This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk06: Good afternoon. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fastly first quarter 2023 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star one again.
spk07: Thank you.
spk06: I would now like to turn the conference over to Vern Essie, Investor Relations at Fastly. Please go ahead.
spk05: Thank you, and welcome everyone to our first quarter 2023 earnings conference call. We have Fastly's CEO, Todd Nightingale, and CFO, Ron Kisling, with us today. The webcast of this call can be accessed through our website, Fastly.com, and will be archived for one year. Also, a replay will be available by dialing 800-770-2030. referencing conference ID number 754-3239 shortly after the conclusion of today's call. A copy of today's earnings press release, related financial tables, and investor supplement, all of which are furnished in our AK filing today, can be found in the investor relations portion of FASA's website. During this call, we will make forward-looking statements, including statements related to the expected performance of our business, future financial results, product sales, strategy, long-term growth, and overall future prospects. These statements are subject to known and unknown risks, uncertainties, and assumptions that could cause actual results to differ materially from those projected or implied during the call. For further information regarding risk factors for our business, please refer to our most recent Form 10-K and Form 10-Q filed with the SEC in our first quarter 2023 earnings release and supplement for discussion of the factors that could cause our results to differ. Please refer in particular to the sections entitled Risk Factors. We encourage you to read these documents. Also, note that the forward-looking statements on this call are based on information available to us as of today's date. We undertake no obligation to update any forward-looking statements except as required by law. Also during this call, we will discuss certain non-GAAP financial measures. Unless otherwise noted, all numbers we discuss today, other than revenue, will be on an adjusted non-GAAP basis. Reconciliations to the most directly comparable GAAP financial measures are provided in the earnings release and supplement on our investor relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Before we begin our prepared comments, please note that we will be attending two conferences in the second quarter, the William Blair 43rd Annual Growth Conference in Chicago on June 6th and the B of A Global Technology Conference in San Francisco on June 8th. Also, we will be hosting our Investor Day on June 22nd at the New York Stock Exchange.
spk02: With that, I'll turn the call over to Todd. Todd?
spk11: Thanks, Vern. Hi, everyone, and thank you so much for joining us today. First, I'd like to give a quick summary of our financial results and first quarter highlights. Then I will provide a brief update on our product strategy and go-to-market motion before I hand the call over to Ron to discuss the first quarter financial results and guidance in detail. We reported record first quarter revenue with $117.6 million. which grew 15% year over year and declined 1% quarter over quarter. I'm pleased that we exceeded our guidance range and were able to maintain healthy revenue in a typically weaker quarter due to seasonality. I'd like to congratulate the Fastly team on closing out a solid Q1. However, as I said last quarter, I still believe there remains an opportunity for us to outperform this level in 2023 and beyond. Our customer retention and growth engine remains strong. Our LTM NRR was 116% in the first quarter, down from 119% in Q4. However, it gained ground compared to 115% in the year-ago quarter. Our debner was 121% in the first quarter, down from 123% in Q4, but expanded compared to 118% in Q1 of last year. Both of these metrics have shown seasonal headwinds in prior years. And despite the declines, they continue to indicate healthy expansion efforts within our existing customers. In an effort to provide more visibility into our current performance, we've changed some of our metrics definitions. Our new total customer count methodology calculates the number of customers based on quarter-end revenue instead of month-end revenue. Our new enterprise customer count is now based on customers spending $25,000 in revenue during the quarter instead of revenue in excess of $100,000 over the trailing 12 months. Accordingly, our average enterprise spend is based on this newer annualized approach. Ron will have more detail on all these changes, and we will provide legacy metrics for the next 12 months. Our average enterprise customer spend was $795,000, representing a 3% quarter-over-quarter decline, but was up 5% from $758,000 compared to Q1 of last year. We've seen continued success in expanding our wallet share with customers as we've aligned our teams to be more focused on customer success, on customer voice and journey as they grow into our complete product portfolio. Similar to last quarter, we saw continued strong momentum in our next-gen WAF portfolio. We've seen both upsell success and new logo wins and standalone sale. Of course, we anticipate over time having the opportunity to sell these new customers our network service delivery, as well as computed edge and observability modules. I'm excited to share some important new strategic wins and key expansion verticals for us. We saw our first win at Frontier Airlines, continuing our momentum in travel and leisure. The first quarter marked five new logo wins in healthcare and life sciences, highlighted by our first win at CareRes, a staffing platform for healthcare professionals. and also HealthSherpa, a solution that helps individuals connect with the appropriate healthcare coverage. We're also seeing momentum in the privacy and cybersecurity vertical with four new logo wins, most notably with Google for their private browsing solution. Our total customer count in the first quarter was 3,100, which increased by 38 customers compared to Q4 and 135 year-over-year. Enterprise customers totaled 540 in the quarter, an increase of seven compared to Q4 and 52 year-over-year. Our gross margin was 55.6% for the first quarter, representing 140 basis point decline quarter over quarter, but a 300 basis point increase year over year. I'm pleased with this