S tart the clock. Thank you very much. My name is Tom Blakey, for those who don't know, I'm the infrastructure, technology, and software analyst here at KeyBanc, and I'm grateful to have the CFO here, Ron Kisling, and the head of Investor Relations, Vernon Essi. Just kicking it right off, you know, you guys had a great quarter. Stock acted very positively to such news, with accelerated growth. Just want to kind of maybe, you know, let you highlight any other features of the quarter that maybe I'm missing in addition to that accelerated growth.
Yeah. No, I think, you know, we typically, you know, Q1 to Q2 typically tends to be flat. We did see a little bit of acceleration in Q2. We had one of our larger customers consolidated their CDN providers down from, you know, 5 to 2 in the first quarter, and subsequent to that, we've seen really good traffic growth from that customer. We've continued to see really good traffic growth in the commerce space going through Q2 that drove some of that Q1 to Q2 acceleration.
Let's talk about the sustainability of that. I mean, you know, you mentioned that this is, cut-- this cut into some of the seasonality. Maybe talk about the seasonality going into the second half, obviously, obviously, fourth quarter seasonally strong. You know, we saw an uptick in, you know, large customer-- the, the percentage of revenue from large customers. I just want to kind of understand your... you know, what, is visibility increasing, you know, staying the same, decreasing?
Yeah. I think, you know, the overall market in terms of sort of sales cycle has been fairly stable, over the last, you know, six to 12 months. We haven't seen any material changes there. I think, you know, going into the second half, that certainly as we move through the year, our visibility increases, and we continue to see, you know, really good traction in the market. If you look at sort of the key dynamics, you know, one of the key dynamics is, you know, just customer acquisition. One of our goals is to accelerate customer acquisition, and we've been doing a lot of initiatives really to sort of drive that go-to-market effort.
We did a reorganization of the sales team at the beginning of the year to make that organization much more efficient by aligning the account executives, the account management, the support, and sales engineers into the same pod, so they're working together with the same customers, reducing some of the friction in that organization. I'm sure we'll talk a little bit more, but we've launched packages, which are preset recurring revenue items that are already structured to sell into the market. That also reduced friction in the sales cycle, all of which are designed to drive up the productivity, increase new customer acquisition, where we then see really good expansion within those, as demonstrated by our LTM NRR, which in the most recent quarter was 116. As we see more and more customer acquisition, there's an opportunity to grow that number.
From a macro perspective, you mentioned traffic. In addition to that, consolidating traffic on your platform increased. I think you mentioned that traffic also increased...
Yeah
if I'm mischaracterized. You know, the CDN market, there's some large players there that aren't, that aren't growing. Maybe they're losing share or... Just what do you see the CDN group market growing at, and, you know, where are your share gains there at?
Yeah. I think if you look at, and we've shared this at Investor Day, I think, you know, broadly speaking, we sort of see the CDN market, I think mostly, growing at around 8%. You know, what we've really seen over the last couple of years is really gaining market share, you know, in that market. So we've seen our growth more kind of in the mid-to-high teens in terms of the growth rate on our CDN, space. What we've seen driving that really is a combination of performance, both in terms of being able to win business by driving lower latency, very easy to manage. We have extremely efficient caching and purging.
Particularly as you sort of see the market begin to be focused on cost management, they're looking at, you know, "What are my costs to support this network?" We're very easy to manage. "What are the costs, my ingress and egress costs?" We're very efficient by our managing caching to, to lower those costs and driving higher performance. So all those metrics have really resonated in terms of us continuing to gain market share.
You talked about product and packaging. Is, is that a, is that a driver of market share gain, like in that 5 to 2 example, you talked about the downsizing or the consolidating of spend from a large CDN customer? Is this, is this helping more, more new logos or both?
