Fastly, Inc. Q3 FY2024 earnings call

Key Points:

• Revenue: Third quarter revenue of $137.2 million exceeded guidance, driven by better-than-expected strength in media customers and share gains outside Top 10 customers.
• Financial Metrics: Reported an operating loss of $520,000, a net profit of $2.4 million, and positive adjusted EBITDA of $13.3 million, all record levels.
• Revenue Diversification: Top 10 customers accounted for 33% of revenue, down from 40% the prior year. Revenue outside Top 10 customers grew 20% year-over-year.
• Product Initiatives: Launched major security portfolio expansions, onboarded new sales leadership, implemented bespoke engagement models with large customers, and rolled out a new self-service model. The AI accelerator is near general availability.
• Customer Metrics: Enterprise customer count was 576, up 5% year-over-year; total customers were 3,638, with a net increase of 343 quarter-over-quarter.
• Go-to-Market: Channel partners saw 33% year-over-year growth in dealer registrations and 46% year-over-year growth in year-to-date bookings.

Third quarter revenue was $137.2 million. Network Services revenue grew 5% year-over-year to $107.4 million, representing a significant portion of total revenue. Security revenue grew 12% year-over-year to $26.2 million. The Other segment, which represents emerging products, grew 85% year-over-year to $3.6 million, driven primarily by compute. Top 10 customers accounted for 33% of revenue, down from 40% the previous year, while revenue outside Top 10 customers grew 20% year-over-year.

Fourth Quarter Guidance:

• Revenue: Expected to be in the range of $136 million to $140 million, reflecting flattish annual growth.
• Gross Margin: Anticipated to decrease approximately 150 basis points relative to the third quarter, primarily due to increased bandwidth and colocation deployment costs.
• Full-Year 2024 Guidance: Revenue expected to be in the range of $539 million to $543 million, representing 7% midpoint growth. Gross margin expected to improve by approximately 70 basis points. Operating loss expected to be in the range of $28 million to $24 million. Free cash flow expected to be in the range of -$40 million to -$30 million.

Risks:

• Dependence on Large Customers: Revenue declines from largest customers have impacted net retention rate (NRR).
• Seasonal Factors: Q4 not expected to see typical sequential lift due to dynamics with largest accounts.
• Market Competition: Potential challenges from other players in the CDN and edge computing space, affecting market share and revenue growth.

Q: Congrats on getting the business here to net income profitability in the quarter overall. Look, I think everybody is wondering here about the competitive environment with one of your competitors going bankrupt. And Todd, you and I talked about that at our conference. But -- what are you guys seeing in terms of that opportunity in particular, especially given -- that entity had very large customers, even some overlapping customers. What programs are you putting in place to try to gain further wallet share with that bankruptcy [ph]?

A: Yes. I think it's making the market like a super interesting place right now and there's definitely potential upside here. We've seen some accounts that have, in fact, shifted traffic towards Fastly and that's largely the overlapping accounts where the transition is straightforward. But largely, I think of this as a significant opportunity in 2025. I think that's where we're going to see big shifts in that area in particular. Maybe just a slightly wider lens. I think it also underscores the importance of a platform strategy here of building a very complete offering with strength, not just in network services but security and compute and observability as well. And that's where we're seeing a lot of the momentum in our business and I think it's going to help us transition these customers over to a more complete offer. So for us, we've seen a little bit of that so far but I think the majority of the upside opportunity for us is probably in '25.

Q: So it seems like the bump in the business here was a little bit more onetime in nature. You're a little cautious that it was. Can you give us an idea of what was kind of driving that media business in the quarter? And any thoughts about what possibly could be replicable. And then on the efforts you've made on the restructuring. Can you walk us through where you've seen success there early on -- are you tracking to the same overall cost savings or you found some new? Is it going to be a little bit higher? Or we just capture that a little sooner than we thought.

A: Sure. We saw some better than projected revenue in those top accounts. And I think you're right to say we are -- we're being very careful not to project too much from those results into the out quarters. And I think that's important. We know there's volatility there and we want to be really sure that we are projecting the correct -- that we're giving you the correct revenue projection moving forward. But I think that like the part of the growth rate and the revenue result in Q3, that's really important is that we saw 20% year-over-year growth outside of the Top 10. We're seeing momentum starting to build in this transition towards approaching the larger market, acquiring customers outside of media and driving a more diversified, a more reliable business and therefore, more projectable and reliable growth rate moving forward on that diversified business. And there's no doubt that this transition has a lot to do with that focus on diversification and focus on long-term reliable growth. As far as the cost savings, largely, we've been pushing cost control and operational efficiency and rigor for a long time. and we've had pretty consistent results in making improvements there. But our restructuring, we were able to do a little bit earlier, a little bit faster and more efficiently than we believe than we believe possible. And that drove a big chunk of the beat on the OpEx side to our projection. Ron, anything on [ph]?

Q: Nice to see getting back to a nice cadence [ph]. I guess my overarching question, Todd, is, is there like a mix between Top 10 and non-top 10 that would essentially signal growth returning to the business. It sounds like the Top 10 business seem to be getting worse but when I look at your Q4 guide, we're looking for about flat year-over-year growth, so probably more sort of your growth headwinds on [indiscernible]. And so is it like sort of getting that mix down to 25%, 20% because it looks like your non-top 10 customers are growing healthily in the double digits. So any thoughts there on like were those kind of 2 lines crossed where that sort of fits out reasonable growth.

A: Yes. I think it's a good question, something we think about a lot. I believe that the growth rate, overall, is going to be more and more dominated by this longer tail of customers and it's why I'm tracking so carefully the nonmedia growth rate and in the public disclosure, the non-top 10 growth rate. And as that concentration reduces then we're going to index more and more on it. I think getting to 30% is going to be a pretty significant momentum time for us. And I think that really will be a healthy place to be. But to be honest, I think it's only upside and diversification. We've seen so much success in diversifying our business and we're going to keep at it not just diversifying our revenue across the customer base. But increasingly, in 2025, you're going to see us pushing really hard on the security side of our portfolio as well.