result as a large amount of our fixed costs have to be sized for our peak traffic, but we continue to work rigorously on our cost of revenue and are finding savings with increased peering, network optimization, and other initiatives that will continue through 2023. Also, let me take a quick moment to talk about our spending pattern. As you can see from our Q1 operating margin, the operating expenses were lower than anticipated by about $2 million. I was happy to see the effects of rigorous cost control keeping our teams on budget. Of the $2 million underspend, roughly half was due to cost controls and cost management. The other half was due to the timing of certain expenses, and we anticipate that those will push into the second quarter. In Q2, we do expect to have some other OPEX headwinds. merit increases, and some seasonal marketing event expenses. But we also expect to see a one-time credit to OPEX from a sales tax refund, a product of the financial rigor and diligence our teams have been adding to our processes in the past few months. Regardless, the first half of 2023 is coming in as expected, as Ron will discuss in detail later on the call. As you will see in the detailed guide, even excluding our one-time tax benefits, Our OPEX is growing far slower than the top line as we reconfigure our business for sustainable long-term growth, and we plan to continue that trend into the second half. Now on to our business highlights. During the quarter, our durable innovation engine shifted into gear as we expanded our product roadmap and feature set. There were several new technology releases you can see in our supplement, such as In the first quarter, we introduced Config Store, giving developers the ability to create even more responsive, more personalized experiences. I'm excited about how this will help us accelerate our computer-to-edge business. We launched the beta of Fastly's Oblivious HTTP Relay. This is a component of the Oblivious HTTP architecture that allows receipt of critical request data from end users without any of the identifying metadata, ensuring user privacy. In the first quarter, we launched a managed security service to protect our enterprise customers from rising web application attacks, this 24-7 service gives our customers direct access to the security monitoring our teams are already performing to secure our existing infrastructure. We're also anticipating our new simplified packaging launch later this quarter, but in early availability, there have already been three customer wins. Moving on to our go-to-market developments, I'm excited to share with you a few milestone announcements that occurred during the first quarter. We introduced a new partner program to deliver greater value for customers and partners in our Fastly global partner network and give those partners access to Fastly's entire portfolio. This program features a new tiered model with simplified pricing and discounting, which we expect will help not only streamline our customers onboarding, but also greatly simplify our quoting and discounting process. The new program received CRN's five-star rating. I'm super excited about that. Our first quarter is also exciting and fascinating since we live streamed the Super Bowl and it gave us an opportunity to showcase some of our most powerful differentiated capabilities. During the event, our streaming bandwidth reached a record 81.9 terabits per second, supported by our automated traffic routing systems, autopilot and precision path. The event was done with less human involvement and utilizing our infrastructure far more efficiently than in prior years and in prior events. Marquee live events have always been a strength at Fastly, backed by our live event monitoring service, which offers real-time observability and telemetry capabilities. And we've been engaging with other major sporting event opportunities in the international markets, thanks to the success of the Super Bowl. As I mentioned earlier, Google selected Fastly's oblivious HTTP relay for its privacy sandbox initiative, Fledge. This solution was designed to enhance online privacy for billions of Chrome users by protecting user privacy with respect to third-party online tracking. To date, we are the only partner in this effort, and we will continue to innovate in the browser security and privacy space. We've put in place structural changes to our processes and realigned our departmental teams into functional groups. This has yielded success across our strategic initiatives, as I just discussed, but most importantly to this audience, it has yielded success in our financial results. So far, I'm pleased with the progress we're making in 2023. I'm glad to see that our projections have been holding and the diligence of our planning is yielding accurate projections. We expect to hold our annual guidance both above and below the line and hope to find ways to outperform that guidance through strong innovation velocity, strategically lowering the friction of our go-to-market efforts, and streamlining our employee experience. Last quarter, I gave you an update on my first six months at Fastly. The excitement I shared for this team and its potential then has only increased. I believe there is an enormous opportunity to simplify our offering, to make it easier to deploy amazing web technology around the world, to reach a larger segment of the mid-market, to acquire customers at a faster rate with a motivated, empowered channel, and to bring the best talent from across the cloud community to Fastly. Our customers have a real passion for Fastly Solutions, and our employees have a real enthusiasm for Fastly's mission to make the internet a better place where all experiences are fast, safe, and engaging. Let me close by saying how excited I am about the road ahead. Of course, there is plenty of work to do, but I believe digital experiences will drive the mission and define the success of almost every organization everywhere, and Fastly will have a significant impact on the way those digital experiences are built and delivered around the world. I look forward to sharing more with you regarding our progress, our focus on fueling growth, our customer acquisition, and our velocity of innovation in the coming quarters and at our investor conference in June. And now to discuss the financial details of the quarter and guidance, I'll turn the call over to Ron. Ron?
