Merck & Co., Inc. Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 1, 2024

There are 12 speakers on the call.

Operator

Ladies and gentlemen, good afternoon. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fast Li First Quarter 2024 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. And after the speakers' remarks, there will be a question and answer Thank you.

Operator

And I would now like to turn the conference over to Vern Essie, Investor Relations at Fastly. Please go ahead.

Speaker 1

Thank you, and welcome, everyone, to our Q1 2024 earnings conference call. We have Fastly's CEO, Todd Nightingale and CFO, Ron Kistling 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 3,239 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 ks filing today, can be found in the Investor Relations portion of FASB's website.

Speaker 1

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 ks and quarterly report filed on Form 10 Q filed with the SEC and our Q1 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.

Speaker 1

Also note that the forward looking statements on 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.

Speaker 1

These non GAAP measures are not intended to be a substitute for our GAAP results. Now, I'll turn the call over to Todd. Todd?

Speaker 2

Thanks, Vern. Hi, everyone, and thanks so much for joining us today. First, I'd like to give a quick summary of our Q1 financial results and related highlights. I'll then discuss our revised revenue outlook and provide an update to our go to market initiatives and customer acquisition as it relates to our path forward to drive revenue growth. I will then hand the call over to Ron to discuss the changes in our metrics, our Q1 financial results and our guidance in detail.

Speaker 2

I'm pleased that we reported revenue of $133,500,000 for the Q1, representing a 14% year over year growth and coming in above the midpoint of our $131,000,000 to $135,000,000 guidance range. Our customer growth and retention efforts showed improvement in the Q1 with our LTM NRR at 114%, up slightly from Q4's level of 113% and reversing quarterly declines in this metric since the end of 2022. Our total customer count in the Q4 was 3,290, which increased by 40 7 customers compared to Q4 and by 190 year over year. Enterprise customers totaled 577 in the quarter, a decrease of 1 from Q4. We brought an 18 net new enterprise customers at the $100,000 annual revenue threshold in the quarter.

Speaker 2

This was mostly offset by customers that dropped below this threshold due to seasonality. On a year over year basis, we grew our enterprise customer count by 37. Our gross margin continues to improve and was 58.8% in the Q1, up 3 20 basis points year over year and ahead of our expectations. Our operating loss was $9,700,000 in the Q1 compared to an operating loss of $14,100,000 in the Q1 of 2023. I'm very pleased with this result as our loss was materially better than our guidance of $14,000,000 to $10,000,000 The upside was roughly split between higher gross margins and better OpEx cost control and Ron will share more details with you in a moment.

Speaker 2

Lastly, we posted positive $3,700,000 in adjusted EBITDA and importantly an $11,100,000 positive cash flow from operations. I'm pleased with the continued momentum on operational execution here, especially as it helps us fuel growth moving forward. Now let me discuss the highlights of the quarter. In the Q1, we continued our success in diversifying our logo wins and penetrating new and existing customer verticals. We had amazing wins in the healthcare sector during the Q1 with a leading health solutions company, a major government research agency and a leading imaging provider.

Speaker 2

These key Lighthouse accounts will help us accelerate more customer acquisition in healthcare, drive growth in an important sector and deliver better vertical differentiation to our business. The healthcare industry has always been focused on reliability and performance making Fastly a perfect fit. We continued to penetrate the mobile app market in high-tech. In the Q1, we won Bending Spoons, a leading mobile app developer serving over a half 1000000000 people across the globe. In France, we are now supporting MWM, a top app publisher, which selected Fastly's content delivery and image optimization services to support its AI driven model.

Speaker 2

In the business services vertical, we're proud to announce that a leading customer data platform will be onboarding with Fastly. We also won one of the world's largest realtor companies over 100,000 agents in over 100 countries. It's a great example of how we landed in the real estate vertical with Moxie Works, which we discussed last quarter and we're able to build upon that vertical expertise with this new real estate win. In the Q1, we introduced Fastly Accelerate, a series of in person global events developed exclusively for Fastly's customer network of developers, security professionals and business leaders. The first event was held at our headquarters in San Francisco on April 4th and was widely attended.

Speaker 2

We will be following up with similar events worldwide in 2024 with London, New York and Sydney to follow. Lastly, I'm pleased to announce that Fastly's OHTTP Private Relay won the 2024 DEVY's Award for Best Innovation in Services Application Development. Our solution is widely used in the top web browsers on the Internet to help extend privacy to millions of users and is beginning to find other use cases in privacy and security. In the Q1, we continued to drive focus and investment into platform unification and expansion. We enabled self-service adoption with a universal login feature across our solutions and improved product trials and upgrades platform wide.

