Q2 2022 Fastly Inc Earnings Call
Ladies and gentlemen, thank you for standing by.
At this time I would like to welcome everyone to the Fastly second quarter 2022 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. If you would like to ask a question. During this time. Please press star followed by the number one on your telephone keypad.
If you would like to withdraw your question again press Star one thank you.
I would now like to turn the conference over to burn Etsy Investor Relations at Fastly. Please go ahead.
Okay.
Thank you and welcome everyone to our second quarter 2022 earnings Conference call.
We have families lead independent director, David Hornick, our CEO Joshua Bixby.
And our CFO , Ron Kisling with us today.
Webcast of this call can be accessed through our website vastly dot com and will be archived for one year.
Also a replay will be available by dialing 870, 702030, and referencing conference IV number 7543239 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 <unk> website.
During this call we will make forward looking statements, including statements related to the expected performance of our business future financial results 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.
Further information regarding risk factors for our business. Please refer to our most recent quarterly report 10-Q filed with the SEC and our second quarter 2022 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 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 Keybanc technology leadership Forum in Colorado on August nine.
In 2022 Global Technology Conference in New York on September 7th.
With that I will turn the call over to David for his comments regarding today's announcement of our new CEO Todd Nightingale, David Thanks.
Thanks, Brian .
Hi, everyone and thank you for joining us today.
You may have seen from the press release, we issued this afternoon I'm thrilled to share that after our broad and extensive search to identify the company's next leader Todd Nightingale has been appointed our next Chief Executive Officer of Fastly.
Gasoline large enterprise customer base robust product roadmap and unrivaled customer satisfaction gives us confidence about <unk> future and the significant opportunities ahead.
As we search for the company's next leader the board was committed to finding a candidate that could help build upon vaseline strong foundation and lead us into the next stage of growth.
The board is confident that Todd customer oriented leadership style and extensive background, helping customers transform their infrastructure and digitize their business, so will greatly benefit fastly and position the company for future success.
Hailing from Cisco, where he currently serves as executive Vice President and General manager of enterprise networking and cloud Todd is a proven and passionate technology leader.
Todd understands that now more than ever enterprises need innovative solutions that enable them to deliver globally, performing secure and reliable applications to their customers.
He will officially join us as CEO on September one and Joshua will remain with the company for a period of time to ensure a smooth and successful transition.
Please note that at this time, we won't be addressing any questions regarding todd's appointment during today's Q&A, but we don't plan to share more information. After it starts with that I'll turn the call over to Joshua.
Thank you, David Hi, everyone and thanks for joining us today.
Today, I will talk about the quarter and then we'll invite Ron to provide some more color on this quarter's results.
Then we will take some questions, which as David indicated we ask that you focus on the results and the outlook.
In the second quarter 2022, we reported revenue of $102 5 million, representing flat sequential growth and 21% growth year over year.
These results exceeded the top end of our guidance range of $99 million to $102 million and represent another record revenue quarter.
Our customer retention and growth engine remains strong our LTM NR with 117% and our D. Var was 120% in the second quarter.
Our average enterprise customer spend was $730000, representing a 1% quarter over quarter increase.
Total customer count in the second quarter was 2894 of which 471, where enterprise customers. Our total customer count increased by 14 in Q2 down from 76 in Q1.
Our total customer count was impacted by higher churn at the low end of our customer base, which we believe was impacted by the uncertain macro environment impacting smaller customers and the dynamics we have described before.
Small customers opt for more robust developer friendly trials.
We continue to focus on landing new enterprise and large customers.
For example in the second quarter. The average monthly revenue run rate of the new customers, we added to the platform with 85% higher than those that churned.
In terms of developer traction we added over 100000 developers to our platform across glitch and are computed edge platform and we're pleased to see so many new developers experimenting with us.
It is encouraging to see our enterprise customer count increased by 14 compared to 12 in the first quarter.
This increase in enterprise customers validates our efforts in sales and marketing to retain and expand our customers revenue.
Particularly focused on larger customers.
This was the case with two fortune 500 customers one of the leading CRM company with World class enterprise customers and the other a global digital payments juggernaut, both customers expanded their use of fastly across multiple product lines in the second quarter.
You may have seen the announcement last week that Fastly is now an official global sponsor of the Mercedes AMG Petronas Formula one team.
This long term partnership reflects our shared commitment to experiences that are fast safe and leading edge both on the track and on the Internet.
You'll be hearing more about this growing relationship on the track and on our platform in the coming quarters.
As we discussed in detail last quarter, one of the key initiatives. We have undertaken in 2022 is the deployment of our new architecture for key Metro regions.
As previously discussed we believe we will achieve material gross margin leverage by doubling down our efforts on server efficiency with this new architecture, which is coupled to our proprietary software development.
