Thank you for standing by. At this time, I would like to welcome everyone to today's Fastly Second Quarter 2024 Earnings Conference Call. [Operator Instructions] After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Vernon Essi, Investor Relations at Fastly. Vernon, please go ahead.

Welcome, everyone, to our second quarter 2024 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 1 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 way. 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 filings with the SEC, including our most recent annual report filed on Form 10-K and quarterly reports filed on Form 10-Q filed with the SEC and our second 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 forward-looking statements on this call are based on information available to us as 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 during the third quarter, we will be attending the Piper Sandler Growth Frontier’s Conference in Nashville on September 10. Now, I'll turn the call over to Todd.

Thanks, Vern. Hi, everyone and thank you so much for joining us. Today, I will cover our results and the dynamics facing our business and then discuss our recent technology developments, go-to-market initiatives and the path forward. I will then hand the call over to Ron to discuss our second quarter financial results and our guidance in detail. We reported revenue of $132.4 million for the second quarter, coming in above the midpoint of our guidance. Our operating loss of $12.6 million was also favorable to the guidance midpoint, thanks to strong gross margins and good cost control across the business. While I'm pleased with these results and execution in the second quarter, unfortunately, it does not offset the challenges we currently face with a small set of our largest customers. The industry has been challenged by the largest delivery customers as traffic projections have softened and focus has shifted to profitability. This has put increased pressure on vendors such as Fastly as our projected growth in those accounts has declined. We've taken initiatives to mitigate this impact. However, these customers constitute a material portion of Fastly's revenue and we're seeing those effects in our projections for the rest of the year. Our Top 10 customers which is a fair proxy for these large delivery customers, has dropped from 30% of revenue in the first quarter to 34% in the second quarter. Despite this drop in our Top 10 customer revenue, we still managed to grow our top line revenue 8% year-over-year. This was due to a 13% year-over-year growth in the rest of our customer base as a result of the actions we initiated a year ago in transforming Fastly's business. Specifically, it underscores the changes in our go-to-market strategy as we continue to drive customer acquisition and expand…

Thank you, Todd and thanks, everyone, for joining us today. I'll discuss our financial results and business metrics before turning to our forward guidance. Note that unless otherwise stated, all financial results in my discussion are non-GAAP based. Revenue for the second quarter increased 8% year-over-year to $132.4 million, coming in slightly ahead of the midpoint of our guidance of $130 million to $134 million. Network Services revenue grew 6% year-over-year to $104.2 million and security revenue grew 13% year-over-year to $25.4 million. In the second quarter, we continued to see sequential declines in revenue from some of our largest customers that partially offset growth in revenue from other areas, particularly social media, development platforms and gaming. The sequential declines in revenue from our largest customers were driven by further impacts from the reversal in the consolidation of network services vendors last year that we discussed in Q1 and also a continuation of lower follow-on traffic than we have historically seen following typical customer rerate. As a result, network services revenue per gigabit declined more year-over-year than the historical trend line we typically experience. We anticipate this dynamic will continue throughout Q3 and then begin to moderate in the fourth quarter. Our Top 10 customers comprised 34% of our total revenues in the second quarter of 2024 compared to 38% in Q1 2024, reflecting the impact of the revenue declines from some of our largest customers. Also, no customer accounted for more than 10% of revenue in the second quarter. As Todd discussed, customers outside of our Top 10 grew revenue 13% year-over-year. As we continue to transform our business towards a bifurcated customer strategy, we will continue to focus our customer acquisition strategy and direct more development and go-to-market investment towards the broader market opportunity outside our Top 10…

[Operator Instructions] And our first question today comes from the line of Jonathan Ho with William Blair.

I wanted to start out with a little bit more detail on what happened with regards to these large customers. And maybe what caught you off guard with these sort of declines? Are they continuing or should we expect sort of stabilization at these levels?

Yes. We mentioned there is definitely softness in the traffic of those large accounts, primarily media, large media accounts. And there's certainly a push to profitability from within those teams and we're seeing that and trying to react to their needs and their business priorities of those customers. We've really transformed our customer success motion for these large multi-vendor customers. We're focusing on delivering the kind of differentiation and the kind of service that they're looking for in a very bespoke way. So we have consumed obviously some headwinds here in terms of the revenue projection for the back half which you see in our outlook. But yes, we believe we've stabilized those accounts at this point.

Got it. And then just in terms of the guidance, can you maybe help us understand how you sort of came up with these parameters with the revised guidance, how derisked do you feel at this point? And are there any other large contract renewals that are coming up in the back half of the year? I think investors really want to understand the downside potential here or whether it's just been completely taken out.

