Q4 2022 Fastly Inc Earnings Call
Yeah.
Good afternoon.
My name is David and I'll be your conference operator today.
At this time I'd like to welcome everyone to the Fastly fourth 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'd like to ask a question. During this time simply prestige Starkey followed by the number one on your telephone keypad, if you'd like to withdraw your question Press Star one once again.
You burned Etsy Investor Relations at Fastly. Please go ahead with your conference.
Thank you and welcome to everyone to our fourth quarter and full year 2022 earnings conference call.
<unk> CEO , Todd Nightingale, and CFO , Ron Kisling with us today.
The webcast of this call can be accessed through our website <unk> dot com and will be archived for one year.
Also a replay will be available by dialing 870, 702030, and referencing conference I'd number 7543239 shortly after the conclusion of today's call.
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 fastest 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.
For further information regarding risk factors for our business, which refer to our most recent quarterly report on Form 10-Q filed with the SEC and our fourth quarter 2022 earnings release and supplement for a discussion of the factors that could cause our results to differ please.
Please refer in particular to the sections entitled Risk factors, we encourage you to read these documents.
Also note that 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.
Reconciliation 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 first quarter. The Raymond James 44th annual institutional Investor Conference in Orlando on March 6th.
And the Morgan Stanley Technology Media and Telecom conference in San Francisco on March eight.
And also Mark your calendars for our Investor day, taking place on June 22nd at the New York.
<unk> stock exchange.
With that I'll turn the call over to Todd Todd.
Got it.
Thanks, Brian .
Everyone and thanks, so much for joining us today.
First I'll give a quick summary of our financial results and fourth quarter highlights and then provide a brief update on our product strategy and go to market motion I will then hand, the call over to Rob to discuss the fourth quarter and annual financial results and guidance in detail.
We reported record fourth quarter revenue of $119 $3 million, which grew 22% year over year and 10% quarter over quarter.
Included in this revenue is $3 3 million take or pay true up payment materially above a similar $973000 true up payment from Q4 of last year.
Correcting for these nonrecurring payments, our revenue would've been $116 $1 million growing 20% year over year.
We reported 2022 revenue of $433 million up 22% year over year.
I'd like to congratulate the fast the team and closing out a strong Q4, however, as I said last quarter I still believe that remains an opportunity for us to outperform this level in 2023 and beyond.
Our customer retention and growth engine remains strong our LTM at <unk> was 119% in the fourth quarter up from 118% in Q3, and our Governor was 123% in the fourth quarter up from 122% in Q3.
Our average enterprise customer spend was $782000, representing a 3% quarter over quarter increase and continues to demonstrate the success of fast these land and expand approach and strategic accounts.
In the fourth quarter, we saw continued momentum in our portfolio expansion strategy with strong cross selling activity just as we discussed last quarter and had multiple follow on sales for our next Gen. <unk> technology. In addition, we had multiple new logo wins for this product as a standalone sale.
We anticipate over time have any opportunity to sell these customers our network service delivery as well as our edge compute and observed ability features.
I'm also excited to share with you that we are gaining traction across multiple verticals.
Fourth quarter, Mark six new logo wins and travel and leisure vertical that is more and more focused on the digital user experience. This is highlighted by one of the world's largest corporate travel management platforms moving to Fastly.
We complemented this with four new logo wins in healthcare and life Sciences highlighted by our first win at Mckesson.
Our total customer count in the fourth quarter of 2958, which increased by 33 customers compared to Q3 <unk>.
Enterprise customers totaled 493 in the quarter, an increase of 11 <unk> compared to Q3.
Our gross margin was 57% for the fourth quarter, representing a 340 basis point improvement quarter over quarter.
I am very pleased with this outcome and I believe it underscores our new cost control rigor and discipline.
We found savings with continued increases in peering and improvements in network optimization, coupled with improved hardware maintenance costs.
We will continue to be focused on margin improvement through 2023.
In the quarter, we were also able to reduce our hardware purchase commitments by over $10 million, reflecting our increased platform efficiency.
Cost of $2 million.
This $2 million cancellation charge impacted our cost of revenue this quarter, but we believe it will support our margin improvement trajectory moving forward and reduce our cash spend.
Excluding the impact of this $2 million payment and the take or pay true up payment I discussed earlier, our gross margin would've been 57, 5% in Q4, increasing 390 basis points from 53, 6% in Q3.
Yeah.
During the quarter, we continued to drive our durable innovation strategy and released powerful important technology to our customer base and all of our product lines.
Election of them are listed in our Investor supplement for you referenced and a few highlights include one we achieved PCI certification with the level and service provider expanding our e-commerce customer reach and making it easier for e-commerce customers to onboard fastly.
Two are driving script SDK for compute at edge when G E offering unmatched initialization performance further differentiating the ability for fastly to provide among the fastest lot of times in the industry. We believe this is a big step forward for developer adoption.
Three our faculty Nextgen WAF now supports automated provisioning and management via Terraform for a cloud based deployment option and.
And for <unk>.
As we continue to see advanced Bot and Ddos activity, we expanded our nextgen WAF advanced rate limiting Walsh.
Okay.