As discussed previously we have been running duplicate sites, which has a gross margin headwind.
However, our gross margin in the second quarter was further adversely impacted primarily by one time cost true ups and other smaller items.
Ron will provide more details in his section as well as our strategic initiatives at reducing supply chain risks and carrying costs on our infrastructure capex.
Our gross margin declines are an area of focus and we remain committed to taking the necessary steps to see this improve like last quarter the pricing dynamics in the business have not materially changed and have not been a major contributor to our recent decline.
The team at Fastly remains United in our common mission, which is to fuel. The next modern digital experience, but providing developers with a programmable secure and reliable edge cloud network that they adopt as their own.
Central to this common mission is the key role developers play in our journey and the new and expanding power distributed edge compute and security.
As they use our trusted platform they become more interested in its features and that keeps them engaged and retained as customers as they scale.
To reinforce this effort we've acquired glitch announced on the heels of our Q1 results our platform of $1 8 million developers, bringing together two of the world's best ecosystems for application development into a single seamless developer experience to deliver globally performance secure and reliable applications at <unk>.
Gail now.
Now developers can innovate create and share full stack web apps without having to run the infrastructure are managed tools themselves. We're very excited about glitch as it provides a giant leap forward in our developer relations efforts.
We're also building partner momentum to broaden and deepen our developer reach as you may have seen last week, we announced a reseller partnership with human to resell our industry, leading bot detection to help security and fraud teams keep cybercriminals out of their online applications and services.
Using superior detection methods hacker intelligence and collective protection across the web human detects and defeats bot attacks and fraud with unmatched scale speed and precision.
Now customers can get all the benefits of fast lease Nextgen WAF, the first and only unified WAF solution with humans exceptional bought protection management capabilities.
In the coming quarters, we will continue to expand our roster of partners to expand the scope and reach of our platform.
Moving on to our product highlights for the second quarter our.
Our delivery products, which are part of our network services portfolio continued to receive strong market validation.
<unk> was recognized as a customer choice in the 2022, Gartner peer insights voice of the customer global CDN.
We received the highest customer rating of four eight out of five stars and the highest customer willingness to recommend at 97% we.
We earned recognition due to our network size and scale developer focus web security and customer support.
Positive customer sentiment continues to lead to significant upsells with our largest customers for example in the second quarter, a leading social media platform with over 50 million daily active users chose to expand our relationship with additional products after undertaking a competitive RFP process.
We continue to accelerate fast lease product delivery in the second quarter. We had 14 releases in total compared to 11 releases in the first quarter.
Observe ability has been a top priority in 2022, and we announced general availability of both origin Inspector and domain Inspector.
Both can be self enabled straight from the faster the UI.
For companies using a single origin, multi cloud or multi CDN architecture origin Inspector unlocks end to end visibility of Internet traffic traveling from the origin to the Fastly edge cloud.
Domain Inspector allows our customers to effortlessly monitor traffic for a single fully qualified domain name or multiple domains assigned to a faster service.
On the security front, we had several new developments faster.
<unk> Nextgen WAF edge deployment is now in general availability given.
Given the rise of new threats in late 2021 and into early 2022, such as log for Jay and spring shell, we added new Apis for deep provisioning improved origin thinking and now support the percentage ramp up feature to control the amount of traffic through the edge security service.
Our delivery customers are easily migrating to our expanded security offering in the second quarter and online discovery platform, serving over 300 billion content recommendations monthly extended it's fastly edge delivery needs with the Nextgen WAF product.
Along with fast lease Nextgen WAF, we added CV signals, allowing virtual patching functionality configured through a web interface.
We introduced Fastly security labs, a new program that empowers customers to be the first to test new detection and security features directly to the security product team bolstering the quality of our Nextgen WAF.
We also added features to our image optimizer, and we added Javascript SDK to computed edge supported languages.
[noise] computed edge continues to be critical in winning new business. For example, the Japanese ecommerce marketplace chose fastly, specifically because of our Javascript support in a competitive deal for compute at edge that did not include delivery.
Our continued strong execution on the product and engineering front is very exciting and our significant increase in release velocity reinforces our commitment to developers and platform builders.
Underpinning all of our technology is our lightning fast network, we continue to remain consistently faster than our peers in the U S and Europe .
Even surpassing some of our toughest critics and customers expectations.
This performance advantage validates our unique architecture, and we are continuing to invest in its development to fuel growth.
Performance paired with security is one of the most critical decision making metrics for our customers.
That is why we are excited and proud to be part of apples, new icloud private relay service designed to protect users' privacy on the internet.
And we're also collaborating with Apple, Google and others to develop and standardize the technology behind private access tokens to provide secure anonymity to end users.