spk04: Thank you, Todd. And thanks, everyone, for joining us today. I will discuss our business metrics and financial results, and then review our forward guidance. Note, unless otherwise stated, all financial results in my discussions are non-GAAP based. Total revenue for the first quarter increased 15% year over year to $117.6 million, exceeding the top end of our guidance of $114 to $117 million. In the first quarter, revenue from Signal Sciences products was 13% of revenue, a 24% year-over-year increase, or a 20% increase, excluding the impact of purchase price adjustments related to deferred revenue. Be aware that we calculate growth rates off the actual figures, and the percentage of revenue is rounded to the nearest whole percent. We continue to see healthy traffic expansion from our enterprise customers, and as we've shared in the past, given our relatively smaller market share, we continue to benefit from share gains in what is typically a seasonally weak quarter relative to the fourth quarter. This coupled with the launch of our partner program, simplified packaging offerings, and investments in our go-to-market efforts give us confidence in our 2023 revenue guidance. Our trailing 12-month net retention rate was 116%, down slightly from 119% in the prior quarter, but up from 115% in the year-ago quarter. We continue to experience very low churn of less than 1%, and our customer retention dynamics remain strong. As Todd stated, we had 3,100 customers at the end of Q1, of which 540 were classified as enterprise. Let me now take a moment to discuss the changes we are implementing in our customer count metrics to provide more real-time visibility to the investment community. As Todd previously indicated, going forward, we will count as an enterprise customer any customer with $25,000 or more in revenue during the quarter, which equates to $100,000 or more in annual revenue. Previously, we reported our enterprise customer account based on LTM revenue, using trailing 12 months revenue of $100,000 or more to identify enterprise customers. Because our new approach provides information with respect to enterprise customer accounts for the most recent quarter, we expect to see more seasonality in new customer enterprise additions than we saw in our LTM enterprise customer count. Additionally, we have simplified our methodology for total customer count and now count customers with revenue in the quarter as active customers. Previously, we counted customers with revenue in the last month of the quarter to be an active customer. This simplifies our calculation by eliminating credits or other adjustments made in a single month on an otherwise active customer. To provide transparency, we will continue to report both the new and prior methodology for both metrics on a trended basis in our periodic reports filed with the SEC and our investor supplement for all of our fiscal year 2023 reporting and intend to discontinue the use of the prior methodologies for 2024. Enterprise customers using our new methodology accounted for 91% of total revenue on an annualized basis, down from 92% in Q4. Our enterprise customer average spend was 795,000, down 3% from 822,000 in the previous quarter, and up 5% from 758,000 compared to Q1 of last year. Our top 10 customers comprised 35% of our total revenues in the first quarter of 2023, a slight decrease from the 37% contribution in Q4 2022. I will now turn to the rest of our financial results for the first quarter. Our gross margin was 55.6% for the first quarter compared to 57% in the fourth quarter of 2022, excluding the one-time adjustment in the fourth quarter. This sequential decline in gross margin reflects our prior expectations that it would decline 100 to 200 basis points due to seasonality from holiday shopping patterns and live sports streaming viewership. As Todd mentioned, a large amount of our fixed costs have to be sized for our peak traffic which results in improving gross margin as traffic ramps. I will expand on this in a moment. Operating expenses were $79.5 million in the first quarter, up 11% compared to Q1 2022, and down 1% sequentially from the fourth quarter. We saw approximately $2 million in favorability in operating expenses relative to our expectations. About half of this was due to expense control measures, with the remainder the result of certain marketing expenses that will slip into the second quarter. This favorability, combined with revenue above the high end of our guidance and gross margins in line with expectations, resulted in an operating loss of $14.1 million, exceeding the high end of our operating loss guidance range of $18 to $16 million. Our net loss in the first quarter was $10.8 million, or a 9 cent loss per basic and diluted share, compared to a net loss of $18 million for a 15-cent loss per basic and diluted share in Q1 2022. Our adjusted EBITDA for the first quarter was negative $1.9 million compared to negative $7.8 million in Q1 2022. Turning to the balance sheet, we ended the quarter with approximately $664 million in cash, cash equivalents, marketable securities, and investments, including those classified as long-term. Our free cash flow of negative $25 million was reduced sequentially by 15 million from the fourth quarter's negative 40 million. A majority of this $15 million improvement was due to a decrease in advance prepayments for property and equipment commitments. We do not anticipate any material advance prepayments for equipment commitments in future quarters. Our cash capital expenditures were approximately 8% of revenue in the first quarter, at the high end of our outlook of capital expenditures of 6% to 8% of revenue for 2023. We expect quarterly capital expenditures to vary due to the timing of deployment, but expect to be in line with our outlook for the full year. As a reminder, our cash capital expenditures include capitalized internal use software. I will now turn to discuss our outlook for the second quarter and full year 2023. I'd like to remind everyone again but the following statements are based on current expectations as of today and include forward-looking statements. Actual results may differ materially, and we undertake no obligation to update these forward-looking statements in the future, except as required by law. Our second quarter and full year 2023 outlook reflect our continued ability to deliver strong top-line growth via improved customer acquisition and expansion within our enterprise customers, driven in part by new and enhanced products. Our revenue guidance is based on the visibility that we have today. We expect expense growth for the year to continue to lag revenue growth and expect a meaningful improvement in our operating losses in 2023 over 2022. As we stated last quarter, we are investing in our go-to-market efforts as part of our revenue growth initiatives to continue our expansion in our existing customers and to accelerate new customer acquisition. We will continue our investments in product and R&D, and we see meaningful opportunities to drive greater efficiencies in our operations, especially across G&A, and expect to see meaningful leverage in our G&A costs in 2023, and for these costs to decrease as a percentage of revenue. Historically, second quarter revenue is sequentially flat with the first quarter. In 2023, we expect to see a slightly better revenue trajectory into the second quarter. For the second quarter, we expect revenue in the range of $117 to $120 million, representing 16% annual growth and 1% sequential growth at the midpoint. As we have discussed, we are managing our network capacity for higher traffic and revenue than we expect in the second half of 2023. In the second quarter, we anticipate our gross margins to generally be in line with our first quarter gross margins plus or minus 100 basis points. For the full year, we expect to see continued gross margin accretion in the second half and to exit the year with gross margins within striking distance of 60%. We did not see any meaningful changes, positive or negative, to our pricing trajectory in the first quarter as compared to the prior quarter. We anticipate our pricing to be lower in the second quarter than its consistent trajectory over the past four quarters, but expect it to return to its normal trajectory in the back half of 2023. This is a result of winning further delivery revenue from a major customer, and we will be ramping that traffic in the second quarter into our fixed cost base size for peak traffic. However, reductions in our bandwidth costs and ongoing network optimization should offset any pricing changes and, as I previously mentioned, we expect 2023 gross margins to remain in line with our existing expectations. Historically, we have experienced a significant increase in our operating expenses from Q1 to Q2 due to the continued impact of employer payroll taxes, annual salary increases at the beginning of the second quarter, and a concentration of sales and marketing events. We then typically see substantially smaller increases in the second half of the year, as the impact of employer payroll taxes begin to diminish in the third quarter, and the concentration of sales and marketing events is less than we see in the second quarter. Additionally, as I mentioned previously, our Q1 operating results were approximately $2 million below our earlier projections, with half of this due to expense control measures we put in place around hiring and spending, and the other half due to certain marketing spend that slipped into the second quarter. We expect this trend to continue and for operating expenses to increase in Q2 relative to Q1. This increase will, however, be partially mitigated by a refund of approximately $3.4 million related to an overpayment of sales and use taxes in prior years. Excluding the impact of this refund, Q2 operating expenses are expected to increase year over year by less than 10%. This lags our revenue growth in the quarter and sets us on a course towards a 10% operating loss margin for 2023. As a result, in the second quarter, we expect a non-GAAP operating loss of $18 to $16 million and a non-GAAP loss of 11 to 9 cents per share. For calendar year 2023, we are maintaining our prior guidance and expect revenue in a range of $495 million to $505 million, representing 16% annual growth at the midpoint. We expect a non-GAAP operating loss of $53 to $47 million, reflecting an operating margin of negative 10% at the midpoint, compared to an operating margin of negative 18% in 2022. We expect a non-GAAP loss of 27 to 21 cents per share. I'd also like to call out that the recent increase in interest rates is resulting in a meaningful increase in interest income on our cash and investments, and we are currently expected to earn approximately $20 million in interest income in 2023. Before we open the line for questions, we would like to thank you for your interest and your support in Fastly. Operator?