Security is top of mind for all of our customers. So we are excited that for the fifth year in a row vastly nextgen WAC has been recognized as our customers choice and the Gartner peer insights voice of the customer cloud web application and API Protection report.
Lastly is the only vendor to receive this recognition for all five years, we're especially proud that customers gave faster than overall five out of five stars the highest of any vendor and 97% said they are willing to recommend it to others.
In keeping with our continued support of our developer community and strong user base, we were happy to bring back our altitude user conference live in New York City in November .
15, keynote speakers, including multiple customers at the conference.
Most of the conference are now publicly available.
Also at altitude, we relaunched our open source a non-profit program fast forward with a renewed focus on building community among the builders and maintain a faster safer and more inclusive internet.
Yeah.
Our developer community continues to grow through our addition of glitch.
It's been less than a year since we acquired their team, but the results. Thus far have been impressive with over 2 million developers.
Community is already starting to drive our compute roadmap and early adoption.
Yeah.
And now I'd like to share my thoughts on my first six months.
I remain incredibly impressed by this team and its potential.
Absolutely, it's an amazing culture and a talented employee base. The team here is passionate about every customer passion about the technology, we built and most importantly, passionate about our mission to make the internet a better place where all experiences are fast.
Safe and engaging.
There is tremendous opportunity in Fastly is an edge cloud platform delivering cutting edge digital experiences for everyone everywhere.
We believe we have an amazing opportunity to achieve our goal to become a more complete one stop shop for the edge cloud delivering a more complete experiences for our developers and for our users.
We have a real opportunity to run a high velocity low friction go to market motion of fascinate, reaching more customers and on boarding them more efficiently.
I'm excited with how the teams have realigned for FY2023 to put the customer first and run a more focused more efficient sales motion.
I've also been pleased that we're making progress to simplify our packaging as we ready our package offerings for the second quarter to streamline customer acquisition and success and provide our edge cloud platform services with reliable billing.
Renewals and a more complete simple offer.
Yeah.
The progress driving gross margin correction has been amazing.
I'm incredibly impressed by our team and we remain committed to ongoing gross margin improvements and continue our efforts to make progress in building a more financially stable faster.
When we look to 2023, we are guiding to 16% revenue growth. There are many uncertainties out there, but I believe fastly is well positioned to outpace the market gain.
Gaining market share through customer acquisition and portfolio expansion is key to our strategy and that is exactly where we are aligning our efforts.
Additionally, I remain committed to meaningfully reducing our operating losses in 2023, both in percentage and dollar amounts.
Let me close by saying I'm very excited about the opportunity here, our customers have a real passion for pathway solutions and our employees have a real enthusiasm for fastest meshing.
Of course, there is plenty of work to come and I'm excited about the road ahead.
But most of all I believe digital experiences will redefine the success and drive the mission of almost every organization everywhere and fast we will have a significant impact on the way digital experiences are built and delivered around the world.
I look forward to sharing more with you regarding our progress are focused on fueling growth our customer acquisition and our velocity of innovation in the coming quarters and at our Investor Day in June .
And now to discuss the financial details of the quarter and guidance I will turn the call over to Ron Bryan.
Thank you Todd and thanks to everyone for joining us today I will discuss our.
Our business metrics and financial results and then review our forward guidance note that unless otherwise stated all financial results in my discussion of our non-GAAP based.
Total revenue for the fourth quarter increased 22% year over year to $119 3 million exceeding the top end of our guidance of $112 million to $116 million.
As Todd explained included in this revenue amount is a $3 3 million dollar customer take or pay true up payment.
As Todd mentioned earlier, excluding this true up our revenue would have been $116 1 million, representing 20% annual growth and 7% sequentially.
In the fourth quarter revenue from Sigma Sciences products was 12% of revenue of 37% year over increase or 31% increase excluding the impact of purchase price adjustments related to deferred revenue.
We continue to see healthy traffic expansion from our enterprise customers and given a relatively smaller market share we benefited from share gain in an otherwise challenging environment.
Dynamics position us well for continued revenue growth into 2023 and beyond.
Our trailing 12 month net retention rate was 119% up slightly from 118% in the prior quarter.
We continue to experience very low churn of less than 1% and our customer retention dynamics remained strong.
As Todd stated, we had 2900 58 customers at the end of Q4 of which 493 were classified as enterprise those customers with an excess of $100000 of revenue over the trailing 12 months.
Enterprise customers accounted for 89% of total revenue on a trailing 12 month basis in line with their contribution in Q3, our enterprise customer average spend grew to 782000 from 759000 in the previous quarter, representing 3% expansion in dollars.
<unk>.
Our strong trailing 12 month net retention rate and growth in average enterprise customer spend demonstrate our continued ability to expand within our largest customers by increasing our share of delivery traffic and adoption of new products in security and in our emerging compute business.
Our top 10 customers comprised 37% of our total revenues in the fourth quarter of 2022, a slight increase to the 36% contribution in the prior quarter.
As I discussed on our Q3 call. We've made a great deal of progress in our financial organization with efforts to closely align with Todd's new leadership.
We're seeing benefits in our gross margin and capital deployment plan from engineering efforts that are increasing the efficiency of our platform and cross functional efforts to simplify our operations and improve our forecasting and review processes.