I'll close out by saying that working closely with world class customers like Apple is further validation of <unk> technology and platform solution and we look forward to further opportunities to collaborate with industry leaders.
To discuss the financial details of the quarter and guidance I'll now turn the call over to Ron Ron.
Thank you Joshua and thanks, everyone for joining us today, I will discuss our business metrics and financial results and then review our forward guidance.
Note that unless otherwise stated all financial results and my discussion on non-GAAP based metrics.
Total revenue for the second quarter increased 21% year over year to $102 $5 million exceeding the top end of our guidance of $99 million to $102 million.
Second quarter revenue from Sigma Sciences product was 13% of revenue a 56% year over year increase or 41% increase after purchase price adjustments related to deferred revenue are reflected.
While we are not immune to the macroeconomic trends, we are seeing healthy traffic expansion from our enterprise customers and given our relatively smaller market share we are benefiting from share gains in an otherwise challenging environment.
Our dollar based net expansion rate or <unk> was 120% up slightly from 118% in Q1, and our trailing 12 month net retention rate was 117% up slightly from 115% in the prior quarter.
We continue to experience very low churn of less than 1% and our customer retention dynamics remained strong.
As Joshua stated we had 2800 94 customers at the end of Q2 of which 471 were classified as interest rates those customers with an excess of $100000 of revenue over the previous 12 months enterprise customers accounted for 88% of total revenue on a trailing 12 month basis down.
Slightly from the 89% contribution in Q1 and increase their average spend to $730000 from 722000 in the previous quarter, demonstrating our continued ability to expand our business within our largest customers and our strong customer retention.
Our top 10 customers comprised 34% of our total revenues in the second quarter of 2022.
In line with their contribution in the first quarter of 2022.
Before I begin the detailed discussion of our financial performance, let me step back and take a moment to discuss the changes taking place within fastest financial organization.
As we've discussed since I joined Fastly, one year ago, we've been in the process of transforming our financial team.
Our operations and the management of our balance sheet.
This has resulted in several changes that we believe will not only strengthened <unk> financial position longer term.
But also improve <unk> competitive positioning and its transparency to the investor community.
Let me briefly discuss these improvements.
First we used our strong cash balance to repurchase approximately $235 million of the <unk>.
Principal amount of our convertible debt at a 25% discount to its principal value, resulting in a $54 million gain on this repurchase.
Secondly, we made advance payments for capital hardware of $29 $3 million to suppliers purchase commitments. We had made in early 2021 to reduce our exposure to supply chain constraints.
These advanced payments will reduce carrying costs by over $1 million over the next 12 months.
Pending all our deployment schedule of the commodity equipment.
Third we have improved our capacity planning process with better forecasting and cross functional review to better align capacity investments with expected traffic levels.
We believe this will result in improved gross margins in the medium to long term.
In addition, we now expect our cash Capex for 2022, which includes purchases of PP&E and capitalized internal use software.
Excludes advanced payments for PP&E and repayments of finance leases to decline to a range of 10% to 12% from our previously expected range of 12% to 14%.
Fourth.
We have improved our controls around cost of revenues and made adjustments to our accounting for free developer and charitable organization accounts and recorded a one time Q1 true up to our cost of revenues of approximately 160 basis points in the second quarter.
And lastly.
For the second half we have put in place additional controls around hiring and non head count spending.
As we previously shared our expenses in 2022 were weighted to the first half of the year and with these adjustments we expect second half operating expenses to decline as compared to the first half.
In addition, as.
As we improved our cost controls we experienced some one time true up of costs in the second quarter, primarily in sales and marketing.
I will now turn to the rest of our financial results for the second quarter.
Yes.
Our gross margin was 54% for the second quarter compared to 52, 6% in the first quarter of 2022.
This gross margin is below the flattish sequential level, we anticipated during our last quarterly earnings call.
This is primarily due to a onetime true up to our cost of revenue I discussed above as well as other smaller one time items that had not occurred would have led to an approximate decline of only 50 basis points sequentially.
We realize the optics of this gross margin trend or unfavorable and I want to confirm that we did not see any meaningful decrease in our pricing in Q2 compared to the first quarter.
And our prior discussion on our network investments and the next generation architecture remains intact, and we expect gross margin improvement in the second half.
We continue to expect gross margins increased meaningfully for the remainder of 2022 towards the low to mid fifties.
Operating expenses were $78 6 million in the second quarter up 18% over Q2 2021 due to increased head count across the organization.
Higher than expected salary increases.
Acceleration in T&D expenses.
Increased investment in product and go to market activities and as I previously mentioned certain one time expense items.
We experienced several onetime expense items in Q2, primarily in sales and marketing that we do not expect to repeat in the second half of 2022 a.
