Fastly, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter ended June 30, 2019; comparisons are with Q2 2018 unless noted. Fastly operates an edge cloud platform, with revenue primarily tied to customer usage. The company completed its IPO on May 21, 2019.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Revenue | $46.2 million | $34.4 million | +34% |
| Gross profit / margin | $25.4 million / 55% | $18.8 million / 54% | Margin +1 percentage point |
| Operating expenses | $37.1 million | $24.2 million | +53% |
| Operating loss | $(11.7) million | $(5.4) million | Loss widened |
| Net loss | $(15.6) million | $(5.8) million | Loss widened |
| Net loss per share, basic and diluted | $(0.26) | $(0.24) |
For the six months ended June 30, revenue was $91.7 million, up 37%; gross margin was 56%, versus 54%; operating loss was $19.8 million, versus $14.4 million; and net loss was $25.3 million, versus $15.1 million. Q2 growth was accompanied by faster growth in operating expenses, particularly general and administrative costs, which more than doubled year over year.
Cash flow and liquidity: For the first half, operating cash used was $15.6 million, compared with $12.6 million in 2018. Investing activities provided $5.1 million, primarily reflecting net sales of marketable securities; financing activities provided $187.1 million, mainly from the IPO. At June 30, cash and cash equivalents were $213.5 million and marketable securities were $32.2 million. Management said available cash, credit facilities, and operating cash flows were expected to cover anticipated working capital and capital needs for at least 12 months.
Debt: Balance-sheet debt at June 30 was $50.7 million, including $32.8 million current and $17.9 million long term. On July 8, 2019, Fastly repaid the $20.0 million second-lien facility and closed it. The repayment occurred after quarter-end. The company reported compliance with debt covenants at June 30.
Other metrics: Fastly had 1,627 customers and 262 enterprise customers at June 30, versus 1,529 and 190 a year earlier. Enterprise customers accounted for 86% of trailing-12-month revenue. Dollar-Based Net Expansion Rate was 132.3%, down from 139.1%. International revenue grew 81% in Q2 and represented 30% of revenue, versus 22% a year earlier. The 10 largest customers contributed 30% of trailing-12-month revenue, down from 35%.
Material changes and notable items
- Fastly raised $192.5 million net in its IPO, sold 12,937,500 Class A shares at $16.00 per share, and converted preferred stock into Class B common stock.
- Class B shares carry 10 votes per share; the filing states Class B holders held approximately 98.4% of voting power at June 30.
- Gross margin improved modestly, which management attributed to better platform optimization. Cost of revenue rose with traffic, bandwidth, colocation, staffing, and network investment.
- Sales and marketing and research and development expenses increased with headcount and investment. General and administrative expense also reflected higher personnel and professional-service costs and transaction taxes, including comparison against a prior-period reserve release.
- Topic 606 revenue guidance was adopted January 1, 2019 using the modified retrospective method. It produced a $5.7 million opening equity adjustment for deferred contract costs; management said adoption did not materially affect revenue.
Outlook, risks, and contingencies
- No specific revenue, earnings, or margin guidance is provided. Management expects operating expenses to continue rising and capital expenditures to increase in absolute terms, and says infrastructure investment could pressure margins and near-term profitability.
- The company has incurred operating losses and negative operating cash flow since inception and reported an accumulated deficit of $165.8 million at June 30.
- Key business risks include customer usage reductions or churn, pricing and competitive pressure, dependence on enterprise customers, service interruptions and cyberattacks, capacity constraints, and the cost and execution risks of international expansion.
- Fastly disclosed that its disclosure controls and procedures were not effective at June 30 because of a material weakness in internal control over financial reporting. The weakness related to insufficient qualified accounting staff, GAAP application, segregation of duties, and controls over close and reporting. Remediation was underway; management nevertheless stated the financial statements fairly present the company’s position and results in all material respects.
- Debt is secured by substantially all assets other than intellectual property and includes financial and revenue covenants. The filing identifies routine legal matters but no proceedings expected to have a material adverse effect; indemnification obligations can be uncapped, subject to insurance and contractual terms.
Important facts for investors to verify
- Whether customer expansion and usage growth can sustain revenue growth as DBNER declines and enterprise customers remain a large revenue source.
- Whether expense growth, network investment, and capital spending can be managed while improving profitability and operating cash flow.
- The effect of the July 2019 $20.0 million debt repayment on cash, interest expense, and remaining debt and covenant obligations.
- Progress and effectiveness of remediation of the material weakness in financial reporting controls.
- Potential dilution and governance implications of equity awards, post-IPO share sales, and the high-vote Class B stock structure.