Fastly, Inc. Q2 FY2023 Earnings Call

Hello. Good afternoon. My name is Jeremy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fastly Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I’d now like to turn the conference over to Vernon Essi, Investor Relations at Fastly. Please go ahead.

Thank you, and welcome, everyone, to our second 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 and 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 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. 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 and our second quarter 2023 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. Before we begin our prepared comments, please note that we will be attending two conferences in the third quarter, the KeyBanc Technology Leadership Forum in Vail, Colorado on August 7th and the Piper Sandler Growth Frontiers Conference in Nashville, Tennessee on September 13th. With that, I’ll turn the call over to Todd.

Thanks, Vern. Hello, everyone, and thank you for being here today. I will start with a brief overview of our financial results and highlights from the second quarter, then update you on our product strategy and market approach before passing it to Ron for a detailed discussion on our financial results and guidance. We achieved second quarter revenue of $122.8 million, marking a 20% year-over-year increase and a 4% rise compared to the previous quarter, significantly higher than last quarter's growth rate of 15%. I'm pleased to see new enterprise customers utilizing Fastly’s platform and our go-to-market teams gaining traction. We surpassed our guidance range due to unexpected strength from some larger customers, which we anticipate will continue throughout 2023. Congratulations to the Fastly team for their efforts in implementing new strategies and delivering strong performance in Q2. I am keen to maintain our momentum for the rest of the year. Our customer retention and growth remain robust, with a Last Twelve Months Net Revenue Retention (LTM NRR) of 116% in Q2, consistent with Q1 but slightly down from 117% year-over-year. Our Dollar-Based Net Expansion Rate (DBNER) was 123% for Q2, up from 121% in Q1 and 120% last year. These metrics show healthy growth in wallet share with existing clients. Our platform's growth continues to enable us to cross-sell more functionalities and traffic to our current customers, bringing our total customer count to 3,072, a drop of 28 from Q1 but an increase of 47 year-over-year. Approximately a third of the quarterly decline resulted from consolidations of smaller customers. We also witnessed positive contributions from enterprise customers, bringing the total to 551, a rise of 11 from Q1 and 52 year-over-year. The average spend per enterprise customer was $818,000, reflecting a 3% quarter-over-quarter increase and 10% growth from Q2 of last year. Continuing our wallet share expansion, we’ve better aligned our teams to prioritize customer success and growth. Our portfolio strategy has yielded strong cross-selling activities, particularly in security and our growth product line, especially with next-gen Web Application Firewall (WAF) technology, which complements our core network services. Our Edge WAF has achieved feature parity and is now simpler to enable for existing Fastly CDN customers. We’ve experienced both upsell successes and new sales in WAF. Additionally, we've seen good traction in our incubation businesses, like compute and observability, with successful sales of Compute@Edge and observability modules in Q2. I'm thrilled about notable strategic wins and key vertical expansions, such as our first win with Abercrombie & Fitch, showcasing our innovative omnichannel selling approach. We've scored several new retail logo wins, including noteworthy luxury brands and a major European home improvement chain. Our travel and leisure presence has grown with Bally's Interactive, while we've attracted interest in high-tech, securing new logos in developer tooling and cybersecurity, like Bugcrowd. Our media vertical is also growing with the addition of Bonnier News and Tango. For more details, please refer to our investor supplement. Our gross margin stood at 56.6% for the second quarter, reflecting a 100 basis-point quarter-over-quarter expansion and a 620 basis-point year-over-year increase. I'm very pleased with this outcome as our continuous focus on managing the cost of revenue and fixed costs is proving effective. Our operating expenses were $77 million in the quarter, approximately $6 million lower than expected. This decline was driven partly by strict cost control and partly by the timing of marketing expenses and greater capitalization of internal-use software. Additionally, we received a $3.4 million benefit in general and administrative costs from a tax refund, which we do not anticipate in future quarters. Ron will elaborate further, but based on