A little over half of the quarter to quarter increase in Opex was due to onetime expense items in the quarter.
While we now anticipate operating expenses for 2022 to be higher than we planned at the beginning of the year as.
As we previously stated we still expect expenses to be lower in the second half as compared to the first half.
Our operating loss for the quarter was $26 9 million and our net loss was $28 million or a <unk> 23 loss per basic and diluted share compared to an operating loss of $17 6 million.
A net loss of $17 $4 million.
And a 15 cent loss per basic and diluted share in Q2 2021.
Turning to the balance sheet, we ended the quarter with approximately $767 million in cash cash equivalents marketable securities and investments, including those classified as long term.
During the quarter, we repurchased $235 million in aggregate principal amount of our convertible debt for $176 $4 million or <unk> 75 cents on the dollar before related fees and transaction costs.
Reducing our debt balance to $703 million from $934 million, we will continue to use our balance sheet strategically to capitalize on low risk opportunities that arise in the capital markets. During these volatile periods.
Our free cash flow reflects the impact of the advanced payments on capital equipment commitments of $29 $3 million capital expenditures of $15 million, which includes cash purchases of capital equipment.
<unk> internal use software and payments on finance leases in the quarter, resulting in the decrease in free cash flow to negative $61 million.
Our cash capital expenditures were 11% of revenue in the second quarter.
Capital expenditures include capitalized software.
This along with our foundational technology drives efficiency and leverage in our network, which is a competitive differentiator.
We previously shared that we made commitments for future equipment needs in early 2021 in response to supply chain challenges.
As I discussed previously as part of these commitments, we made advanced payments of $29 3 million in the second quarter.
Making additional advanced payments of approximately $16 million over the next three quarters.
Your availability of this equipment and reduce ongoing Harry in coffees from these vendors.
We expect to take delivery of equipment covered by these commitments and deploy it over the remainder of 2022 and 2023.
These payments will favorably impact our gross margin by reducing carrying costs and.
And we do not incur any operating costs, including depreciation until we deploy this equipment.
And despite our transition to our next generation network architecture and acceleration of some investments due to supply chain constraints as I previously.
As Lee discussed with the benefits from our approved capacity planning processes.
We now expect our cash capital expenditures in 2022 to decline to a range of 10% to 12% of revenue from our previously expected range of 12% to 14%.
I will now turn to discuss the outlook for the third quarter and full year 2022.
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 2022 outlook reflects our continued ability to deliver strong top line growth.
Improved customer acquisition and expansion within our enterprise customers driven in part by new and enhanced products.
Our revenue guidance is based on the visibility that we have today.
And given our usage based business model, we expect to gain additional visibility to our annual guidance as the year progresses.
Historically, our first and second quarter revenues are generally flat with revenues increasing in the second half of the year.
As a result for the third quarter, we expect revenue in the range of $100 million to $105 million, representing 19% annual growth at the midpoint.
We expect a non-GAAP operating loss of 21, and a half to 2018 and a half million dollars in it.
non-GAAP loss per share of <unk> 18 to <unk>.
For the full year 2022, we are increasing our prior revenue guidance by $10 million to a range of $415 million to $425 million, representing 19% annual growth at the midpoint.
We expect our non-GAAP operating loss of $78 million to $72 million and a non-GAAP net loss of 68 to 63 per share, reflecting the impact from lower gross margins and higher expenses I discussed previously.
And to reiterate we anticipate gross margins to improve in the second half of 2022.
Before we open the line for questions, we'd like to thank you for your interest and your support and vastly.
Operator.
At this time I would like to remind everyone. If you would like to ask a question. Please press star followed by the number one on your telephone keypad.
Your first question comes from the line of Frank <unk> with Raymond James Your line is open.
Okay.
Great. Thank you so just to be clear on the gross margins.
If you adding back the charge you took it would've been more like 46, 5% is that correct and then I missed what you said the back half would be.
And does this mean that the upgrade you are doing there is finished in the back half of sort of the full benefit of that or can we still expect gross margins to ramp going into 'twenty three thank you.
This is Ron on gross margin, if you back out kind of the one time activities or adjustments.
Said, we would've been about 50 basis points below where we had sort of guided which was flat. So that would work out on a non-GAAP basis to be around 52% gross margins in the quarter.
Ignoring the one time cost.
As for the technology.
Migration at our largest sites that is on track.
<unk> is one of the drivers in the second half our improved gross margins as we are decommissioning the redundant sites that we put in place as we made this technology migration.
Okay, great. Thank you and can you walk us through the acquisition and just how you expect that to boost your other offerings in the space.
Sure Frank it's Joshua here.
As we've said all along as a platform for platform builders and as an organization that.
