Fastly, Inc. (NYSE:FSLY) Q1 2024 Earnings Call Transcript May 1, 2024
Fastly, Inc. misses on earnings expectations. Reported EPS is $-0.32267 EPS, expectations were $-0.07. Fastly, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, good afternoon. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fastly First Quarter 2024 Earnings Conference Call. [Operator Instructions]. And I would now like to turn the conference over to Vern Essi, Investor Relations at Fastly. Please go ahead.
Vernon Essi: Thank you, and welcome, everyone to our first-quarter 2024 earnings conference call. We have Fastly 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 and referencing conference ID number 754-3239 nine 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 8-K filing today can be found in the Investor Relations portion of Fastly’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. And for further information regarding risk factors for our business, please refer to our filings with the SEC, including our most recent annual report filed on Form 10-K and quarterly report filed on Form 10-Q filed with the SEC and our first-quarter 2024 earnings release and supplement for a 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. Now, we’ll turn the call over to Todd. Todd?
Todd Nightingale: Thanks, Vern. Hi, everyone, and thanks so much for joining us today. First, I’d like to give a quick summary of our first-quarter financial results and related highlights. I’ll then discuss our revised revenue outlook and provide an update to our go-to-market initiatives and customer acquisition as it relates to our path forward to drive revenue growth. I will then hand the call over to Ron to discuss the changes in our metrics, our first-quarter financial results, and our guidance in detail. I’m pleased that we reported revenue of $133.5 million in the first quarter, representing a 14% year-over-year growth and coming in above the midpoint of our $131 million to $135 million guidance range. Our customer growth and retention efforts showed improvement in the first quarter with our LTM NRR at 114%, up slightly from Q4’s level of 113% and reversing quarterly declines in this metric since the end of 2022.
Our total customer count in the fourth quarter was 3,290, which increased by 47 customers compared to before and by 190 year over year. Enterprise customers totaled 577 in the quarter, a decrease of 1 from Q4. We brought in 18 net new enterprise customers at the $100,000 annual revenue threshold in the quarter. This was mostly offset by customers that dropped below this threshold due to seasonality. On a year-over-year basis, we grew our enterprise customer count by 37. Our gross margin continues to improve and was 58.8% in the first quarter, up 320 basis points year over year and ahead of our expectations. Our operating loss was $9.7 million in the first quarter compared to an operating loss of $14.1 million in the first quarter of 2023. I’m very pleased with this result as our loss was materially better than our guidance of $14 million to $10 million.
The upside was roughly split between higher gross margins and better OpEx cost control, and Ron will share more details with you in a moment. Lastly, we posted positive $3.7 million in adjusted EBITDA and importantly, an $11.1 million positive cash flow from operations. I’m pleased with the continued momentum on operational execution here, especially as it helps us fuel growth moving forward. Now let me discuss the highlights of the quarter. In the first quarter, we continued our success in diversifying our logo wins and penetrating new and existing customer verticals. We had amazing wins in the health care sector during the first quarter with a leading health solutions company, a major government research agency, and a leading imaging provider.
These key lighthouse accounts will help us accelerate more customer acquisition in healthcare, drive growth in an important sector, and deliver better vertical differentiation to our business. The healthcare industry has always been focused on reliability and performance, making Fastly a perfect fit. We continued to penetrate the mobile app market in high tech. In the first quarter, we won Bending Spoons, a leading mobile app developer, serving over 0.5 billion people across the globe. In France, we are now supporting MWM, a top app publisher, which selected Fastly’s content delivery and image optimization services to support its AI-driven model. In the business services vertical, we’re proud to announce that a leading customer data platform will be onboarding with Fastly.
We also won one of the world’s largest realtor companies with over 100,000 agents in over 100 countries. It’s a great example of how we landed in the real estate vertical with MoxiWorks, which we discussed last quarter, and we’re able to build upon that vertical expertise with this new real estate win. In the first quarter, we introduced Fastly Xcelerate, a series of in-person global events, developed exclusively for Fastly’s customer network of developers, security professionals, and business leaders. The first event was held at our headquarters in San Francisco on April 4, and was widely attended. We will be following up with similar events worldwide in 2024 with London, New York, and Sydney to follow. Lastly, I’m pleased to announce that Fastly’s OHTTP Private Relay won the 2024 DEVIES award for best innovation in services: application development.