our guidance, our spending in 2023 is favorable, and we aim to surpass our previous 10% operating loss target for the year. In Q2, our innovative efforts continued to advance our feature set, with several new technology releases, including support for Mutual TLS bidirectional authentication for our customers’ origins. This feature will streamline MTLS setup and management for our customers. We've also released Dynamic Backends to facilitate the creation of new backend server definitions and a new Core Cache API to enhance the Edge Compute platform. We're looking forward to future launches in our Next-Gen WAF solution, including Advanced Rate Limiting and Site Flagging IP signal, completing our migration to our native edge platform. We have also introduced Certainly, delivering domain-validated TLS certificates through our Fastly managed TLS services, enhancing website security and reliability. Expect further developments regarding website authentication in future quarters. Regarding AI, we’ve received many inquiries from investors, and I'd like to share our perspective. As previously mentioned, we plan to leverage our edge cloud for AI inference, with generative learning models primarily operating in the central cloud. We are engaging customers across various sectors contemplating AI's implications, risks, and potential advantages. In e-commerce, AI can facilitate low-latency interactions and improved recommendations. For media, we see applications in sentiment analysis and user-generated content moderation, while others may explore computer vision AI for enhanced user experiences. We feel confident in our role as a platform for developing the next generation of user experiences that are fast, secure, and engaging. Moving on to our market development, I'm excited to announce the introduction of new pricing and packages for Fastly’s portfolio, including flat-rate pricing and tiered options, simplifying the process for customers of all sizes. The feedback from our clients has been overwhelmingly positive. We're pleased to welcome Peter Alexander as our new CMO, bringing his expertise from Check Point, Harmonic, and Cisco, along with Marshal Erwin as our CISO, who comes from Mozilla and the U.S. intelligence community. Furthermore, Karen Greenstein has been promoted to General Counsel after serving as interim GC since 2019. I'm enthusiastic about the evolution of our leadership team, as I believe they will significantly contribute to our growth through innovation, streamlined employee experience, and a focus on new customer acquisitions. During the third quarter, we will host our annual user conference, Altitude, in New York on September 26, which will include a webcast invitation to the investor community as our customers share their experiences with Fastly’s platform. Financially, we repurchased $236 million in convertible debt for $196 million, achieving a 17% discount to par, leading to a $37 million net gain in Q2. Our finance team remains vigilant in monitoring capital markets for liquidity needs while optimizing our cost of capital for shareholder returns. I also want to highlight our first-ever Investor Day in late June at the New York Stock Exchange, where we appreciated the engagement from all attendees, in-person and virtual. If you haven’t, I encourage you to check our IR website for more information. Now, I'd like to mention the internal transformation at Fastly. We have implemented structural changes to our processes and realigned our departmental teams into functional groups, yielding positive outcomes for our strategic initiatives and financial results. I'm pleased with our progress in 2023, reflected in our updated annual guidance for revenue and operating loss. We aim to exceed this guidance by enhancing innovation speed, reducing friction in our go-to-market efforts, and streamlining employee experiences. Over the long term, I believe our commitment to delivering the optimal end-user experience will align with market needs in the edge cloud, presenting significant opportunities. As we simplify our offerings and facilitate the deployment of outstanding web technology globally, we will attract new customers. By targeting a larger segment of the mid-market, accelerating customer acquisition through a motivated channel, and attracting top talent from the cloud community, we aim to monetize the edge cloud effectively and deliver positive returns to our shareholders. Our customers are passionate about Fastly solutions, and our employees are enthusiastic about our mission to enhance the internet experience. In closing, I'm excited about the path ahead. We have much work to do, but I believe digital experiences will shape our mission and the success of organizations worldwide, with Fastly playing a crucial role in how these experiences are developed and delivered. Now, I'll turn the call over to Ron for financial details and guidance.