Really supports developers that journey doesn't it just start when you are ready as an enterprise to adopt the technology, we have known for the lifetime of our business that that journey starts when you start experiment. When you have a problem at two o'clock in the morning that you can't sleep and Youre trying to solve developers will wake up and they'll try to solve problems.
So for us.
The glitch acquisition is incredibly important because it continues that journey actually drives that journey earlier into the developer lifecycle glitches of tool and as we said it's used by million plus developers who are out there solving problems and really what compute at edge is designed for us to solve problems for these people who build platforms.
Who are delivering platform. So we see it as being very important on the sales journey.
Not only.
That developer moment of inspiration, but that carries through the entire enterprise cycle. So we believe it's going to sort of two main purposes, obviously on the revenue side, but the other thing when you get so many people experimenting with with the tools you actually start to find new use cases and the innovation.
The community starts to become part of that innovation cycle and one of the things that you've seen from the business over the last few quarters and it was really highlighted this quarter is we are delivering theres 14 important releases are are we are accelerating we are getting faster and I'm really proud of the team for <unk>.
That and when we look at our community of millions of people experimenting that only accelerates that so I think it really helps in both areas of the business is very exciting.
Alright, great. Thank you very much thanks, Mike.
Your next question comes from the line of <unk> <unk> with Citigroup. Your line is open.
Hey.
Afternoon, guys. This is mark on for Mark Thanks for taking our question.
So sounds like.
Strong expectations for the balance of the year, but can you give us a sense of the puts and takes and maybe drive results guidance for a second half that you guys are seeing that.
With your confidence for the robust outlook on the top line for the back half, especially in the current environment. Thanks.
Yes, it's Joshua here I think that as.
As we talked about and you look at the enterprise number for the quarter. What we're seeing is largest our largest customers and those that are growing into that that scale.
We are more optimistic or in the middle of these transformations have large budgets and so we're definitely seeing that side of the market for the market, we really focus on continuing to grow and I think when you. When you look at the guidance for the year in the quarter in the next quarter. What you see is it's really off the back of those.
Large customers. So we acknowledge that there is uncertainty across the entire customer base, but we are definitely seeing within our larger more established customers we're seeing more.
Their ability to plan further out and there and the projects that they're working on are central to their digital transformation and what we've seen historically in all of these times of economic upheaval is that people do invest in digital transformation. They do invest in the channels that are working.
And they invest in ways to innovate right now those channels or on the Internet and the innovation is directly related to where the edge cloud provides so much value performance matters security matters and it matters, even more in some of them. It's uncertain times. So I think it's very much related to the momentum in the largest customers thats really.
Why.
We've been able to raise guidance and we continue to see strength in the business, but by no means is it a is it a clear path failing here, we absolutely see that there is uncertainty ahead of us.
Okay, great. Thanks for that and then maybe just moving on to the security business. Thank you for the high level of details, but maybe can we get an update on the momentum of anything quantifiable would be much appreciated whether it's year over year or sequential growth on your assets. There and then just given your 1% increase on the <unk>.
Average enterprise customer spend when can we maybe see some more apparent ramp there to.
On the security business, maybe adoption from our customers. Thanks.
Sure. So on the customer spend side I think that that's a number that you have to look at over a longer period of time, there's puts and takes to that I think overall, we're going to continue to see that go up because as you say as our customers start to and.
And continue to adopt the security offering, but also the compute offerings as well as other offerings. So while we continue to see and I mentioned that with few fortune 500 customers, who have broadly adopted across the portfolio and increase their usage. That's a pattern that we're seeing and that will take some time to flow through I think overall on the security business Ron.
On the fixed.
Specific numbers, but if you go zoom out a little bit and look more broadly what youll see is that momentum is broad we can.
To innovate in that product line, we talked about the introduction of our security labs product, we talked about some of the private really work that we're doing I mean security is very much top of mind for our customers and we continue to see wide adoption one of the encouraging.
Elements for me is how often the next generation Wap platform is being leveraged into our largest accounts across across all of our all of our business units. So from media sort of high Tech for the technology, we are seeing.
Is that absolutely be adopted even in areas where.
Actually when we when we acquired signal Sciences, we werent sure how broad that adoption would be so we have been pleasantly surprised and you can see that from the growth in that particular product offering.
Yeah.
Perfect. Thank you guys so much.
Your next question comes from the line of Rudy Kessinger with D. A Davidson your line is open.
Great guys. Thank you for taking my questions joined a little bit late so I apologize. If you addressed this in your prepared remarks, but when I look at the guide for the year you are taken Rev up $10 million you are taking the operating loss guide.
Down by $10 million, what are the puts and takes I know youre still saying gross margins will ramp in the second half, but if I look at that $10 million op loss reduction how much of that is attributed to the glass attributed to a lower gross margin outlook increased opex spend on product or sales elsewhere, just could you break it down for me.