Sure. The -- I should mention that the correction or the adjustments we made to our guidance were -- largely weren't due to renewals but they were due to softness in the traffic projections in the back half. The -- and obviously, it pushes to profitability from those accounts. And look, we're taking a much more high touch much more bespoke approach in these accounts and that's given us more confidence in our projections now. This change is sort of the customer engagement motion and the internal analytics that we're using to make those projections are pretty significant and fundamental to how we're operating and that's giving us a lot more insight into the dynamics in the Top 10 and we believe we've got a pretty good view here for the back half of the year.

I mean, the only thing I would add is with our overall process, Todd mentioned, we've kind of revised our engagement model. We've added regular senior engagement with these largest customers. We believe that's given us a lot better visibility into the dynamics of these customers than we had at the beginning of the year. And we have a much more reliable outlook in terms of what the dynamics are at those customers that -- where patterns really changed a lot earlier this year.

Our next question comes from the line of Fatima Boolani with Citi.

I wanted to ask you about the restructuring efforts that are going to be underway and, of course, to in the back half of this year. I wanted to typically do in on your comment that, hey, this is going to be more of a broad-based recalibration in terms of resources. But why would sales and marketing be kind of lumped into that? Specifically, if the aspirations are for driving new customer acquisition. So why would it be more of a blanket structure? What kind of give confidence that you're not potentially hollowing out your sales capacity and your sales organization that could prove kind of detrimental potentially to some of those other growth aspirations? And then I have a follow-up.

Yes, absolutely. And I think the question point at the -- real point for the restructuring we need to adjust our spend to the top line. And we're always focused on delivering discipline on the bottom line regardless of volatility in the top line. But how we're doing this as a restructuring and very specifically, not a sort of peanut butter across the org is we're restructuring the company in order to allow ourselves to invest in the go-to-market and most importantly, there'll be efficient -- the most efficient parts of our go-to-market to help us drive customer acquisition and wallet share growth in key accounts. And at the same time, in technology innovation that will help us drive revenue growth and sales efficiency in the long run and specifically, that really means focus on security, on compute and on AI. And the restructuring is really designed not just to align our spend to our top line to maintain that discipline but also to give us room to continue to invest in customer acquisition and in the -- in these key areas of innovation.

Got it. And then just a follow-up on Ron's commentary with regards to CapEx. I think you talked to 9% to 10%, longer-term model 6% to 8%. But you just have come out of a pretty meaningful network rebuild, rearchitect and up leveling. So I'm wondering why that envelope still remains high, particularly in the context of some of your large media delivery customers ratcheting back their traffic level. So why would that not alleviate some of the incremental CapEx pressures?

Yes. I mean there's a lot of dynamics beyond it. I think one of the things that we have seen this year has been a positive thing is, on a global basis, more traffic. And so as we look at traffic levels geographically. A lot of this is the CapEx needed to support regions where we've seen expanding traffic levels which ultimately in the long term, play out well because as we see higher traffic levels in some of these low historically low volume areas. We're able to drive lower cost on bandwidth and other costs and ultimately in the long term will drive efficiency. So, some of it is largely driven by some of the -- just the changes in the geographic traffic mix. And why we believe in the medium to long term, that 6% to 8% of revenue is still the right medium to long term as we really adjust our geographic footprint.

And our next question comes from the line of Frank Louthan with Raymond James.

Has Scott changed sales metrics revised any quota guidelines so far? And if not, when will that be completed? And then where do you think quarter bearing head -- where is quarter bearing headcount now? And where does that need to be to reach your goals?

The -- Scott has only been on for a couple of months and it's amazing how much impact you've had already. You've got, I think, a pretty great sort of focus on both the customer acquisition side but also driving revenue growth specifically through cross-sell. And he's been looking very carefully at that. And look, I've been incredibly impressed with the way he has come up to speed in our business which probably shouldn't be surprising giving us background and how quickly he's been making changes already, including changes here in order to make that team more efficient and capable of growing and maturing really in the short term.

Okay. And can you clarify what percentage of your sales come from the channel today?

We don't disclose the percent from the channel. We've had pretty good success growing that channel and we'll continue to invest there. But it's not a number we disclose. I will say, I think a part of this future success of this transformation is going to be in optimizing those channel investments, especially around leveraging that channel to drive deal registration and customer acquisition.

And our next question comes from the line of Sanjit Singh with Morgan Stanley.