Thank you, Todd, and thanks to everyone for joining us today. I’ll discuss our business metrics and financial results and then review our forward guidance. Note that unless otherwise stated, all financial results in my discussion are non-GAAP based. Total revenue for the second quarter increased 20% year-over-year to $122.8 million, exceeding the top end of our guidance of $117 million to $120 million. Revenue from Signal Sciences products was 14% of revenue, a 32% year-over-year increase or a 27% increase, excluding the impact of purchase price adjustments related to deferred revenue. Also, note that we calculate growth rates of the actual results with the percentage of revenue rounded to the nearest total percent. As Todd shared, in the second quarter, we saw traffic expansion in major customers as well as strong upsell and cross-selling activity. This led to a better-than-typical seasonal growth pattern in the second quarter relative to the first, which is usually relatively flat sequentially. We have a number of initiatives focused on increasing demand generation, motions to simplify our pricing and packaging, partnership programs, and marketing activities that give us confidence in our 2023 revenue guidance. Our trailing 12-month net retention rate was 116%, flat with the prior quarter and slightly lower than the 117% in the year-ago quarter. We continue to experience very low churn, and our customer retention dynamics remain strong. As Todd shared, we had 3,072 customers at the end of Q2, of which 551 were classified as enterprise, an increase of 11 compared to an increase of 7 in the first quarter. Enterprise customers accounted for 92% of total revenue on an annualized basis, up from 91% in Q1. Our enterprise customer average spend was $818,000, up 3% from $795,000 in the previous quarter and up 10% from $742,000 compared to Q2 of last year. Our top 10 customers comprised 37% of our total revenues in the second quarter, an increase from the 35% contribution in Q1 2023. Let me take a moment to discuss our RPO, or remaining performance obligations. Our RPO reflects future committed revenue from current customer contracts and deferred revenue. As we augment our primarily consumption-based revenue model with predictable revenue packages, we anticipate our RPO will become more meaningful to the investor community. Also, our RPO will fluctuate on a quarter-to-quarter basis due to the timing and seasonality of customer contract renewals. So looking at the year-over-year change is a meaningful way to evaluate the changes in our RPO. For the second quarter, our RPO was $231 million, down 5% from $242 million in the first quarter of 2023 and up 33% from $173 million in the second quarter of 2022. I will now turn to the rest of our financial results for the second quarter. Our gross margin was 56.6% for the second quarter compared to 55.6% in the first quarter of 2023. As Todd discussed, we are seeing the results from our continuing efforts to manage our cost of revenue and fixed cost footprint. Operating expenses were $77.3 million in the second quarter, a 2% decline compared to Q2 2022 and down 3% sequentially from the first quarter. This reflects the favorable impact of a $3.4 million sales and use tax refund we discussed on our Q1 call, as well as approximately $6 million in favorability in operating expenses relative to our expectations. About half of this was due to expense control measures with the remainder due to the timing of marketing expenses, where we see certain programs and related costs moving to the second half from the first half and an increase in the capitalization of internal-use software. This favorability, combined with revenue above the high end of our guidance, and better-than-expected gross margins resulted in an operating loss of $7.8 million, exceeding the high end of our operating loss guidance range of $18 million to $16 million. Our net loss in the second quarter was $4.6 million or a $0.04 loss per basic and diluted share compared to a net loss of $28 million and a $0.23 loss per basic and diluted share in Q2 2022. I’m pleased to report that our adjusted EBITDA turned positive in the second quarter, coming in at $5.2 million compared to negative $16 million in Q2 2022. Turning to the balance sheet. We ended the quarter with approximately $475 million in cash, cash equivalents, marketable securities, and investments including those classified as long term. During the quarter, we repurchased $236 million in aggregate principal amount of convertible debt for $196 million which reflected a 17% discount to par value and resulted in our recording a $37 million GAAP net gain. We will continue to monitor the capital markets and are focused on improving our liquidity and cost of capital, and we’ll continue to evaluate buybacks of our convertible debt at appropriate discount levels. Our free cash flow for the second quarter was positive $7.8 million, a $33 million sequential increase from negative $25.2 million in the first quarter. This improvement was primarily driven by an improvement in working capital and expanded operating margins. Our cash capital expenditures were approximately 9% of revenue in the second quarter, above the high end of our outlook of capital expenditures of 6% to 8% of revenue for 2023. We expect quarterly cash capital expenditures to decline in the second half of 2023, and 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 third quarter and full year 2023. 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. Our third quarter and full year 2023 outlook reflects our continued ability to deliver strong top-line growth via improved customer acquisition and upsell and cross-sell expansion in our existing customers, driven in part by new and enhanced products. Our revenue guidance is based on the visibility that we have today. We continue to expect expense growth for the year to lag year-over-year 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 our 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 percent of revenue. Historically, third quarter revenue experienced a sequential growth that accelerates into the fourth quarter. For the third quarter, we expect revenue in the range of $125 million to $128 million representing 17% annual growth and 3% sequential growth at the midpoint. As we’ve discussed, we are managing our capacity for higher traffic and revenue expected in the second half of 2023. While we continue to be very disciplined in our network investment and cost of revenues, which contributed to our second quarter gross margins being approximately 100 basis points better than we initially expected, we have onboarded newer traffic patterns that have a modest adverse impact on our variable bandwidth cost. As a result, in the third quarter, we anticipate our gross margins will decline approximately 100 basis points relative to the second quarter, plus or minus 100 basis points. And we expect to see gross margin accretion in the fourth quarter of at least 150 basis points above Q2 levels. As we shared on our first quarter call, we saw some increase in price declines in the second quarter as a result of winning additional delivery traffic from a major customer. We expect our pricing trajectory to return to its normal trajectory in the second half of 2023. Normal reductions in our bandwidth cost and ongoing network optimization, combined with increasing traffic into our fixed cost base in the second half, are expected to offset any pricing changes. As we mentioned previously, our Q2 operating loss was approximately $6 million better than our earlier projections with half of this improvement due to the timing of marketing expenses and an increase in the capitalization of internal-use software. Our Q2 operating loss also reflected the expected benefit of $3.4 million from a sales and use tax refund. For the third quarter, we will continue our cost control efforts. However, we will see a reversal in both the marketing expense benefit and the nonrecurring sales and use tax benefit experienced in the second quarter. As a result, for the third quarter, we expect our non-GAAP operating loss to increase by $5 million to $7 million to a loss of $15 million to $13 million and a non-GAAP loss of $0.09 to $0.07 per share. Given these results and our working capital expectations, we also expect our free cash flow to be negative for the third quarter. For calendar year 2023, we are raising our revenue guidance for a range of $495 million to $505 million to a range of $500 million to $510 million. This increase represents 17% annual growth at the midpoint. We expect our non-GAAP operating loss to improve to a range of $49 million to $43 million, reflecting an operating margin of negative 9% at the midpoint compared to an operating margin of negative 18% in 2022. We expect our non-GAAP net loss per share to remain at $0.27 to $0.21 per basic and diluted share, reflecting the improvement in our operating loss expectations, offset by lower interest income in the second half resulting from the $196 million spent on our convertible debt repurchase in the second quarter. Before we open the line for questions, we would like to thank you for your interest and your support in Fastly.