Sure Ron you want to count.
Certainly.
Couple of drivers here I think first we did see Q2 operating expenses come in higher than we had planned at the beginning of the year. Some of that was driven by increased head count across the organization, which was a contributor to that increased head count across the organization.
We saw higher than expected salary increases acceleration of <unk> and increased investment in product and go to market activities in the first half as.
As well as certain one time expense items. So when you look at the impact on the first half.
We now look or anticipate that operating expenses for the year as a whole will be higher than we planned at the beginning of the year, Although we still expect to see expenses down in the second half from first half.
As we put in place a lot of controls around our spending and hiring levels.
But largely due to that increase in spending from those drivers is why.
Why are we took up the operating loss ranges for the year.
Taking into account recognition of the increase in revenue and from a gross margin perspective, what we still expect to see accretion in the second half Q2 gross margins were lower than we had anticipated beginning of the quarter.
Okay.
Got it and then jump into the gross margins I mean understanding theres, a 160 basis point impact in Q2, it's really only down 50 points sequentially.
But if I take a step back and.
Compared to gross margins in say Q1 of 2020 pre Covid, we were at 57, 6%, a non-GAAP basis, and if I assume signals sciences is still about 80% gross margins.
Basically I would say that the rest of your business is running at about 46% gross margins down about 12% from where you were pre COVID-19.
And then you got some boost later in 2020 on gross margins, but I guess, just with a 12% kind of reduction in the rest of the business.
What else is at play here. Besides the migration of some of your sites and the upgrades going on there and some pull forwards on capex I have to imagine there's got to be some pricing pressure or mix shift in your in your business what else is driving the gross margin compression.
Yes, I mean, the big drivers and we've talked about this through 2021 was an increase in our investments.
Our network infrastructure, both just in terms of investments and overall capacity as well as expansion internationally, and particularly with new international sites. When you initially deploy them.
You are running at less than sort of bulk capacities of those tend to be also a drag on gross margins. So a lot of that was driven by the investments we made in the network over the last a year or 18 months.
Prospectively as we look at the network one because of the investments we've made and two as we continue to improve our forecasting.
We're able to why is that much more tightly with expected traffic and so over time, we would expect capacity and traffic to come much more in line.
And drive improved gross margins.
As that sort of invest ahead of traffic.
It is behind us.
Yeah.
Okay fair enough. Thanks for taking my questions.
Thanks, Rick.
Your next question comes from the line of Jim Fish with Piper Sandler Your line is open.
Hey, guys. This is quentin on for Jim fish. Thanks for taking my questions. Maybe just first enterprise revenue growth to dip slightly compared to Q1. Despite similar enterprise editions as last quarter are you seeing enterprise customers may be slowed down on spend a little bit or take longer to decide on net new spending.
Or was there something else impacting the mix of commercial versus enterprise. This quarter like some of your smaller enterprises, maybe moving into the higher end of the commercial bucket.
Ron you want take that sure.
Sure.
I guess you had a couple of different dynamics around enterprise customers I think when you look at it over kind of the medium term continue to point to one strong business with our enterprise customers.
While on a trailing 12 month basis.
It was down slightly at 1%, 80%, 88% total revenues from 89, we did see an increase in new enterprise customers. This quarter of 2014 compared to 12 in the last quarter and the average spend across our enterprise customers increased from 722700 <unk>.
So we're seeing continued increase in terms of expansion within our enterprise customers.
And seeing some growth in new enterprise customers.
It is clearly a focus to take that growth and enterprise customers and look at how we accelerate that through the work that we're doing in marketing in terms of brand awareness and lead and the development of the sales organization to accelerate that.
Okay. That's helpful. And then maybe last question from US is we've heard from recent reports how the gaming vertical specifically has continued to slow, especially as we move through the summer.
To what extent is this slowdown along with slowing results from other verticals like streaming or e-commerce baked into the rate outlook provided are we assuming things continue to.
Improve in the back half of the year or our current trends embedded into this guide. Thank you.
Brian .
Yes, so as we look at guidance in the second half I would say we look at a couple of things we look at the macro environment and certainly are taken into account what we believe the trends are across the key verticals that we play as well as we look at what is this.
The specific.
Traffic, we expect to gain from our customers.
Do a very detailed review of our customers in terms of what their plans are and as I said, we've seen good expansion within those customers and based on discussions with those customers.
Built out what we think are your traffic levels are traffic shares are likely to be.
And so it really is.
Looking at our business, our traffic levels with our specific customers with.
With recognition that the challenging environment and I think the.
As we sort of said on the call.
We continue to see great expansion, we continue to see new customers.