Speaker 2

Expanding our platform is key to our platform strategy and that's why I'm so excited for bot management becoming generally available in Q1. Our bot management solution combats automated bot attacks at the edge and significantly reduces the risk of fraud, distributed DOS attacks, account takeovers and other online abuse. This is an important cybersecurity milestone for the company, significantly expanding our security offering. Our DDoS services, best in class WAP and bot management solution make up incredibly tight complete security offering in the web application and API security space. We've already seen significant uptick here and it is great to see both customer expansion and acquisition leveraging this new capability so quickly.

Speaker 2

Security is a great example of innovation velocity at Fastly. Our WAF continues to be highly differentiated with low false positives and a predominance of customers operating in full blocking mode. Our bot management solution was 100% developed in house and is already competing well against the most mature products on the market and there is significant innovation and product enhancement to come. We set up a very strong foundation in 2023 with our newly introduced packaging motion that gained momentum throughout the year. In the Q1 of 2024, we updated Fastly packages by launching observability SKUs, fixed price add ons and enhancements to our packages, especially in security to continue delivering simplicity, value and choice for our customers.

Speaker 2

I'm excited to share with you that in the Q1 we already exceeded all the customer packaging purchases sold in the first half 2023. Our packaging motion gives customers reliable billing and shows their confidence in Fastly by signing up for longer term commitments. Package billing provides predictable pricing for our customers and predictable reliable revenue for Fastly. Additionally, our channel program continues to grow and mature. In the Q1, deal registrations and revenue contribution more than doubled year over year.

Speaker 2

In fact, for the first time, the largest deal in a quarter closed through a channel relationship. Our channel partners continue to have strategic importance in our go to market efforts. Our CRO search has been a key focus this quarter. I'm happy with the progress we've made as we're now in the final stages. We've interviewed numerous candidates to find the right expertise and a balance of operational expertise and the strategic ability to grow and scale.

Speaker 2

I'm pleased that we've narrowed our candidates down to just a handful and we should have a selection finalized within a few weeks. I expect to announce a new Chief Revenue Officer in the 2nd quarter. Now let me turn to address our outlook going forward. Our 2nd quarter guidance of 6% to 9% year over year growth and modified 2024 annual guidance of 12% year over year growth are not where we expected our business to perform and of course are disappointing. Ron will discuss the financial details of this forecast in a moment, but let me first address this outlook and our path forward.

Speaker 2

There are a few factors that contributed to a challenging short term environment. The biggest factor is a reduction of revenue from a small number of our largest customers. The first quarter revenue from our top 10 customers dropped from 40% to 38%. Many of the top 10 accounts run a multi vendor strategy and we did see significant volatility here and there are a few reasons for this. Firstly, historically, Fastly has gradually won greater traffic share in our largest accounts, but with the timing of rate and volume changes, we saw increased volatility this quarter.

Speaker 2

To be clear, we have not been removed from any of our largest customers and we remain in a strong strategic position with each of them long term. Secondly, in some accounts we did see an addition of CDN vendors, a reversal of the vendor consolidation we saw last year. And thirdly, we are seeing a slight uptick from the typical level of rerates with our largest customers. But we have not yet seen the commensurate traffic expansion usually associated with this motion. Very positively, we are seeing continued success with the new customer acquisition motions and notably added 2 very large new logos in Q1, one of which will move into the top 10 over the course of the year.

Speaker 2

We aim to see the long term results of our new customer acquisition motion having an increasing effect on our revenue as the year goes on. Going forward, we strongly believe our strategy is correct and we will remain committed to our focus on growth. We will continue to invest in our customer acquisition and go to market motions. We are shifting the way we engage with our largest multi vendor customers to focus on improving our visibility and driving traffic and revenue share in those accounts. We remain committed to platform unification and expansion, helping us drive cross sell and growth.

Speaker 2

We will continue to drive engineering investment in this effort, coupled with the expansion of our security portfolio with bot management to drive stickiness and wallet share with our customers. As a backdrop to these investments, we will continue to drive discipline in managing our spend with a clear focus on efforts leading to long term growth. In summary, we are pleased with our Q1 performance, but we are not satisfied with our Q2 outlook and 2024 guidance. We're laser focused on revenue growth initiatives, innovation, velocity and customer acquisition. And now to discuss financial details of the quarter and guidance, I will turn the call over to Ron.

Speaker 2

Ron?

Speaker 3

Thank you, Todd, and thanks everyone for joining us today. I'll first discuss changes to our metrics disclosures before turning to our financial results and business metrics. I will then review our forward guidance. Note that unless otherwise stated, all financial results in my discussion are non GAAP based. We continue to focus on sharing the business metrics to provide the most useful information to understand and monitor the progress of our business.