Our solution is widely used in the top web browsers on the Internet to help extend privacy to millions of users and beginning to find other use cases in privacy and security. In the first quarter, we continued to drive focus and investment into platform unification and expansion. We enabled self-service adoption with a universal log-in feature across our solutions and improved product trials and upgrades platform-wide. Expanding our platform is key to our platform strategy, and that’s why I’m so excited for Bot Management becoming generally available in Q1. Our Bot Management Solution combats automated bot attacks at the edge and significantly reduces the risk of fraud, distributed DoS attacks, account takeovers, and other online abuse. This is an important cybersecurity milestone for the company, significantly expanding our security offering.
Our DDoS services, best-in-class WAF, and Bot Management Solution makeup incredibly tight, complete security offering in the web application and API security space. We’ve already seen significant uptick here, and it is great to see both customer expansion and acquisition, leveraging this new capability so quickly. Security is a great example of innovation velocity at Fastly. Our WAF continues to be highly differentiated with low false positives and a predominance of customers operating in full blocking mode. Our Bot Management Solution was 100% developed in-house and is already competing well against the most mature products on the market. And there is significant innovation and product enhancements to come. We set up a very strong foundation in 2023 with our newly introduced packaging motion that gained momentum throughout the year.
In the first quarter of 2024, we updated WAF packages by launching observability skews, fixed price add-ons, and enhancements to our packages, especially in security, to continue delivering simplicity, value and, choice for our customers. I’m excited to share with you that in the first quarter, we already exceeded all the customer packaging purchases sold in the first half of 2023. Our packaging motion gives customers reliable billing and shows their confidence in Fastly by signing up for longer-term commitments. Package billing provides predictable pricing for our customers and predictable reliable revenue for Fastly. Additionally, our channel program continues to grow and mature. In the first quarter, deal registrations and revenue contribution more than doubled year over year.
In fact, for the first time, the largest deal in a quarter closed through a channel relationship. Our channel partners continue to have strategic importance in our go-to-market efforts. Our CEO search has been a key focus this quarter. I’m happy with the progress we’ve made as we’re now in the final stages. We’ve interviewed numerous candidates to find the right expertise and a balance of operational expertise and the strategic ability to grow and scale. I’m pleased that we’ve narrowed our candidate down to just a handful, and we should have a selection finalized within a few weeks. I expect to announce a new Chief Revenue Officer in the second quarter. Now let me turn to address our outlook going forward. Our second-quarter guidance of 6% to 9% year-over-year growth and modified 2024 annual rent of 12% year-over-year growth are not where we expected our business to perform, and of course, are disappointing.
Ron will discuss the financial details for this forecast in a moment, but let me first address this outlook and our path forward. There are a few factors that contributed to a challenging short-term environment. The biggest factor is a reduction of revenue from a small number of our largest customers. The first-quarter revenue from our top 10 customers dropped from 40% to 38%. Many of the top 10 accounts run a multi-vendor strategy. And we did see significant volatility here. And there are a few reasons for that. Firstly, historically, Fastly has gradually won greater traffic share in our largest accounts. But with the timing of rate and volume changes, we saw increased volatility this quarter. To be clear, we have not been removed from any of our largest customers and we remain in a strong strategic position, each of them long term.
Secondly, in some accounts, we did see an addition of CDN vendors or reversal of the vendor consolidation we saw last year. And thirdly, we are seeing a slight uptick from the typical level of rerates with our largest customers, but we have not yet seen the commensurate traffic expansion usually associated with this motion. Very positively, we are seeing continued success with new customer acquisition motions, and notably, added two very large new logos in Q1, one of which will move into the top 10 over the course of the year. We aim to see the long-term results of our new customer acquisition motion having an increasing effect on our revenue as the year goes on. Going forward, we strongly believe our strategy is correct and we will remain committed to our focus on growth.