These efforts not only strengthened <unk> financial position longer term at all.
Allow us to drive increased efficiency in our business, but also improve our competitive positioning and our transparency to the investor community.
I will now turn to the rest of our financial results for the fourth quarter.
Our gross margin was 57% in the fourth quarter or 57, 5%.
Excluding the $3 3 million take or pay true up and the $2 million cancellation fee Todd discussed earlier compared to 53, 6% in the third quarter of 2020.
This sequential improvement in gross margin reflects our prior expectations that it would lift in the second half of 2022, primarily due to the results of our efforts to improve our gross margin.
As we shared on our Q3 call we saw a reduction in our bandwidth right at the end of Q3, which favorably impacted all of the fourth quarter and we continue to increase the percentage of our peering traffic, which further reduces our bandwidth cost.
We continue to see benefits of improvements in our network investment capacity planning for more closely matched capacity and investment with our traffic patterns and demand are.
Our efforts to further reduce our existing capital commitments through commitment cancellations Todd spoke about earlier reflect this work to align our capacity investments with expected traffic demand coupled with a meaningful increase in the efficiency of our platform.
We also benefited from the seasonal increase in revenue in the fourth quarter, which favorably impacts our utilization of platform overhead costs note that our seasonal revenue decline in the first quarter relative to the fourth quarter will have a modest gross margin headwind I'll expand on this in a moment.
Operating expenses were $80 million in the fourth quarter up 21% over Q4, 'twenty, one and up 3% sequentially from the third quarter.
This level of operating expenses combined with the higher revenue and gross margin achievement resulted in an operating loss of $12 million exceeding the high end of our operating loss guidance range of $14 million to $18 million.
Our net loss in the fourth quarter was $9 $5 million or <unk> <unk> loss per basic and diluted share compared to a net loss of $11 7 million or <unk> <unk> loss per basic and diluted share in Q4 2021.
Our adjusted EBITDA for the fourth quarter was negative 91000 compared to negative $3 5 million in Q4 'twenty one.
Turning to the balance sheet. We ended the quarter was approximately $683 million in cash cash equivalents marketable securities and investments.
<unk> those classified as long term.
And our free cash flow of negative $40 million with reduced sequentially from the third quarter's negative $44 million.
Our cash capital expenditures were approximately 14% of revenue in the fourth quarter and 10% for fiscal year 2022 landing at the low end of our revised outlook shared in Q3 of a range of 10% to 12% for the year.
Our cash capital expenditures include capitalized internal use software and deployments of prepaid capital equipment.
For 2023, we expect our cash capital expenditures to decline further to a range of 6% to 8% of revenue.
I will now turn to discuss our outlook for the first quarter and the full year 2023.
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.
We undertake no obligation to update these forward looking statements in the future except as required by law.
As we look to 2023, our first quarter and full year 'twenty three outlook reflect our continued ability to deliver strong top line growth via 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.
We expect expense growth for the full year to lag revenue growth and expect a meaningful improvement in our operating losses in 2023 over 2022.
More specifically we are investing in our go to market efforts as part of our revenue growth initiatives to continue our expansion in our existing customer and accelerate our new customer acquisition.
We will continue our investments in product and R&D and as we discussed on our last call, we see meaningful opportunities to drive greater efficiencies in our operations, especially across G&A and we expect to see meaningful leverage in our G&A costs in 2023 and for these costs to decrease as a percentage of revenue.
The nature of network traffic drivers in the fourth quarter, including holiday shopping patterns and live sports streaming dealership historically, our first quarter seems flat to down revenue relative to the fourth quarter and we expect to see a similar trajectory in 2023 and.
In the first quarter of 2022. This seasonality was favorably impacted by the return of traffic. After the Q2 2021 outage.
I'd also like to remind you that excluding the onetime take or pay true up in the fourth quarter of 2022 fourth quarter revenues were $116 1 million.
As a result.
For the first quarter, we expect revenue in the range of $114 million to $117 million, representing 13% annual growth at the midpoint.
As I mentioned earlier, given the seasonality in our business, we expect gross margins in our first quarter to be down 100 to 200 basis points from our Q4 gross margin of 57, 5% adjusted for the aforementioned true ups for.
For the full year, we expect to see continued gross margin accretion and to exit the year with gross margins within striking distance of 60%.
We did not see any meaningful changes positive or negative to our pricing in the fourth quarter as compared to the prior quarter.
We expect operating expenses will increase in Q1 relative to the fourth quarter of 2022 due to an increase in payroll taxes, which will extend into the second quarter and the timing of sales events that impacted the first quarter.
However, as I mentioned above we anticipate expense growth for the year to lag revenue growth with a meaningful improvement in our operating losses in 2023 over 2022.
We expect our non-GAAP operating loss of 18% to $16 million and a non-GAAP loss per share of 12 to eight cents per share.
For calendar year 2023, we expect revenue in a range of 495 million to $505 million, representing 16% annual growth at the midpoint.
We expect our non-GAAP operating loss of 53% to $47 million, reflecting an operating margin of negative 10% at the midpoint compared to an operating margin of negative 18% in 2022.