I think it's helping more with new logos. It's largely to reduce some of the friction, by offering a delivery package that has, you know, all the components that you need if you want to deploy delivery, to a customer at a fixed recurring rate. It's not a bespoke contract. I think one of the things that we've seen as we've rolled this out that it's really resonated with people, is having this predictable cost structure. We offer these, a delivery package, a security package, and a compute package, and particularly in compute, which is a fairly new offering, and customers are trying to figure out where to use it and how to deploy it.
When we launched the, the package with fixed price, we saw a significant increase in the number of customers who began to start to use it and experiment with it. We found that one of the barriers was: "It's a new product. I don't know what the uptake is going to be, and so I don't know what it's going to cost." We found predictability is really resonating with customers, and it's going to, one, reduce the sales cycle, so it's going to increase the productivity of our sales team. It's also an opportunity to make it much easier to sell into the mid-market, where our bespoke consumption-based contracts, are much more challenging to sell.
It has an added benefit that as we leverage our partner network that we currently use across our security business, is that by having a delivery package, they are also able to expand our capabilities by selling delivery-
... You mentioned one of those packages is security. It's about, I think, 14% of your revenue in 2Q, 2023. let's, let's talk about like, the, like you said, the, the, the product and packaging changes in security.
Yeah
The growth therein, and then I'd like to hear more about that roadmap or services that you'd like to expand, the, you know, the basically the, the, the offering that you bring into your customers.
Yeah. If you look at our security portfolio, we really are focused around web application security, you know, the security that web application developers are using. In Q2, as you mentioned, our Signal Sciences was 14% of revenue. We have other security offerings, and while we don't break out the total security piece, you know, that's going to be in the mid to high teens as a % of revenue. Our security offerings, and we're really focused on developing, is really across our Web Application Firewall that we acquired from Signal Sciences. It's an industry-leading firewall. More customers run it in blocking mode than any other product. It now has full feature parity running on our platform as it does in the non-platform version.
On DDoS, we've had in our delivery, you know, D-DDoS protection, but we haven't productizing that with visibility to customers, reporting, visibility to what those traffic stats are, so they have visibility if they need to take other actions, and that is one of the goals for this year. Then the third leg of that stool is really bot protection, where we're developing a protection, a bot protection product to help our customers, particularly those in commerce, make sure that the products they're selling are going to legitimate customers rather than, you know, brokers who are using bots. We've launched the beta on that, and both of these are planned for this year delivery, and so our security package would include WAF, Web Application Firewall, DDoS, bot protection, and API protection.
The DDoS and bot you said is more on the horizon. What, what, what is additive to, like, say, in 2Q 2023, you said it's mid-to-high teens? What, what, what are the security services, does Fastly offer?
The security services broadly, as, as I spoke about, is, you know, the across WAF.
Yeah
... you know, DDoS, which we again offer today.
Today. Okay.
Today, yeah.
Yeah.
Then the bot protection will be coming later this year.
Okay. Maybe just switching gears to everybody's favorite topic on, on AI. I think we talked about it a little bit on the call, but just maybe summarize for us what, if at all, Gen AI is a catalyst for, for Fastly in terms of the increased usage, increased need for performance on the on, and, and the like, and what, what kind of timing would you expect that to start impacting the top-line growth of your company?
Yeah, I mean, I do think, you know, ultimately it's a driver. To me, it is another expanded driver around what the compute capabilities are. It's about, you know, engaging web experiences, moving from the level of personalization we have today to more high-fidelity personalization or experiences on the web. I think customers are beginning to experiment with AI today. I think it's probably we'll start to see revenue, I would say probably, you know, 12, 15 months. I think as you get to the end of 2024, I think we'll start to see customers deploying it, as we go through a period of experimentation, and then with growth from that.
This would drive your, the content?
I think it would drive really the compute business primarily.
I think it's another opportunity as you really look at the opportunity with our platform to drive growth and expansion. It's a cross-sell opportunity that could accelerate our cross-sell motion.
Yeah. You mentioned at your, I think it was your Analyst Day in June, this, like, symbiotic relationship with the hyperscalers. You know.