We will continue to invest in our customer acquisition and go-to-market motions. We are shifting the way we engage with our largest multi-vendor customers to focus on improving our visibility and driving traffic and revenue share in those accounts. We remain committed to platform unification and expansion, helping us drive cross-sell and growth. We will continue to drive engineering investment in this effort, coupled with the expansion of our security portfolio with Bot Management to drive stickiness and wallet share with our customers. As a backdrop to these investments, we will continue to drive disciplined in managing our spend with a clear focus efforts leading to long-term growth. In summary, we are pleased with our first-quarter performance, but we are not satisfied with our Q2 outlook and 2024 guidance.
We’re laser focused on revenue growth initiatives, innovation velocity, and customer acquisition. And now to discuss the financial details of the quarter and guidance. I will turn the call over to Ron. Ron?
Ronald Kisling: Thank you, Todd, and thanks, everyone, for joining us today. I’ll first discuss changes to our metrics disclosures before turning to our financial results and business metrics. I will then review our forward guidance. Note that unless otherwise stated, all financial results in my discussion are non-GAAP based. We continue to focus on sharing the business metrics to provide the most useful information to understand and monitor the progress of our business. Beginning with this first-quarter 2024 release, we have discontinued the disclosure of quarterly NRR, , the number of markets and countries, and our bandwidth statistics. Conversely, we are now disclosing our revenue by product line between network services, which is our core delivery products offering; security, which is our growth offering; and other, our emerging products offering, which includes compute and observability product.
We have provided a trended eight-quarter history of this revenue in our investor supplement because we are now providing revenue from our full security portfolio. We will no longer be reporting Signal Sciences revenue on a stand-alone basis. Signal Sciences acquired firewall solution has been integrated with Fastly’s legacy firewall, which we now refer to as our next-gen WAF. Our legacy firewall revenue has largely transitioned into the Signal Sciences WAF or next-gen WAF. Note that our combined security revenue reflects the impact of the decline in our legacy WAF revenue taking place during that integration. Lastly, as our supplement only includes the trailing eight quarters, I will provide the revenue breakout for the first quarter of 2022 here in my prepared comments.
Network services revenue was $83.9 million. Security revenue was $18.2 million. And other revenue totaled $0.3 million. Turning to our financial results, revenue for the first quarter increased 14% year over year to $133.5 million, coming in slightly ahead of the midpoint of our guidance range of $131 million to $135 million. Specifically on our two largest product line, network services grew 12% year over year to $106 million and security revenue grew 16% year over year to $24.6 million. In the first quarter, we experienced normal seasonal traffic pattern. This resulted in a sequential decline in revenue, highlighted by expansion in some areas, particularly gaming, offset to a lesser degree, a e-commerce related traffic, and lower traffic at our largest customers.
Our top-10 customers comprise 38% of our total revenues in the first quarter of 2024 compared to 40% in Q4 2023, reflecting the impact of lower traffic and our largest customers. Also no customer accounted for over 10% of revenue in the first quarter. Our trailing 12 months net retention rate was 114%, up from 113% in the prior quarter and down from 116% in the year-ago quarter. These figures continue to demonstrate our very low churn and healthy customer retention dynamics. At the end of the first quarter, our RPO was $227 million, down 4% from $236 million in the fourth quarter of ’23 and down 6% from $242 million in the first quarter of 2023. This decline is primarily due to our largest customers, working through their remaining obligations over their contract term.
As Todd shared earlier, we had 3,290 customers at the end of Q1, of which 577 were classified as enterprise, a net decrease of 1 compared to an increase of 31 in the fourth quarter. Enterprise customers accounted for 91% of total revenue on an annualized basis in Q1 compared to 92% in Q4. And enterprise customer average spend was $846,000, down 4% from $880,000 in the previous quarter and up 6% from $795,000 in Q1 of last year. I will now turn to the rest of our financial results for the first quarter. Our gross margin was 58.8% compared to 59.2% in the fourth quarter of 2023. Recall that fourth-quarter gross margins were 58.3% after adjusting for the onetime $2.8 million take-or-pay true-up payment, reflecting a 50 basis point quarter-over-quarter improvement.