Speaker 3

Beginning with this Q1 2024 release, we have discontinued the disclosure of quarterly NRR, debner, the number of markets and countries and our bandwidth statistics. Conversely, we are now disclosing our revenue by product line between network services, which is our core delivery products offering security, which is our growth offering and other, our emerging products offering, which includes compute and observability products. We have provided a trended 8 quarter history of this revenue in our investor supplement. Because we are now providing revenue from our full security portfolio, we will no longer be reporting Signal Sciences revenue on a standalone basis. Signal Sciences acquired firewall solution has been integrated with Fastly's legacy firewall, which we now refer to as our next gen WAF.

Speaker 3

Our legacy firewall revenue has largely transitioned into the Signal Sciences WAF or next gen WAF. Note that our combined security revenue reflects the impact of the decline in our legacy WAF revenue taking place during that integration. Lastly, as our supplement only includes the trailing 8 quarters, I will provide the revenue breakout for the Q1 of 2022 here in my prepared comments. Network services revenue was $83,900,000 security revenue was $18,200,000 and other revenue totaled $300,000 Turning to our financial results. Revenue for the Q1 increased 14% year over year to $133,500,000 coming in slightly ahead of the midpoint of our guidance range of $131,000,000 to $135,000,000 Specifically, on our 2 largest product lines, network services grew 12% year over year to $106,000,000 and security revenue grew 16% year over year to $24,600,000 dollars In the Q1, we experienced normal seasonal traffic pattern.

Speaker 3

This resulted in a sequential decline in revenue highlighted by expansion in some areas, particularly gaming, offset to a lesser degree by e commerce related traffic and lower traffic at our largest customers. Our top 10 customers comprised 38% of our total revenues in the Q1 of 2024 compared to 40% in Q4 2023, reflecting the impact of lower traffic at our largest customers. Also, no customer accounted for over 10% of revenue in the Q1. Our trailing 12 months net retention rate was 114%, up from 113% in the prior quarter and down from 116% in the year ago quarter. These figures continue to demonstrate our very low churn and healthy customer retention dynamics.

Speaker 3

At the end of the first quarter, our RPO was $227,000,000 down 4% from $236,000,000 in the Q4 of 2023 and down 6% from $242,000,000 in the Q1 of 2023. This decline is primarily due to our largest customers working through the remaining obligations over their contract terms. As Todd shared earlier, we had 3,290 customers at the end of Q1, of which 577 were classified as enterprise, a net decrease of 1 compared to an increase of 31 in the 4th quarter. Enterprise customers accounted for 91 percent of total revenue on an annualized basis in Q1 compared to 92% in Q4 and enterprise customer average spend was $846,000 down 4% from $880,000 in the previous quarter and up 6% from $795,000 in Q1 of last year. I will now turn to the rest of our financial results for the Q1.

Speaker 3

Our gross margin was 58.8 percent compared to 59.2% in the Q4 of 2023. Recall that 4th quarter gross margins were 58.3 percent after adjusting for the one time $2,800,000 take or pay true up payment, reflecting a 50 basis point quarter over quarter improvement. Our gross margin improvement was the result of continued cost control efforts in bandwidth transit costs and related services costs. Operating expenses were $88,200,000 in the first quarter, an 11% increase compared to Q1 2023 and up 5% sequentially from the 4th quarter. While our operating expenses were better than expected due to our continued management of costs, remember that we do see a seasonal increase in our employee costs in the first half of the calendar year to the increased employer payroll taxes.

Speaker 3

This favorability in our operating expenses, combined with slightly better than expected gross profit, resulted in an operating loss of $9,700,000 in the first quarter, exceeding the high end of our operating loss guidance range of $14,000,000 to $10,000,000 In the Q1, we reported a net loss of $6,500,000 or $0.05 loss per basic and diluted share compared to a loss of $10,800,000 or $0.09 loss per basic and diluted share in Q1 2023. Our adjusted EBITDA was positive in the Q1 coming in at $3,700,000 compared to negative $1,900,000 in Q1 2023. Turning to the balance sheet. We ended the quarter with approximately $331,000,000 in cash, cash equivalent, marketable securities and investments, including those classified as long term, up from $329,000,000 at the end of Q4 2023. Our free cash flow for the Q1 was negative $2,200,000 a $19,700,000 sequential increase from negative $21,900,000 in the 4th quarter.

Speaker 3

This increase was primarily driven by an increase in our cash from operations to positive $11,100,000 compared to negative $7,400,000 in the 4th quarter. Our cash capital expenditures were approximately 9% of revenue in the Q1, coming in just above the high end of our guidance of 6% to 8% of revenue we shared on our Q4 call. As a reminder, our cash capital expenditures include capitalized internal use software. For 2024, we anticipate our cash CapEx will be in the 6% to 8% range with deployments to be weighted toward the first half of the year. I will now discuss our outlook for the Q2 and full year 2024.