spk06: As a reminder, to ask a question, please press star followed by the number 1 on your telephone keypad. In the interest of time, we ask that you please limit yourselves to one question and one follow-up question. Thank you. Our first question comes from Fatima Boulani from Citi. Please go ahead. Your line is open.
spk08: Hi. Good afternoon. Thank you for taking my question. Todd, I'll start with you on the Google win. That seems like a really important beachhead in a very marquee customer. And so I was hoping you can share with us some of the contours of the win. of the mechanics of why you are the sole source provider of the private relay around the browser security. And if you could just give us the, you know, Ron, maybe you can give us some complexion on, you know, what the contract looks like and, you know, some of the financial implications, both near term and medium term. And then I'll have a quick follow-up, please.
spk11: Sure. Thanks for the call. Thanks for the question. Yeah, it was a great deal. I think It was really a product of a great partnership between the FASTA team and the Google team. And it helped, I think, that the missions are so aligned, adding privacy to the browsing experience, making that web experience not just faster, but safer. It's really close to our core. I think it helps that the infrastructure that we needed was really in place. The technology had been built out, had some experience in private browsing technology with other partners, and in a lot of ways, I think, you know, Fastly made the best proposal and really was the obvious partner for this stuff. We've been incredibly focused on security over the past couple of years. In this case, I think it was a real landmark win for the team. I'm super excited to be sole sourced for the Google architecture here. And I think that's really just a product of performance, the ease with which onboarding the technology was built out, and the way the teams partnered together.
spk04: Ron? Yeah, I think on the deal side, I mean, we've done, you know, a couple of these sort of privacy, you know, browser privacy engagements that, you know, leverages our technology really well. They are, you know, high margin business. I think from a revenue opportunity, while they're, you know, nice contributions to the overall revenue, I think, you know, as you said, one, it gives us really an opportunity to sort of expand sort of within those customers into other opportunities to grow to, from what I would say is a nice contributor to revenue to, you know, potentially, you know, meaningful revenues over time with those customers.
spk16: Hello? I think I lost you there. Oh, are you there?
spk02: Yep. Any other questions?
spk08: Yes, thank you. I thought I left you there. Ron, just on some of the pricing commentary, you mentioned a very specific instance of a particular transaction that's bringing some pricing fluctuations that are going to put pressure in the interim period. I'm curious if you can comment on any larger renewals within the base that might be coming up that might be subject to maybe similar entering downward pressure, just thinking back to some of your customer concentration commentary that did come down a little bit, but just curious if this is just sort of a, you know, one off large customer with whom you've transacted for larger delivery revenues at that lower pricing, or if there's kind of any more down the pipe that we should be mindful of from just a regular standpoint. Thank you.
spk04: No, that's a good question. I think the one we mentioned, I think, was sort of a unique situation where there was a consolidation of suppliers, and so our traffic levels increased materially. And so less impacted really by sort of the, what you would say is sort of the annual renewal price discounts, but more impacted by just the volume of traffic driving an impact from this particular customer in terms of pricing per volume. I think one of the things, though, as this, as we sort of see this, and we talked a little bit about the impact on gross margins, is, you know, the efficiency we're seeing, you know, across our network, the increased peering, you know, allows us to, you know, take this additional traffic on with, you know, no adverse impact really, you know, to our gross margin expectations. I think more broadly, and I think one of the reasons we called this out as a Q2 is, you know, we've been, it's been really great to see, you know, a couple of quarters where we've really seen, you know, lower, if you want to call it re-rates or, you know, discounts on an annual basis than maybe we saw historically. I think as we go forward, there's nothing particular I would call out other than I think, you know, an element of, you know, the market is, you know, as customers are looking for efficiency. um you know i think that trajectory you know could see some you know increase over time um but you know we don't see that being a material issue and again the the one we spoke about was specifically more trying to volume than what you would characterize as an annual renewal uh and a price down i really appreciate the details thank you our next question comes from frank ralvin from raymond james please go ahead your line is open
spk15: Great, thank you. And just to kind of follow up, how are you thinking about those larger deals as far as you know, being more price discipline? What is what is that that's changing now that you're able to keep those margins there? And are there any other? Is there any capabilities or things you're doing for these customers that you think you could could leverage just some other larger streaming or web players? Thanks.
