largest customers.”

More importantly, Cloudflare does not believe it is capacity constrained akin to the hyperscalers, as again the company can shift workloads to wherever necessary and minimize or eliminate pain points where excess demand stalls one network point. Management also said that because they use off-the-shelf equipment with no customization, their “reaction time to deploy hardware where we need it is really, really fast,” letting them quickly stand up new networks whenever needed and quickly convert this to revenue.

Leveraging an Inference Advantage

Cloudflare’s network architecture and positioning at the edge gives it a strong advantage to offer high-performance, low-cost inference, yet the company continues to harp on the fact that inference remains de minimis to overall revenue – i.e., the growth curve of inference has not yet been felt in results. Cloudflare clarified that no inference customer is larger than 2% of revenue, while leading AI firms primarily tap Cloudflare for security rather than inference products at the moment.

While competition for inference workloads from the hyperscalers remains high, Cloudflare believes its key advantage lies in its TCO from handling workload optimization:

“It continues to be the model of do you want to do this work yourself and have to optimize yourself, or do you want to hand it off to Cloudflare. And I think in the cases where we're in the conversation, we're able to show that there's just a much better TCO, total cost of ownership, a much lower cost, much better performance when we manage that for you.”

CEO Matthew Prince also added that once customers test the platform and witness the TCO and optimization advantages, the platform becomes very sticky and can land those customers for the long-term. To this point, Cloudflare is continuing to bolster its platform for optimization, recently acquiring Replicate to integrate its expertise with containerized model building on a 50,000+ model catalog to facilitate AI deployments.

While it still may be early for inference, as more use cases pop up, Cloudflare is well positioned to capture inference-driven workloads. Again, this ties back into its network architecture, high utilization and proximity to users with ultra-low latency.

For example, management explained that “when you have human computer interaction, especially with something that seems almost alive when you're interacting with it, every millisecond counts, because it breaks that illusion if things slow down, especially as you get to things like voice communication and other things that need to have kind of a natural rhythm to them.” Management believes that while a lot of inference will run on handsets or in driverless vehicles, the next best place to run inference that can’t be run in those locations will be in the network, providing a structural tailwind to drive new workload wins.

Although it may be later in the future before some of these inference vectors and use cases materialize in full swing, and meaningfully contribute to Cloudflare’s revenue, the company can leverage this network advantage to remain a key enabler of the AI inference era.

Cloudflare to be Natively Available on Oracle Cloud

In mid-October, Cloudflare announced a partnership with Oracle’s Oracle Cloud Infrastructure (OCI) platform, making Cloudflare’s services natively available to OCI customers in hybrid, multi-cloud and OCI hosted environments.

Cloudflare says this gives it access to Oracle’s large pool of customers, and more importantly, an outlet to tap into OCI’s rapid growth runway through 2030. For example, Oracle is projecting a rapid 75% CAGR in OCI revenue, from $10 billion in FY25 to $166 billion by FY30, though OpenAI is projected to account for a majority of this, around $120 billion in FY30. Multi-cloud database revenue was a strong point for Oracle in fiscal Q1, rising 1,529% YoY, and Oracle is also projecting 8X growth in AI-powered database and AI platform revenue by 2030 to $20 billion.

However, the more important piece was management stating that both companies are aligned on a multi-cloud future, which requires ‘one consistent interface where they can apply security rules, have consistent network performance,” with Cloudflare the provider of choice.

A multi-cloud future could be a game-changer for both companies, with Oracle benefitting from incremental cloud workloads anchored by its extensive database integrations across AWS, Azure and GCP. In turn, Cloudflare benefits from its positioning as a ‘control plane’ offering unified security, performance and reliability across clouds, which will be likely increasingly important as AI proliferates. This positioning is anchored by Cloudflare’s R2 eliminating cross-cloud data sharing costs, thus addressing some of the main drawbacks of adopting a multi-cloud approach.

More on Act 4: Pay Per Crawl

Cloudflare discussed its new product, Pay Per Crawl, in more detail this quarter, aiming to solve an emerging pain point arising from growing LLM consumption – AI crawlers freely scraping websites for data. Reddit is a great example of this, as the site is a treasure trove of human-generated content perfect for improving AI models, yet it has seen AI companies scrape its site without consent.

For example, Cloudflare noted that a global web infrastructure platform signed a $1.2 million, 14-month contract for AI Crawl Control and Bot Management as they experienced a “massive surge in AI scrapers and malicious bots hitting their origin servers, inflating costs without revenue conversion and obscuring visibility into legitimate traffic.” Cloudflare noted it was “already exploring a much larger opportunity with this customer for Pay Per Crawl.”

Pay Per Crawl aims to put creators and publishers in control of who can access their content utilizing HTTP source codes. The feature will give creators three distinct options on regulating AI crawlers and unlock new monetization abilities: 1) allow full, free access to content, 2) block access entirely, or 3) require payment for crawling at a flat, per-request price.

Under the new feature, if a publisher decides to charge for crawling, they still retain the choice to let certain crawlers access the site for free, and can still negotiate other content-accessing deals separate from Pay Per Crawl. With the new service, Cloudflare’s relationship with customers strengthens significantly, as it is no longer simply an infrastructure vendor but now a revenue generator.

It is still extremely early for Act 4, but given the vast amount of data generated daily on the internet and the need for AI models to constantly crawl to retrieve up-to-date information, this holds potential to be quite an impactful product.

Financials

$3 Billion Revenue Run Rate by Q4 ’26, $5 Billion by Q4 ‘28

Cloudflare provided some insights into its near-term and medium-term revenue targets, with management expecting to reach a $3 billion annualized run rate in Q4 2026, and scale to a $5 billion run rate by Q4 2028.

At first glance, the $3 billion run rate forecast is not especially impressive, as it implies quarterly revenue of $750 million at the end of next year, whereas analyst estimates were $729 million prior to Q3’s report. This is just a 3% raise to consensus, and essentially signals that management is highly confident in maintaining a 27-28% YoY growth rate through the end of 2026.

To reach the $5 billion annualized target, or quarterly revenue of $1.25 billion by Q4 2028, Cloudflare would need to maintain this 28% YoY trajectory for the next three years, at a minimum. This is slightly higher than consensus through fiscal 2027 for 26% growth, while exceeding this to ~30% could see revenue reach more than $1.3 billion.

Other Key Metrics Strengthen

Billings growth accelerated sharply, from 33% in Q2 to 40% in Q3, rising to $624.4 million. Cloudflare said close rates had notably ticked up both YoY and QoQ in Q3 and bookings from partner-initiated opportunities doubled YoY.

Paying customer growth accelerated six points sequentially to 33% YoY, impressive at this scale considering paying customers now total 295,552. Growth was 10% QoQ, the highest on record since at least 2022. Cloudflare said the growth here was in part driven by customers graduating from free tier to small paid accounts during its AI Week and Birthday Week promotions.

Making Progress on Margins

Cloudflare made some progress on GAAP margins and nearly broke to positive territory on the bottom line on a GAAP basis; however, gross margins continued to contract.

GAAP gross margin was 74.0% in Q3, down 3.7 points YoY and 0.9 points QoQ. Adjusted gross margin was 75.3%, down 3.5 points YoY and 1 point QoQ, again impacted by increases in allocated costs from higher network traffic from paying customers. 

GAAP operating margin was (6.7%), up 0.5 points YoY and 6.4 points QoQ. Adjusted operating margin was 15.3%, up 0.5 points YoY and 1.2 points QoQ; for Q4, adjusted operating margin was guided to be 14%. Driving both a YoY and QoQ expansion on operating margin while gross margin contracts shows strong cost management while driving this revenue reacceleration, with opex up 24% YoY.

GAAP net margin was (0.2%), up 3.4 points YoY and 9.6 points QoQ. Adjusted net margin was 18.3%, up 1.4 points YoY and 3.6 points QoQ.

Earnings

Cloudflare reported a solid adjusted EPS beat in Q3, reporting 35% YoY growth to $0.27 versus the $0.23 estimate. GAAP EPS was on the brink of shifting to positive territory at ($0.00), versus the ($0.07) estimate.

For Q4, Cloudflare guided for adjusted EPS to be flat QoQ at $0.27, up 42% YoY. For fiscal 2025, Cloudflare raised its adjusted EPS forecast to $0.91, up from $0.85 to $0.86 previously. However, GAAP profitability is not expected on an annual basis until 2027.

Cash Flow Margins Strengthen

Cash flow margins strengthened in Q3, with operating cash flow margin up 11 points sequentially.

Operating cash flow was $167.1 million for a 30% margin, up from a 24% margin in the year ago quarter and a 19% margin in Q2. Free cash flow was $75 million for a 13% margin, up from 11% in the year ago quarter and 6% in Q2. Network capex was 14% of revenue.

Cash, equivalents and available-for-sale securities totaled $4.04 billion, while convertible notes outstanding totaled $3.26 billion.

Valuation

Cloudflare is second to only Palantir when it comes to elevated multiples in large-cap AI-exposed software, trading at 30.7x forward sales, more than 50% above its five-year average of 20x. Shares have pulled back quite sharply from nearly 42x forward sales at the end of October, its highest level since early 2022.

On the bottom line, Cloudflare is not yet GAAP profitable, but on an adjusted basis, it trades at 205x forward EPS, above its 147x average but below its 278x peak.

Cloudflare’s valuation presents the largest risk as the company is trading at the highest multiples in 3.5 years, with only one strong quarter under its belt to help confirm its AI-aided revenue reacceleration story. While key metrics are strong, the company still must prove that it can sustain >30% revenue growth through FY26 or the valuation may need to come to terms with a return to mid to high-20% growth.

Conclusion

There is a quiet strength in Cloudflare’s fundamentals and key metrics, and this became more evident in Q3, with revenue reaccelerating to nearly 31% YoY, its highest growth in seven quarters. Paying customer growth accelerated six points sequentially to 33%, DBNRR increased five points sequentially to 119%, and billings growth accelerated seven points sequentially to 40%. Cloudflare added a record number of >$1M and >$5M customers for a fourth consecutive quarter, with accelerating spending from these cohorts noted as a strong driver of the DBNRR expansion in the third quarter.

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

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Cloudflare: Revenue Accelerates to >30%, Key Metrics Strengthen

Posted on November 28, 2025June 30, 2026 by io-fund

Material Evidence of Revenue Reacceleration, Driven by US and Enterprise Clients

Key Metrics Strengthen, Aided by Enterprise Transition

Moving forward, it will be important to see consistent strength in both DBNRR and RPO as further evidence that Cloudflare’s large customers can continue to support >30% revenue growth.

Bringing GPU Utilization up to 70-80%

Leveraging an Inference Advantage

While competition for inference workloads from the hyperscalers remains high, Cloudflare believes its key advantage lies in its TCO from handling workload optimization:

Cloudflare to be Natively Available on Oracle Cloud

Financials

$3 Billion Revenue Run Rate by Q4 ’26, $5 Billion by Q4 ‘28

Other Key Metrics Strengthen

Making Progress on Margins

Cloudflare made some progress on GAAP margins and nearly broke to positive territory on the bottom line on a GAAP basis; however, gross margins continued to contract.

GAAP net margin was (0.2%), up 3.4 points YoY and 9.6 points QoQ. Adjusted net margin was 18.3%, up 1.4 points YoY and 3.6 points QoQ.

Earnings

Cash Flow Margins Strengthen

Cash flow margins strengthened in Q3, with operating cash flow margin up 11 points sequentially.

Cash, equivalents and available-for-sale securities totaled $4.04 billion, while convertible notes outstanding totaled $3.26 billion.

Valuation

On the bottom line, Cloudflare is not yet GAAP profitable, but on an adjusted basis, it trades at 205x forward EPS, above its 147x average but below its 278x peak.

Conclusion

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

Microsoft FYQ4: One of the Strongest Earnings Reports in Multi-Decade History

Posted on July 31, 2025June 30, 2026 by io-fund

Recently, in the Top 15 AI Stocks analysis it was stated “If Nvidia holds the crown in the AI hardware arena, then Microsoft holds the crown in the AI enterprise arena.” Tonight, Microsoft proved why the AI Enterprise crown is rightfully theirs.

Management came out swinging this evening on multiple fronts. First off, the acceleration in Azure and Other Services to 39% up from 35% last quarter was significantly higher than expected, with the Street calling for growth of 33.7%. To grow nearly 40% at this scale is impressive.

Microsoft also revealed its Azure revenue number for the first time of $75 billion for FY2025 (although not entirely surprising as we were modeling for Azure to be hitting $80 billion very soon). From there, the CFO guided for 37% growth in Azure for next quarter – indicating continuing a high growth rate at scale will not be a problem in the near-term (note, H2 is expected to see lower growth than H1).