We expect a non-GAAP loss per share of <unk> 27 to 21 says.
And I'd like to call out that the recent increase in interest rates is resulting in a meaningful increase in our interest income on our cash and investments and we currently expect to earn approximately $20 million in interest income in 2023.
Before we open the line for questions, we'd like to thank you for your interest and your support of vastly operator.
Thank you at this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad well pause for just a moment to compile the Q&A roster. We will take our first question for Frank Louthan with Raymond James Your line is now open.
Great. Thank you.
So walk us through your path to getting more towards EBITDA positive do you think that.
It can happen this year, that's more next year and then with that what are some of the top things where youre finding.
Thank you.
Yes, So I guess, if you look at sort of adjusted EBITDA in Q4. This year, we ended at about 91000 or so.
I'd say, that's fairly within striking distance of credit breakeven I think as we look to going forward I think there's a couple of drivers around improving our operating margins. One as we said we expect to continue to see accretion and improvement in our gross margins.
That to continue beyond 2023, and our efforts to drive leverage in operating expenses once.
Once or just the efficiency things we've spoken about.
Continue to bring down opex as a percent of revenue so.
That's generally the trajectory that gives us high confidence in getting to that breakeven point in terms of kind of specific timing will be sharing a lot more in terms of.
Sort of the timelines and revenue levels, where we achieve that metric at our Investor day.
In June .
Alright, great and anything specifically you can point to you that the major areas, where you're finding the cost improvement. Thank you.
I can add a little bit.
A little bit there.
We have efficiency.
In the cost of revenue that we're certainly finding efficiencies.
Efficiencies on the infrastructure just due to the engineering improvements and also cost reductions.
Our networking cost because our network optimization efforts.
Efforts as well as contract negotiations so on so for cost of revenue, we've got a few levers and we've seen progress.
We think we'll be able to continue in that trajectory.
And then as far as the Opex goes.
We are starting to see some success in removing duplicative systems.
That aren't needed.
Across the board.
We're seeing that on the G&A line, but also to some degree in the go to market.
R&D side of the house.
And really being thoughtful about our.
Our hiring and really focusing on customer facing roles and durable innovation and engineering roles primarily.
Alright, great. That's very helpful. Thank you.
Thanks.
Next we'll go to <unk> <unk> with Citi. Your line is now open.
Hi, good afternoon, and thank you for taking my questions.
Rami I wanted to go back to something that you mentioned in your prepared remarks as it relates to the vertical diversification that you saw in the quarter I wanted to get a better and more granular understanding of some of the drivers that are enabling you to more effectively compete in end markets that are maybe newer and not traditional to you and what type of wallet.
Capture Youre seeing and then a follow up please.
Yes for sure.
That's great question, and it's something that we're thinking about quite a bit right now in terms of.
Growing.
A more balanced way across all verticals E Commerce for example.
A place where we have focused in the past we've seen lots of success.
There are a ton of verticals.
Verticals, where our real focus on the digital experience, whether it be through the website or through applications.
Yes.
I think it is driving interest in Fastly.
For sure on the content delivery side, which enabled the lower latency more engaging experience, but I think the edge compute side and the ease with which our security platform can be on boarded for the developer experience is making a difference there too. So travel leader leisure is a great example, traditional retailer.
I think there's another great target for us.
And starting to see it in healthcare to me is incredibly.
It's an incredibly positive signal I think.
The health care industry pretty much across the board is looking at this.
More and more and what that patient experience really looks like.
And we have a real opportunity with.
Our emerging edge compute.
Portfolio, coupled with our network services content delivery side of our house I think so.
Huge impact there that's all of the wallet share part of your question goes.
I think we're really scratching the surface right now.
And we have a huge opportunity to deploy to.
These customers that are just starting the ones, we mentioned earlier and expand broader and broader set of our of our portfolio. There in Atlanta expand motion, but also really I think using these as lighthouse accounts to penetrate those verticals or.
I appreciate that detail Todd Ron for you just on some of the.
One time impact in the quarter, So you really fleshed out for us.
The true apps, but I'm curious from an event standpoint.
Can quantify what the World Cup might've done to the business and then the superbowl and anything else, we should be mindful of as it relates to the sequential compare.
From some of these one time events and then just as it related matter.
Customer concentration did tick up so was that in.
In any particular.
Vertical or end market that drove that and do you expect that constant customer concentration level to increase as you continue to focus on penetrating the installed base and that's it for me. Thank you.
Good question. So we don't get into specific traffic levels around sort of specific event I think the way to look at it is if you kind of look at the seasonality change.
<unk> sort of Q3 Q4 across the quarters that will give you some indication of some of the traffic increases will be particularly seen in Q4 is as you know a number of live sports events occur in the fourth quarter.
As well as seasonal shopping patterns and that's been a pattern that's been pretty consistent.
No.
On the past couple of years.
I think as we.
Look too.
Okay.
And the second part of your question.
On.
Perfect. Thank you very much.
Okay.
Oh, just the customer concentration where that should trend.
Yeah, Yeah, Yeah, I think we will see some fluctuation in it I think as we continue to accelerate new customer acquisition.