Operator Instructions. Our first question comes from the line of James Fish.

Hey, everyone. Congratulations on the quarter. I have a couple of questions for you. First, your net retention rates have stabilized over the past twelve months, which is great to see, but you’re about to face some high numbers in the next quarter. What gives you confidence that we will see this number improve? How should we view net retention rates in the latter half of the year, especially considering you have lost some customers, although it sounds like you have gained increased traffic from one of your larger customers? Ron, could you provide clarity on the gross number of new additions this quarter? I'm trying to understand the quality of these additions, as it seems that new business did quite well.

When we examine the net retention rate, we observe some organic growth in platform usage, which has a significant seasonal impact. However, I believe our most crucial factor contributing to the confidence in our retention rate is cross-selling. We have made considerable strides in unifying our platform and simplifying the sales process. A growing portion of our largest deals are platform wins, including for new logos, which indicates multi-portfolio successes. Our cross-selling efforts are gaining substantial momentum, and that’s why we have confidence in the net retention rate.

And looking at total customers, I think, one, as you saw, our enterprise customers actually accelerated a little bit from plus 6% to plus 11%. When you look at the aggregate number of customers, when you exclude customers at the low end, we actually did see a net add. If you take customers under 1,000 ARR, you would have seen some increase in the total customer number on a quarter-on-quarter basis. So, at the medium and high end, we’re seeing good customer quality and adds.

Got it. And Todd, maybe for you, sales incentives mainly have aligned for kind of new use cases today. But at the Analyst Day, we all talked about the big security opportunity, both as a spear for new logos and for expansion in the existing base. I guess, what’s going to be the differentiation and ability to replace your competitors and a lot of these overlapping and major customer accounts? And additionally, do you feel a need to potentially change sales incentives to align more with security cross-sell rather than new logos at all?

We are mainly concentrating sales incentives on new logo growth and overall revenue growth, particularly new logo growth when it comes to special incentives. The security cross-sell is a natural extension of our sales relationship with customers, especially as we excel with our Next-Gen WAF offering. The last component is finalizing our platform unification strategy. In the past quarter, we achieved feature parity between our Edge WAF and our Next-Gen WAF solution on the Fastly platform compared to the traditional SigSci solution, which is a significant advancement for making that cross-sell easier. We anticipate having the platform unification for management in the market by the end of the year, which should complete that aspect of our strategy. I do not expect that we will need special sales incentives for the cross-sell, as my expectation is for new customer acquisition to be our primary focus.