... you guys are focused on the edge, and there are other edge providers that are trying to build out their own core provide services. Can you maybe update us on your relationship, or, or give us a review of your relationship with the public clouds and hyperscalers and, you know, maybe, you know, even from a channel perspective, the way you guys are working together generating business?
I think, you know, we work very closely, I think, with, with the hyperscalers. I think if you look at the delivery, you know, there is a need for that central cloud, central compute. It's an efficient way to, to store. It doesn't make sense to store that globally, but in terms of actually deploying that to users around the world, at an edge platform, you know, is the strategy. We work very closely with them. We participate in the, the AWS Marketplace, you know, as a channel to sell. We really see, you know, as an opportunity for, you know, us being able to deliver to the edge, you know, this information efficiently.
Am I characterizing correctly that there could be a relationship where you're helping drive business their way in terms of storage or compute, and they're obviously in the need of some of the unique attributes of an edge network, vis-a-vis like regulatory, geolocation related to sovereign and regulatory? Is there, or is that currently in the business model today, like in terms of, you know, related revenues?
We certainly have-
Could it be bigger?
Yeah, yes, there certainly have been instances with customers where, you know, we bring an opportunity to them, they bring an opportunity to us. I'd say it's, it's a small piece of the business, but.
Okay
We do engage in opportunities, you know, from time to time, in terms of being able to really deliver a solution to the customer that provides, you know, a fast, engaging, and safe experience at the edge, utilizing, you know, immersive data.
Makes sense. Any... I'll just pause for a minute. Is there any questions from the audience? No, keep going. Maybe this is an opportunity to switch to the model. We, we commented, or I commented earlier that you guys are, you know, just maybe in the, in the more immediate term, increase your percentage of revenues from large customers, and there could be no relation at all, but you also guided gross margins down versus consensus and I think even relative to a, a prior guide. I mean, walk us through any, you know, kind of near-term, just temporal movements there in the gross margin and, you know, if, if, if at all, you would expect gross margin pressure overall on the delivery side as you kind of target more-
Yeah
large customers.
Yeah. I mean, I think if you look globally, you know, our gross margin accretion and the, the value proposition and efficiency of the network is intact. You know, it is not a linear progression.
Right.
You know, in the first quarter, as I talked about, we had a large customer who consolidated their CDNs. We gained a lot of traffic from that, which you saw in our Q2 revenues. A lot of that traffic was in regions where we had very small presence, and so given that small presence, a lot of our cost structure was relatively high. The good news is, is with the higher traffic, we're able to go back into those regions, negotiate much better pricing on our bandwidth because we now bring much more better volume. There's a short-term impact where we go through that process of renegotiating those contracts.
The benefit, though, is we continue to drive traffic through our network, is with this higher traffic and these lower bandwidth costs, that benefits all the traffic in those regions, not just, this new customer. While it may be a short term, you know, the, the medium to long-term growth margin trajectory is intact.
You guys along those lines, you guys are definitely best in class in terms of the percentage of, you know, revenue you spend on CapEx.
like just talking about near-term movements here on the agenda.
Yeah.
longer term, how low could that go? I mean, you know, you know, and I assume these kind of numbers in terms of percentage of spend on CapEx has embedded in your longer-term goals. I think your 2026 target-
... is about 65% gross margins.
Yes.
The current kind of mid to high fifties, currently, you know, does CapEx need to stay at that level or go lower to meet those targets? Can CapEx, given your, the software nature of your network, go lower?
Yeah, I, I think in the, in the medium term, which is where we have visibility, I think, you know, that 6%-8% range is a sustainable level. You know, that's, that's down to almost half of what it was, you know, two and a half years ago when we were 12%-14%. I think it is a sustainable number. I think, you know, beyond that, I think it's probably too early to tell whether there's, you know, future benefit beyond that. Certainly, as, you know, we expand geographically with some of these larger customers, you know, there is an element of expansion baked into that 6%-8%.