Speaker 3

I'd like to remind everyone again that the following statements are based on current expectations as of today and include forward looking statements. Actual results may differ materially, and we undertake no obligation to update these forward looking statements in the future except as required by law. As Todd shared in his remarks, we are facing a challenging environment of revenue declines in our largest customers overshadowing the impact of new customer acquisition and product pipeline. Our guidance reflects these dynamics in our business and the visibility that we have today. We expect a flattish to modest sequential decline in Q2 revenues compared to our Q1 results due to lower traffic, specifically at our largest customers.

Speaker 3

We also will not benefit in 2024 from the favorable impact of the CDN consolidation that occurred in early 2023 that drove favorable sequential growth in the prior year same period. For the Q2, we expect revenue in the range of 130 dollars to $134,000,000 representing 6% to 9% annual growth. We continue to be very disciplined in our network investment and cost of revenues, which contributed to our Q1 gross margin being approximately 60 basis points better than we had initially expected. We typically see a seasonal decline in gross margins in the first half with improvement in the second half as we build capacity for peak traffic. For the Q2, we anticipate our gross margins will decrease approximately 130 basis points relative to the 1st quarter plus or minus 50 basis points.

Speaker 3

As we mentioned previously, our Q1 operating loss was moderately better than our earlier expectations by continued cost management and slightly slower hiring. Our 2nd quarter operating results reflect the impact of the seasonal decrease in gross margins and the impact to our operating expenses of higher first half employer payroll expenses. As a result, for the 2nd quarter, we expect our non GAAP operating loss to increase to $16,000,000 to $12,000,000 and our non GAAP loss to be $0.10 to $0.06 per share. For calendar year 2024, we expect revenue in the range of $555,000,000 to $565,000,000 reflecting annual growth of 11% at the midpoint. We expect to continue to see gross margin improvement in 2024 and to continue our spending discipline while increasing our investment in go to market and product development.

Speaker 3

We anticipate our 2024 gross margins will improve by approximately 200 basis points, plus or minus 100 basis points relative to 2023. As a result, we expect our non GAAP operating loss to increase to a range of $28,000,000 to $22,000,000 reflecting an operating margin of negative 4.5 percent at the midpoint, an improvement of over 35% over 2023's operating loss margin of 7.2% and by over 70% over 2022's operating loss of 17.7%. We expect our non GAAP loss per share to improve to $0.12 to $0.06 reflecting the improvement in our operating loss expectations, and we expect our free cash flow to be close to breakeven in 2024 compared to negative $59,000,000 in 2023. Before we open the line for questions, we would like to thank you for your interest and your support in Fastly. Operator?

Operator

Thank you. And we will now begin the question and answer And your first question comes from Rishi Jaluria with RBC. Your line is open.

Speaker 4

Wonderful. Hey Todd, Aaron. Thanks so much for taking my questions. Todd, let me start with you. Last quarter, after the kind of first guide down, you talked about the pricing environment and being relatively kind of in line with how it's been historically.

Speaker 4

It sounds now like there's maybe a little bit more intensifying pricing pressure in spite of the fact that there is consolidation going on as you pointed out and vendors exiting the space. Can you speak to what has maybe changed in the past 90 days in terms of that? And what tools do you have in your arsenal to maybe start to counteract those headwinds? And I've got a quick follow-up for Ron. Thanks.

Speaker 5

Yes, I appreciate the question.

Speaker 2

I think in the general market, I would say the pricing trend that we had been seeing sort of continues. But what we saw in our top 10, 15 largest accounts, we saw some or slightly more kind of pricing pressure than we're used to. And that's got an outsized impact for us and we are trying to make sure that we're doing the right adjustments to our projection based on that. Usually with these kinds of pricing changes, we see a commensurate volume increase as well. And we still hope to see that, especially in some of these key accounts, but it's really in that high in the large, primarily media accounts we're seeing a little bit more pricing pressure than normal.

Speaker 2

The rest of the market, I still feel pretty confident in the pricing. Trends have been pretty good. Anything you could add there, Ron? No,

Speaker 3

I think the period of more we saw more modest rerates historically. I think that continues across kind of the broad market, but we have seen a change in the largest accounts.

Speaker 4

Okay, got it. That's helpful. And then Ron for you, when I look at the investor supplemental, you talk you're highlighting now RPO as a metric. Can you maybe speak to why this is now a more relevant leading indicator, especially given you still do have a good amount of the business on kind of consumption that isn't pre committed? And what we should be making of the fact that RPO declined sequentially and then even more so year over year?

Speaker 4

What needs to happen for that to kind of return back to more healthy levels? Thank you.

