Fastly, Inc. Q3 FY2022 Earnings Call

Good afternoon. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Fastly Third Quarter 2022 Earnings Conference Call. I will now turn the conference over to Vern Essi, Investor Relations at Fastly. Please go ahead.

Thank you, and welcome, everyone, to our third quarter 2022 earnings conference call. We have Fastly's CEO, Todd Nightingale, and CFO, Ron Kisling, 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 754-3239, shortly after the conclusion of today's call. A copy of today's earnings press release, related financial tables, and investor supplement, all of which are furnished in our 8-K filing today, can be found in the Investor Relations portion of Fastly's 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, please refer to our most recent quarterly 10-Q filing with the SEC and our third quarter 2022 earnings release and supplement for a discussion of the factors that could cause our results to differ. Please refer in particular to the sections entitled Risk Factors. We encourage you to read these documents. Also note 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. Reconciliations to the most directly comparable GAAP financial measures are provided in the earnings release of 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 fourth quarter: the RBC Capital Markets Global TIMT Conference in New York on November 16 and the Credit Suisse 26th Annual Technology Conference in Arizona on November 29. With that, I'll turn the call over to Todd.

Thanks, Vern, and hello, everyone, and thank you so much for joining us today. Let me start by thanking the Fastly team for such a cordial welcome and an amazing onboarding experience when I joined 60 days ago. The team here has been very supportive during my first two weeks in this role, and I want to thank Joshua for such a smooth handoff and the Board for their support and guidance. I see tremendous opportunities ahead of us, and I'm excited to work with this incredible team. First, I will give a quick summary of our financial results and third quarter highlights and then provide a brief overview of my first impressions and near-term path forward at Fastly. I will then hand the call over to Ron to discuss the third quarter financial results and guidance in detail. We reported record third quarter revenue of $108.5 million, which grew 25% compared to last year and 6% quarter-over-quarter. I'd like to congratulate the Fastly team on this rate of growth, which takes pride in its achievement. However, I believe there still remain more customer opportunities out there to grow beyond the 22% year-to-date revenue growth we just posted as outlook. Our customer retention and growth engine remains strong. Our last 12-month NRR was 118% in the third quarter, up from 117% in Q2, and our DBNER was 122% in the third quarter, up from 120% in Q2. It's great to see such a passionate loyal customer base and the continued growth from these existing accounts. Our average enterprise customer spend was $759,000, representing a 4% quarter-over-quarter increase from Q2 and continues to demonstrate the success of Fastly's land-and-expand approach in strategic accounts. In the third quarter, we saw continued momentum in our portfolio expansion strategy with strong cross-selling activity in both Compute@Edge and Security. We saw Compute@Edge cross-selling wins at marquee accounts like New Relic and with Canada's leading content creation company. With Security, we saw cross-selling motion was one of the largest drugstore chains in Europe, which is now using our Next-Gen WAF on top of content delivery from Fastly and from a major Japanese video game company, which is now using Next-Gen WAF in addition to our content delivery and Compute@Edge capabilities. Our total customer count in the third quarter was 2,925, which increased by 31 customers compared to Q2. Enterprise customers totaled 482 in the quarter, an increase of 11 compared to Q2. I'm pleased to report that our third quarter gross margin of 53.6% improved 320 basis points quarter-over-quarter. Ron will talk in more detail about this in just a moment. Of course, this is an area we are focused on intently, and we've been able to remove duplicate site costs, improve our bandwidth costs, network utilization, and capacity planning. It's important to me to run an efficient, healthy business. And to that end, we will continue to focus on margin improvement in Q4 and through FY '23. It's also important to note that we've gone to great lengths to secure our supply chain to ensure that our platform expansion can continue uninterrupted, even in the presence of supply chain disruptions to support existing Fastly customer growth and new logo acquisition. We continue to expand Fastly's product offerings. In my first few weeks, I have been impressed with the speed of innovation here. And in Q3, these releases include: service search, allowing our customers to more easily access our technology; compliance routing, which is in alpha right now, helping customers with data sovereignty requirements better manage how and where their data is processed; and websockets and data providing our customers real-time, low latency solutions capable of supporting the most responsive, engaging applications. We've also listed additional product releases in our investor supplement for your reference. In my first few weeks at Fastly, I talked to customers, partners, key stakeholders, and I have immersed myself in Fastly's culture and organization. This process yielded a tremendous amount of feedback in the form of praise and constructive suggestions. I’m grateful for everyone's thoughtfulness and the teams who facilitated all of those discussions. Fastly has an amazing culture and a talented employee base. The team here is passionate about every customer, passionate about the technology we build, and most importantly, passionate about our mission to make the Internet a better place where all experiences are fast, engaging, and safe. There are tremendous opportunities in Fastly as a complete application experience platform to deliver cutting-edge digital experiences for everyone, everywhere. The more Fastly becomes a one-stop shop for edge cloud, content delivery, network services, security, and edge compute with observability, the more it will drive a more complete experience for our users. And for our customers to drive a differentiated experience for their developers, for their operations teams, I believe that staying true to that vision and focusing on our users, our developers and our customers, we can have an incredible impact on the industry. We have a real opportunity to run a high-velocity, low-friction motion at Fastly. And I will be focused on: number one, simplifying our product packaging. This will enable our customers to understand and purchase our technology more effectively, and our team can operate with less friction. Number two, we're also focused on embedding the Signal Sciences offerings more deeply into the Fastly platform and continuing to expand our security offerings. Number three, our Compute@Edge launch from last year has had great early success, in part due to our developer relations investment and Glitch acquisition. I plan to continue to invest here as our customers demand even more dynamic capabilities at the edge. Four, I plan to align our go-to-market, service, and customer success teams to focus more deeply on the customers they serve. And five, our goal is to ensure that our investments are in line with these priorities while implementing cost controls to ensure that every dollar at Fastly is being used to fuel growth. And with regards to investments, I am acutely aware of our high operating expense levels, and I take this very seriously. We will focus on investing in our go-to-market and on our innovation engine to fuel growth while driving efficiency in everything we do. You will hear more about our long-term growth and spending forecast next quarter, but let me leave you with the understanding that I am very committed to meaningfully reducing our operating losses in '23. Let me close by saying that I'm very excited about the opportunity at Fastly. Our customers have a real passion for Fastly's solutions, and our employees have a real enthusiasm for Fastly's mission. Of course, we have plenty of work ahead of us, but I believe we can have a significant impact on the way digital experiences are built and delivered around the world. I look forward to sharing more regarding our progress, our focus on fueling growth, our customer acquisition, and our velocity of innovation in the coming quarters. And now to discuss the financial details of the quarter and guidance, I will turn the call over to Ron.