Our gross margin improvement was a result of continued cost control efforts in bandwidth transit costs and related services costs. Operating expenses were $88.2 million in the first quarter, an 11% increase compared to Q1 2023 and up 5% sequentially from the fourth quarter. While our operating expenses were better than expected due to our continued management of costs, remember that we do see a seasonal increase in our employee costs in the first half of the calendar year, the increased employer payroll taxes. This favorability in our operating expenses combined with slightly better-than-expected gross profit resulted in an operating loss of $9.7 million in the first quarter, exceeding the high end of our operating loss guidance range of $14 million to $10 million.
In the first quarter, we reported a net loss of $6.5 million or $0.05 loss per basic and diluted share compared to a loss of $10.8 million or $0.09 loss per basic and diluted share in Q1 2023. Our adjusted EBITDA was positive in the first quarter coming in at $3.7 million compared to negative $1.9 million in Q1 2023. Turning to the balance sheet, we ended the quarter with approximately $331 million in cash, cash equivalents, marketable securities, and investments, including those classified as long term, up from $329 million at the end of Q4 2023. Our free cash flow for the first quarter was negative $2.2 million, a $19.7 million sequential increase from negative $21.9 million in the fourth quarter. This increase was primarily driven by an increase in our cash from operations to positive $11.1 million compared to negative $7.4 million in the fourth quarter.
Our cash capital expenditures were approximately 9% of revenue in the first quarter, coming in just above the high end of our guidance of 6% to 8% of revenue we shared on our Q4 call. As a reminder, our cash capital expenditures include capitalized internal-use software. For 2024, we anticipate our cash CapEx will be in the 6% to 8% range with deployments to be weighted toward the first half of the year. I will now discuss our outlook for the second quarter and full year 2024. I’d like to remind everyone again that 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.
As Todd shared in his remarks, we are facing a challenging environment of revenue declines in our largest customers, overshadowing the impact of new customer acquisition and product pipeline. Our guidance reflects these dynamics in our business and the visibility that we have today. We expect a flattish to modest sequential decline in Q2 revenues compared to our Q1 results due to lower traffic, specifically at our largest customers. We also will not benefit in 2024 from the favorable impact of the CDN consolidation that occurred in early 2023 that drove favorable sequential growth in the prior year same period. For the second quarter, we expect revenue in the range of $130 million to $134 million, representing 6% to 9% annual growth. We continue to be very disciplined in our network investment and cost of revenues, which contributed to our first quarter gross margin being approximately 60 basis points better than we had initially expected.
We typically see a seasonal decline in gross margins in the first half with improvement in the second half as we build capacity for peak traffic. For the second quarter, we anticipate our gross margins will decrease approximately 130 basis points relative to the first quarter, plus or minus 50 basis points. As we mentioned previously, our Q1 operating loss was moderately better than our earlier expectations on continued cost management and slightly slower hiring. Our second-quarter operating results will reflect the impact of the seasonal decrease in gross margin and the impact to our operating expenses of higher first-half employer payroll expense. As a result, for the second quarter, we expect our non-GAAP operating loss to increase to $16 million to $12 million and our non-GAAP loss to be $0.10 to $0.06 per share.
For calendar year 2024, we expect revenue in the range of $555 million to $565 million, reflecting annual growth of 11% at the midpoint. We expect to continue to see gross margin improvement in 2024 and to continue our spending discipline while increasing our investment in go-to-market and product development. We anticipate our 2024 gross margins will improve by approximately 200 basis points plus or minus 100 basis points relative to 2023. As a result, we expect our non-GAAP operating loss to increase to a range of $28 million to $22 million, reflecting an operating margin of negative 4.5% at the midpoint, an improvement of over 35% over 2023’s operating loss margin of 7.2% and by over 70% over 2022’s operating loss of 17.7%. We expect our non-GAAP loss per share to improve to $0.12 to $0.06, reflecting the improvement in our operating loss expectations, and we expect our free cash flow to be close to breakeven in 2024 compared to negative $59 million in 2023.
Before we open the line for questions, we would like to thank you for your interest and your support in Fastly. Operator?
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