spk11: Yeah, great question, and something we've been looking at a lot lately when we analyze LTMNRR and we think about growth of the existing customers. To be honest, one thing that's really helping here is the portfolio expansion, seeing the velocity within the security portfolio, the compute portfolio, and even observability. We're seeing our customers at renewal time sometimes taking the opportunity to explore the rest of our portfolio as part of that renewal, which has been helping. And that success, I think, in some ways changes that negotiation to a degree. It also, I think, puts us in a stronger position as a strategic partner. I think there's always going to be a natural amount of movement here. You know, there's more bandwidth on the Internet every year, and that bandwidth costs a little bit less every year. We're always going to see that. But by expanding the portfolio and using these renewals as an opportunity to become a more significant part of the customer's infrastructure, we've seen lately, I think, some real success there in driving wallet share expansion and more of a strategic partner status within those customers.
spk04: The only thing I would add is I think that renewal cycle, what we typically see is that really is one of the opportunities when we see that expansion motion. So a lot of times these renewals come up, and it's not just kind of that annual pricing you see change relative to the market, but it's also tied to either increasing the product portfolio that the customer is adopting or increasing traffic levels. And so we get that expansion motion, and then I think the efficiencies that over the last year that we've really built into our network, which allow us to take advantage of that continuing dropping cost of bandwidth, the efficiency of our network and increased server efficiency, allow us to kind of absorb that additional traffic very efficiently. So these renewals, while there's maybe a pricing component, are also an opportunity for us to expand within that customer.
spk02: All right, great. Thank you very much.
spk06: Our next question comes from Jonathan Ho from William Blair. Please go ahead. Your line is open.
spk16: Hi. Good afternoon. Can you hear me okay? Yeah. Yeah. Yeah.
spk14: Perfect. Perfect. So, you know, one thing I wanted to understand a little bit better was, you know, what are you seeing out in the macro environment? And is there anything that's maybe changing either, you know, I guess the term or length of some of these sales cycles? or customers willing to commit, just given what's happening out there?
spk02: I'll start, yeah.
spk11: Yeah, we've been trying to read as much of the analyst work and trying to see how the macro effects might affect our business. We don't have a lot of exposure to like financials, financial companies or service providers, telco slash service provider. I'd like to have a little more exposure to that SMP space, but we don't today. So the macro effects that might be slowing down those parts of the market really don't affect us. As far as the deal cycles go, Sure, there's puts and takes here, but we haven't seen a significant shift. We do see some of our large strategic customers looking at vendor consolidation. They want to manage fewer vendors. That tends to be good for us as the performance leader. Being price competitive puts us in a good negotiating position around vendor consolidation. And I understand why teams are looking to do that, to simplify their operation, make their teams more efficient. But from a deal cycle point of view, maybe there's some puts and takes, but we haven't seen a prevailing trend there.
spk04: Yeah, I don't think I'd add anything. I think, you know, we're, you know, as a providing the service, we're kind of core to the company. So it's not, you know, on the list of where, you know, companies are looking to necessarily cut. They are looking to drive efficiency. You know, that has played out well for us in terms of expansion. But I haven't seen any real change. Like I said, I think there's puts and takes. on the deal cycle. Some of these dynamics of trying to drive efficiency have actually accelerated some cycles, and I'm sure some cycles are taking longer.
spk11: But anecdotally, some of our largest deals have gone incredibly quickly. Yes. Yeah.
spk14: Excellent. Excellent. And, you know, I guess I also wanted to understand a little bit better why the decision now to change your enterprise customer count and enterprise, I think it's revenue as well. I guess, what were you maybe not capturing with the prior methodology that maybe is a little bit more accurate with the current methodology? Thank you.
spk04: Yeah. Thank you. It's something we've talked about for a while. We've actually have heard some input from investors that uh you know the historical way we did it was very backwards looking and so it didn't give a real uh contemporaneous view in terms of the progress we're making in terms of adding enterprise customers uh by looking at a 12-month trailing average and so the view was and we've been starting to look at this internally really over the last you know 12 to 18 months uh in terms of you know what is our enterprise level customer acquisitions in the current quarter look like and we think this provides uh better real-time information of the progress we're making uh in customer acquisition um and uh definitely reflects better on uh how the business is doing uh as we did this we we want to make sure that you know for the next for this quarter the next three quarters we are going to share both numbers i want to be fully transparent but we think this is a much more timely metric to understand how we're doing in the business
spk11: Yeah, I'll just add that 100% the motivation was just to try to be more transparent about what's happening now and making the data more relevant. It also helps, you know, within the way we're managing our business, we're always looking for leading indicators. And so we're tracking these numbers internally with our teams much more in line with these new metrics. So I think that helps as well.
spk14: Thanks for the additional disclosure.
spk06: Our next question comes from James Fish from Piper Sandler. Please go ahead. Your line is open.
spk13: Hey, guys. Todd, you had talked there about the new packaging and pricing, a little bit of details before, but can you walk us through how that is different versus what you had before? Remind us on that and what the adoption kind of feedback has been so far, how many kind of partners you have signed up at this point with kind of the new program and how long until we could get the majority of customers on kind of the new packaging modules? Sure.