I was going to ask that as a follow-up. I mean, it's... You could Fastly's gone through, through some iteration with a new CEO in September of last year, and you talked about Product Impact Bill. You know, the, the, the turning down of some business, some small businesses and making sure, you know, the, the infrastructure spend is more optimized. From a strategic perspective, along those lines, trying to encapsulate all that, is, is Fastly in, in the mindset of, of moving, of turning away business, in the, in the concept of making sure that CapEx stays at this level?
You know, I, as I indicated, that 6%-8% does incorporate, you know.
It does.
... you know, on a geographic basis. I don't think we've been in a position where we've had to turn down business. I think the, the overall efficiency of our network, you know, it allows us to, you know, compete very, very effectively with the other competitors in the market, and still generate really good growth margins.
Yeah. One more last one.
Sorry?
It's important to.
Thank you, sir.
We get a lot of them about from investors, too, and I'm sure you do in your private, you know, conversations.
Yes, we do.
on the notion of just splitting it out by, and you don't guide this way.
Yeah
I think I've heard commentary from, from management on a couple of calls that, you know, you, you, you believe that the CDN margins could even go upwards of 60%.
... irrespective of the higher margin value added services. Is that, is that accurate, and is that encapsulated in the, in the 6%-8% CapEx as a percentage?
I think, I think that's, that's, that's accurate, and, and in the, you know, the, the midterm, you know, 2026 outlook, you know, that, that reflects our view on kind of the overall mix of traffic.
Yeah.
Yeah, I think it I'd be remiss not to say, though, if you, if you look at our investor presentation, for our Investor Day in June, we have a slide in there that talks about how we were able to drive more efficiency with a software upgrade on the same server fleet, in North America. It drove a 29% year-over-year improvement quarter-on-quarter without a $0.05 of extra hardware spend. I mean, obviously, that's a flashpoint in time, but it, it demonstrates what, what our platform is capable of.
Is that replicable? That was going to be my next question. I wasn't going to ask about the 29%. I missed that. I forgot that slide.
Right.
The, you know, this is important. This is the software-
Right
as opposed to maybe, you know, others that were built longer ago.
Yeah. What I would say, you know, the engineering team I know is specifically working on a number of, you know, additional, you know, engineering updates that would have meaningful improvements in the efficiency of the hardware when they roll it out. As, you know, as Vern shared, I mean, this is, you know, one of the, the benefits is we can roll out this patch, and it's equivalent to getting, you know, deploying 29% more hardware with simply a software patch.
Yeah.
switching off.
Getting used to it.
You talked about the channel, you know, helping from a customer acquisition perspective. Talk to me about where you are in terms of utilizing the channel today, where you expect it to be in the future, and I'm always interested in what the, what the drivers are, 'cause channels need to be incentive?
Yeah.
It's pretty, it's pretty, you know, relatively straightforward business. What would be the incentives for the channel to work with you?
Yeah. Well, I think first and foremost, I think, you know, the, the good news is we have a really, I think mature channel motion, particularly around our security products. You know, we acquired Signal Sciences, you know, they had a large channel presence. We, we maintained that. We have a sales channel organization that supports the channel today, and so this isn't a, a spin up of the infrastructure to support it. What we're able to do with a delivery package is give our channel partners, something else to sell. And a lot of times we see very high attach rate between our Web Application Firewall and our delivery, and so this gives them another, another product to sell.
Particularly as you look at just the efficiency of overall sales organization, this is an opportunity to really expand that reach, to reach into that, that mid-market, and accelerate new customer acquisitions by having not only our sales team, adding to our customer base, but a whole set of channel partners going out and selling delivery. I think there's a unique piece, which is, I think we're unique in this space in terms of utilizing the channel to sell delivery.
Right. and you are, and I'm just wondering again. Well, first of all, as an adjunct to that, where are you in that building that base to sell delivery? Again, what, what does the business model, quite frankly, look like for the channel partners?
Yeah
in terms of selling delivery?