Speaker 3

Yes, that's a good question. First and foremost, over time as we start to see more and more of the business packages, see that momentum gain, As Todd mentioned on the call, we saw more packages in Q1 than we saw in the full first half of last year. Those will be additive. So over time, it will be a better indicator of our business. And as it grows, it's also going to reduce some of the volatility that we've seen particularly in the first half of this year.

Speaker 3

In terms of the decline, 1st and foremost, I really look at it kind of on a year over year basis. A lot of our customers do have annual commit, but some of our largest customers do have 2 year contracts. And so what you're really seeing is some of our largest customers who have multiyear contracts, as they sort of burn through that ahead of their renewals, is creating some headwinds or declines on a year over year basis in the RPO.

Speaker 2

I'll just add this. I think the reason I do believe that's a good metric for us to start looking at and it will become more and more relevant over time is that for the packaging transition will start to hit. We're seeing more and more of our large enterprise and even midsize enterprise accounts engaging on packaging and that impact is going to be shown on that line as we move forward.

Speaker 4

All right. Wonderful. Thank you, guys.

Operator

And we will take our next question from Frank Louthan with Raymond James. Your line is open.

Speaker 6

Great. Thank you. First, just to kind of clarify on the guide. Last year at the Analyst Day, you guide to free cash flow breakeven for the year. Is that still attainable?

Speaker 6

And then, Dodd, you mentioned the shift in the engagement approach to customers. How long is it going to take to train the sales team on this engagement shift and when can we see that turn into higher growth in net retention rate? And then what gives us the confidence in the strategy here versus where you were in mid February and the market clearly was different? What have you learned in that last few weeks that tells us the path and the guide are going in the right direction?

Speaker 3

Yes. On the free cash flow, I think we're continuing commitment to managing our expenses in line with our revenue outlook. As I mentioned in the prepared remarks, this does create some headwinds, but we expect to be very close to breakeven for 2024 on our free cash flow.

Speaker 2

As far as the large account management and large account engagement, look, I think that's incredibly important question for us right now. And look, I believe you have to react to the reality of the market and you have to react with real conviction and real speed. And that's what we're doing right now. The top 15 or 20 accounts at Fastly, they carry a lot of our revenue and the way that we engage with them, the way that we drive platform like product line penetration, the way we drive price control and discount control, the way that we optimize their performance and drive a more significant and complete technology solution. I believe we have an opportunity in all of those categories to improve the way that we engage and dedicate more resources and more focus to it.

Speaker 2

And that's exactly what we're doing. Right now, we have already launched a new engagement model. We're driving a far higher touch across all of those major accounts. We've been running it for a couple of weeks now and we're, I'm pretty happy with the progress so far. But, just looking at the, where our projection is for those accounts and how much it's changed in just 1 quarter.

Speaker 2

Like you said, since last February, I think decisive change in our engagement model was warranted and that's exactly the transition that we're undergoing right now.

Speaker 6

And and you've been doing this for 2 weeks and that's and and now and you think that you've got the right formula or it's just gonna take

Speaker 1

a little longer to evolve? How should we about it?

Speaker 2

I mean, look, I think we're gonna be evolving that formula for quite a while, but I think we have the right resourcing on it now. We have deployed a lot of resources, a lot of the most significant resources into that effort very quickly and I'm happy with the progress so far.

Speaker 6

Okay, thanks.

Operator

And we will take our next question from Madelyn Brooks with Bank of America. Your line is open.

Speaker 7

Hi, team. Thanks so much for taking the question. Todd, I guess this is more so for you. If we look at the back half of the year and if we look at your guide, we're going down 7.5% growth for Q2 and then there's reacceleration in the back half of the year to 12% growth. What's giving you the confidence in that right now?

Speaker 7

And additionally, too, if we look into Q2, what about Q2 is driving so much of the volatility?

Speaker 2

Yes. As I look at the second half projection and Ron can add color on this as well. We've got ramping customers and new customer acquisitions been strong. We have been able to move the needle there. We're seeing those revenues ramp and new customers being added to the platform.

Speaker 2

And so I can I think we've got pretty high conviction that we're going to see that revenue materialize in the second half? The weakness and the shift in the projection from last quarter to this quarter is really in those large accounts and it's why we've changed our engagement model with them so significantly. But the reason really comes down to that. We've seen a little bit of a pullback in the vendor consolidation trend and that's reversed and we see some folks even adding an additional vendor here and there and we see a little more pricing pressure up there and that has those are large accounts for us and has a large impact.

Speaker 3

The only thing I would add on the acceleration.

Speaker 7

Yes.

Speaker 3

Go ahead.