spk11: Yeah, so traditionally Fastly has been largely sold on a utility model, really like I think what I call a pure utility model. And that model for a lot of customers is kind of a la carte. You buy and pay for things a feature at a time. And for large strategic customers, that works great. They want to do that type of tuning, and they want to analyze their costs with that level of sophistication. And for them, nothing will change. Our existing models continue and will continue to run that motion. But in order to simplify our offering for the rest of the market, really looking at ways to give them a solution that, feels more comfortable in that initial buying motion, in that customer acquisition motion. And so our package is, number one, it's product line based. So it gives you all the basic functions that you would need within a product line. And those product lines are content delivery, security, observability, and edge computing. And so you buy one of those packages and you get everything you need. There's three tiers of those packages, kind of like a small, medium, and large, and customers can choose the one that works best for them. And it gives the benefit, and we've heard a lot of positive feedback on this, of predictable billing. They buy the package to their size, they get billed the same amount every month. And that takes a little bit of the risk and concern off the customer knowing what they're going to be billed, not having to guess and get surprised by a bill. We're starting to hear some feedback. We believe that will lower some of the friction, especially for new customers onboarding to the platform. So that's the reason. Those are the primary motivations on moving to an all-in-one predictable billing package model and are super excited about it. We're starting to get some good feedback. We've got a big launch coming up. this quarter on it, and we're excited to bring that out to customers. I was super excited to see that a couple of Seahills even closed early, which is great. As far as the partner program goes, really we're excited to bring the whole portfolio to our partner network. VARs, resellers, MSPs, service provider partners, have been an amazing channel for our security business in the past, and this new program brings our entire portfolio to bear through that channel, which is great. We believe that the packages will also be easier to transact through the channel because they're all inclusive, because there's fewer SKUs to buy, and because of this reliable, predictable billing piece. And so, you know, we're kind of bullish on that. The partner program also just kicked off, so we're really getting started. We're tracking, of course, we're tracking, you know, partner activations, but deal registration especially to see how the motion is working and how we're driving new customer acquisition through the partner community. I expect and I hope to see some real movement and to see this starting to affect the pipeline later this year. and to start affecting the revenue numbers in a big way, maybe by the end of the year, but definitely next.
spk02: That's helpful details.
spk13: Just to follow up there, really with the packaging, it sounds as if it's kind of, let's call it subscription-based as opposed to the utility or usage-based. Ron, does that kind of act a little bit as a near-term headwind to growth artificially this year, just given kind of that movement away And if so, is there a way to think about kind of the quantitative impact unless you really start accelerating kind of customer count?
spk04: Yeah, I mean, I don't think it really impacts kind of our current trajectory in that most of the customers who are going to be adopting this are going to be new customers and incremental business from a segment that we really haven't penetrated deeply in the past. I think our larger customers, the enterprise customers, I mean, most of those are going to continue to buy on the current model. So I don't anticipate it having an impact. The impact that it will have as it becomes a bigger piece of revenue is it's going to reduce a lot of the volatility. It's going to improve the predictability of our revenue as we build up a bigger base of these packaging and sort of recurring revenue streams.
spk16: Makes sense. Thanks, guys.
spk06: Our next question comes from Sanjit Singh from Morgan Stanley. Please go ahead. Your line is open.
spk01: Hi, it's Matt Wilson on for Sanjit. Thanks for taking our question, and congrats on a solid quarter. I wanted to circle back to the customer consolidation efforts, the commentary you made there. It's a theme we've heard more of lately across software and in our FAFSA checks. But when a customer that has a multi-CDN strategy decides to consolidate vendors, Like, what does this conversation look like in terms of how many vendors they consolidate down to, how much traffic share can fastly gain in these efforts, and can, like, the new pricing and packaging, does that kind of, like, accelerate these, like, consolidation efforts in the customer base?
spk11: Yeah, I can give you my two cents on that. It's a great question. The vendor consolidation tends to happen, is really solely for multi-CDN customers. And the packaging largely isn't designed for those folks. People who are running multi-CDN architecture would fall into that category, I think, of like large sophisticated customers who really want utility billing. And so I'm not expecting that to have an effect there. But what it looks like generally is a discussion about the metrics that matter, like what that customer's, you know, metric of success is, whether it's total latency, time to interactivity on their application or their website, whether it's the load on their origin, whether it's total cost, and total performance in a whole host of different ways get measured by our customers. Our tools are largely designed to give our customers those metrics right off the Fastly system. And then there's a discussion about trimming the vendors who either aren't delivering on the metrics that matter or are overpriced or difficult to work with, et cetera. And so for us, I think we've seen success here because we are a performance leader. We have a ton of focus on customer sat and customer success. Our services team is extremely, extremely active in working with our customer base to ensure the real kind of success that they care about, which is their user experience, their end user experience. And so it's largely, I think, been a headwind for us for those reasons.
spk01: Excellent. And one more on gross margins. As fastly exits the year within striking distance of 60%, like what are the efforts to get gross margins above that 60%? Is there still peering and network optimization work that can be done in 24? Are there kind of like other levers on the call side to help gross margins?
spk11: Yeah. You know, it's interesting. We just had this call this week, so I've been tracking this stuff pretty closely. It's amazing the efficiency work that's being done. On the network engineering side, for sure, there's peering, network engineering work that we're looking at, and there's contract negotiation, you know, As our network continues to reach new record levels of traffic, then we become a bigger buyer of bandwidth. And so we're able to negotiate better rates, which is great. There's another side to it, which is the hardware infrastructure side. And our teams have been doing really amazing work making our existing infrastructure more and more efficient. There's even a guy with a hat that reads, fully depreciated, still in use. And that is a great, I think that's a great mantra for the team. And so by making our infrastructure more efficient, both compute, but also making our cash more efficient, our storage more efficient, we're able to deploy less hardware. And in doing so, increase, obviously, how much we depreciate every month. That's helping on the gross margin side, but I'll also mention it really helps on the cash flow side in a more immediate way. And I think you'll see that. You've seen it in the last quarter or so, but you'll see it in the next four quarters. Just the amount of cash out the door to buy hardware and infrastructure is dropping precipitously because of that efficiency work.