However, if we look at Commercial RPO, it’s clear something big is going on. Last quarter, we pointed out that Commercial RPO was the one key metric we were watching, stating: “Commercial RPO growth above 30% suggests that Microsoft’s stock could (finally) resume strength again.” At the time, RPO was at $315 billion, up 34% and 33% on a constant currency (CC) basis.

This quarter, Commercial RPO has accelerated to $368 billion, up 37% and 35% on CC basis. Microsoft’s Commercial RPO was in the mid-$100 range in 2022-2023 period to help illustrate how quickly contracted revenue has grown. Wow. We do not typically see such large growth rates on such a large RPO base. It’s almost inconceivable.

A few years back, I described in detail why AI is first and foremost an enterprise technology, specifically calling out Microsoft’s path to $100 billion in AI revenue by 2027. We are seeing this materialize now. Microsoft is putting formidable distance between itself and best-of-breed cloud players. To illustrate, stocks like Confluent are down 27% after hours following the loss of a large customer.

In addition to the key metrics stated above, management carries a sense of confidence when analysts question the ROI on capex. And when Mark Zuckerburg boasted about building a gigawatt-plus cluster called Prometheus next year, Satya made sure to lead his introduction by saying “We stood up more than 2 gigawatts of new capacity over the past 12 months alone.” You’ll find more commentary on this below.

Revenue – Azure reported as standalone segment for first time

Revenue was up $76.4 billion for growth of 18% or 17% in constant currency. This is up from last quarter with growth of 13% or 15% in constant currency and beat consensus of $73.83 billion. For the fiscal year ending in June, the company reported revenue of $281.7 billion, up 15%.

Azure revenue was reported as a standalone metric for the first time, being stripped out of “Azure and Other Services.” The company stated Azure saw $75 billion in revenue or growth of 34%. For comp purposes, the original segment grew 39% up from 33% / 35% on CC basis last quarter.

Below, you can see the visible acceleration in overall revenue

Below you can see that 39% is the highest growth rate we’ve seen in some time for Azure and Other Services:

Looking forward, management guided for revenue of $75.25B at the midpoint, beating consensus of $74.15B. This would represent growth of 14.7%.

According to the CEO, Microsoft is ahead of other hyperscalers in speed of data center buildouts: “We continue to lead the AI infrastructure wave and took share every quarter this year. We opened new DCs across 6 continents and now have over 400 data centers across 70 regions, more than any other cloud provider. There is a lot of talk in the industry about building the first gigawatt and multi-gigawatt data centers. We stood up more than 2 gigawatts of new capacity over the past 12 months alone. And we continue to scale our own data center capacity faster than any other competitor.”

Revenue segments – Cloud has highest growth rates since 2022

Cloud reported some of its highest growth in three years. The CEO stated: “Through software optimizations alone, we are delivering 90% more tokens for the same GPU compared to a year ago” as well as “

Microsoft Cloud was up 27% and up 25% on CC basis for revenue of $46.7B. This marks the highest quarterly growth rate since CY2022
Gross margin was 70% up 100 basis points from 69% last quarter
Productivity and other Businesses was $33.1 billion, up 16% and 14% on CC basis.
Intelligent Cloud was up 26% and up 25% on CC basis for revenue of $29.9 billion. This was the highest growth rate since CY2022
More Personal Computing was up $13.5B for growth of 9%

Commercial Bookings Surpasses $100 Billion for the first time

To help support the case for future growth, both commercial bookings and commercial RPO came in surprisingly strong.

The CFO stated that for the first time commercial bookings surpassed the $100 billion mark, increasing 30% on CC basis. Commercial RPO increased to $368 billion, up 35% on CC basis with 35% recognized in revenue in the next 12 months.

Additional key metrics: 500 trillion tokens processed last year; 800M AI Product Users

Azure is always the main metric looked at, yet we should pause and share a few more important key metrics in this banner report.

Copilot apps have surpassed 100 million monthly active users across commercial and consumer.
Across broader AI features, there are over 800 million monthly active users.
Foundry Agent Service is now being used by 14,000 customers to build agents.
80% of Fortune 500 use Foundry, processing 500 trillion tokens, up 7X YoY.
Microsoft Fabric is a data and analytics platform for AI workloads, with revenue up 55% year-over-year and over 25,000 customers. According to management: “It's the fastest-growing database product in our history.”
There are 20 million GitHub Copilot users. GitHub Copilot enterprise customers increased 75% quarter-over-quarter and 90% of the Fortune 100 use GitHub Copilot.

Margins & Earnings

EPS of $3.65 beat consensus estimates of $3.38.

Gross margin was 68.5% up from 68.1% last quarter for gross profit of $52.4B.
Operating margin of 44.9% was up from 44% for operating profits of $34.3B.
Net margin was 35.6% up from 34.9% last quarter for net profits of $27.2B.

Cash flows & capex raised to eye-watering $30B per quarter

Operating cash flow of $42.6B was up 15% YoY
Free cash flow of $25.6B was up 10% YoY
Capex of $24.2 billion was up 27% YoY with management guiding for capex of $30 billion next quarter.

Earnings Call Q&A:

Capex Spend Correlates to $368B in RPO:

Every Big Tech company will be asked about ROI on capex spending, and the CFO handled the question quite well, stating: “when you think about the full year comments I've made on CapEx as well as the Q1 guidance of over $30 billion, you first have to ground yourself in the fact that we have $368 billion of contracted backlog we need to deliver, not just across Azure but across the breadth of the Microsoft Cloud.

So in terms of feeling good about the ROI and the growth rates and the correlation, I feel very good that the spend that we're making is correlated to basically contracted on the books business that we need to deliver and we need the teams to execute at their very best to get the capacity in place as quickly and effectively as they can.

And so when you look, and we've talked about the growth rate [of capex] will decline year-over-year, but at its core, our investments, particularly in short-lived assets like servers, GPUs, CPUs, networking storage, is just really correlated to the backlog we see and the curve of demand. And I talked about, my gosh, in January and said I thought we'd be in better supply demand shape by June. And now I'm saying I hope I'm in better shape by December.”

Conclusion:

This was an earnings report for the ages – simply because the Commercial RPO is massive, and Microsoft is proving they can grow at a scale we haven't seen yet in AI software. Earlier today, I had stated on Bloomberg that Microsoft could see $40 billion in AI revenuesometime in 2026 – which is a massive number, but what's most important is the rapid ascent in reaching that number.

If you zoom-out, a few years back I've made the case that Microsoft could see as much as $100 billion in AI revenue by 2027 and then I upped it to $200 billion by 2028. Should we see this ballpark figure, it would mark a rapid ascent hard to fathom a few years back. This earnings report is a step in the right direction to meet that mark.

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Oracle Cloud May Grow Much Faster than Big 3

Posted on July 18, 2025June 30, 2026 by io-fund

This article is a continuation of our free newsletter from July 17, Can Oracle Become the Next $1 Trillion AI Stock?

Find out the following below:

If Oracle can become the next $1 trillion AI stock – or if Stargate is a one-time deal that will leave the stock flat from exorbitant GPU costs
Bull, base and bear case scenarios, with detailed revenue and segment projections showing where and when revenue upside lies
An invitation to our next webinar – exclusive only to subscribers. In our upcoming 1-hour webinar, we will detail our buy, trim and sell zones for Oracle and other leading AI stocks.

Oracle Cloud May Grow Much Faster than Big 3

Though Oracle is growing off a much smaller cloud base than say Azure, robust IaaS momentum could drive its Cloud growth at a much faster rate than the Big 3 – defined as Microsoft, Amazon and Alphabet — over the next few years.

As stated above, consensus currently models in $46 billion in IaaS revenue in FY28. For the IaaS segment to increase 4.5x from FY25’s $10.2 billion in revenue, this requires growth at a 65.2% CAGR, or a slight deceleration from >70% YoY in FY26 to >60% YoY in both FY27 and FY28.

This rapid IaaS growth could fuel a 40% CAGR for Oracle’s total Cloud growth by FY28, taking its Cloud segment from $24.4 billion to $66 billion. This 40% CAGR will far outpace AWS’ growth in the high-teens, and Google Cloud and Azure in the high-20% to low-30% range.

While this represents a significant reshapement of Oracle’s business model towards high-growth cloud, it also implies that Oracle is aiming to be much more competitive in AI and firmly establish itself as the fourth AI hyperscaler. Despite coming off a much smaller revenue base, Oracle’s forecasted 40% cloud CAGR suggests that it will start to take market share from the Big 3.

Scenario Analysis

Quick Look into FY26, Long-term Targets

Before we present the scenario analysis, it’s prudent to briefly touch upon Oracle’s FY26 guidance and long-term targets, as these pertain directly to the three scenarios.

For FY26, Oracle slightly raised its revenue guidance, now expecting revenue to be $67 billion, for YoY growth of 16.7%, up $1 billion from its prior view for $66 billion. Management remains confident in exceeding its 20% growth target for FY27, or $80.4 billion.

Oracle has maintained its FY29 revenue target of $104 billion, which would require growth at a 14.5% CAGR since FY24. Given FY26 was raised, if the company maintains that CAGR then it will see 4% higher revenue in FY29 versus that target. For comparison, the consensus estimate for FY29 has risen $6 billion over the last three months, from $100.5 billion to $106.5 billion.

Bull Case Projects 55% Upside

Based on the model below through FY29, Oracle could see IaaS maintain a robust 59% 4-year CAGR to nearly $65 billion in revenue, with a deceleration to 40% YoY in FY29. This could drive Cloud revenue at nearly a 39% CAGR to more than $90 billion, or 85% of revenue, doubling its share from 43% in FY25.

This also assumes an (8%) CAGR in licensing, support, hardware and other revenue, driven by increased cannibalization of on-prem licensing beyond FY27 as Oracle’s cloud shift accelerates.

Overall, this bull case projects revenue slightly below FY27’s target, but sees much greater upside versus consensus by FY29 as the $30 billion deal begins to kick in and as Oracle benefits from increasing synergies with OpenAI.

To note, OpenAI is optimistically forecasting $125 billion in revenue by 2029, which could translate into tens of billions to Oracle from AI infrastructure costs. This forecast also likely hinges on limited hardware constraints to allow Oracle to meet such high demand.

However, high capex requirements to build out multiple GWs of capacity are likely to keep free cash flow limited – this model projects FCF margins in the mid-single digits by FY29. On a cumulative basis from FY26 through FY29, free cash flow is expected to under $7 billion.

The bull case scenario also assumes adjusted operating margins are slightly softer in FY26 and FY27 as amortization of intangible assets decreases, before expanding into FY29 as cloud and IaaS mix expands substantially.

Adjusted net margin is expected to increase slightly towards 32%, on the possibility that high capex requirements lead to debt raises and increased interest expenses.

Under this scenario, topline growth is expected to remain rather robust at an 18.8% CAGR from FY25, more than four points ahead of Oracle’s guided 14.5% CAGR. Peak revenue growth is forecast for FY28 at almost 22%, while EPS growth is expected to be >20% YoY for FY27 through FY29. As a result, Oracle is assigned a 10x P/S multiple and a 31x P/E multiple.

This is approximately in line with Oracle’s peak top-line valuations over the past five years and a 15% discount on the bottom line, accounting for a slight YoY deceleration in FY29. However, this is around a 40% premium to Oracle’s five-year average P/S multiple and a 30% premium to its five-year average P/E.

This valuation is also approximately in line with Microsoft’s current five-year average forward P/S and P/E multiples of 10.7x and 30.5x. To note, Oracle is projected to have a much higher cloud mix at 85% of revenue, growing at a 39% CAGR, versus Microsoft’s Intelligent Cloud at 66% share by 2029 on a 16% CAGR.

These assumptions return a price target of $386, or a 55% return, propelling Oracle into the $1 trillion club.

Base Case Sees Potential 27% Upside

The base case scenario assumes revenue remains roughly in line with consensus estimates through FY27, with low-single digit upside in FY28 and FY29 as Oracle begins to recognize growth from the recent mega-deal.

Under this scenario, IaaS growth will decelerate a bit quicker into FY29, with revenue at 36% YoY versus 40% YoY in the bull case scenario. This still results in a 57% IaaS CAGR to $62.3 billion in revenue, driving a 37% cloud revenue CAGR, nearly 2 points below the bull case.

In the base case, Oracle is assumed to maintain operating margin in the 43% level moving forward, with some slight net margin expansion to the 31% range. This would project FY29 EPS of $11.69, or almost 2% ahead of consensus.

This scenario sees Oracle maintaining solid topline and bottom-line growth rates, at almost 16% YoY for revenue and 18% YoY for adjusted EPS in FY29. In this, Oracle is assigned an 8.5x P/S multiple and a 27.1x P/E multiple, a 15% premium to its current five-year averages of 6.9x and 23.7x, respectively, as the company exceeds its long-term targets on strong cloud momentum.