Speaker 7

Go ahead. The only

Speaker 5

thing I

Speaker 3

would add on second half acceleration is typically we do have seasonality in the business that we historically have about second half tends to be up about 10% or 11%. So when we took a look at the second half, we looked at where the business was in Q2. And as Todd mentioned, a number of new customers that we've signed and we believe that seasonality that we've seen is intact coming off of the dynamics we're seeing in the Q2.

Speaker 7

And then maybe just a quick follow-up to you. As those customers ramp, understand

Speaker 8

what's going on with

Speaker 7

customer acquisition. But if we just state in Or do you think we should expect and model declines in that Or do you think we should expect and model declines in that cohort through the end of the year just given the trends that you're seeing in the market now?

Speaker 2

Yeah. I mean, we are I think our projection is relatively conservative. I believe we're going to see traffic levels come up and we're going to find some success in recovering revenue

Speaker 8

in those large

Speaker 2

accounts. We're signaling the guide here because obviously there's a new projection and we want to reflect that. But look, I believe there's an opportunity for us to beat that projection and reverse not just stop the decline, but really reverse the trend in the second half.

Speaker 7

Great. Thanks so much.

Operator

We'll take our next question from Fatima Boolani with Citigroup. Your line is open.

Speaker 8

Hi, good afternoon guys. This is Mark on for Fatima. Thanks for taking our question. Maybe just to kick off on the package and bottling uptake, can you maybe just give us a sense of penetration in the base currently and the impact on from a new level acquisition pipeline build standpoint? And then understand that packaging is designed to really deep variability and improve the visibility on revenues.

Speaker 8

Can you maybe just quantify in any way how it's showing up in the revenue predictability today? Thanks.

Speaker 2

Yes. Look, I think in the long run, the channel engagement will help us drive customer acquisition through deal registration. And we're starting to see some effect of that broadening significantly beyond where our channel was strong a year and a half ago, which was really just in the security portfolio. We're seeing the channel engaging across the board. This past quarter, our largest deal closed, our large new booking closed not just through the partner, but also on the packaging solution.

Speaker 2

And so I think the both of these trends are helping not just in the mid size and small accounts, but in large accounts as well. So we've had, I think, some real success on the channel growth and the importance of the channel on the go to market. The packaging has, I think, in large part helped us move more quickly, bringing new customers to the platform, especially midsize and large traditional enterprises to the platform. It has a very kind of attractive feature of sort of a no overages model for those customers. It gives them very predictable billing and it really gives us much more predictable revenue, which has been a great has had great impact so far.

Speaker 2

I'm pretty happy with both of those. And I think it we're doubling down on both of those initiatives. And really that's a big part of this kind of initiative across the board where our biggest focus is on revenue growth and driving that revenue growth back up into the 20s where it really should be.

Speaker 8

Got it. Okay. Thank you for that. Maybe just a quick follow-up. Maybe just to touch on some of the recent regulatory that one of your large social media customers seeing.

Speaker 8

Can you give us how you're thinking about that logo and the impact of the business overall? And is this also reflected in your updated guidance?

Speaker 2

I'm sorry, you broke up a little bit. Could you repeat that Mark?

Speaker 1

I know you're asking about a restructuring of the social media customers, is that what you said?

Speaker 8

Oh, no. Can you hear me now?

Speaker 3

Yes, much better.

Speaker 8

Okay, great. Now I just wanted to touch on some of the recent regulatory scrutiny that one of your large social media customers see. Just wanted to get a sense of how you're thinking of that logo and the impact on the business? And is it also reflected in your updated guidance? Thanks.

Speaker 2

Yes, completely. And thanks for repeating the question. For sure, I think 1st and foremost, we are fully committed to supporting all of our media customers through any sort of transition they happen to be having in this case that you're referring to, Should there be any sort of transition or significant transition there, we're doubling down on being able to support them and support them through that transition. However, it may come to life. But our engagement with that account has been super strong and we're pretty positive on the way that will shake out any way you slice it.

Speaker 2

We are of course modeling some risk in here, but I'm pretty confident in the path forward.

Operator

And we will take our next question from James Fish with Piper Sandler. Your line is open.

Speaker 5

Hey, guys. Maybe the best way to ask this one, Ron, for you, is Dydney now set to the minimum contract levels you guys haven't completed? Or what are you assuming for those customers that you're seeing the issues with? And per our discussions, you said you really weren't seeing any large renewals like your competitor your main competitor was year. Are you just seeing that earlier now just because you saw more volumes than anticipated and so that moved up or walk you through that?

Speaker 3

So I think if you look at each customer, I think you look at the large customers, there are different dynamics in each one. And within their multiyear commit, the amount of traffic that they're running, in some instances, as Todd spoke about, we did see some pricing changes that were not accompanied with traffic increases. Our renewal is sort of spread across the year. And then secondly, we did see some of our largest customers where they added in an additional CDN that reduced some of our traffic levels at those customers. And so those were the dynamics.