I just have a higher-level question in terms of where fast he is in its growth and sort of profitability curve. With overall top line growth coming down to the low single digits. The company is still unprofitable and understanding the restructuring actions that you're taking, still likely to be unprofitable. And with the sort of uncertain macro backdrop, I mean, is there a risk that you start to see weakness on sort of your nonmedia business? And does that sort of -- I just want to get a sense of like how you guys are thinking about pushing further on the profitability side while the top line, they seem still uncertain at least for the next few quarters or maybe for a couple of years, if you go into more of a macro downturn.

No, I think it's an important question. Really, I mean, I think the way we see this is as a moment of transition. You can see the change in our customer concentration happening extremely rapidly here. And what we're doing is really building a foundation in those on Top 10 large media multi-CDN accounts. And that's the foundation upon which will really build the business and especially build that business around a complete edge platform, including not just delivery but security, compute, observability, AI, et cetera. And we really see this as a period of transition. It's why we're restructuring in order to be able to drive investments into those other areas and drive investments in the go-to-market that's needed to run a true platform play. A true multiproduct line play to make that revenue base stronger, stickier and higher growth through cross-sell. We are adjusting that top line. We are adjusting our spend to our top line to maintain bottom line discipline despite this volatility. We're doing it in a way to really transform the company and take this as an opportunity to drive growth in 2025 as well as profitability.

Understood. And with the new Chief Revenue Officer being onboarded, how do you see the sort of go-to-market strategy execution in sort of year 1 of this tenure in terms of the magnitude of change that you expect to bring to the organization?

Yes. The restructuring is kind of accelerating that in a lot of ways. And the -- a big chunk of the restructuring and the reconfiguration that Scott had begun planning for next year. I think we're able to do NAV instead taking this as an opportunity to drive urgency. And pulling that forward, I think, is great. I think it's also helping us prepared to really push hard on the cross-sell motion and upsell motion throughout that long tail of enterprise accounts.

[Operator Instructions] And our next question comes from the line of James Fish with Piper Sandler.

This is Quinton [ph] on for Jim Fish. Maybe for Ron. As we think about the guide change here, when you got in the prior quarter, it sounded like delivery expectations for these largest customers have been dropped down essentially just to minimum commitment levels. Was this not the case? And so now the updated guide is just embedding minimum commitments? Or are you seeing those Top 10 customers fall below prior kind of minimum commit? And so the downside is just a little bit tougher to gauge?

Yes. So when you look at our largest customers, not all of them actually have a commit. And in many instances, the commitment levels are low or meaningfully below where their expected traffic levels are. So the commit really isn't, if you will, a guide. Think of these customers really on a utility basis with variable traffic. And I think that's something we've spoken about in terms of kind of the dynamics of our forecasting process. And I think while historically, we had reliable model around this. I think the break in patterns that we saw with these largest customers really have a significant impact because they're our largest customers and this impact was a lot greater and more sustained than we had anticipated last quarter. I do believe with the increased engagement model that we put in place, the senior level engagement regularly with these customers is that we now have much better visibility into their own internal dynamics around their traffic expectations and traffic allocations, that visibility translates into a much more reliable view of how their business will play out over the remainder of the year.

Got it. That's helpful. And then sticking with the Top 10 customers. Obviously, it sounds like the vast majority of pressure sits on the delivery side rather than security. Are there any sort of impact from the customers taking down traffic that's impacting security that's kind of driving some of this deceleration? Or do you need to kind of see kind of reacceleration? It sounds like packaging is going well and the incentives across kind of sales and marketing are in place but we just haven't seen kind of stabilization across that segment.

Yes. Top 10 -- those Top 10 accounts tend to be very delivery heavy, very media heavy. And so it does tend to be concentrated on the delivery side and certainly concentrated in the media vertical. And we see the momentum building outside those Top 10 accounts and very specifically outside of these large multi-vendor primarily media accounts. And it's about putting fuel on that fire. It's about investing in that enterprise motion, while at the same time, building bespoke customer engagement with those top accounts and returning them to growth and the growth we've been used to there. And it's really -- our focus is really on trying to make sure that we stay on top of both of those initiatives at the same time.

And our next question comes from the line of Will Power from Baird.

Great. I was hoping just to drill down maybe just a little bit more on the Top 10 pressure. I guess I'm just trying to understand, is this 2 or 3 customers? Or is it really kind of broad-based across all the Top 10? And anything else you could share just on industry traffic trends versus potential share loss to competitors?

Yes. It really is a small number of accounts, all of the Top 10 to small handful, less than a handful, I guess. And -- but these are large accounts and there is a lot of revenue in those accounts and we take it very, very seriously. It's why we've changed our motion in the way we engage not just in those handful but across that top tier of media, multi-staticaps [ph]. There's really a strength in that rest of that business. And as we're bringing more technology to market, especially on the security side, we're starting to see some real potential for the remainder of the business. And we've also seen a lot of stabilization in the Top 10 just at a lower level than we had expected.