spk06: Our next question comes from Tal Liani from Bank of America. Please go ahead. Your line is open.
spk07: Hi, guys. We have Madeline on for a call today. Good to talk to you, and thanks for taking the question. Just one quick one on packaging, and then I have a follow-up pivot on product. But on packaging, if we take a customer like for like who would be a good candidate for the new packaging, do you expect to see any uplift at all?
spk02: Yeah, a great question.
spk11: And I'll tell you, you know, our intention is that it would be about breakeven. I'm sure that for some customers, it'll be puts and takes here, too. For some customers, maybe there'll be a little more spend and for others, a little less. But the benefit that we're really trying to drive here is a better user experience, an easier onboarding experience, and to lower the friction of that onboarding motion so that we can reach new customers faster and making it easier for them to buy, making it easier for them to onboard. And the three tiers really help with that. By having kind of a starter pack, mid-level and high-end package, that starter pack gives an entry point that can give new customers a lot of confidence that they won't have surprises as they learn more about the platform. And then, of course, our customer success team can work with them over time to right-size the package to their usage. So that's the goal. That's really the benefit we're looking to drive. I don't expect it to be a headwind or a tailwind. If it was, we would adjust.
spk07: Thanks so much. And then just to pivot on the product side, any chance you could just talk to how Edge Compute has been going, as well as any security priorities for this year in terms of product development? And on top of that, too, could we potentially see some uplift on the growth side from either of these categories? Thanks so much.
spk11: Yeah, great. On the compute side, part of our incubation portfolio category. So I'll tell you, we're really focused on customer acquisition. That is our driving force. And we're tracking a lot of things in that incubation zone, like how quickly our customers are able to ramp their load onto the Fastly platform, how easy the developer experience is, uh you know what kind of you know additional features that they need so that we can bring those to the platform and drive a broader and broader uh motion and compute i expect us to stay focused on that at least through this year uh and maybe start to see some real revenue uh tailwinds from compute next year but you know Optimistically, I'd love to see something Q4 there that has significant uplift, but it has been going pretty well. And we are finding new use cases, new customers there in some really interesting ways, especially in tech. From a security point of view, it was just RSA a couple of weeks ago. We had a great experience there and a really great showing with tons of interest, tons of demand gen and lead gen from the teams at that conference. There's a ton of interest in the work that's being done around bot protection, tons of interest on the new DDoS visibility that's being introduced onto the platform. And it's interesting because, you know, we've always run a SOC motion, Security Operations Center motion, that's doing real-time monitoring of the security of our system, monitoring DDoS attacks all around the world, et cetera. And for the first time, we've opened that up as a paid service, a managed security service, and let our customers sort of enjoy the benefits of that. And we're getting a ton of interest there, which is great. It's very cost efficient for us. It's resources and a service we already run internally. And, yeah, I'm pretty bullish on that and hoping to see some significant deals in the second half.
spk07: Great. Thanks so much.
spk06: Our next question comes from Rishi Jaluria from RBC Capital Markets. Please go ahead. Your line is open.
spk10: Hi, this is Richard Polin on for Rishi Jaluria. Thanks for taking my question. Just kind of a follow-up on the security roadmap. It was nice to see the managed security service roll out in the quarter. But just as you think about different areas of the product portfolio on the security side, are there any maybe features or capabilities that you think Are kind of a key focus for you as we head into the rest of 2023 or anything that you've identified that. You know, customers really want that maybe, you know, fastly could start to roll out and then I have a follow up. Thanks. Sure.
spk11: Yeah, I, I, it's an area that we're. That's very top of mind for us, as it is for our customers. We've just seen a ton, a ton of interest here. The private browsing stuff has been super interesting and thinking about different types of anonymous proxy work that have use cases across that space has been great. But I think for the bulk of our customers, bot protection is very top of mind, especially in e-commerce. It's just incredibly top of mind. It's a really interesting area with the technology. state-of-the-art is constantly changing and the methods being used and the signals that we use to send bot information back to the origins are changing and we are investing a ton here to really understand what is going to be best in class for the next five ten years the there's some interesting early work and sort of early discussion around technology that can be used specifically in the streaming space around security too. But I will say across the board, bot protection, new types of visibility for DDoS and a real managed security service, those three areas you get just a ton of interest right now and a ton of focus and R&D going on. But on the streaming side, privacy protection, and providing different levels of controls for compliance, especially geocompliance and statistics and analysis on that stuff. I'm not sure if the compliance stuff would technically be considered security, but our customers look at it that way, and we focus on it that way too. So there's some early work and early discussions going on in that space as well.
spk02: Piracy, regional compliance.
spk10: Got it. And then as we just think about the rollout of the new pricing and packaging, And some of the more, I guess, I don't want to say developer-led, but product-led growth initiatives. How should we think about the mix of S&B versus enterprise? I know you didn't necessarily reference a number as where you're at today, but it'd be great to get a better understanding of just kind of where you're at today and where you expect the business to go long-term.