Our next question comes from the line of Frank Louthan. Frank, Please go ahead. Frank, are you there? You might be on mute.

Sorry about that. Okay. Hey. Thanks a lot. Can you explain the current status of the channel program, when it will start, and where you see it headed? Additionally, could you provide more details on your cross-sell efforts with Signal Sciences and delivery, including your progress in rolling it out to customers and their responses?

Yes. The channel program was launched about two quarters ago, and we've seen a good uptick. There are significant increases in deal registrations, which I view as a leading indicator of a successful channel launch. Deal registrations also aid in acquiring new logos, which is a major focus for us. We've formed some really innovative partnerships. Traditional systems integrators, particularly in security, are very strong. Partners embedding Fastly technology into their platforms, like A10, have also experienced great success. Currently, we are optimistic about the channel program's progress. One interesting aspect is the channel we developed over the past year prior to the major launch, which began with the Signal Sciences business. Historically, the Signal Sciences business has been mainly North America-based, so our channel there is somewhat more mature. We are actively working to develop a comparable channel in the EU, but it's currently lagging behind, and we recognize that. We are investing to ensure we have solid channel coverage in both primary markets.

Great. And with that on the channel side, can you give us what sort of percentage of your sales came from the channel in the quarter, or where do you expect that to end up by year-end?

Yes. So, the channel launch, particularly the security side coming from Signal Sciences has been a heavily channel-led business. And that business in the aggregate was 13% in the quarter or 14% of revenue in the quarter. The big piece of that is channel led. The channel delivery, which we’ve launched two months ago is we’re starting to see some early traction. But in terms of a percentage, it’s still a fairly nominal percentage at this point. We should start to see that ramp more in the second half and more of the business outside of Signal Sciences being sold through the channel partners.

I will emphasize the channel deals and will get the approval to share more about that in the future. It was encouraging to see some of our largest deals, particularly a few of the top five deals in the quarter, being processed through the channel. This is significant because it encourages our sales team by showing that they can achieve success through the channel, which supports our ongoing momentum.

Our next question comes from the line of Sanjit Singh.

Congrats on the quarter and regaining that 20% growth threshold. I want to get a sense of, Todd, from your perspective, as you guys sort of expand into new industries and you guys called out tech, how is the composition of traffic on the network changing? And does that have any sort of impact or mix effect on your the gross margins that you expect that you still saw a lot this current quarter and what you sort of expect going forward?

That is a really great question because we have discussed this internally. The shift in mix by vertical is quite significant, especially regarding time of day loading. Our infrastructure experiences the highest load in the evenings when people are streaming entertainment. In contrast, sectors like tech, which have a more balanced workload, positively influence our margins. Other verticals with similar time of day patterns also contribute to our margins. Additionally, industries such as tech hospitality, which have extensive personalization needs, as well as e-commerce and retail, show considerable interest in our compute platform. This mix is likely to benefit our margins. We've seen positive impacts from these factors, and I anticipate we will see more of this effect in the next 24 months.

And then sort of a broader question sort of picking up on some of the themes from the Investor Day. The sort of one Fastly kind of unifying go-to-market product engineering, sort of customer advocacy. What inning do you think we’re in? I mean, you sort of launched the channel program, which you talked about a couple of minutes ago, but what’s more coming down the pipe over the next 3 to 4 quarters that we should be paying attention to?

When we think about one Fastly, the biggest piece that’s coming is the full platform unification. And what that means is all of the product offerings can be managed from a single management suite, no swivel care management regardless of which type of Next-Gen WAF deployment you’re using, if you have Next-Gen WAF and you add content delivery, if you expand the compute, if you deploy observability, there’s one platform, meaning one management plane, one API and importantly, one set of infrastructure. And what that means is a benefit for the user experience because they don’t have that civil chair, it’s easier for them to operate and expand from one portfolio to the next. It makes our sales team’s job in that land and expand easier for sure. And of course, it drives a real simplicity in our operation. We don’t have to run multiple different types of infrastructure. We don’t have a completely different infrastructure for compute. We have one set of infrastructure where all of our services run, one management plane, one API. And I think there’s a benefit from the ops and sales and certainly in the customer experience. You asked what inning. I’m saying we’re in the fourth.

Our next question comes from the line of Jonathan Ho.

Congratulations on the impressive results. Could you provide more details about the AI opportunity you mentioned? What are some specific use cases, what is the potential for revenue, and when should we expect this to become a meaningful driver?