Yeah, I, I would say where we are, you know, we launched this, you know, earlier this year. We've seen very successful deal registration in those customers, and I would anticipate we will start to see, you know, delivery sales and be able to see the success of it as we get into late this year. I, I believe it'll be a meaningful contributor to new customer acquisition in delivery in 2024.
How's the model, how does it work in terms of, you know, the channel? How do they get paid on this, and how recurring is that?
Yeah. I mean, there, there is a, you know, a margin works very similar to how it works with the, the security model today. In that, you know, they resell the security at a margin, and this works very similar to that, with the same incentives in place that they have on the security model. It's a well-worked model. They're familiar with it, so they're not having to learn something new.
Yeah. You mentioned it's unique in terms of the delivery side. Why, why do you think that hadn't been taken up by others then?
You know, it, it's a good question. I know, I know for us, you know, we were selling a, you know, largely consumption-based business with bespoke contracts, which was a barrier to being able to sell through the channel. You know, as we rolled out these packages, it makes it very easy. I think for us, it was the barrier historically was a way of selling. You know, not really sure, kind of more broadly. I think it's a perfect fit, particularly kind of in, in the space that our channel partners work. It's a great opportunity to also to just sell across the platform, because they're very, very big on security, and a lot of times these two go together.
Perfect sense. Let me just pause one more time for the audience anymore questions?
I'm just curious, how, how far out do customers, yeah, lock in many of their contracts? I'm just kind of think the visibility that you have, is it awesome? Can it massively move up and down throughout the quarter?
You know, I think.
Repeat the question, by the way.
What's that?
We should re-repeat the question.
Yeah, repeat the question was.
Yeah, go.
Go ahead.
It's just the visibility of revenue in terms of how far out do your contracts go, and-
Yeah.
Yeah.
Yeah. I think, you know, today, the biggest piece of our business is consumption-based contracts. You know, typically, they're on a 12, 12-month basis. Some of them do have commits. You know, one of the things we have talked about is that one of the challenges is the predictability of the business or the volatility being consumption-based. You know, we certainly see a lot of seasonality based on, you know, traffic patterns, and that's a factor of the seasonality. You know, over time, I think we've continued to develop closer and closer relationships and communication with our largest customers to get better visibility from a perspective.
With these packages, as we sell more of these, as security becomes a bigger piece of revenue, which is sold on a recurring revenue basis, this is gonna give us more predictability, and more visibility to our revenue than we have today.
Thank you. Just my, my final question, just be from a CFO's perspective, you know, the, the go-to-market, we've talked about something unique is the hyperscalers and this, great opportunity to build out the channel here and, maybe impacting in numbers sooner than later. What about internally? I mean, what, what is the kind of, like, plan to build out, the go-to-market infrastructure? Now that you've kind of reproductized, repackaged a lot of the portfolio, where do you think you need to make, additive investments there, or, or, or maybe none at all?
Yeah. I mean, I think there's really 2 areas. I think, you know, we're gonna continue to invest, you know, in direct quota-carrying sales reps to drive that. You know, we've just brought on a new Chief Marketing Officer, and so lead development and, you know, marketing are going to be an adjunct to that to drive more leads into the sales organization. A lot of the focus this past year has really been around trying to drive up the efficiency of our sales organization through pricing and packaging, through organization of that team, and we're working on systems as well, really to drive efficiency.
I think the other thing I would add when you start to just look at, you know, I, I pay a lot of attention to margins and cash flow, is that we've put a lot of focus on financial rigor. You know, eliminating duplicate SaaS systems, really creating a robust purchasing function so that we have been able to actually drive a much more efficient business, able to make some of these incremental investments out of those savings rather than driving incremental savings. This year, we've, we've been able to add to our quota-carrying sales reps.
We've been able to make investments in marketing, and yet we're still driving leverage in our operating expenses, growing those, you know, at a lower rate than revenue, bringing down our operating loss from, you know, 18% of revenue last year to 9% this year at the midpoint of our guidance that we just shared on the last call. It's, it's all of this working together to be able to make those investments in the areas that accelerate...