These assumptions return a $316 price target, or 27% upside from current levels.

Bear Case Projects Flat Return

The bear case scenario assumes revenue again remains roughly in line with consensus estimates through FY27, before lagging consensus in FY28 and FY29. However, this scenario still assumes Oracle remains ahead of its FY29 target due to the mega-deal, as even a delayed ramp to 2029 still likely derisks that $104 billion revenue target.

IaaS revenue is projected at a 56% CAGR through FY29, with growth decelerating rather sharply from 70% in FY27 to 34% by FY29. SaaS growth is estimated at a slower 11% CAGR, with mid-single digit growth in FY29. This combines for a 35% cloud revenue CAGR, nearly 4 points slower than the bull case and 2 points slower than the base case. Even with these assumptions, FY29 revenue is still projected more than 1% ahead of Oracle’s target at $105.2 billion.

In this scenario, margins are projected to decline marginally through FY27 on account of that decreasing amortization expense, with further softness into FY29 from an aggressive pursuit of capacity expansion and high capex in an effort to support stronger IaaS growth.

This also assumes that Oracle will turn to the debt markets to fuel this capacity expansion, adding hundreds of millions to interest expenses and creating up to a ($0.20) EPS headwind by FY29.

As such, topline growth is projected to peak just below 20% in FY27, before decelerating to the low 14% range by FY29, resulting in a four-year CAGR of 16.8%. Similarly, EPS growth would peak at 21% in FY27 before decelerating 9 points to 12% YoY by FY29.

As such, Oracle is assigned a 7x P/S multiple and 23.3x P/E multiple, approximately in line with its current five-year averages, accounting for this two-year deceleration in growth rates. It’s also possible under this scenario that cumulative FCF generation through FY29 remains negative to barely positive, assuming capex growth comes in above >15% YoY in both FY28 and FY29.

This scenario would return a price target of $249, or essentially flat with its current share price.

Conclusion

Oracle laid out rapid growth targets for fiscal 2026 driven by strong AI momentum, forecasting cloud infrastructure growth to accelerate 20 points and total cloud revenue to accelerate 16 points. Coupled with r >100% RPO growth guidance, its expanded arrangement with OpenAI and its mega $30 billion/year cloud deal, confidence is increasing in Oracle’s long term cloud trajectory.

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Cloudflare: Entering Act 3 to Become a Leader in AI Inference at the Edge

Posted on June 27, 2025June 30, 2026 by io-fund

Two years ago in the analysis Cloudflare: Bringing AI Inference to the Edge, we discussed in a deep dive on the stock why “Act 3 and the Workers platform is where the most explosive moment could occur” for Cloudflare while stating:

“[…] what’s crazy is that Cloudflare rolls out features that exceed hyperscaler performance at minimal cost. It is this combination of competing with the hyperscalers, delivering app performance at faster speeds — while keeping prices low — that is unique to Cloudflare.”

Act 3 refers to the Workers platform, which is the company’s attempt to compete with hyperscalers – but most importantly, it sets up the company well for AI inference at the edge.

Cloudflare executes runtime for an application close to the user combined with removing cold starts by running isolates that create an advantage at the edge. This is distinct from pushing compute from a centralized data center to the edge. It’s also distinct from containerized processes that require cold starts. Cloudflare also offers R2 object storage, which helps developers eliminate unnecessary fees on cloud storage. This is used by AI startups to help arbitrage the lowest GPU cost to train their models.

When it comes to AI inference-driven revenue, it’s still relatively early in the growth curve. Hyperscalers and model providers only recently began to disclose rapid AI token growth over the last three to four months. However, Q1’s earnings report shows signs of surging AI inference demand filtering into Cloudflare’s platform. For example, Q1 witnessed nearly 4,000% YoY growth in Workers AI inference requests, and more than 1,200% YoY growth in AI Gateway requests.

These growth numbers are off a small base (which is true for all inference statistics for now), yet when you take a company with product-market like Cloudflare and combine it with a massive trend on the verge of taking off – what you get is an irresistible stock that the I/O Fund has a high probability of entering and holding for an extended period of time.

Connecting the Dots:

As discussed in the product deep dive two years ago, Cloudflare’s core products as a CDN and best-of-breed leader in cloud-based security and application security including Zero Trust may not seem connected its future as an AI inference leader, but they are intricately connected. You can read more on the background of the points below and Cloudflare’s core products here.

Cloudflare references its business units as “Acts” – Act 1, Act 2 and Act 3. The company defines Act 1 as application security, Act 2 as Zero Trust and Act 3 as the Workers Platform. For our purposes as stock investors, it’s Act 3 we are most interested in. The analysis below makes it abundantly clear as to why Act 3 and the Workers platform is where the most explosive moment could occur.

Cloudflare has a few distinct advantages as the platform of choice for AI developers. Here’s a summary:

Does not rely on Big 3 infrastructure and can drive down costs
Is faster on performance because of its position at the edge; this lowers costs and latency for AI inference and keeps data as close to the user as possible
Geographically equipped to handle compliance issues that will inevitably result from using training data for inference.
The company has moved diligently into compute, storage and application services. Combined with its global network, this positions the company for AI inference as-a-service. There is no other company doing both edge network plus compute and storage except the hyperscalers. However, in some cases such as serverless, Cloudflare exceeds the performance of the hyperscalers.
CDN as a core product and security as a seamless upgrade shows the importance of being a middleman, helping to position Cloudflare to innovate around Serverless in ways that outperform even AWS.
Training models is prohibitively expensive by requiring upfront costs, Nvidia GPUs are hard to obtain, and AI development is not democratized for developers with proprietary, blackbox APIs that run counter to an open-source movement (GPT-4 versus Llama). Cloudflare aims to solve these problems by allowing popular models to run closer to the user, which is the next logical step for AI.

Ultimately, the bigger and the faster a network is, the more it’s capable of providing “as a service.” AI can create a fortuitous moment for Cloudflare because the company is both positioned to offer AI inference-as-a-service yet also solves important pain points for developers.

Workers AI Built for High-Speed AI Inference at the Edge

Cloudflare’s Anycast network routes traffic to the most available data centers, and can spread traffic across the entire network, improving resiliency during surges and minimizing latency. Cloudflare said in Q1 that the network now spans over 13,000 major service providers in 500 locations across 400 cities in more than 100 countries. By routing requests to the edge, Cloudflare is less than 50 milliseconds away from 99.9% of Internet traffic and 95% of the Internet-connected population.

Cloudflare recently revealed at Morgan Stanley’s Tech, Media and Technology (TMT) Conference in March 2025 that when it first developed its Workers platform nearly eight years ago, it had no idea it would foresee what AI agents would become. The platform was originally born with the idea of creating a new way to deploy code at the edge, or as Cloudflare puts it, the “Goldilocks zone of high compute performance with low latency” as close to devices as possible.

Workers has a unique platform architecture: it eliminates cold starts by running close to GPUs instead of in a container or virtual machine, executing code the second it is received. It also uses isolates, which run 100x faster than node processes and consume significantly less memory without requiring separate resource allocation. Essentially, developers pay for Javascript runtime once and can then run “limitless” scripts across hundreds or thousands of isolates, all without additional overhead costs.

It is this unique isolate-based architecture, with ultra-low latency and an ability to execute thousands of requests concurrently at minimal cost, that provides Cloudflare an advantage for AI inference. What Cloudflare offers is exactly what AI inference needs – exceptionally fast performance with no lag at the edge, as that is where the data is located.

Cloudflare is working to significantly expand GPU accessibility across its global network to serve growing inference demand, having GPUs across 190 cities worldwide as of March 2025. Cloudflare had doubled its GPU capacity in one year with more powerful GPUs as of September 2024, and is aiming to double its capacity again in 2025.

Source: Cloudflare

Cloudflare is also expanding support for increasingly large models, such as Meta’s Llama 3.1 family, and a broader range of models with its ‘Run Any’ support feature (this is limited however to models compatible with its GPU fleet and inference stack).

Cloudflare’s vector database Vectorize aids in the full-stack AI app development process by storing and remembering previous inputs. Vectorize can now support indexes with up to 5 million vectors, up 25x from 200,000 previously. Median query latency has been reduced nearly 18x from 549 milliseconds to 31 milliseconds. This allows AI apps to search and recall relevant data quickly while keeping costs lower.

By expanding access to larger models and larger context windows at faster speeds, AI apps built on Workers AI now can handle increasingly complex tasks with greater efficiency at similar or lower costs. Put together, Cloudflare says that Workers platform can end up ~3x cheaper per CPU-cycle versus competing platforms like AWS’ Lambda, at $0.50 per million requests versus $1.84 on Lambda. As developers now begin to increasingly use Cloudflare and Workers for AI API requests, they benefit directly from these lower overhead costs in addition to higher performance and lower latency offered by the global network.

These key advantages are helping Cloudflare land and expand enterprise customers with AI in mind. CFO Thomas Seifert explained that customers migrating to Workers can see cost or performance improvements of ~300% in the migration. It was this exact reason that drove its largest deal on record in Q1, a $130 million five-year deal with an existing customer, primarily for Workers. Cloudflare said this customer was deeply engaged with a hyperscaler who was confident in winning the deal, but the customer “made the decision to switch to Cloudflare when they saw our better performance, lower development costs and more modern platforms.”

AI Gateway: Additional Benefit for Enterprise AI

It is also no surprise that Cloudflare is becoming a platform of-choice for AI providers, with 80% of the leading AI companies as customers of Cloudflare. Yet it has one new, underdiscussed product that could help pave the way for broader enterprise AI adoption: AI Gateway.

Although AI Gateway was launched more than a year ago, Cloudflare has been especially quiet about the new offering. Q1 saw the first mention of growth for the product, while management said at Morgan Stanley’s TMT that it was its largest new feature that “might not have gotten enough attention yet from a Wall Street perspective.” As of October 2024, Gateway had proxied over 2 billion requests in just one year.

Gateway is a centralized AI ops platform for Workers AI. It acts as a control center for AI applications running on Cloudflare with multi-vendor observability and analytics, sitting between customer applications and AI APIs they make requests to.

Source: Cloudflare

With Gateway, customers have detailed insights into traffic patterns, such as the amount of requests, token usage, and costs over time. Customers can limit requests to help control costs, while custom response caching allows Cloudflare to make repeat requests, saving costs and lowering latency by serving from the cache and bypassing the original API. Gateway pairs natively with Workers AI and Vectorize to help developers build full-stack AI products within the platform.

Cloudflare noted that it has plans to expand features to include dynamic model routing with A/B testing, usage alerts, advanced caching and more. However, its future vision for Gateway embeds more data security tools to ease enterprise adoption and smooth other privacy concerns, a major hurdle to adoption at the moment.

Cloudflare says that in the future, its goal for AI Gateway is to transform it into a product that helps enterprises monitor how employees utilize AI. With Gateway, enterprises could route all API requests to AI providers through Cloudflare’s platform first, letting organizations log user requests, set access policies and rate limiting, and implement data loss prevention strategies. Cloudflare says that if an employee accidentally pastes sensitive data into ChatGPT, enterprises could redact that or block the request entirely, preventing it from reaching AI providers and thus into the public domain.

The end goal with Gateway is to create a platform that lets enterprises tap into efficiencies that AI unlocks while providing a high level of data security and privacy. This is a key concern – a Deloitte survey from late 2024 found that nearly 75% of tech professionals listed data privacy as a top three concern from genAI use in the enterprise. Around 40% had listed data privacy as the number one concern, up from 25% in 2023. A survey from Reveal in June 2025 also found that while 73% of tech leaders prioritize expanding AI use this year, 78% listed data privacy as their top concern.

For enterprises utilizing AI, costs trump all, as even small changes in token/API costs at high usage, such as hundreds of thousands of API calls daily, could quickly drive usage costs higher and adversely impact margins. Cloudflare’s focus on providing high visibility into AI usage, while simultaneously boosting data privacy and minimizing costs and latency provides an additional benefit when it comes to inference and AI application deployment.

Workers Shows Hints of Rapid AI Momentum

Cloudflare’s Workers platform is seeing considerable AI-driven momentum, both in active developers growth and now AI inference requests. Active developers first reached 1 million in November 2022, nearly tripling YoY. By April 2024, or approximately two quarters after the launch of Workers AI, active developers had doubled to more than 2 million.

Though Cloudflare did not provide an update in Q1 or at TMT, active Workers developers crossed 3 million at the end of 2024, marking a 50% YoY increase. Overall, this represents nearly 9x growth in just over three years.