Yes. I mean, I think it’s a good question when it will become a meaningful driver. You should know we’re not planning for it to be a meaningful driver for the remainder of this year. But the use cases are incredibly interesting. We see AI and especially inference-based algorithms that are being used for deep personalization, content recommendation, product recommendation, et cetera. And the sophistication of that algorithm truly matters directly to the ROI of some of our customers, especially in e-commerce and media, et cetera. And I think those folks are starting with it right now. But this is a very interesting intersection for us, where personalization matters and user experience matters. And where there’s a strong ability for those two things in our sector, I feel like that’s where we’re going to see AI at the edge. And this is a great example of the kind of multi-cloud strategy that we talked about at Investor Day. We know these models are going to be trained in the central cloud on AWS and GCP and then deployed to the edge in order to make those real-time decisions. And I think that’s good. I think that’s the way developers want to operate, and that puts the central cloud and the edge in a place where they can both shine.

And then just in terms of the new traffic patterns that you described that potentially impact gross margins. Is there any additional detail that you can provide? And do you expect this to be a continued trend over time?

I do expect it to be a trend. We are focusing on differentiating within our customer base and acquiring new logos in non-media and non-publishing sectors. This differentiation is important, not only because of the time of day but also due to the types of workloads they have. Compute and security workloads usually contribute positively to our gross margin. We'll need to consider this further, and while I don't have more data to share at the moment, I do anticipate it will be beneficial as we continue to differentiate our customer base.

Our next question comes from the line of Madeleine Brooks.

Congrats on the strong quarter. Just two quick follow-ups from me. I guess, first, it’s the environment. From a guidance perspective, it looks like the most of the raise is really coming from the beat this quarter. So how are you feeling about the environment going into the back half of the year? And then just one quick follow-up on AI after that. Thanks.

Sure. Regarding the environment, I feel quite optimistic. While some others in the market are expressing concerns about their user base growth, we have minimal exposure to those issues. There might be some impact in the service provider or banking sectors, but we don’t have much involvement there. I wish we did, but currently we don’t. As for our guidance, I appreciate the recognition. We aim to be transparent and responsible with our forecasts, and I'm confident we can achieve those targets. I'm proud of our team's ability to provide clarity and adjust the annual guidance, and I hope to do it again in the future.

And then on AI, understand training the model at the core and then really doing everything on the edge. From a SaaS perspective, do you see inferencing and doing storage on the edge be something that will require more CapEx than you’re already planning for when it does become an opportunity, or do you feel confident that the CapEx that you have spent so far is sufficient for that storage at the edge?

No. We have absolutely deployed for this. And you see it in the future releases over the last few quarters. We launched big store as well as KV Store, key value pair store, which can absolutely be used in order to deliver outcomes using an inference-based model. And you’re going to see more storage features from us as we go forward. But this has been in the plan. And edge storage as part of our compute platform is absolutely part of what we have already built out for. We’re not expecting a significant change to our build plan because of that.

Our next question comes from the line of Will Power.

Just on pricing and packaging. I think you mentioned that you started to introduce it this quarter. Kind of where would you say you are in that journey right now? And when do you expect to finish the transition? And when do you expect the bulk of the benefits to kind of kick in there? Any color would be great. Thanks.

Yes. I think it’s going to be a relatively long transition, in part because we’re not trying to force it. We have lots of customers that want to run a true utility motion. And especially customers in media, entertainment back promotion, they want to run. We have no intention of making any changes there. But there’s a huge chunk of the enterprise market that wants an all-in-one package and especially, they want reliable billing. And that’s something that I think is good for us and that it makes our revenue a little bit more reliable, gives us a strong sort of monthly renewing or monthly commit and revenue. We’re seeing the improvement in things like the RPO, which run out into the disclosure this time around. And in part, I think, so that you can track the progress here. I would say our sales motion, I hope to be kind of transition maybe in another 12 months. But I think the customer base will shift towards this maybe over the next two years until we hit kind of a steady state. It was nice to see that, again, some of the big deals that we called out and named were using packages. And that new packaging system was a reason why some of them made the change from a deeply entrenched incumbent. Flat-rate packaging, no overages all in one feature set. That was nice to see.

And then just quickly on the competitive environment. What are you seeing in the core CDN biz, the business there? Any changes on the competitive environment? Thanks.