Speaker 3

Each one is a little bit different, but it was really a combination of some pricing changes, traffic share with increasing the number of CDNs at some of our largest customers.

Speaker 5

Right, Ron. But my question is more, look, you guys tend to have RPO doesn't reflect this to Rishi's earlier kind of question, where RPO won't include essentially the minimum contract levels that you guys have. I think historically you guys have had roughly 80% visibility to any given year just on those minimum contract levels. So as we think about this kind of revised guide, I guess how much above like minimum contract level are you guys having that we're not going to be sitting here in another 90 days saying why is Taply dropping guide again?

Speaker 3

Yes. I guess, 2 things to clarify. I mean, when you look at our largest customers, while some of them do have commitment, a significant portion of them are utility based, not commitment based. And so that's I guess that's not reflected in the RPO when there is not an underlying commitment on the customer contract. And so you're going to see a mix of customers that do have a commit and customers where they don't.

Speaker 9

Even in

Speaker 3

the cases of commit, the customers may be running traffic above that consistently. And so we are still predicting it. We're forecasting it based on a level of traffic or utility basis.

Speaker 2

Slightly broader lens, I think look, it's fair to say that we've seen some more rerates in our largest 10 or 15 accounts in this past quarter. And I take your point on the competitive messaging we've heard. I think that is a fair point.

Speaker 5

I'll say I've got high

Speaker 2

confidence in the adjusted guide here because I think we've shook through that largely and we're really moving back to the path of growing those accounts and expanding not just the volume we see, but the product penetration in those accounts as well.

Operator

And we will take our next question from Tim Horan with Oppenheimer. Your line is open.

Speaker 10

Thanks guys. Sorry to hammer on the same topic here. But, so maybe when you mentioned like multiple products, like what else is in that network services revenue? Like how many of those how many different products do you have in there? And what are you typically selling to customers?

Speaker 2

Yes. So on the network services side of the house, we sell services around, obviously content delivery, which includes both video streaming and full site delivery and replication around the world. We sell it different kinds of technology in terms of image optimization and live events and streaming and live event monitoring, rate reservations, etcetera. When I talk about product penetration across the platform, though, I'm talking about expansion into security, expansion to observability and largely and starting to really gain traction expansion into compute as well.

Speaker 10

Well, and thanks for the revenue breakdown. But I mean it looks like compute is only 1% of revenue and is observability in network services or is that in a different category?

Speaker 2

Observability falls into other.

Speaker 10

Okay. And one of your largest competitors last quarter said they were going to bundle really aggressively with compute. They kind of implied they were going to use price on CDN to win customers back. I mean, are you seeing them pull back on that at this point? I mean, it would seem like that would last for a year or 2 if they're going to make comments like that and pursue that strategy.

Speaker 10

Are you seeing them pull back? Or do you think your quality at this point is such that your core customers are not going to be impacted by what they do on the pricing or bundling front?

Speaker 2

The largest customers, I don't think they're going to be impacted on the pricing front there because it is these are high-tech customers that are deeply engaged in the performance, the service level, the reliability especially. And there's I think the customers are extremely mature and there's only so much sort of pricing flexibility that you can deploy in an account like that. We are super aggressive, not just on the performance, but on the pricing as well in those top 10 accounts. And again, I think we're driving a new level of engagement in those accounts to really return that cohort back to growth. But I do think that bundling has real potential, stronger bundling down market.

Speaker 2

And if anything on the competitive front, that's where I've seen some success. We are also with our packaging solution getting more aggressive in bundling and we've seen success there as well.

Speaker 10

But I guess to be fair, I mean Akamai has they're going after basically legacy virtual machine workloads and legacy storage, which is a huge market. And if they could price that down, would that impact customers' decision on the core on your like core network services business? Or do you think that's like not enough to make customers move back to Akamai or somebody else?

Speaker 2

I think customers who are moving to Fastly are looking for sort of next gen solutions, serverless compute, edge storage, the type of technology that we're delivering. Moving back to sort of legacy virtual machines, I don't see that as being compelling. I do think though there's real opportunity on the compute side. I wouldn't discount it because it's currently small. It's growing quickly.

Speaker 2

It has extremely it drives extremely high stickiness with accounts. Our compute customers have very high customer sat. We're pushing on that business very hard because it works so complementary with our CDN business. It helps drive both sides of our customer engagement there.

Operator

And we will take our next question from Rudi Kessinger with D. A. Davidson. Your line is open.

Speaker 11

Hey, thanks for taking my question. So I just want to understand, I mean, you guys gave that guide halfway through Q1. When exactly in the quarter did these customers start re pricing contracts and adding other CDNs and moving share, etcetera. And with these repricings, I guess, you guys just have no control over it whatsoever. They just ask for repricing.