Source: Cloudflare

Additionally, Cloudflare noted that Act 2 and Act 3 products – Zero Trust and Workers – contributed significantly to its strong ACV growth in Q1. Net-new ACV recorded its highest YoY growth in three years last quarter, with products from the two acts driving two-thirds of that.

We recently covered Workers developer growth and other strong key metrics in our free newsletter from February, Encouraging Growth in Key Metrics Drives 60% Gain YTD for Cloudflare Stock.

When it comes to AI inference-driven revenue, Cloudflare has not offered any insights, as it’s still relatively early in the growth curve. Hyperscalers and model providers only recently began to disclose rapid AI token growth over the last three to four months. However, Q1’s earnings report did show some hints of surging AI inference demand filtering over to Cloudflare’s platform.

Q1 witnessed nearly 4,000% YoY growth in Workers AI inference requests, and more than 1,200% YoY growth in AI Gateway requests. This builds upon Q4’s first large inference customer win of approx. $7 million. While growth is likely off a rather small base considering the relative newness of both platforms, it is a solid indicator of accelerating inference demand.

Capex is a bit more unusual metric to point to in support of strong inference-driven growth, but Big Tech has been straightforward in saying that AI capex is correlated with demand, and higher demand necessitates higher capex. Cloudflare’s network capex has accelerated sharply, up from 6% of revenue in Q2 to 15% of revenue by Q4 and now 17% of revenue in Q1. This quick increase in capex suggests that Cloudflare is rapidly ramping up GPU and hardware purchases to meet heightened AI demand signals.

Quarterly Growth Projected to be Flat Through 2025

Cloudflare reported a 2% beat in Q1 with revenue increasing 26.5% YoY to $479.1 million. This growth was attributed to the strength of Cloudflare’s largest >$1M and >$5M ARR customer cohorts, which saw record customer additions in the quarter.

By geography:

US revenue rose 20% YoY to $234.9 million, or 49% of revenue. Any deceleration here as a core revenue generator could present a headwind to growth reaccelerating.
EMEA revenue rose 27% YoY to $133.9 million, or 28% of revenue.
APAC revenue rose 54% YoY to $73.4 million, or 15% of revenue. Cloudflare says key go-to-market strategies are producing robust growth in the region.

Looking ahead to Q2, Cloudflare guided for 24.8% YoY growth to $500 million to $501 million in revenue, representing a 1.7 point sequential deceleration. Analysts are much more optimistic on the quarter, projecting growth above the top end of the range at $501.8 million, or up 25.1% YoY.

Through the rest of fiscal 2025, growth is expected to be essentially flat around 25% YoY. However, management expressed confidence in driving a reacceleration through 2025, opening the door for potential upward surprises driven by AI inference. While flat growth does not usually stand out, each of the prior two fiscal years saw a notable deceleration in growth from Q1 to Q4 at ~4 points, with FY25 possibly set to break this trend.

It's also important to note that estimates for both Q3 and Q4 been revised slightly lower over the past three months, with Q3’s estimate down (0.6%) and Q4’s down (1.0%). This represents a decline of around $3.5 to $6 million for each quarter, or 0.5 to 1.3 percentage points shaved off of growth.

FY25 Guide Maintained at 25.3% YoY

For FY25, Cloudflare opted to maintain its initial revenue guidance of $2.09 to $2.094 billion, corresponding to 25.3% YoY growth at midpoint. Analyst estimates call for flat growth over the next few quarters but a slightly stronger second half of the year, with QoQ growth of 8% for Q3 and 7.5% for Q4 even after some negative revisions.

However, by maintaining guidance despite the $10M beat in Q1, Cloudflare is essentially saying Q2 could be softer than expected. With that said, Cloudflare tends to be conservative during macro events such as what we saw in April, and thus it could also be a non-issue.

Although we are seeing a 1 to 2 point acceleration in the fiscal year consensus estimates, the hint that there could be an acceleration is what helps Cloudflare stand apart from peers since more cloud companies are decelerating sharply below 20% growth.

For example, Snowflake’s revenue growth is forecast to decelerate from 29.2% last year to 24.7% in 2025 and below 23% next year. Datadog's revenue is forecast to decelerate from 26.1% last year to sub-19% by 2026, while MongoDB’s revenue decelerated from 31% in 2023 to a projected 13.9% this year.

Key Metrics Support Growth Acceleration

Cloudflare’s underlying key metrics are supportive of revenue growth accelerating. In the most recent quarter, the company reported accelerating paid customer growth and billings, stabilizing DBNRR, and record large customer additions.

In Q1, paid customer growth accelerated 2 points sequentially to over 27% YoY, with Cloudflare reporting 250,819 paid customers. Growth has doubled from 13% two years ago, an impressive acceleration given the scale is now reaching a quarter-million paid customers.

Cloudflare also noted it had driven record customer additions in its >$1M and >$5M ARR cohorts in Q1, with growth in both metrics up 48% and 54% YoY, respectively.

Billings growth also accelerated 1 point to 32.8% YoY in Q1, recovering from the 20% range in 2024. Billings activity likely benefitted from QoQ improvements in sales cycles as noted in Q1, as well as stronger deal activity and larger contracts.

Cloudflare’s DBNRR stabilized at 111%, though it has yet to see a strong acceleration like Palantir. Compared to last year, DBNRR is 4 points lower. Management did note that “churn rates improved in the quarter,” while they saw stabilization in customer businesses after April’s bout of volatility alongside reduced pricing pressures from competitors. These factors should provide more headroom for DBNRR to expand again as AI consumption increases.

RPO also reaccelerated in Q1 to nearly 39% YoY to $1.86 billion, though there has been consistent quarterly variability in growth over the last two years. Current RPO accounted for 66% of total RPO, down from 70% in Q4.

Margins Show NET Regressing from Path to GAAP Profitability

Margins are the one real blemish for Cloudflare, as the company has regressed on its path to reach GAAP profitability in Q1. Gross margins have been compressing slightly, due to an increase in paid versus free traffic, while operating margins slipped sequentially in Q1.

GAAP gross margin was 75.9% in Q1, down 0.5 points sequentially and 1.6 points YoY. Adjusted gross margin was 77.1%, down 0.5 points sequentially and 2.4 points YoY. Cloudflare said the softness was due to a significant increase in paid vs. free traffic which led to a “higher allocation of expenses to cost-of-goods-sold from sales and marketing,” similar to Q4.

GAAP operating margin was (11.1%) in Q1, down 3.6 points sequentially and a setback from three consecutive quarters of progress towards profitability in the (7%) to (8%) range. Adjusted operating margin was 11.7%, marginally above guidance for 11.6% and down 2.9 points sequentially. For Q2, Cloudflare guided for adjusted operating margin to improve one point to 12.6%.

As seen below, there exists a wide, nearly 23 point gap between GAAP and operating margins. This is driven primarily by high SBC at ~20% of revenue, and it highlights that either SBC would need to move much lower, or costs much lower, in order to drive Cloudflare to a sustainable path to GAAP profitability. For example, Q1’s sales & marketing expense was 38% of revenue, 10 points above Cloudflare’s long-term model of 27% to 29% of revenue.

GAAP net margin was (8.0%) in Q1, a rather substantial decline from (2.8%) last quarter, driven by the QoQ decline in operating margin. Adjusted net margin was 12.2%, the lowest reported level since Q2 2023.

EPS Growth Minimal in FY25

Cloudflare reported adjusted EPS in line with estimates at $0.16 in Q1, for flat YoY growth. Q2 is expected to see adjusted EPS decline mid-single digits YoY, with the full-year on track for just mid-single digit growth with an acceleration expected in Q4.

For Q2, Cloudflare guided for adjusted EPS of $0.18, down from $0.20 in the year ago quarter. Adjusted EPS growth is expected to resume in 2H, with EPS seen exiting the year at $0.23, up 22.6% YoY.

For FY25, Cloudflare maintained its guidance for $0.79 to $0.80, corresponding to growth of approximately 6% YoY. For FY26, analysts are projecting EPS growth to accelerate sharply to 30.3% YoY to $1.04, which likely would require solid improvement in adjusted margins given the topline acceleration is minimal.

Cash Flows & New Debt Raise

Operating cash flow continues to improve, touching a 30% margin in Q1, though free cash flows remain pressured by heightened network capex at 17% of revenue. Cloudflare also raised a substantial amount of capital on June 13, an interesting move given the company still has nearly $2 billion in cash on hand.

Operating cash flow rose more than 98% YoY to $145.8 million, for a 30% margin. This marked a substantial 11 point improvement from a 19% margin a year ago and a 2 point sequential improvement.
However, free cash flow rose 48.6% YoY to $52.6 million, for an 11% margin, up only 2 points YoY. This was driven by heightened network capex in the quarter at 17% of revenue, increasing from 15% of revenue in Q4 and more than double last year’s 8% of revenue.
For FY25, Cloudflare maintained guidance for network capex to be 12-13% of revenue with some quarterly variability, which may allow FCF margin to expand throughout the year as it suggests capex spend will normalize at a lower level.
Cash and investments totaled $1.92 billion, while Cloudflare reported $1.29 billion in convertible debt still outstanding, due in 2026.
On June 13, Cloudflare announced it priced $1.75 billion in 0% convertible notes due 2030. Cloudflare said the conversion price is ~$247.67, and the capital will go towards general corporate purposes, including working capital, network capex, M&A or paying outstanding debt.

Valuation is the Primary Drawback

The primary drawback to Cloudflare’s AI inference opportunity at the moment is its valuation. Key metrics and comments of 12x to 40x growth in AI inference requests support revenue reaccelerating, but it is hard to justify a rapid repricing from a 16x forward revenue multiple in April until there is tangible evidence of the topline accelerating.

Cloudflare is trading at a hefty 30x forward revenue multiple, second only to Palantir’s 85x multiple. This represents Cloudflare’s most expensive valuation on a forward revenue basis since 2022, and far above historical resistance at around 22x.

Source: YCharts

While Cloudflare may have a clearer AI inference opportunity than other best-of-breed cloud stocks such as Snowflake and DataDog, it is trading at a significant premium to both. At 30x, Cloudflare is near a 100% premium to SNOW and a 115% premium to DDOG, despite all three are reporting revenue growth in the 25% to 27% range for the most recent quarter.

Source: YCharts

On a forward PE basis, Cloudflare is valued just 5% shy of Palantir, at nearly 228x forward EPS. Cloudflare is nearly 20% more expensive than SNOW at 192x forward PE, and far above DataDog’s 76x multiple. Cloudflare also has the second lowest adjusted EPS growth this year, at 6% versus 42% for Palantir, 33% for Snowflake, and (7%) for DataDog.

Conclusion

Cloudflare is uniquely positioned to capture AI inference at the edge, and we are seeing more signs of surging AI inference demand from hyperscalers. Cloudflare has been relatively quiet about AI inference-driven growth until Q1 when it dropped 12x growth in AI Gateway requests and 40x growth Workers AI inference requests.

The takeoff in AI inference is expected to drive an inflection in Cloudflare’s growth, with revenue expected to begin a prolonged acceleration through FY27, starting in the back half of 2025. However, Cloudflare’s valuation presents a real drawback after a rapid rerating higher, considering the acceleration has not yet tangibly materialized and margins regressed from a path to profitability.

For stock setups, including potential entry prices, consider upgrading to our Advanced tier with real-time trade alerts and weekly webinars held on Thursdays at 4:30 p.m. EST. To receive $100 off our Advanced tier, use code ADVANCED100 or click here and email your request to upgrade.ADVANCED100 or click here and email your request to upgrade.

Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis

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Microsoft FQ2 Earnings: Soft revenue guidance

Posted on January 31, 2025June 30, 2026 by io-fund

Microsoft beat the top-line and bottom-line consensus estimates. However, the revenue guidance fell short of estimates. The company’s December quarter revenue grew by 12.3% YoY to $69.6 billion, beating estimates by 1.2%. The EPS grew by 10.2% YoY to $3.23, beating estimates by 3.9%, driven by strong operating efficiencies.

The company guided the March quarter revenue in the range of $67.7 billion to $68.7 billion, representing YoY growth of 10.3% at the midpoint. However, they were short of analyst estimates of $68.8 billion. The strong US dollar is expected to negatively impact the revenue growth by two percentage points.

Azure grew by 31% and came in at the lower-end guidance range of 31% to 32%. The company’s AI revenue met the management’s expectations. However, the non-AI revenue was slightly lower than expected due to the company’s challenges in the go-to-market execution.

Management provided a soft guide for the next quarter between 31% and 32% in constant currency. Demand for AI products exceeds Microsoft's current capacity, as the company faces challenges building enough data centers to support the high demand. Management expects supply constraints to be resolved by the end of the first half 2025.

Financials

Revenue

The company’s FQ2 (December quarter) revenue grew by 12.3% YoY to $69.6 billion, beating estimates by 1.2%, driven by strong AI and cloud demand.