We have observed some consolidation in the market along with increased interest. The two main trends we are noticing are that large customers with multiple CDNs are considering vendor consolidation, which is beneficial for us as they often select the performance leader among the vendors they are evaluating. Additionally, we are seeing that CDN is increasingly being integrated into edge cloud solutions. Having a complete platform is a significant advantage, and we notice that some of our major competitors are pursuing similar strategies. It is encouraging for the industry that this is evolving into more of a platform approach rather than merely a point solution.

Our next question comes from the line of Rudy Kessinger.

I have two quick questions for you. First, I recall you mentioned at the Analyst Day that revenue per server in Q1 was about 12% below the peak. I wanted to know if there was any further improvement in Q2.

That’s a great question. We don’t track revenue per server every quarter. I guess, what I can tell you is we did not have to deploy any significant additional hardware in this quarter and the revenue went up. So, I feel like there’s a good chance that the revenue per server increased. But to be honest, it’s not a figure we track every single quarter. It was disclosed during Investor Day because the trend was interesting and certainly in hindsight, I think painted the picture, but it’s really the cost of revenue that we are tracking most carefully. If I can optimize cost of revenue by adding a few servers and reducing other types of costs, we’ll take that trade-off all day long. I don’t want my ops team chasing down a goal around revenue per server instead of just optimizing for gross margin overall.

And then just second one, just any early feedback you’ve gotten from the bot mitigation beta? And then when will bot and DDoS products go GA?

That's a great question. My security team will be very pleased. We’ve received an excellent response to the bot mitigation, and we currently have several beta deployments in our customers' hands. It's been going well, and we're quite enthusiastic about that initiative. On the DDoS side, we've offered DDoS technology through Fastly for many years, but gaining enhanced visibility into DDoS has been a positive development. The remarkable aspect has been the significant customer interest in the fully managed security service, which includes DDoS mitigation. This has provided a nice boost, and honestly, I believe it is an attractive service. Some of our competitors have offered similar services previously. It allows direct access to our security operations team and provides in-depth threat mitigation. We are extremely confident in both the security managed service and the bot mitigation, and we're currently experiencing robust pipeline growth.

Our next question comes from Rishi Jaluria.

This is Rich Poland on for Rishi. Thanks for taking my questions. First one is just on the pricing and packaging, you mentioned it’s good for some of those new industry wins and use cases, I think you called out retail and hi-tech in particular. Is there anything else besides the pricing and packaging that you’ve done over the past couple of quarters to help be more suitable for those types of use cases? And just anything now that you could expand on a little bit?

We have made significant strides in automation, including enhancements like Dynamic Backends that streamline Fastly management. We've also focused on security improvements, such as implementing Mutual TLS. Our efforts are aimed at strengthening the platform while making it easier to use and automate. We're committed to simplifying the customer experience to ensure Fastly is not just a powerful cloud platform, but also user-friendly and easy for development. We're seeing a steady increase in the platform's capabilities, and we're particularly excited about recent security improvements. One key area of focus is achieving complete platform unification, as many enterprise verticals, beyond just media, desire a comprehensive edge suite with a single vendor for a straightforward onboarding process. We have made progress in areas like account linking and UI consolidation, and we're confident that the full realization of our platform unification will attract new clients in various expansion sectors.

And then just a follow-up on some of the security products that are rolling out. How should we think about just in terms of like monetization for some of those products? And how does that kind of flow into the model as we think about maybe just generally speaking, but then also as it applies to the pricing and packaging changes.

Sure. We aim to offer our web application security solution as a unified package, particularly with our new modern packaging options. This includes DDoS protection, anti-bot mitigation, and Next-Gen WAF as part of one consistent offering. We do sell these products a la carte, but we expect to increasingly bundle them together as a package for web application security. The TLS and certificate solution is typically sold alongside the CDN, which simplifies things, especially for users who manage multiple web presences. However, I believe that will still be offered separately. Essentially, we see our core security solutions being packaged together, while items like TLS and certificate management will continue to be sold individually.

And that looks like all of our questions. I would now like to turn it back over to Todd and the team.

Thanks so much. Before we close the call, I want to thank our employees, our customers, our partners, and our investors. We remain as committed as ever to make the internet a better place where all experiences are fast, safe, and engaging. Moving forward, we remain focused on execution and bringing lasting growth to our business and delivering value to all of our shareholders. Thank you so much for your time today.

That concludes today’s call. Have a pleasant day.