Challenging environment, given our relative market share, yes that does give us some ability to sort of if you will mute.
Some of the macro drivers.
Your next question comes from the line of will power with Baird. Your line is open.
Hey, guys. This is Charlie Ehrlich on for Baird. Thanks for taking the question.
I just wanted to ask about maybe asking another way that the revenue guidance.
And with further potential.
The growth algorithm are you seeing any sort of shift in <unk>.
Growth contribution from maybe new.
Bookings are new customers added to the platform versus growth from existing customers or has it been pretty consistent because we've heard from others that maybe existing customers are growing faster than new customer growth relative to past periods.
I think we are aware of what we saw in the second quarter.
It was really driven by growth within existing customers and it was a combination of traffic as well as <unk>.
Gaining new types of traffic and new types of business with those customers. So the expansion is really around both delivery and the types of services, where within those customers. We continue to see new customers.
Enterprise customers did increase in the quarter.
We added to our total customer base, but.
Our core dynamic if you look at our business is typically customers that we add in the current year contributed 5% to 87% of our revenue because our customers do typically ramp and contribute and expand over time and I would say that pattern that we've seen in the past is intact.
Okay that makes sense.
Also I just wanted to ask if there was any changes in trends between like April versus May versus June and now that July behind US was there any change in the trend between those months or was it pretty consistent throughout.
Yes, I think what we saw is kind of mirrors kind of what you see from our revenue traffic. We started to see traffic trend up as we got toward the end of the quarter I think that's fairly consistent with our overall pattern Q1, and <unk> tend to be relatively flat we start to see.
Increased revenues.
In Q3.
A further acceleration in Q4.
And so traffic ramped as you move through the quarter with higher traffic in June going into the summer months, where we see the higher levels of traffic.
Got you alright. Thanks.
Thanks Chuck.
Your next question comes from the line of Philip Rigby with RBC capital markets. Your line is open.
Hey, great. Thanks for taking the question wanted to start with a follow up on the guidance. If I look at your guidance it seems to imply a bit of a deceleration in.
For Q.
Is that just pertaining to the uncertainty that you talked about are there other factors or assumptions that play there.
Yes, I'd say its primarily.
Good to kind of the uncertainty I mean, we've taken a strong view that were a usage based business that creates some volatility and so as we build our guidance, we take that into account and certainly.
As to the earlier question, we take into account kind of the macro trends that we're seeing as well as the trends, we're seeing kind of on a macro basis within our own customer base.
Got it thanks.
And then you mentioned.
Increased salaries for employees, but I'm curious.
If I look at where the.
The stock is performing relative to some of the <unk> issuances would be curious to hear your thoughts on stock based comp for existing employees.
Any change.
Changes in philosophy or strategy as you are thinking of taking there any insight would be great. Thank you.
Yes.
Okay. So yes.
No real change in philosophy, I think retaining employees has been really critical particularly in this competitive environment.
We've used a combination of things that we talked a little bit about salary increases in the first half being a little higher than we anticipated and we.
Used a combination of equity and salary to place to be competitive.
Dissipate.
As you look at kind of the changes in the macro economy and the hiring environment.
The competitiveness and the hiring environment to become less competitive rather than more competitive as we kind of see the rest of the year based on where you are seeing.
Kind of the economy and overall hiring statistics.
Which will certainly impact the level of competitiveness in the hiring environment.
Uh huh.
Okay.
Yeah.
Your next question comes from the line of Jeff Van <unk> with Craig Hallum Capital. Your line is open.
Hey, this is Daniel on for Jeff and just a quick question on developers and the traction there and glitch.
Just if you could give us any additional color walk us through you know you said 100000 incremental developers on the platform.
Any sort of sense of the scale of that relative to developing currently.
Pathway or just any other metrics or color you have around developer momentum. Thanks.
Yes, absolutely.
When we when we acquired the platform is around $1 $8 million. So you add 100000 in the quarter you get a sense for sort of how that's scaling one of the things that glitches done exceptionally well it's been very Intel.
Intelligent about how it scales. It's community so instead of sort of opening the doors and encourage everyone to come they've been very thoughtful. This is a team that comes out of building. Some of the best developer led products that the world has ever seen so they understand how that works in one of the things that they've learned is that in order to build an exceptional developer community you need to have.
Exceptional features and you need to be listening to your community early and Iterating. So they followed that model. So what we're seeing is a very consistent growth path. That's what we saw very consistently over their history and that's what we'll continue to see.
Compared to fast lease history.
These numbers are huge I mean, if you look at what we were doing before glitchy was a fraction of this and thats what what's so exciting about about this deal for us as it just absolutely turbocharges our ability to get developers one of the things that was also very.
Important was at 60%.
Or in that range of their of their of their developers really were enterprise developers and so that also was a.