Well, no, I was just going to ask if there was any other color on this being more of an industry slowdown in traffic versus some of your Top 10 customers just looking to diversify their vendors to reduce costs?

Yes. I mean we mentioned this in the call last time. There's certainly softness in the traffic projections that we are expecting. There are people who are, again, like focused on that multi-vendor strategy and maybe adding a vendor here or there. We haven't like been removed from any of those accounts. We continue to have very strong partnerships in each of them. We just have drops in the revenue projection which is affecting the guidance.

And our next question comes from the line of Jeff Van Rhee with Craig-Hallum.

Great. Just two for me. Just to follow up on Will's question is can you just break it down roughly proportionately, how much of the revenue reduction was share loss at media customers versus reduced spend expectations at those customers overall?

Yes. It is a good question. It's just that we don't break down those numbers. We can disclose them. But there's a handful of those. There are areas where -- both of those promotions are happening, we're seeing softness on the traffic side for sure and we're seeing less revenue due to repricing in a handful of accounts. And both of those things are occurring. We do always expect to see some repricing, not just in our large counts but across the board. And with those repricings, we also expect to see increases in traffic as a natural part of our business. We just haven't seen that traffic increase as much as historically we've seen as Ron mentioned. And because of that, we're just seeing this impact on the revenue guidance.

Okay. And then if I were to look at the revision to the guide, implicit in there outside of media, how did your outlook change on nonmedia revenue?

We don't disclose it exactly in media and nonmedia but we do disclose the Top 10 and outside the Top 10. And the numbers outside the Top 10 are momentum is building there. We feel pretty strong about it. And again, I really believe that is what's going to drive a more diversified revenue base for Fastly in the long run. It's going to drive a healthier and more accurate projection and broader growth really globally and across all the enterprise verticals, more predictable growth. And growth that will be tied more closely to the portfolio expansion in security and compute, et cetera. So we feel pretty good about the projection outside those large Top 10 accounts and outside the media accounts, especially in the back half.

And our next question comes from the line of Madeline Brooks with Bank of America.

Just one for me. So if I look at the implied guide for 4Q, that would suggest roughly 1% decline in revenues. If I then take that with the Top 10 customer in talent, just projecting out similar growth trends, right, so 13% for not Top 10 customers and to continue to climb with your Top 10. My rough math would suggest that around 80% of the business by fourth quarter should be those non-Top 10 customers. We also -- I just want to point to comments from last quarter's call where you did suggest that we should see a healthy momentum from customers that were signed a year will kick in, in the back half of the year. So given those 2 trends, right, where we should see customers outside of Top 10 being over 80% of the business and we should see healthy contribution from customers that were added over the last couple of months. I guess, how do -- can you help me bridge the gap as to why that implied negative 1% guide is the correct guide because those 2 seem to be in contradiction of each other?

Yes. I mean I think addressing kind of the question of Top 10 concentration while I think -- while we expect to see some continued decline in the concentration in our Top 10 customers, we do expect that decline to be slower or decline from what we really saw in the first half, where we saw the main 38% to 34%. We'll see some continued decline but not at the rate we saw in the first half. That does sort of imply as that comes down, that we continue to see strength in the growth rate of the non-Top 10, very healthy. And I think to the earlier question, we really haven't seen any real change in our outlook outside of the Top 10. Sorry, Madeline, could I clarify what you meant [ph] by that 1% number?

If you just take the 3Q guide and then back out first quarter and second quarter and then implied -- or -- and then your 3Q guide, you would get the implied 4Q of roughly -- if I'm rounding 1% but you think it's negative 0.6% decline; that's what I'm getting. Also sorry, Ron, just to reiterate that then; so the 13% growth trajectory that you saw outside of Top 10, you’re expecting it to continue at that pace for the remainder of the year?

I think implicit in the math, if you see some continued deceleration, although at a slower rate in the Top 10, that non-Top 10 growth rate you should see some nominal improvement in gross rates outside of the Top 10 in the second half.

I think that's really what's going to drive the diversification of our revenue. As the customer -- as the effect of customer acquisition that you mentioned become more and more impactful, our customer concentration to continue to come down. That dropped from 38% to 34% in just 1 quarter, obviously, I think it's an anomaly. But I do expect and I think it's healthy for that to slowly continue to decline as the growth of the rest of the accounts becomes more of the predominant driving force there.

And our next question comes from the line of Rudy Kessinger with D.A. Davidson.