I expect it to remain relatively stable, it's going to move around a few percentage points as we continue to see expansion within our largest customers that expansion rate within enterprise customers is one of the motions that we do particularly well.
But I would expect it's going to move around a little bit, but I don't see any major.
Either increase in it or.
Or decrease prospectively.
Thank you.
And next we'll go to Sanjeev Singh with Morgan Stanley . Your line is now open.
Yes, Thank you for taking the questions and I wanted to get.
The tools perspective on.
The factors that can ultimately drive gross margin and so I think you mentioned on your prepared remarks, Rob that pricing was neither a tailwind or a headwind.
You guys took the tradeoff to rich.
<unk> reduced your purchase commitment and so I'm trying to get a sense of.
And ultimately getting a path to 60% what sort of needs to happen is it a better pricing environment is higher.
Higher mix of flash.
<unk> HD continues to come online as you sort of draw that picture for us.
Getting.
Up to 60% and hopefully north of that over time, what are the sort of things that we're looking to execute upon.
Yeah, that's a great question.
So on the gross margin side.
Thank you Christian I think its a good milestone and something we're looking at closely.
I think youre right to mention.
Ramping up the compute business faster.
I think have had a tendency to help in that area.
And also a mix change that would shift towards security would help.
Yes.
Even under current.
Even with the current mix.
We're targeting a goal of getting within striking distance of 60%.
So whether the mix changes or not.
We're going to drive towards that through effectively through increased efficiency in the infrastructure.
That comes from building out the technology that delivers that which is a big part of it.
It comes from cost controls and managing our spend.
Effectively it also comes from.
Better and more sophisticated demand planning and our teams have really focus there. So that we're not deploying equipment that we that we wont need and that makes a big difference which is exactly what motivated.
Our.
Are focusing on.
Some of these purchase commitments kind of lay the groundwork for better margins in the future.
That makes perfect sense, it's encouraging to hear.
One quick question on the guidance, so heard you loud and clear on like the seasonality in Q1 in particular sort of taking the account.
Factors in Q4.
When I sort of look at the full year guide it does imply.
Stronger growth generally in the back half of the year.
Against compares that at least by my model look a little bit tougher and so I just wanted to get your perspective on that potential stronger growth in the second.
Half against tougher compares.
Yes, it's.
Good question and I think if you look at kind of the midpoint of Q1 guidance and the midpoint of the year. There is some acceleration that we anticipate as we move through the year. Despite some of the more challenging comparisons that we have.
In the second half I think Theres a couple of drivers one I think last year Q1.
Saw a return of a lot of traffic.
Coming back from the outage that we had in the year before so it makes Q1, a particularly challenging compare because we typically do see some seasonality down and we didn't see that last year and then I think as we move through this year.
<unk> is building off of the really strong expansion motion that we saw across our customers as we continue to add new customers in the second half of this year.
As they ramp their traffic and we increased our expansion effort in those those start to really take place as you move through the second third and fourth quarters of the year.
Understood. Thank you very much.
Next we'll go to James Breen with William Blair. Your line is open.
Thanks for taking the question can you talk a little bit about the network and the Capex side.
It was 14% you said for the full year and I think you said, 68% for 2023.
Just talking about where you are in terms of network evolution.
Pending on that over the next couple of years as you see increased revenue on the network.
Yes, so just to clarify on the Capex as a percent of revenue, we've almost 14% in the fourth quarter Capex for the full year was 10% of revenue.
That was down from what we guided at the beginning of the year as we move into next year based on a lot of efficiencies that Todd spoke about.
In terms of platform efficiency, we see that capital intensity coming down further.
Where 2023, we would expect capex to be somewhere between 6% to 8% of revenue.
And how were you able to do that in terms of taking some of those absolute dollars down.
I think one of it is just.
Probably two particular drivers around the efficiency. One is just the engineering work around the hardware that makes our hardware more efficient and so we can manage more traffic through the same amount of hardware, which allows us to accommodate additional capacity without expanding our capital equipment. The other piece is your engineering efforts too.
Better manage the use of our bandwidth.
Being able to automatically route traffic to lower cost bandwidth.
Bandwidth rates increase our peering percentages.
Those will be the biggest drivers that allow our platform to become more efficient reduce the amount of capex that we have to add and reduce our bandwidth costs.
As traffic increases.
And offset that scale helps so as we grow we have more opportunities to scale and the engineering work needed to drive these types of platform efficiencies.
Why on those become more and more attractive for us to deploy our resources and so.
Scale kind of helps us drive these efficiencies, which we're starting to see.
In that gross margin number.
Great. Thanks.
Next we'll go to Tim Horan with Oppenheimer. Your line is open thanks.
And to clarify the 6% to 8% Capex do you think that's more permanent kind of going forward or.
This is just another one maybe a onetime true up this year.
So I think the.
Just to I guess clarify the 68, 6% to 8% of revenue Capex is kind of what we expect for next year. This year. It was about 10%. So we do see capital intensity coming down in 'twenty. Three are the increased efficiency that we spoke about I think as you look beyond that.
We don't expect it to increase I think there is opportunities to maybe move towards the lower end of that range.
A lot of that is kind of tied to how traffic ramps in the future, but we should continue to see meaningful increased efficiency.