He is a very important metric for us in terms of thinking about where the targets are because we want all developers to use fastly and we particularly want those that work in enterprises to use us.
Thanks.
Thank you.
Your next question comes from the line of Tom Blakey with Keybanc. Your line is open.
Hey, guys.
Thanks for taking the question My question I have a couple of I have a follow up for Ron here, but my first question was on compute at edge and developers as well.
We're at a couple of million dollars almost a couple of million developers now.
Fast and thinking about incentivizing. These developers to work on compute at edge I don't I'm sure not all of them are.
Well versed in that just incentives Darin and also maybe as an illustration.
Joshua like maybe what is that Japanese wind like what are they working on and what is kind of economic opportunity alongside the App development platform. That's my first question sure.
Sure, Yes, it's a great question I think youre absolutely right.
Is it is an area that is novel and new for a lot of developers. So it really starts with bringing making sure those tools are available and giving people the financial.
Leeway in order to experiment. So we talked about a program very successful program that we launched in Q4 and carried through to Q1, and we're still looking at ways, where we can take this idea of taking the financial risk out of it in order for people to experiment and the reason that that's.
Beneficial to take the financial risk out is because it comes back to that question about about use cases is because it brings so much value. So we see customers dramatically reducing their central cloud builds we see customers dramatically improving the performance of their.
Their applications, we see customers.
Like some of the examples we've stated earlier, where the sites are becoming significantly more personalized without playing off.
Consistent theme of I could make it personalized but it is going to make it slow what computed edge brings is the ability to not be making that trade off and those are the kinds of things that we're seeing but it absolutely starts with.
It starts with this idea of experimentation and taking the risk out of it and so that's really what we see and we see a lot of use cases, which speak to.
Together, the unique capabilities of Fastly, and and which really come back to this idea of performance scale and security that's what's central to all of us.
Good answer.
Identify its usage it sounds like you are.
And for Ron on the gross margin sorry, Ron.
The.
On the last call we talked about mid.
Mid $50 for the year and 'twenty two.
Now, it's kind of low to mid <unk>, there's a lot of one timers in here, that's kind of a question I suppose.
And engaging with the percentage of maybe one timers in the second half going to the <unk>.
Second half of 'twenty two.
What are you building fast week for structurally in terms of what gross margins can be sustainable long term 'twenty three and beyond I think that'd be helpful.
Yes, I think Thats a good question and I think what I would look to as.
As referenced earlier, if you kind of look back to kind of the margins, we saw sort of in 'twenty one.
I think theres, an opportunity to get back to those margins as.
As we get some of these one time things behind us.
With the efforts, we've put in place to better align our capacity investments with.
Traffic on a go forward basis, and then I think from there.
And you can see additional accretion over time.
As we add a security grows as a share of that as we add more compute at edge, but I think as.
What I would say, maybe a medium term guideline would be to see kind of where we were in 'twenty, one and that attainable.
Just by getting beyond some of this technology transition that we talked about last quarter.
And managing capacity aligned with traffic and bringing those two closer in line.
Yeah, that's great. So thanks, thanks for the clarity Ron and just as a clarification.
Last question for me is that 10% to 12% Capex comment impressive does that include advanced that can't include the advance payments in <unk> and 'twenty two does it in.
Okay.
Correct. It does not include the advance payments when we take delivery of that and actually deploy it. We will include that in our cash capex.
So that's when we actually take title of the equipment is when we start depreciating. It so as we take deliveries out of that that will be reflected in our cash capex.
We'll take some deliveries from some of those commitments in the second half and so the deliveries against those purchase commitments.
<unk> reflected in that outlook.
10% to 12%.
Cash capex.
That's interesting and maybe it's part of the upgrades that youre, making to the network could you state now that you expect.
That range to kind of be consistent for at least.
For the foreseeable future like 20 years.
I mean, I think generally I think as you look you know absent any sort of.
Other major sort of.
Changes to the product generally I see that as the level I mean, ultimately I think we're getting more efficient in terms of our capital deployment across the network.
And that would be kind of a good sort of medium term guide.
Okay.
Alright, very good thanks, guys.
Thank you.
Thank you.
There are no further questions at this time I'd like to turn the call back to CEO , Joshua Bixby for closing remarks.
Thank you.
Before we sign off I want to thank our employees customers partners and investors.
We remain as committed as ever to fueling and securing digital experiences and moving forward, we remain focused on execution.
Bringing lasting growth to our business and delivering value to our shareholders.
I will remain in my role until Todd joined and I look forward to supporting him.
I want to reassure you that positioning fastly for long term success is my number one goal throughout this process. Thank.
Thank you.
Yeah.
This concludes today's conference call you may now disconnect.
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