Speaker 11

Got to do it within a couple of days. I mean, I just don't understand how 3 months ago, you told us you didn't have any large repricing expected. And now it turns out you did within a 6 week timeframe.

Speaker 8

Yes. I think a couple

Speaker 3

of things. I think in terms of the dynamics that Todd spoke about both in terms of the pricing, a lot of that arose really at the end of March and in early April when the we saw, 1, the motion

Speaker 5

of some of our customers

Speaker 3

kind of reversing their trend to consolidating on CDNs, which affected our traffic projections for the year. And then as we engaged in some of the rerates that we knew were coming, those negotiations resulted in bigger discounts than we thought that did not come with the typical increase in traffic that we've seen historically. And so those were the big drivers. I would say the timeframe really was late March, early April when we saw these different dynamics, but all affecting some of our largest customers that have an outsized impact on our revenue outlook and growth rate.

Speaker 11

Okay. And so is it the larger than expected pricing pressure, I guess it would go against the conventional wisdom when several of the smaller low cost vendors have exited the space over the last 6 months. And so what just any thoughts on why you had to concede so much on price with less traffic growth than typical given there's fewer competitors, fewer low cost competitors in the space? And then lastly, Ron, just what level of visibility do you have to second half revenue? Like what percent of that second half implied second half revenue guide is actually the minimum commitment?

Speaker 2

Yes. I'll take the first half. I think look, I think it's a fair question. We did see the pricing and traffic projections change a lot at the end of the quarter, beginning of and the beginning of this quarter, Q2. But I think it's I think an important piece of this is, look, there's a small number of accounts where we had where our revenue projection has pulled back.

Speaker 2

And those are large accounts that have very significant swing and they need to be handled and managed and optimized very specifically. It's why we're changing our motion there. And look, I believe we have an opportunity to move back to growth in those accounts, but our projection reflects where we currently are.

Speaker 3

Yes. The only thing I would add on the second part is, while again, a significant portion of our business is on a utility basis, The largest accounts had their pricing and or these adjustments in traffic in March April. And so our outlook reflects those activities that occurred in those largest accounts. So the variability in the smaller accounts should have less volatility as we move through the year.

Operator

And we will take our next question from Jeff Van Rhee with Craig Hallum. Your line is open.

Speaker 9

This is Daniel on for Jeff. You referenced earlier the volatility with some of the larger customers. Can you just expand on that in terms of volatility? Volatility is a term referencing some one time changes or some quarterly changes just into this quarter or just sort of what did you mean in terms of some of the volatility?

Speaker 2

Yes. We had a couple of accounts in that very large set that negotiated rerates in the past quarter. Usually a rerate like that would come up, would come with like a commensurate volume increase and we tried to model that very carefully, but our projection there was a little bit aggressive, I believe. And we have seen this trend towards which we saw a strong trend last year towards vendor consolidation as folks with 5 or 6 CBN vendors consolidate all the way down to 2 or 3. We saw a little bit of pulling back there and people adding a vendor here or there.

Speaker 2

And those two trends caused some volatility, which affected our projection.

Speaker 9

And then just a second for me. 1, I believe earlier when you were asked about the assumptions contemplated in the guidance and just with the top 15 customers, what sort of is baked in, in terms of the traffic levels. Let me just read you back and see if I got that correct. With the notion that you expected you were modeling in for those traffic levels to stay flat from Q2 into Q3 and Q4, although you actually thought that was conservative. You thought it could actually tip up from Q2.

Speaker 9

Is that correct? And what would you think would drive those to actually go back up somewhat here in Q3 and Q4?

Speaker 2

What we're modeling all the time is sort of the seasonality of our traffic patterns, but I believe we have an opportunity to increase the revenue and the wallet share at those large accounts by demonstrating superior performance, showing and demonstrating the ROI of using Fastly more clearly and expanding the product portfolio that those accounts use. And so it's why I think it was so pertinent for us to really change our engagement model and move very quickly here to react to what we're seeing in the market. That's why we're pushing so hard on that right now.

Speaker 9

Thanks for taking my questions.

Speaker 3

Thank you.

Operator

And ladies and gentlemen, that concludes our question and answer session. I will now turn the conference back to Mr. Todd Nightingale for closing remarks.

Speaker 2

Thanks so much. I want to thank all our employees, our customers, our partners and our investors. We remain focused on execution, bringing lasting growth to our business and delivering value to all of our shareholders. Thank you so much for your time today.

Operator

Ladies and gentlemen, this concludes today's call and we thank you for your participation. You may now disconnect.

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Merck & Co., Inc. Q1 2024
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