Microsoft's revenue guidance for the March quarter is $67.7 billion to $68.7 billion, representing 10.3% year-over-year growth at the midpoint. This fell short of analyst estimates of $68.8 billion. A strong US dollar is projected to impact revenue growth by 2 percentage points negatively.

Segments

The company’s Productivity and Business Processes segment, which includes Microsoft 365 subscriptions and LinkedIn, grew by 14% YoY and 13% in constant currency to $29.4 billion, driven by strong Microsoft 365 Commercial offerings. Management expects revenue to grow between 11% and 12% in constant currency or $29.4 billion to $29.7 billion in the next quarter.

The Intelligent Cloud segment, which includes Azure AI revenue, grew by 19% YoY to $25.5 billion. The revenue was below management expectations due to lower non-AI revenue due to the company’s challenges in the go-to-market execution, specifically with customers reached through partner and indirect sales channels as the company balances its resources driving strong AI revenue. The lower non-AI revenue was offset by better-than-expected Azure AI revenue.

Azure revenue grew by 31% and included 13 percentage points contribution from AI services. Management provided a soft guide for the next quarter between 31% and 32% in constant currency. The company is facing challenges in building enough data centers to support the high demand. Management expects supply constraints to be resolved by the end of the first half of 2025, helped by the investments it has made in long-lived assets.

Management expects Intelligent Cloud revenue to grow between 19% and 20% in constant currency or $25.9 billion to $26.2 billion in the next quarter.

More Personal Computing revenue was flat at $14.7 billion. Management expects revenue in the next quarter in the range of $12.4 billion to $12.8 billion as it continues to prioritize higher margin opportunities in this segment.

Margins

The company’s margins have improved this quarter despite AI investments, which are driven by operational efficiencies.

FQ2 gross margin was 68.7% compared to 68.4% in the same period last year. It was better than the guide of 67.9% due the to focus on higher margin business and partially offset by increased AI investments. Management guide for the next quarter is 68.1%.
FQ2 operating margin was 45.5% compared to 43.6% in the same period last year. It was better than the guide of 44%, driven by operational efficiencies. Management guide for the next quarter is 44%.

Net margin of 34.6% was better than the guide of 33.8% compared to 35.3% in the same period last year. Management guide for the next quarter is 34.9%.

EPS

The EPS grew by 10.2% YoY to $3.23, beating estimates by 3.9%, driven by strong operating efficiencies.

Cash Flow and Balance Sheet

FQ2 operating cash flow grew by 18% YoY to $22.3 billion, driven by strong cloud billings and collections, partially offset by higher supplier, employee, and tax payments.
Free cash flow was down (-29%) YoY to $6.5 billion due to higher capital investments to support the strong AI demand.
Cash and short-term investments were $71.55 billion and debt of $44.97 billion compared to $78.4 billion and $45.1 billion at the end of FQ1.
The company paid $6.2 billion in dividends and repurchased shares worth $3.5 billion in FQ2.

Key Metrics

The company’s commercial RPO grew by 34% YoY and 36% in constant currency to $298 billion. Commitments from OpenAI drove the strong acceleration from 22% growth in FQ1 and also from existing and new Azure customers.

Microsoft Cloud revenue grew by 21% YoY to a record $40.9 billion. The AI business surpassed the annual revenue run rate of $13 billion, up 175% YoY. Cloud gross margin was 70% and in line with the guidance. Management guide for FQ3 is 69%, down from 72% in the same period last year due to higher AI investments.

Risks to consider

The company’s Azure growth in the coming quarters is to be watched. Management provided a soft guide for the next quarter between 31% and 32% in constant currency. Demand for AI products exceeds Microsoft's current capacity, as the company faces challenges building enough data centers to support the high demand. Management expects supply constraints to be resolved by the end of the first half 2025.

Morgan Stanley analyst Keith Weiss asked about the lower Azure growth during the earnings call. The CFO, Amy Hood, provided more context and clarified that the slowdown was due to the challenges in the non-AI Azure revenue. Microsoft's Azure AI revenue in FQ2 exceeded expectations due to operational teams pulling in delivery dates. However, non-AI Azure Compute Revenue (ACR) faced challenges in sales through partners and indirect methods. The company shifted its sales and marketing budgets and resources over the summer to balance AI workloads with ongoing migrations and other customer needs. However, adjustments are still being made to optimize resource allocation. Some impact on non-AI ACR is expected through the first half of 2025 as these adjustments take effect. However, management has not provided a definite timeline for when the non-AI revenue will recover.

The company’s capex is another area to watch in the coming quarters. The rising capex will put pressure on the margins and the cash flows. Capex, including assets acquired under finance leases, was $22.6 billion, up 97% YoY. Cash paid for property and equipment was $15.8 billion. Management expects the spending to be similar to FQ2 spending in the next two quarters. For FY2026, which ends in June, management expects to continue to invest. However, the growth rate will be lower than the FY2025, which is positive news, and the mix will shift back to short-lived assets that are more correlated to revenue growth. The company recently announced plans to invest approximately $80 billion in AI-enabled data centers in FY2025, up 44% YoY.

Valuation

The company is trading at a P/E ratio of 34.3 and a forward P/E ratio of 32, higher than the 5-year average P/E ratio of 33.1. It is trading at a P/S ratio of 12.2 and a forward P/S ratio of 11.1.

Analysts Notes

Morgan Stanley analyst Keith Weiss lowered the firm's price target on Microsoft to $530 from $540 and keeps an Overweight rating on the shares. Commercial bookings growth of 75% year-over-year in constant currency accelerated well beyond expectations, though Azure growth of 31% in constant currency in Q2 came in 1% point below expectations, the analyst tells investors. While Azure was disappointing, strength in the GenAI ramp and moderating capex growth should support accelerating FY26 free cash flow growth, the analyst added.

UBS lowered the firm's price target on the company to $510 from $525 and keeps a Buy rating on the shares. Microsoft's quarter was weaker than expected, with the company pulling its guidance for a second half Azure acceleration, citing sales execution, the analyst tells investors in a research note. While the improvement in the fiscal 2025 margin guidance as well as the guide for capex growth to moderate in fiscal 2026 will help, three straight quarters of an Azure disappointment with a different explanation each time undermines confidence in the growth outlook, the firm argues.

Mizuho lowered the firm's price target on Microsoft to $500 from $510 and keeps an Outperform rating on the shares. The company reported a decent fiscal Q2 but Azure revenue growth of 31% year-over-year was at the low end of management' guided range as Microsoft' non-artificial intelligence go-to-market execution was subpar, the analyst tells investors in a research note. Meanwhile, the company's Q3 revenue guidance was below Street expectations due to a $1B currency headwind, adds Mizuho. Despite the disappointment, the firm remains confident that Microsoft's revenue growth opportunities over the medium-term and beyond are greater than many realize.

Conclusion

Microsoft beat the top-line and bottom-line consensus estimates. However, the revenue guidance fell short of estimates. The margins have improved this quarter and the company has controlled costs well despite increasing AI investments. The key hurdle for the company in the coming quarters is to resolve the supply constraints and the challenges in the go-to-market execution.

Over the coming months to year, we are looking for an entry into Microsoft as we ultimately foresee Azure accelerating from AI. For now, the market is discounting the stock on the high capex spend and relatively low ROI from AI, perhaps affording a lower entry for this cloud and AI juggernaut

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

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Microsoft FQ2 Earnings Preview: Growth acceleration from AI expected in the 2H 2025

Posted on January 29, 2025June 30, 2026 by io-fund

Microsoft will release its Q2 FY2025 (Dec Q) results on Jan 29th. Analysts expect FQ2 revenue to grow 11% YoY to $68.8 billion and EPS to grow 6.3% YoY to $3.12. Revenue is expected to accelerate to 13% growth in FQ3 and 13.6% in FQ4.

The December quarter (fiscal Q2) is expected to be a challenging quarter for Microsoft, as it battles weaker momentum in gaming, device sales, 365 Commercial products and a slight hiccup for Azure’s growth. Wells Fargo analyst Michael Turrin expects balanced December quarter results with continued growth in Microsoft Cloud revenue and bookings due to continued consolidation across software, the company’s leading position in AI (especially Azure AI), and a year-end budget flush.

Morgan Stanley analyst Keith Weiss said that the recent CIO survey suggests that Microsoft will maintain its lead as the number one share gainer of IT wallet due to a shift to the cloud on both a one-year and three-year view. Microsoft Azure was the preferred vendor for CIOs in the AlphaWise survey, handling about 54% of overall workloads and about 41% expected to keep Azure Open AI for the next twelve months.

The company also recently announced plans to invest approximately $80 billion in AI-enabled data centers in FY2025, a significant increase from the $55.7 billion capex in FY2024. Investors will look for clarity during the earnings call on the timeline for the returns on these long-term investments.

Revenue

Management provided a soft FQ2 guide of $68.1 billion to $69.1 billion, representing YoY growth of 10.6% at the midpoint. While acknowledging temporary supply chain constraints, particularly delays in data center infrastructure deliveries, management expects these issues to be resolved in the second half of the fiscal year. This resolution and increased AI capacity resulting from prior investments are anticipated to drive Azure and overall revenue acceleration in the second half of the fiscal year.

FQ1 revenue grew by 16% YoY to $65.6 billion, driven by continued strong business gains.
Analysts expect FQ2 revenue to grow 11% YoY to $68.8 billion. Revenue is expected to accelerate to 13% YoY growth to $69.9 billion in FQ3 and 13.6% to $73.5 billion in FQ4.

Looking further out, analysts expect revenue to grow 13.7% YoY to $278.6 billion for the FY2025 ending June. Revenue is expected to accelerate to 14.4% growth in FY2026 and 15.3% YoY growth in FY2027.

Segment Revenue

The company's Productivity and Business Processes segment delivered stronger-than-expected results in the FQ1. However, the Personal Computing segment encountered challenges due to weaker consumer demand. Revenue within the Intelligent Cloud segment was in line with management expectations. The company is experiencing temporary supply chain constraints impacting Azure AI revenue in FQ2, which are anticipated to be resolved in the second half of the fiscal year.

FQ1 productivity and business processes revenue grew by 12% YoY and 13% in constant currency to $28.3 billion, driven by better-than-expected revenue across all the businesses. Management expects FQ2 revenue in productivity and business processes to grow between 10% and 11% in constant currency or $28.7 billion to $29 billion.
M365 commercial cloud revenue is expected to grow 14% in constant currency, with moderating seat growth across customer segments and ARPU growth through E5 and M365 Copilot. LinkedIn revenue is expected to grow by about 10% and Dynamics 365 (A suite of business applications like CRM and ERP for improving operational efficiencies) is expected to grow mid to high teens in the December quarter.
More Personal Computing FQ1 revenue grew by 17% YoY to $13.2 billion, which included the net impact of 15 percentage points from the Activision acquisition. Management expects More Personal Computing revenue to be $13.85 billion to $14.25 billion in FQ2. Windows OEM and devices revenue is expected to decline in the low to mid-single digits. Search and news advertising ex-TAC revenue is expected to grow in the high teens, and gaming is expected to decline in the high single digits due to hardware.
FQ1 intelligent cloud revenue grew by 20% YoY and 21% in constant currency to $24.1 billion. Azure revenue grew by 33% and 34% in constant currency, with healthy consumption trends that were in line with management’s expectations. Azure growth included roughly 12 percentage points from AI services.

Analyst see Azure accelerating to +35% growth

Management expects FQ2 Azure growth to be between 31% to 32% in constant currency and expects roughly 12 percentage points contribution from AI services. The soft FQ2 guidance is due to supply constraints, which is expected to improve in the second half of the fiscal year, and Azure growth is expected to accelerate in H2 FY2025. Berstein analyst Mark Moerdler expects Azure growth to accelerate to 35% to 40% YoY growth in the first half of CY2025.
KeyBanc analyst Jackson Ader said, “Over the December quarter (fiscal 2Q) Azure instances were up 17.3% sequentially and 28.0% year-on-year, each of which are multi-year highs." The analyst believes that non-AI growth from increased CPUs could positively surprise investors, given the supply constraints in FQ2 that will impact Azure revenue.

Margins

Microsoft has maintained strong margins driven by operating efficiencies. However, in the recent quarter’s investor sentiment has come down due to rising capex. Investors will be looking for more clarity during the earnings call on the timeframe of the returns on these long-term investments.

The company is continuing with its cost-cutting initiatives. Microsoft announced recently that they had frozen new hires in U.S. consulting and that minor layoffs were possible. In the second week of January, it revealed it was cutting less than 1% of its employees across multiple departments based on performance.