So your Top 10 were about $45 million in revenue in Q2. What's the floor? Are all of those customers pure utility and they all got off 100% of traffic tomorrow? Or is there any floor? Is it $10 million, $20 million? I guess just how much potential further downside could there be? I know you guys are saying you have -- you feel you have a good handle on it but you also said that 90 days ago.

Yes. I mean, fair point. I think if you look at the Top 10, there is a mix. As I said earlier, not all of the customers do have a commitment but some of the customers do have a commitment in their traffic levels sort of that point. If they hold to their commitment, there is a meaningful amount of committed revenue across those Top 10 and hold. Again, not all of those customers are in streaming where, as Todd mentioned earlier, it's a small handful of these where we've seen the headwind. We've seen some positive momentum and some new customers come into the Top 10 this year. So it's -- you've got different dynamics moving there across each of the customers. So to the point these headwinds are not across all there are commitments in there and there are customers where the dynamics are positive.

Just to add one point to that. Part of this new customer engagement motion that we have implemented in the last few months, is about driving additional commitments into that space. Traditionally, that part of the market has relatively small commitments and a huge utility upside. And we've been working hard at improving that balance and getting a larger commitment in exchange for more traffic and rate changes.

Okay. And then security, it slowed to 13% year-over-year which is lowest on record. What's the expectation for growth in security input in your second half guide? Do you expect any acceleration with the hot product out there?

Yes. We don't disclose projections by product line. But I can tell you, we're deeply focused on security. I'm certainly not that exciting but the 13% number there and that represents some softness on that -- in that product line that is regrettable. We're going to be deeply focused on bringing that security growth rate back into the high 20s if not higher.

[Operator Instructions] And our next question comes from the line of Tom Blakey with KeyBanc Capital Markets.

I think what I'm trying to just understand what's kind of baked into 2025, I guess, a little bit with regard to these large media customers. I think you've given a lot of color there. Maybe just shifting to pricing. I think pricing commentary in prior quarters was okay. There was no kind of like alarm there. But I think some of Ron's comments was maybe [indiscernible] from a quarter-on-quarter perspective. If you could just get an update on pricing? And if you could, if you wanted to help us focus on the pricing dynamics of the nonmedia, what's going on just in the general health there? And I have a follow-up.

I think the point in Ron's statement. We have seen pricing pressure in those large media accounts there's definitely a trend that those accounts are deeply focused on profitability. We're seeing that in their disclosures as well and I'm sure your teams are tracking it. Outside of those media accounts, the pricing model has been pretty successful. We're seeing good momentum in packaging, I think, because that SaaS-style model and the pricing environment is pretty healthy. And that's not just on the delivery side but across security and the surge we saw in the launch of the observability packages. The pricing has been pretty good across that space. is helping us keep our gross margins on target which is great despite less top line revenue and I feel pretty good, to be honest about pricing outside of media for sure.

Great. Thanks, Todd. Yes, it is a signal for the second question to round about the gross margin. I'll perform then the second quarter seems to be taking a step down in the third quarter. Just walk us through maybe the dynamics there and helping us kind of like understand where we could exit heading into '25 around 50% kind of like targets that we were talking about in prior quarters, that would be helpful.

I think one of the dynamics on the gross margin decline you saw sequentially it was a fairly small decline is we're seeing a little bit higher pricing adjustments than we've seen in the past. Those tend to fluctuate a little bit. If you recall, we saw higher pricing declines in the first half of '23, that sort of moderated in the second half. I think we're going to see the same dynamic this year where we saw higher pricing discounts in the first half as some of these largest customers focused on profitability and we didn't see traffic. We saw rerates that didn't bring additional traffic. We expect that to soften a little bit in the second half over the course of the year. And with this transition, that Todd spoke about as these largest customers become a smaller percentage and we see increasing growth in the non-Top 10 that's going to drive some favorability in our gross margins moving forward as some of this pricing pressure starts to mitigate in the second half and those largest customers where we're seeing this are a smaller concentration.

All right. Thanks, Tom. And that concludes our Q&A session today. So I will now turn the call back over to Todd Nightingale for closing remarks. Todd?

Thanks. This time marks a moment of transition for Fastly and I want to thank the team for their commitment and continued focus on our customers and on Fastly's growth. Restructuring the company is a necessary step but this decision was not taken lightly as we care deeply for all of our employees and all of our teams. To everyone on the call today, I want to thank you for joining us and for your interest and support. Thank you so much.

Thanks, Todd. And ladies and gentlemen, that concludes today's call. Once again, thank you all for joining and you may now disconnect.