Use of Capex and I would say next year is a good guide to that trend.
I think really over moving from sort of 14 to be 21 to where we are today, we've gone from about 14% to around 6% to 8% next year, so meaningful movement there.
Got it. Thank you. Thank you and then are computed edge can you just maybe talk a little bit more about customer interest and competitive differentiation and how meaningful is it for customers in terms of both latency and cost then how differentiated are you and and then the same thing.
Just talk about the potential for AI to run on top of this infrastructure at a high level. Thanks.
Sure.
Great question, it's something that's super top of mind for us here.
Computed edge for US is I think it's <unk>.
Credibly important.
Because in addition to being I think Super interesting technology, it's really an extension of fastest core value proposition delivering fastest Davis, most engaging user experience.
And that.
That speed that engaging application performance.
The content delivery network service portfolio.
<unk> delivered that in really significant ways.
And a lot of ways. The next step the next natural evolution is computed edge and driving.
Driving some of these processes all the way to the edge as close to the user as possible.
We've seen a lot of folks looking carefully around metrics tied to indoor activity.
Sites and applications.
And that I think super interesting that some of our most sophisticated customers focusing deeply on that and so we as a content delivery helps deliver that edge compute can make a huge huge difference.
And and it had been we see it in.
We see it both on the website and the App side.
For people, who care deeply about that E. Commerce is certainly an area where that's incredibly important.
What we're seeing at intact, we're seeing it in other verticals as well.
As far as.
As far as sort of how our differentiation.
That's how we fared differentiation in that space I'll tell you I think this is an area where being developer led is incredibly important.
And you see that in <unk>.
See that in some of the.
Technology announcements in our supplement.
And I think it's incredibly important because developers are moving workloads to the edge, they're driving towards these performance goals and they need how confident that a.
A computer desk platform is going to be there to serve them serve developers in the future. It's what motivated our glitch acquisition, we're getting a huge amount of feedback and input there what's driving our roadmap platform support language support I should say.
It looks like the Java script launch, we mentioned and even automation toolkits like like Terraform support.
And do you think impact in AI is a major driver of growth potentially for this product.
Yes, sorry, I missed that part has an interesting question I would say sort of our growth trajectory isn't dependent on that but.
But there is it fair to <unk>.
Interesting.
It's an interesting idea.
In my mind no.
No matter how much GPU you start deploying on at the edge I missed.
Instead of traditional Cpus, but for US right now we're focused on more traditional workloads.
Next we'll go to James Fish with Piper Sandler Your line is open.
Hey, this is quentin on for Jim fish, Thanks for taking our question.
Looking first at the security side of the business.
Focus for a lot of investors and the team really looked inorganically. The last time, it really tried to level up kind of the capacity portfolio can you talk about how you are balancing organic and inorganic opportunities in our security platform and maybe what opportunities are available for fast data can take on from the security side.
Sure absolutely when it comes to the security space.
Enormously enormous.
Enormously diverse.
Market, we're really focused on web application security and so the <unk> acquisition represented.
Inorganic move to bringing an entire component and really operating business partner motion.
Around next Gen WAF.
We're looking at now really bolstering that signal science portfolio, where ddos.
Detection and more advanced and more manage Ddos protection for our customers as well as Bot protection.
And that really kind of fulfilling this vision of a deep focus on web application security.
<unk>.
Never say never but.
In at least in those areas, we're really looking at organic innovation from some capacity team.
This is.
Fastly platform team has been doing advanced Ddos protection since practically infection, and it's an amazing opportunity for us to bring more insights more more management more visibility to our customers.
And our security platform and.
On the <unk> side, we see a ton of interest from customers there.
Are we done interesting partnerships, there, but again I think we'll be looking at.
Organic innovation in that space.
The single Thanks Ram acquisition represented a really sort of strategic product line acquisition.
For Fastly I think.
Right now there is nothing like that on the horizon for us, we're really looking and focusing on organic innovation.
Got it helpful and then Ron maybe for you on the guide what are you implying here from a macro standpoint.
Get to the numbers you are laying out for 'twenty three do we need to see any sort of improvement kind of in the back half of the year from an underlying macro or is this kind of baking in things are remaining the same from here. Thank you.
It largely assumes that the things moved out or the economies broadly the way. It is now our growth is really predicated on market share gains and expansion within our existing customers and given our relative market share, we're not 100% immune from the macro economy. The key driver is going to be share gains and we've.
Assumed similar environment to what we have today, but that's not the biggest.
Driver to our growth in 2023.
Got it thank you.
Next we'll go to rich Hilliker with credit Suisse. Your line is open.
Hey, guys. Thanks for taking my questions.
What I was wondering if you can update us on your near term intention to leverage peering in the path towards that and then Ron maybe on that same topic, how should we think about peering playing into the 'twenty three versus 24 margin story.
I'm, so sorry, rich you broke up just a little bit could you ask that question again.
Absolutely can you hear me better this time.
Thank you.
Great.
First for you I was wondering if you can update us on the near term intention and you're really passed towards leveraging peering I know you've talked about that in the past and then Ron on that same topic. I was wondering if you can give us a sense of how we should think about peering contributing to the margin progression in 'twenty three as opposed to 24.