spk11: No, it's great. It's a great question. And today, our business is largely, I think, what anyone would refer to as enterprise-based, with a real enterprise sales motion, a high-touch sales motion with not just an account executive and sales team, but a customer success team as well. And that's been very successful for us. And right now, When we look at how we think about product assisted sales motion, product led sales motion, product led growth, Our first step is really focusing on the product assisted enterprise sales motion. So that's that's our first step. And we've made some amazing strides here with full automation and sort of full of free trial management for our sales teams, new types of visibility, new types of visibility for our customers and sales folks around entitlements and of that sales motion again. All of that work will apply to a pure kind of product-led growth motion in the future that will, I think, help us attract and really lower the friction for smaller customers on board. And really thinking about the true developer community, student community get more and more comfortable with our platform, especially our compute platform, earlier and earlier on in the cycle. I think it's a little bit out for us, to be really honest. We're focused on product-supported enterprise sales motion this year, and next year I think we'll be starting to look at the pure PLG motion.
spk06: Our next question comes from Will Power from Baird. Please go ahead. Your line is open.
spk03: Okay, great. Thanks for taking the question. I guess maybe, Todd, maybe sticking with the security thing for just a second. I'd love to get the latest thoughts on your next-generation WAF. Maybe just if you could help remind us what some of the key differentiators are there, what the trend lines look like. And then I guess the other element that I'm not sure we've touched on much on the product side is observability. Maybe just any kind of update on trends you're seeing on that front.
spk11: Sure. Yeah, next-gen WAFs really be – I think it's the crown jewel of our security portfolio. And in so many ways, it's the most important part of the application security stack. The next-gen WAP technology comes from the Signal Science acquisition. It's remarkable market-leading technology. And the real differentiation is accuracy. And we see it in the market every day. An enormous percentage, almost 90% of our customers, run our next-gen WAP in full blocking mode. which means they have the trust and the faith that the accuracy is going to be so solid that they won't be spuriously blocking their users and customers, but instead blocking attacks and malicious usage only. And that differentiation is just enormously important. It's the number one thing that I found myself talking to customers about at RSA this year. And really, I think it is the crown jewel of our security portfolio we're incredibly proud of it that signal science technology it's remarkable it really is on the observability front it's very early days but we've seen some really interesting and really interesting kind of early customer use cases we are deeply focused on this concept of edge observability we're not looking to compete in the in the complete kind of fso full factor really space but instead really focus on edge observability and the ability to give the signals the kind of rolled up and analyzed log content that's needed for people who are running a full stack observability solution and building the most resilient, most reliable applications and websites in the world to get this new type of sort of observability right from the edge as close to the users as possible. So they can be tracking not just reachability of their users, but the performance that those users are experiencing. We're starting to get some really early traction. You know, I'd love to get the question a quarter or two from now, and I think we'll know a little bit more. It's very early days for us.
spk03: Sounds good. That's helpful. I'll try to remember to follow up. Thanks.
spk06: Our last question will come from Jeff Van Ree from Craig Hallam. Please go ahead. Your line is open.
spk09: Hey, this is Daniel Hitchman on for Jeff. Just on the channels and the push to the channels, anything that we can quantify there in terms of the goals, either in terms of number of channel partners or percent of revenue or just what would be success in terms of the channel push?
spk11: That's a great question. We aren't disclosing our data slice by channel and not channel, but I'd be happy to uh give you some thoughts in terms of you know internal goals that i'd like to see i i believe in the fullest of time we should be seeing you know 50 or more of our total business going through the channel both uh the reseller of our service writer managed service channel as well as our cloud uh marketplace channels and i think that would show a healthy a really you know healthy vibrant partner community which largely uh will not just help us reach more customers, but also help our customers onboard this technology more easily. A big part of the goal here is that the software expertise at those systems integrators shops can be brought to bear to help integrate Fastly technology and leverage the power of Fastly faster and more effectively, lower the barrier to entry and increase the speed of adoption. And I think at 50%, we would be in a position where we'd really be seeing the expertise of those systems integrators being brought to bear enough that it would be worth their investment. And that's a big part of it for us, is making sure that our partner program is profitable enough for those trusted partners so that they want to invest and that it makes sense for them. And for me, that's what success would look like.
spk09: Thanks, and then just one more for me. Any thoughts on the trend line in terms of the customer ads in the next several quarters? You know, that's been trending in a decelerating pattern. Just looking at the pipe, you know, how are you guys thinking about customer ads over the next year or so?
spk11: Yeah, I track that very closely, so I appreciate that question. um i think we have i think we have a lot of opportunity to tune the motion here to be honest it's an area where uh we can improve uh deal registration the partner is a huge part of it and that's why we're really focused there i think our partner community has a huge opportunity to contribute um on that sort of bringing customers the platform Lowering the friction of the onboarding motion with what we talked about in terms of optimizing and lowering the friction on free trials, we believe we can bring smaller customers more efficiently to the platform to do that. And, of course, deeply focused on demand gen, like I mentioned, on the RSA event, et cetera. I think that I see the trend you see, and I believe we can turn that around. So we're going to be super focused on it in the next year.
spk16: Thanks so much. Thank you.
spk06: We have no further questions. I would like to turn the call back over to Todd Nightingale for closing remarks.
spk11: Amazing. Thanks so much. Before we close the call, I do want to take this opportunity to thank our employees, our customers, our partners, and of course, our investors. We remain as committed as ever to making the internet a better place where all experiences are fast, safe, and engaging. Moving forward, we remain focused on execution, bringing lasting growth to our business and delivering value to our shareholders. Thank you all so much for the time today. Thank you.
spk06: This concludes today's conference call. Thank you for your participation. You may now disconnect.
Disclaimer