Microsoft increased the prices of the Consumer version of Microsoft 365 by $3 per month and now bundles with Copilot features, marking a 43% hike. The price increase reflects Microsoft’s plan to capitalize on the growing demand for AI services and enhance its revenue and profitability.

Management has guided a gross margin of 67.9% for FQ2 compared to 68.4% in the same period last year.
FQ1 operating margin was 46.6% compared to 47.6% in the same period last year. Excluding the impact of the Activision acquisition, the operating margin would have been up 1 percentage point compared to last year, driven by operational efficiencies.
Management operating margin guide for FQ2 is 44% compared to 43.6% in the same period last year.

Net margin FQ2 guide is 33.8% compared to 35.3% in the same period last year.
The company also expects a $800 million impairment charge in FQ2 over its investment in robotaxi startup Cruise after General Motors announced that they would halt the development of Cruise autonomous vehicles. This charge was not included when the company provided the guidance for FQ2. It is expected to have a negative impact of $0.09 on the FQ2 EPS.

EPS

FQ1 EPS grew by 10.4% YoY to $3.30, beating analysts estimates by 6.3% driven by operational efficiencies.

Analysts expect FQ2 EPS to grow 6.3% YoY to $3.12 and accelerate to 7.5% growth in FQ3 and 11.5% in FQ4.
Looking further out, analysts expect better EPS growth in the coming years. Analysts expect FY2025 ending June EPS to grow 10.5% to $13.04, followed by 15.6% and 18.5% growth for the next two years.

Cash Flows and Balance Sheet

The company has strong cash flows. However, due to the strong growth in AI, the company has a higher capital investment plan. The company recently announced plans to invest approximately $80 billion in AI-enabled data centers in FY2025, a significant increase from the $55.7 billion capex in FY2024.

FQ1 operating cash flow grew by 12% YoY to $34.2 billion or 52.1% of revenue compared to 54.1% in the same period last year. The cash flow growth was driven by strong cloud billings and collections, partially offset by higher supplier payments, and employee and tax payments.
FQ1 free cash flow was down (-7%) YoY to $19.3 billion, reflecting higher capital expenditures to support the cloud and AI offerings. The free cash flow margin was 29.4% compared to 36.6% in the same period last year. Capex was $20 billion and included roughly 50% towards long-lived assets and the remaining towards servers, including CPUs and GPUs. Management expects capex to increase sequentially in FQ2.
The company had cash and short-term investments of $78.4 billion and debt of $45.1 billion compared to $75.5 billion and $51.6 billion at the end of the FQ4.

Key Metrics

Key metrics like Commercial RPO are demonstrating positive trends. Wells Fargo analyst Michael Turrin expects continued growth in Microsoft Cloud revenue and bookings in the December quarter driven by consolidation across software, the company’s leading position in AI (especially Azure AI), and a year-end budget flush.

Commercial RPO

Commercial remaining performance obligation grew by 22% and 21% in constant currency to $259 billion in FQ1. Roughly 40% is expected to be recognized in revenue in the next 12 months, up 17% YoY. The remaining portion, recognized beyond 12 months, grew by 27%.

Commercial Bookings

The company witnessed increased demand and long-term commitments to the Microsoft Cloud platform in FQ1. Commercial bookings increased 30% and 23% in constant currency, driven by growth in contracts worth more than $10 million for Azure and Microsoft 365. In addition, the company witnessed a strong increase of over $100 million in contracts for Azure.

Microsoft Cloud

Microsoft Cloud revenue grew by 22% YoY to $38.9 billion in FQ1. Microsoft Cloud’s gross margin was 71% in FQ1 compared to 73% in the same period last year. Management expects gross margin to be around 70% in FQ2, down from 72% in the same period last year due to the increased AI spending.

Azure Arc, a tool that allows organizations to manage resources not hosted on Azure, had over 39,000 customers in FQ1, which is up 80% YoY and 8% QoQ.
The next-gen analytics platform, Microsoft Fabric, had over 16,000 customers in FQ1, up 14% QoQ.
Power Platform, a collection of low-code development tools, has been used by nearly 600,000 organizations, up 4x YoY.
Monthly active users in Copilot across CRM and ERP portfolio increased by 60% QoQ.

AI Revenue

During the FQ1 earnings call, management announced that its AI business is on track to surpass an annual revenue run rate of $10 billion in the FQ2. This remarkable achievement marks the fastest growth for any business in the company's history, reached within just 2.5 years. Management emphasized that this AI revenue primarily stems from inferencing services, which are known for their greater stability. This milestone also underscores Microsoft's strong relationships with Fortune 500 companies. Analyst Mark Moerdler of Bernstein estimates that Azure AI contributes significantly to this revenue, with approximately $9.7 billion. Moerdler also anticipates that the AI revenue mix will likely deliver healthy profit margins.

Valuation

The company is trading at a P/E ratio of 36.6 and a forward P/E ratio of 34, higher than the 5-year average P/E ratio of 33.1. It is trading at a P/S ratio of 13 and a forward P/S ratio of 11.8.

Conclusion

Microsoft's diverse product portfolio and strong leadership under Satya Nadella position the company for continued success. The company is expected to surpass the $10 billion annual AI revenue run rate in FQ2, showcasing the company's dominance in AI. Investors will be keen to understand the anticipated timeline for returns on AI-related investments. Also, the confirmation of Azure's growth trajectory in the second half of FY2025 are the key catalysts to watch in the upcoming earnings.

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

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Palantir Stock: How High Is Too High?

Posted on November 12, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Nov 7, 2024,09:08pm ESTForbesForbes on Nov 7, 2024,09:08pm EST

Two weeks ago, I highlighted that Palantir is “one of the rare few that sees AI drive both real returns for its business and real value for its customers,” while it continues to crush its software peers in AI-related growth. AI offerings have driven a clear acceleration in customers and overall revenue, while many SaaS peers, such as MongoDB and Salesforce, struggle to say the same.

This week, Palantir proved again in Q3 that it’s undeniably one of the stronger AI software stocks in the market outside of the cloud hyperscalers. The company reported visible AI-driven growth and persisting business momentum for AIP, strong revenue acceleration to 30% YoY, combined with strong profitability – a rare combination for growth stocks.

Despite proving again that it’s one of the only software names with real revenue in the market, Q3’s report pushed the valuation even higher. Due to an outlandish valuation, price momentum may soon be approaching a peak.

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Blistering AI Momentum Continues

Palantir’s third quarter was characterized once again by strong underlying AI momentum. Palantir beat Q3 revenue expectations by more than $21 million, reporting revenue of $725.5 million in the quarter. The FY24 revenue guide was boosted to just above $2.80 billion, up from $2.75 billion last quarter.

Revenue growth continued to accelerate, with Palantir reporting revenue growth of 30.0% in Q3, ahead of its guidance for 25.2% growth and up from 27.2% in Q2.

Palantir’s Q3 highlights: Strong AI momentum with $725.5 million revenue, exceeding expectations by $21 million. FY24 revenue guidance increased to over $2.80 billion. Q3 revenue growth at 30.0%, surpassing guidance and Q2’s 27.2% growth rate. – I/O Fund

Q3’s results have marked quite the turnaround in just over a year for Palantir, with revenue growth accelerating more than 17 percentage points from Q2 2023 (AIP’s release) to Q3 2024. This was also the highest revenue growth rate recorded since Q1 2022.

AIP has been the primary driving force of this revenue reacceleration, with strong adoption in the US commercial segment. AIP’s scalability, interoperability and versatility allow it to quickly be integrated by enterprises. Commercial customers can lever Palantir’s AI and machine learning tools to harness the power of the latest large language models (LLMs) within Foundry and Gotham for near-instant analytics & insights, and productivity & efficiency gains.

For a closer look at AIP and how it separates Palantir from the rest of the SaaS universe, read This Stock Is Crushing Salesforce, MongoDB And Snowflake In AI Revenue.This Stock Is Crushing Salesforce, MongoDB And Snowflake In AI Revenue.

AIP Aids US Commercial Growth

What’s interesting to note in Q3 is that government revenue growth outpaced commercial growth, at 33% YoY versus 27% YoY, a contrast to recent quarters where commercial had been the primary driver. Government’s outperformance was driven by 15% QoQ growth in US government revenue, its fastest growth rate in 15 quarters, while commercial was impacted by a 7% QoQ decline in international commercial revenue due to European headwinds and “a step down in revenue from a government sponsored enterprise in the Middle East.”

However, US commercial growth remained strong in the quarter, with a growth rate nearly in line with Q2’s. Management said that AIP drove “new customer conversions and existing customer expansions in the US,” as AI models continue to be deployed into production. Here’s what the growth in US commercial revenue looks like:

Palantir’s US commercial revenue rose 54% YoY and 13% QoQ to $179 million, slightly decelerating from 55% YoY growth in Q2. FY24 US commercial revenue is expected to exceed $687 million, indicating at least $199 million in Q4 revenue, with ~52% YoY growth. – I/O Fund

US commercial revenue increased 54% YoY and 13% QoQ to $179 million, slightly decelerating from 55% YoY growth in Q2. Palantir guided for US commercial revenue to exceed $687 million, or 50% YoY growth, for FY24, implying Q4 revenue of at least $199 million, or ~52% YoY growth, representing a 2 point deceleration should it meet that target.

US commercial customer growth remained strong, with customers rising 77% YoY to 321 in Q3. This decelerated from 83% YoY in Q2. Here’s what the US commercial customer growth looks like:

US commercial customer growth remained strong, rising 77% YoY to 321 in Q3, slightly down from 83% YoY growth in Q2. Here’s what the US commercial customer growth looks like. – I/O Fund

US commercial customer count has essentially doubled since AIP’s release, but Q3 was the second quarter to show slightly slower customer growth, indicating that Palantir may be relying on existing customers to drive revenue, whereas customer acquisition should be monitored moving forward. Most importantly, NRR has risen to a two-year high, while RPO is surging, suggesting customer spend could remain elevated for the next few quarters.

Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, as well as various stock entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.Learn more hereLearn more here.

Net Retention, RPO Strong, but Watch US Net New Adds

In Q3, net dollar retention expanded to 118%, up from 114% in Q2, 111% in Q1, and 107% a year ago. Management said that this “increase was driven both by expansions at existing customers and new customers acquired in Q3 of last year, as we see the effect of the AI revolution in both industry and government.” Net dollar retention has reached the highest level in two years, but still has room to expand, given that rates were >120% in 2021 and 2022.

In Q3, Palantir’s net dollar retention rate increased to 118%, up from 114% in Q2 and 107% a year ago. This growth was driven by expansions at existing customers and new acquisitions, reflecting the impact of the AI revolution in both industry and government. Net dollar retention reached its highest level in two years, with further growth potential, previously exceeding 120% in 2021 and 2022. – I/O Fund

Palantir has an advantage over other software peers due to its differentiated AI offerings, while adding significant new customers this year and expanding deal sizes with new customers (with FY24’s additions not appearing until FY25) — this provides a path forward for NRR to continue expanding. Initial AIP customers are beginning to appear in NRR, and a few more quarters will provide a clearer picture of how far NRR could expand and at what level it will plateau.

RPO is also sharply rising, implying that customer spend is likely to remain strong over the next few quarters. RPO growth has accelerated over the past four quarters, from 27.8% in Q4, breaking a string of declines in the rest of 2023, to 58.6% YoY by Q3. This is the highest RPO and growth rate since the I/O Fund began tracking Palantir in late 2023, and another data point underlying its AI-driven momentum.

Palantir’s RPO (Remaining Performance Obligation) is sharply rising, indicating strong customer spending over the next few quarters. RPO growth accelerated over the past four quarters, from 27.8% in Q4 to 58.6% YoY in Q3. This is the highest RPO and growth rate since the I/O Fund began tracking Palantir in late 2023, highlighting its AI-driven momentum. – I/O Fund

However, net additions in the commercial segment are slowing, both in the US and overall. In Q3, Palantir added 31 net new customers in its commercial segment, down from 40 net new customers in Q2 and 52 net new customers in Q1.

This has been predominantly driven by the US, as international commercial has yet to scale. In the US, net new commercial customers have dropped over the past two quarters, falling from 41 net new adds in Q1 to 26 net new adds in Q3. There is a clear deceleration from peak customer acquisition following AIP’s ramp, where net new adds surged from 6 in Q2 2023 to 41 by Q1, before slowing again. Palantir has acknowledged hiccups and issues in its sales cycle, saying in Q1 that they are “at the way early days of figuring out how to actually get customers to buy [AIP]” and “we're not flawlessly executing on our sales motion.” The friction is appearing within lumpy net new adds.