Yeah, Great question, and something our team thinks about a lot and peering.
Is an incredibly powerful tool for us because it actually has.
Two positive impacts.
First and foremost it improves the user experience drives lower latency.
Performance for applications and websites it improves.
<unk> core value proposition by.
In network distance, putting families pops closer to the user which is amazing.
Also drives lower networking cost and our cost of revenue and so for us finding the strategically the best places to add peering.
It's really a win win for us on both sides of the house, how often do you get to lower costs and improve the offering at the same time. So yes, it's something that we do focus on quite a bit yes, I think as you look to peering I think one of the things as Todd said earlier. It is obviously as we scale. There is an opportunity to increase the amount of hearing that we do which brings down our bandwidth costs.
We've said bandwidth is about a third of our costs and so the the drivers they are going to be peering and theyre going to be more efficient use of overall bandwidth, which will drive I believe increased efficiency.
Our platform for bandwidth costs in 2004, so as you look at where we exited I think theres an opportunity to continue to see accretion in gross margins into 'twenty four driven.
Driven from the cost structure side of things.
Other piece is.
Capital intensity and I think the efforts we've spoken about in terms of making our hardware more efficient, allowing us to.
Run more traffic through the same amount of traffic also is a tailwind that allows us to continue to show accretion in gross margins.
Off of 23 into 'twenty four.
The bandwidth is the big one is the single biggest cost Colo.
<unk> and depreciation.
Those three are probably.
Two thirds of our overall cost of revenues.
Great and so maybe the next question here changing gears packaging has been a clear focus.
I am not mistaken I think you mentioned you'd be ready for Q2, and some of the changes to drive simplification.
I'm wondering how does that how does the sales playbook change relative to that that packaging evolution and how are you positioned to kind of leverage those and all of that hard work <unk> been doing to kind of mobilize those changes. Thanks.
Oh, I love a packaging question.
Yeah. So I think there is just an incredible opportunity both internal up absolutely.
And externally.
Internally packaging helps us operate more quickly.
It gives us offers for the market that are designed to be inclusive of everything that a typical customer would need whether that's in network service and security and edge compute an observer ability and thats before areas.
That we're really looking to launch packaging in Q2.
But externally I think it just provides.
A much easier motion, especially for mid market customers onboard and that's something we'll be tracking very carefully.
Also provides.
It provides other benefits to customers like reliable billing simple renewals et cetera.
And also importantly it.
It provides a more channel friendly option.
Simple skus with straightforward pricing and discounting et cetera that can just move through not just our go to market, but our systems integration and MSP channel partners.
Go to market more efficiently.
Yes.
Thanks, guys.
Okay. Thanks for the question.
Next go to Rishi <unk> with RBC. Your line is open.
Wonderful. Thanks, so much for taking my questions guys nice to see some some some good <unk>.
Resilience and a path to better margins.
Maybe two questions if I may 1st.
As we talk about the developer ecosystem and I know that gets accelerated with the acquisition of glass.
Maybe I'd love to talk a little bit more about going down.
<unk> strategy some of the efforts you want to make too maybe returned to erode as that may kind of think about it.
And what I guess, what steps need to be taken to to actually get that traction and what sort of impact do you think that could actually have on your margins and sales efficiency going forward and then I've got a follow up.
Yeah.
Great questions also I think.
We've been very thoughtful about CLG.
His first couple of quarters that I've been here.
Specifically really on building out product support for motion that allow our teams to move more efficiently and for customers and users to be able to sell.
Or more.
Specifically.
We focused a lot on automat automating, our free trial motion and making it so that customers who are at Fastly can start that expand motion in a real product led.
Product line growth style and that our go to market teams can help engage and help smooth the way as we go so I think there's a huge opportunity here, especially as we focus right now on free trials and how the product support for fully automated free trials.
And Thats really just one example of the packages I think give us another opportunity to really lower the friction be able to operationalize that sort of platform wide free trials.
Individual product or feature by feature free trials.
Maybe thats just a good example of sort of how we see product line growth evolving fastly not fighting against our sales and partner team, but really helping fuel and drive that enterprise sales motion.
I think that we have.
Maybe the biggest area, where this where we expect to see real impact right away given that mid market commercial accounts, where.
We're having a fully automated motion.
And having the ability to kind of bring in the right fastly resources, where needed to smooth the land and expand play.
Can you really make a difference as far as supporting margins I always believed mid market business is good for margins good for customer retention, so I like that.
Alright wonderful.
Really helpful. And then just one financial question, so so nice to see.
Improving margin.
Guidance talking about margins improving more significantly from here.
At the end of the day right cash flow is what's ultimately going to matter I guess two pieces, how should we be thinking about cash conversion for 2023, and maybe more importantly, what's kind of the glide path to get from here to.
Being free cash flow breakeven or even starting to generate cash.
Yes, so I think our leverage off of some of the comments, we made about some of the opportunities of the business to improve from an operating margin.
And bringing that to sort of breakeven.
As you look at 'twenty three 'twenty four there's a couple of sort of a significant tailwind.