US commercial has been a driving factor for Palantir, as the primary segment adopting AIP and concentrating AI momentum. Palantir guided for a larger QoQ revenue deceleration for Q4 than in Q3, implying ~26.4% YoY growth, a 3.6-point deceleration from 30% YoY. Last quarter, Palantir’s guidance implied a 2-point deceleration from 27.2% YoY in Q2 to 25.2% in Q3, but a significant beat pushed growth to 30%. – I/O Fund

US commercial has been a driving factor for Palantir as the primary segment adopting AIP and where this AI momentum is concentrated. Palantir guided for a larger QoQ revenue deceleration for Q4 than it had in Q3 – guidance implies revenue growth of ~26.4% YoY, a 3.6-point deceleration from 30% YoY. Last quarter, Palantir’s guide implied only a 2-point deceleration, from 27.2% YoY in Q2 to 25.2% in Q3 – the large beat pushed growth to 30% in the quarter.

Analyst estimates do support this, with Q4 revenue estimated at $777 million, nearly 1% above Palantir’s guide as the market expects a beat once more; yet given the size of the recent beat, estimates may be lagging the underlying business momentum. The estimates correlate to 27.8% YoY growth, a 2.2 point deceleration, while Q1 is expected to decelerate further to 24% YoY before continuing to decelerate in each quarter of FY25.

Cash Flow and Margins are Bonkers

Palantir is in uncharted territory, as it is separating itself as a rare breed in SaaS to see both strong and profitable AI-driven growth. The company’s revenue growth plus GAAP operating and net margins have been in the double-digit range for four consecutive quarters. Additionally, Palantir’s Rule of 40 (revenue growth + adjusted operating margin) reached 68%, up from 46% last year.

To be consistently expanding on the Rule of 40, from the ~40% range at the end of 2022 to nearly 70%, is important as it shows that Palantir is efficiently investing in AI to drive revenue growth higher while increasing its profitability.

Cash flow margins were bonkers in Q3 — operating cash flow was nearly $420 million, or a 58% margin, while adjusted free cash flow was $435 million, a 60% margin. This was a large step up from cash flow margins in the low-20% range in the first half of 2024.

For FY24, Palantir is targeting adjusted free cash flow in excess of $1 billion, implying a margin of ~36%. Fundamentally, to have revenue growth around 30%, free cash flow margin of 30%, and adjusted operating margin nearing 40% is impressive, to say the least.

Valuation is Stretched

Palantir is at Mount Everest valuations, trading at topline multiples more than double the next three most expensive enterprise and AI-exposed SaaS stock in the market – Cloudflare, ServiceNow, and CrowdStrike. At $55, Palantir is valued at 50x TTM revenue, and 45x forward revenue – its highest ever multiples, exceeding even 2021’s peak – versus 18x to 20x forward revenue for those three peers. Even down the line, Palantir is trading at double its peers, at 146x forward earnings, versus 88x for CrowdStrike and 71x for ServiceNow.

Palantir is trading at Mount Everest valuations, with topline multiples more than double those of Cloudflare, ServiceNow, and CrowdStrike. At $55, Palantir is valued at 50x TTM revenue and 45x forward revenue, the highest ever, surpassing 2021’s peak. In comparison, its peers trade at 18x to 20x forward revenue. Palantir’s forward earnings multiple is also double, at 146x, compared to 88x for CrowdStrike and 71x for ServiceNow. – YChartsYCharts

Growth investors should not forget when we saw this happen before; which was Snowflake, a Wall Street darling trading 2X more than any other cloud stock at 45X Forward PS with retail investors cheering Warren Buffet’s participation in the IPO. It currently trades at an 11.7 forward PS.

The primary question here is not whether Palantir is a strong AI stock, but will buyers continue to step-in?

Conclusion

Palantir’s Q3 report was met with quite the enthusiasm from the market, but the fundamentals must be immaculate at this valuation. RPO growth has surged over the past four quarters, while Palantir’s Rule of 40 continues to rise as adjusted operating margins expand and revenue growth accelerates. Net retention has risen to two-year highs, reaching 118% in Q3, as deal expansion continues.

However, Q4’s revenue guidance implies a larger sequential deceleration than what was expected for Q3, while US commercial net new adds continue to decline sequentially. This may sound like splitting hairs, but the company is priced far above what any peer is trading, and that typically doesn’t resolve well for tech investors.

Given the outsized valuation, the I/O Fund is looking for a lower entry in Palantir before adding the stock to our portfolio. Join the I/O Fund’s next webinar on Thursday, November 14th where Knox Ridley, Technical Analyst, will discuss the firm’s buy zones and targets for AI leaders. Learn more here.

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Cybersecurity Stocks Seeing Early AI Gains

Posted on October 1, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Updated Sep 26, 2024, 10:29pm EDTForbesForbes on Updated Sep 26, 2024, 10:29pm EDT

Cybersecurity is becoming increasingly important in the age of AI, as the number and sophistication of threats increase. Combining cybersecurity with AI has a natural affinity as cyberattacks are computer generated, and in turn, computers are uniquely capable of finding computer-generated threats. Utilizing AI to identify threats and for pattern recognition and anomaly detection is not new by any means, but rather what is now rapidly coming to market are platforms enabled with generative AI, to enable threat detection and prevention before attacks occur.

Despite cybersecurity being one of the most promising sectors to reap the benefits from AI, popular stocks have stumbled this year. CrowdStrike had a faulty update that caused global outages with high profile airlines affected. Palo Alto also recorded its largest-ever one-day decline as it cut its outlook; the company is taking a near-term hit as it pivots toward becoming a platform, which will fare better for AI purposes rather than a collection of disparate vendor products.

AI offerings are becoming more prevalent, and the first signs of AI-related growth are arising in the leading names in the industry. Below, I look at the demand environment for leading cybersecurity stocks CrowdStrike, Zscaler, Palo Alto, and Fortinet, and which ones have key metrics hinting toward underlying strength.

AI Opening New Opportunities as Threats Rise

Nearly one year ago, the I/O Fund discussed for its free newsletter readers how cybersecurity was the next industry to be disrupted by AI, not only by improving threat detection and prevention capabilities but also because AI-based attacks were on the rise. AI is aiding enterprises to expedite threat prevention, yet hackers are similarly expediting the end-to-end attack life cycle, and could potentially execute larger and more complicated attacks faster than ever before.

According to McKinsey, 51 percent of organizations believe generative-AI is driving new risks in cybersecurity, down slightly from 53 percent in a similar survey from 2023. However, only 33 percent of organizations are actively working to mitigate AI-related cybersecurity risks, with 16 percent already witnessing a negative consequence or event.

A report from the World Economic Forum predicts that AI could push cyber incidents and data breaches to a new record high in 2024, even after a 72% YoY increase in data breaches in 2023. Palo Alto said it is seeing an “uptick in mega-breaches” with multi-billion dollar impacts, as ransomware public extortion activity has risen more than 50% from 2022. Zscaler also sees ransomware attacks continuing to rise, up 18% YoY, though victims and payloads have gotten increasingly large, with 57% more victims and 144% more payloads.

Zscaler sees ransomware attacks continuing to rise, up 18% YoY, though victims and payloads have gotten increasingly large, with 57% more victims and 144% more payloads

Source: I/O Fund

The new dynamic created by AI in the industry from both a threat and protection standpoint offers a long-term growth runway. As Palo Alto puts it, the year 2024 “will be a phenomenal year in the utilization of AI in cybersecurity,” but it “will pale by comparison to what is yet to come.”

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Palo Alto Networks: 4x Growth to $200M AI ARR

Palo Alto’s management believes AI “continues to generate significant excitement in the market,” and “adoption is proceeding at a rapid pace faster [than] any other new technology.” They see AI not only creating “transformative use cases” enabling new revenue streams and efficiencies, but also enabling cybercriminals to broaden attacks, improve targeting, and scale beyond what can currently be controlled by humans.

Palo Alto is rolling out a comprehensive AI product suite, with the launch of AI Access, AI SPM, and AI Runtime Security in May, combined with its AI-driven SecOps platform Cortex and AI integrations in its Prisma Cloud and SASE offerings. Palo Alto noted in Q4’s earnings call that its AI Access could be deployed to its 5,000+ Prisma Access customers, while nearly 1,000 customers were also interested in AI Access. This is an incredibly strong response given that early access to the solution was launched in July, only one month prior to management’s comment.

In fiscal Q4, Palo Alto disclosed that its AI ARR (AI Access, AI SPM, AI Runtime) had surpassed $200 million to close out the year, for 4x YoY growth. While growth is rapid, AI’s scale is still small, due to the recent timing of launches. However, AI already accounts for nearly 5% of Next-Gen Security (NGS) ARR, and is set to grow its share of NGS ARR as products scale.

Palo Alto is also seeing strong growth in Cortex, with ARR surpassing $900 million in fiscal 2024. Cortex XSIAM delivered north of $500 million in bookings, with customer count rising 4x YoY. Palo Alto has previously noted that XSIAM drives much higher ARR, with customers who adopt XSIAM having >5x ARR compared to those that do not. Continuing to accelerate customer adoption of XSIAM while growing Cortex’s customer base (up nearly 20% YoY to >6,100) can drive strong long-term growth for the fastest-growing product in Palo Alto’s history.

With the strengths arising in AI, Palo Alto is expecting NGS ARR growth to remain robust, though headline growth is decelerating due to the law of large numbers. NGS ARR is guided to increase 34% to 36% YoY in Q1 of fiscal 2025, reaching between $4.33 billion to $4.38 billion. On a dollar basis, that represents YoY growth of $1.13 billion, marginally higher than the $1.12 billion it added from Q1 2023 to Q1 2024, where YoY growth was reported at 53% — essentially, Palo Alto is maintaining the same growth in dollar terms despite operating at a larger scale.

Zscaler: AI Contributing 3 Points to Growth

Zscaler launched its AI Analytics solutions at the end of 2023, and is already seeing strong contributions from these new products, including its Risk360, Business Insights, Unified Vulnerability Management and more. Zscaler’s management believes that “the increasing use of AI is creating new avenues of growth,” and “the rising adoption of Gen AI is exposing new gaps in organizations' security posture.”

Management said that AI Analytics was “seeing strong traction” in Q4, and “contributed nearly 3 points to new and upsell business growth in Q4 and 2 points for the entire fiscal '24,” even with the products being available for just a portion of the year. While Zscaler did not break out AI’s contribution in dollar terms, it noted that it saw record new and upsell business in Q4 and a record $1 billion-plus in quarterly bookings (driven by the new and upsell business), suggesting that the AI Analytics was a strong driver for the quarter under the hood.

Zscaler is also prioritizing data center and AI investments to support this growth in AI Analytics. For fiscal 2025, management said that they expect “data center CapEx to be approximately 3 points higher as a percent of revenue compared to fiscal 2024,” due to investments to upgrade cloud and AI infrastructure. Property and equipment purchases have been accelerating on a quarterly basis to nearly $50 million in Q4, and totaled 7% of revenue for the entirety of FY24, so Zscaler looks to be eyeing a move closer towards the 10% range. As a result of these increased data center investments, free cash flow margin is expected to decline from 27% in FY24 to 23.5% to 24% in FY25.

Zscaler's property and equipment purchases have been accelerating on a quarterly basis to nearly $50 million in Q4, and totaled 7% of revenue for the entirety of FY24

Source: I/O Fund

Additionally, despite closing out its fiscal 2024 with a double beat in Q4, Zscaler’s guide for FY25 was light, pointing to a revenue growth deceleration of ~6 percentage points YoY. Zscaler also left clues that AI Analytics and other new products will continue to see strength in FY25, saying that sales productivity was better than expected, driven by new and upsell business. The trend is set to continue in FY25 and strengthen in the second half of the fiscal year.

Fortinet: AI-Driven Ops Account for 10% of Billings

Fortinet did not break out AI revenue or ARR like Palo Alto has, but management said that in fiscal Q2, “AI-driven SecOps accounted for 10% of total billings,” an increase of 1 point QoQ but flat YoY. Fortinet’s FortiAI solution is currently available in its FortiAnalyzer, FortiSIEM, and FortiSOAR products but will be expanded to more products in the future.

However, AI-driven SecOps’ billings have been lumpy, and are lower in Q2 than they were in Q4. Based on the 10% figure, Q2’s AI-driven SecOps billings were approximately $154 million, up just over 22% QoQ but down more than (17%) from $186 million in Q4. AI-driven SecOps also has not surpassed 10% of total billings in each of the last four quarters.

Fortinet's Q2 AI-driven SecOps billings were approximately $154 million, up just over 22% QoQ but down more than (17%) from $186 million in Q4

Source: I/O Fund

Management guided for billings to be approximately flat to up low single-digits QoQ in Q3, implying that AI-driven SecOps’ contribution will not rise significantly unless SASE or Secured Networking declines significantly, which is unlikely to be the case. As a result, Fortinet may not see its AI-driven products meaningfully contribute to billings growth or drive a newfound acceleration in the metric.

Despite this, Fortinet took steps to broaden its AI security portfolio, acquiring Lacework in Q2. Management expects Lacework’s “organically developed AI-driven cloud-native application protection platform will be combined with the power of Fortinet’s Security Fabric platform, ensuring broad protection across the network, cloud, and endpoint.” The move is expected to add $10 billion to Fortinet’s TAM, per management’s projections.

CrowdStrike Discusses AI Opportunities Without Disclosing AI Numbers

While peers Palo Alto and Zscaler put forth some early AI revenue and growth numbers, CrowdStrike has not, but management has discussed AI-related opportunities in some detail.

CrowdStrike has not broken out any AI-specific growth numbers or contribution, but arguably has a very strong product suite with its Falcon platform and its new generative AI-powered security analyst Charlotte AI. Management sees a long runway ahead for AI in cybersecurity, with a $225B 2028 AI-native security TAM, explaining that “decreasing TCO and increasing efficiencies through AI and automation are clearly voiced organizational priorities and will be for years to come.”

CrowdStrike believes Charlotte AI holds “an incredible amount of promise,” and has been training this AI security assistant to “be a malware reverse engineer, … to translate threat hunting queries, … to help automate reporting, … [and] to do some incident response use cases,” to improve efficiency and accelerate back-end processes when working in conjunction with humans. Management says that its “best-in-class module adoption” is “supercharged by Charlotte AI [and] makes the Falcon platform sticky for all users.”

Adoption rates for CrowdStrike’s modules remain strong, with adoption of 6+ and 7+ rising 1 point each sequentially to 45% and 29%. Additionally, similar to Palo Alto, CrowdStrike’s ‘hypergrowth’ products (LogScale next-gen SIEM, Cloud and Identity Security) are witnessing strong growth, with ending ARR for the group surpassing $1 billion, up 85% YoY.

Conclusion

Cyberattacks are rising in both number and sophistication. While 2024 has been a bit of a wild ride for the industry, cybersecurity is only growing in importance in the age of AI. The industry’s leading companies are progressing with AI-powered product deployments, seeing long runways ahead despite minimal signs of growth at the moment.

Palo Alto’s AI portfolio is contributing ~$200 million, or 5%, of total ARR, while Zscaler’s products are contributing just 3 points to upsell growth. Fortinet is seeing AI-driven SecOps contribute 10% of billings, though that has been relatively unchanged for four quarters. Meanwhile, CrowdStrike has yet to put a firm number on AI-related growth, though next-gen products are recording rapid growth.

Cybersecurity stocks command a premium to the broad SaaS universe with early signs of AI growth.

Source: YChartsYCharts

Due to their early exposure to AI and revenue streams, cybersecurity stocks command a premium to the broad SaaS universe. Despite its valuation crunch after its incident, CrowdStrike remains the third most-expensive software stock on a top-line basis, with Palo Alto also in the top ten. Fortinet and Zscaler both trade around the 10x forward revenue level, nearly double the median 5.5x multiple for the sector.

Our goal (always) is to perform deep dive research to identify winners, and then to subsequently identify a good entry. I will be direct and say our firm is not a buyer in this market as I believe most tech stocks will trade lower in the next 3-6 months. Yet, it’s never too early to perform research and get our ducks in a row for when the market affords solid entries. Interestingly, despite cybersecurity AI revenue numbers looking low, it’s one of the only software verticals where there is AI revenue. I think investors should pay attention to these early green shoots.

While Wall Street is worried about how much AI is costing, the I/O Fund is busy calculating how big the AI opportunity can get in the next few years and how investors can participate. Learn more about the I/O Fund’s holdings and consistent deep dive research on AI stocks, crypto and more here.here.

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Cloudflare Q2: Significant Margin Expansion, Customer Acceleration

Posted on August 2, 2024June 30, 2026 by io-fund

Cloudflare’s adjusted operating margin reported significant expansion and the company is nearing GAAP profitability. In addition, its free cash flow grew 92% YoY and there was noticeable customer acceleration in the key metrics.

Cloudflare is going through a transition in customer contracts, transitioning from annual recurring contracts to offering more platform deals that are on monthly, pay-as-you-go terms with 3+ year duration. This is causing DBNRR and RPO to look lumpy, yet the company’s beat/raise is helping to shrug off any concerns from this transition.

Ultimately, Cloudflare is well positioned for AI inference at the edge and it’s operating leverage is a near-term bonus. We look at this and more below!

Revenue and EPS:

Q2 revenue topped estimates by nearly 2%, with Cloudflare’s revenue growth rate decelerating 50 bp to 30% in the quarter. Management increased full year revenue guide. Most importantly, Cloudflare reported significant progress toward becoming GAAP profitable.

Revenue of $401 million beat estimates by $6.5 million, representing YoY growth of 30.0%.
For Q3, management guided revenue between $423 million and $424 million, slightly ahead of the analyst consensus for $423.34 million. This represents YoY growth of 26.2%, a 380 bp deceleration.
GAAP EPS of ($0.04) beat by $0.06, marking significant improvement from ($0.28) in the year ago quarter.
Adjusted EPS of $0.20 beat estimates by $0.06, for YoY growth of 100% from $0.10 adjusted EPS last year and QoQ growth of 25% from $0.16 EPS last quarter.
Management guided adjusted EPS of $0.18, ahead of estimates for $0.15.

For FY24, Cloudflare now sees revenue between $1.657 billion and $1.659 billion, for YoY growth of 27.8%. This also represented an $8 million increase from the guidance given in Q1. Management also boosted the adjusted EPS outlook to $0.70-$0.71, up from the prior view for $0.60-$0.61.

Margins:

Cloudflare showed strong improvement in operating margin and net margin, and significantly boosted its full-year operating margin outlook.

Based on management’s guidance for adjusted operating income of $50-$51 million in Q3, adjusted operating margin is expected to be 12%. For the full year, management boosted its adjusted operating income guide to $196-198 million, a nearly 22% increase from the prior view for $160-164 million. This pulls full-year adjusted operating margin up to 11.9%, a 210 bp increase from Q1’s view for a 9.8% margin and is suggesting that Cloudflare expects to witness strong operating leverage in the back half of the year.

GAAP gross margin was 77.8%, up from 75.6% last year and 30 bp QoQ expansion. Adjusted gross margin was 79.0%, up from 77.7% last year but a 50 bp QoQ contraction.
GAAP operating margin was (8.7%), a significant improvement from (-18.2%) last year and up from (-14.4%) last quarter.
Adjusted operating margin was 14.2%, a significant improvement from 6.6% last year and up from 11.2% last quarter, reaching its highest quarterly level.
GAAP net margin was (3.8%), a significant improvement from (9.4%) last quarter. Adjusted net margin was 17.3%, up from 10.9% last year, and up 190 bp QoQ.

Cash and Debt:

Cash flow continued to expand as well, certainly a plus in this environment for a cloud stock. Free cash flow expanded significantly by 92% YoY.

Operating cash flow was $74.8 million, for a margin of 19%, flat QoQ but up 6 percentage points YoY. OCF increased 16% YoY.
Free cash flow was $38.3 million, for a 10% margin, up from 9% in Q1 and 6% last year. Free cash flow increased nearly 92% YoY.
Cash and available-for-sale securities totaled $1.76 billion.
Debt (convertible senior notes) totaled $1.28 billion.

Network capex was 6% of revenue compared to 8% in the previous quarter. Management reiterated to expect network capex in the range of 10% to 12% in the second half of the year.

Key Metrics:

DBNRR was 112% in Q2, a 3 percentage point deceleration from 115% in Q1. Per the CFO’s opening remarks: “The decline in [DBNRR] was driven by slower net expansion in our larger customer cohorts, increased platform deals in the form of pool of funds contracts, which reduced friction to adoption across our product portfolio but can impact the shape of revenue recognition as well as deferred revenue and current RPO, especially for existing customers that transition into this structure and anniversarying the price increase to our Pro and business pay-as-you-go plans last year. For the next several quarters, we expect new customers to contribute a higher percentage of our overall year-over-year revenue growth. similar to the second quarter.”

There were questions about the pool of funds contracts in the Q&A, detailed below.

Billings increased 23% YoY and 9% QoQ to $421.7 million. This represents a 9% QoQ growth from $387.6 million last quarter. With that said, Billings growth has been decelerating for a few quarters and is down 9 points from 32% growth YoY in the year ago quarter.

Deferred revenue totaled $394.5 million, a 5.5% QoQ increase.

RPO of $1.421 billion represented an increase of 6% QoQ and 37% YoY. This is lower growth than last quarter, when RPO grew 8% QoQ and 40% YoY. See below discussions around Pool of Funds accounts.

Paying Customers & Workers Platform Accelerated

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. Of course, this is large growth on small numbers, but take notice that Cloudflare is one of the only best-of-breed software companies able to quantify their AI impact right now.

Paying customers totaled 210,166 in Q2, a 21% YoY increase. This represented a 400 bp acceleration from 17% YoY growth reported in each of the last three quarters. On a QoQ basis, Cloudflare added more than 13,000 customers, compared to sequential additions of less than 10,000 in each quarter in the last two years.

For customers with 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.

Earnings Call:

Pool of Funds Accounts

The CFO explained that Cloudflare is seeing a transition in their 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.

This is how the CFO explained it: “So as it relates to revenue, the revenue is now recognized as the customer consumes the service, and as a result, the record revenue recognition might be nonlinear and might ramp over time with respect to deferred revenue because those deals have monthly billing terms, we do not report upfront deferred revenue, and this can result then in lower deferred revenue growth. And then current RPO is also impacted because the contract duration is longer. So you recognize upfront less in current RPO. So while there the deals are very beneficial and healthy to the business. They generate some noise in this transition in our DNR and in the other metrics.”

There was a question about this from an analyst where the CFO pointed toward this creating lumpy, yet “significantly higher total contract values.”

Question
Fatima Boolani (Analysts)

Matthew and Thomas, this is for you both. I had a bare picture question around the pricing strategy across the portfolio. So at a tactical level, you had some meaningful price increases that you're first ones ever. Thomas wondering if you could just opine on how far deep those have pervaded the installed base. And if you can kind of talk to where we are in terms of the innings in terms of how that inferred in the base?

And then Matthew, the bigger picture question for you is, if I piece together a lot of what you shared in the prepared remarks as it relates pool of fund deals, more pay as you go, more consumption, payment modalities especially as the Workers' portfolio scales, how should we generally think about the business impact and sort of revenue elasticity, if you will.

Answer
Thomas Seifert (Executives)

There's not much to add to what Matthew just said. Some of the impacts of this transition, you have seen, we talked about how pool of funds deal impact the lumpiness or make our numbers a little bit more lumpy. We will also have an increasingly higher share of variable revenue in our numbers, while this number is still small today, and it will grow meaningful over time.

But this is less driven by price increases, as Matthew said, but it's more driven by the structural changes that this transition implies. And with all the overall benefits of more stickiness, longer-duration deals, platform fills with better expansion capability and significantly higher total contract values.

Cloudflare’s View on the Inference Market

We’ve discussed in the past how Cloudflare is uniquely positioned to capture inference at the edge. Per the opening remarks, Cloudflare signed a $500,000 contract for Workers AI for inference tasks across their edge network. The key metrics around 2.4M developers on the Workers platform and 67% QoQ growth on Workers AI are also important to pay attention to as we go along.

The CEO explained that his view on inference is that half of it will be run on devices and the other half will be run on networks like Cloudflare: “That also has the benefit of making it as performant as possible. And it also means that you can have the AI that's responding have regional differences more easily so that if you're responding in the U.K., the — an AI can spell color with a U, whereas if it's in the U.S., it can spell it with no U. I think all of those things then drive a lot of the other 50% of inference tasks to be running at a network like Cloudflare.

And so we are trying to build that network out ahead, make sure that we can answer any inference tasks that can't get determined on your own device as close as possible to that device and then make it very easy to get that inference task from us are from the device to us in a standard-based API-driven way, so that it's seamless to that end user […] But I really think that inference is going to be between the end devices themselves and a network that is like Cloudflare that spans the globe and is incredibly close and in every jurisdiction where end users might be.”

Conclusion:

The operating leverage is helping Cloudflare’s stock price today while its AI inference positioning is more of a medium-term story. We are encouraged by the initial ramp of the Workers platform and believe key AI winners are being decided today, evidenced by this early traction. Cloudflare is physically positioned at the edge to where there is no way around Cloudflare when it comes to inference (literally) as hyperscalers are positioned too far away from devices for the low latency that AI inference will require. Management being able to improve margins and cash flow help make it an easy choice to keep Cloudflare in the portfolio as we wait for the medium-term story to solidify.

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

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