During 'twenty two we spoke a lot about some of the prepayments we made toward capital equipment. So a portion of that 6% to 8% of Capex that we're going to deploy in 2023, we paid for in 2022, so our cash.
<unk> is for equipment to be down materially.
And then I think alternative as we continue to drive margins and efficiency in the business. We believe that there is a significant opportunity to improve the.
Cash flows from working capital.
And bring that along with the improvements in our operating margin I think as we look to some of the specifics.
You can look at kind of the progress you've made on kind of adjusted EBITDA, but.
At Investor Day, we will provide a lot more granularity in terms of sort of the timelines and again kind of revenue levels at which we get to kind of a cash flow breakeven but.
In addition to the efficiency, we see the operating margins there is efficiency in our cash going into 'twenty three that are meaningful tailwind to cash flow usage.
Wonderful thank you.
Thank you next we'll go we'll go to Jeff Van <unk> with Craig Hallum. Your line is open.
Great just a couple for me I think on the go to market improvements it sounds like the packaging you see is a big catalyst. So maybe that's the answer but when I look at the enterprise customer.
Additions relatively flat for a handful of quarters now how do you think about that number in particular, when we should think about an uptick.
Yes, that's a good question.
Our enterprise customer count, it's been growing kind of slow and steadily.
We measure that in arrears, so a 100 K revenue over the last four quarters.
And so it's a little bit of a trailing statistic for us.
<unk>.
I think its sort of slow and steady growth.
Thats, what im expecting to kind of hope to accelerate slowly over time and not find a big huge pop all at once.
Perhaps the perhaps the driving forces packaging would be one, but maybe something else would be platform unification.
By unifying our platform I think we're making a lot easier for our customers to start with one product line and expand into the next into next because it's all being built now on one unified user experience unified developer experience and that will.
By doing that help ease or expand motion drive a more strategic relationship with our customers as they become sort of a multi portfolio users.
In helping cross that threshold by 'twenty, five K quarter thresholds.
But again I think in terms of like are we going to see a big pop in that number and I hope to accelerate that.
The growth in that number just as we accelerate.
The rest of our revenue.
Got it and you commented on taking share in terms of the competitive landscape.
If you want to clarify who are you taking share from and then just in terms of that land you comment on the platform unification.
Has that initial use case or initial capability slash pinpoint changed.
In terms of.
The reason Youre land excuse me landing in the first place.
Yes, that's a great question I don't want really want to name correctly named competitors I'm sure you can I'm sure you can guess that when we look at content delivery.
Yeah.
We're picking up share and I believe we have an opportunity to pick up share specifically by focusing on user experience.
Lastly, we're not a CDN company or cloud security company or an edge compute company, we're focused on being a cloud platform company that delivers user experience outcome leveraging all of this together and so this idea of platform unification is that you are building a more complete offering for our customers that is the <unk>.
<unk> that we hope to use to deliver a better user experience for everyone and that is the differentiation I think that's going to drive market share gains for us a true focus on user experience fast.
<unk> and engaging digital experiences.
Okay got it thank you.
Thanks.
And we have time for one final question, we'll go to Rudy Kissinger with D. A Davidson your line is open.
Hey, great. Thanks for squeezing me in here.
Just want to clarify on the quarter to $3 $3 million in trip did you have any I expect like in the original guide you gave is there any expectation that you would get any of that in the quarter and now.
Yes, I think going into the guide I think there was an expectation that we would have some true up I think what we saw in the quarter in terms of the level of over achievement was the magnitude of that as well as overall traffic pattern we.
So really good expansion within existing customers over the course of the quarter.
As well that actually grow over achievement in the quarter.
Okay got it and then on the.
On the guide for 'twenty three.
Curious if you could give any more specifics with respect to the assumptions on growth for <unk>.
<unk> sciences or security versus CDN and compute.
Just any breakdown you could share there.
Yes, I mean, we haven't broken out I think what I would sort of generally speak to is we have seen.
Security or signal sizes reported being a faster growing element securities certainly important I think the other piece is compute is also a faster grower, although starting at fairly nascent levels.
So those are going to be the the higher growth items I would say security is probably the one of a magnitude that a key contributor to the growth, but we're also seeing going to see growth in core traffic.
Both from new customers, but also we're seeing in some of our largest customers continuing to gain.
Traffic share within some of those largest customers based on that user experience and so.
We see growth across that I think one way to frame. It is todd sort of framed it as we have the core business. If you will.
Which is growing nicely.
We have really the growth engine, which is security.
And we have sort of the incubation stuff compute that's probably moving from that in the near term kind of into that growth engine.
And continue to have new things and compute that we'll grow into part of the growth drivers.
Yeah.
Anything further Rudy.
No thats it from me great. Thank you, Okay, I will turn the call back over to Todd Nightingale for any additional or closing remarks.
No. Thanks, so much everyone.
<unk> today before we close the call I want to thank our employees customers partners and investors, we remain as committed as ever to making the internet better place, where all experiences are fast pace and engaging.
Moving forward, we remain focused on execution, bringing lasting growth to our business and delivering value to our shareholders. Thank you so much.
Thank you so much for the time today.
This concludes today's conference call you may now disconnect.
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Sure.
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Okay.
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