Thank you, Todd, and thanks, everyone, for joining us today. I will discuss our business metrics and financial results and then review our forward guidance. Note unless otherwise stated, all financial results in my discussion are non-GAAP-based metrics. Total revenue for the third quarter increased 25% year-over-year to $108.5 million, exceeding the top end of our guidance of $102 million to $105 million. In the third quarter, revenue from Signal Sciences products was 13% of revenue, a 44% year-over-year increase, or a 33% increase after purchase price adjustments related to deferred revenue are reflected. While we are not immune to the macroeconomic trends, we are seeing healthy traffic expansion from our enterprise customers, and given our relatively smaller market share, we are benefiting from share gains in an otherwise challenging environment and believe these dynamics position us for continued revenue growth. Our trailing 12-month net retention rate was 118%, up slightly from 117% in the prior quarter. We continue to experience very low churn of less than 1%, and our customer retention dynamics remain strong. As Todd stated, we had 2,925 customers at the end of Q3, of which 482 were classified as enterprise. Those customers with excess of $100,000 of revenue over the trailing 12 months. Enterprise customers accounted for 89% of total revenue on a trailing 12-month basis, up slightly from their 88% contribution in Q2. However, the key highlight here is that our enterprise customer average spend grew to $759,000 from $730,000 in the previous quarter, representing 4% expansion in dollars spent and further demonstrating our continued ability to expand our business within our largest customers and our strong customer retention. Our strong trailing 12-month net retention rate and growth in average enterprise customer spend demonstrate our continued ability to expand within our enterprise customers due to our increased share of delivery traffic and adoption of new products in Security and in our emerging compute business. Our top 10 customers comprised 36% of our total revenues in the third quarter of 2022, slightly above the 34% contribution in the prior quarter. As I last spoke to our Q2 results, we made a great deal of progress within our financial organization with efforts to align closely with Todd's new leadership. We completed the transformation of our finance leadership team and continue to enhance our cross-cultural efforts to streamline and improve our business visibility, including forecasting and review processes to better align capital investments with traffic expectations, and improve management of our balance sheet and capital structure. As I stated last quarter, these efforts not only strengthen Fastly's financial position longer term and allow us to drive increased efficiency in our business, but also improve Fastly's competitive positioning and its transparency to the investor community. I will now turn to the rest of our financial results for the third quarter. Our gross margin was 53.6% for the third quarter, compared to 50.4% in the second quarter of 2022. Recall that excluding onetime true-up costs, the gross margin for the second quarter would have been approximately 52%. This sequential improvement in gross margin reflects our prior expectations that it would lift in the second half of 2022. As we previously discussed, this is due to the discontinuance of site implications expenses in the first half of 2022, improvements in our network investment capacity planning to more closely match our traffic patterns and demand, and a focus on reducing the cost of components of our cost of revenue, including in the third quarter, a reduction in our bandwidth cost. As a result, we expect gross margin improvement of roughly 200 basis points in the fourth quarter relative to the third quarter. We do not see any meaningful changes, positive or negative, to our pricing in the third quarter as compared to the prior quarter. I appreciate your patience through this phase of our gross margin volatility. As Todd stated, we will continue to focus on gross margin improvement and efficiency through 2023 as our planned investment in our next-generation network architecture, ongoing management of network investments in line with expected traffic, continued improvement in efficiency and traffic handling, and management of our costs positions us for further gross margin improvements in the medium to long term. Operating expenses were $78 million in the third quarter, up 24% over Q3 2021 and down 1% sequentially from the second quarter. This was higher than we had previously forecasted, but was offset by higher-than-anticipated revenue, resulting in an operating loss of $19.8 million, near the midpoint of our operating loss guidance range of $18.5 million to $21.5 million. During the third quarter, we accelerated our sales and marketing investments to position us for strong revenue growth in 2023. Additionally, despite our more disciplined hiring in the third quarter, our headcount costs were higher than we had previously forecast, as we saw a decrease in our employee attrition rate during the quarter. As Todd indicated, we are investing in our go-to-market efforts as part of our revenue growth initiatives. As these initiatives are put into motion, we anticipate fourth quarter sales and marketing expenses will increase sequentially, while R&D and G&A expenses will remain relatively flat. And despite our increasing investment in our go-to-market efforts, there are meaningful opportunities to drive greater efficiencies in our operations, especially across G&A that give us confidence in meaningfully reducing our operating losses in 2023 and beyond. Our net loss in the third quarter was $16.8 million, or $0.14 loss per basic and diluted share, compared to a net loss of $13.2 million and a $0.11 loss per basic and diluted share in Q3 2021. Turning to the balance sheet, we ended the quarter with approximately $719 million in cash, cash equivalents, marketable securities, and investments including those classified as long-term. Our free cash flow of negative $44 million was down sequentially from the second quarter's negative $61 million, primarily due to a $27 million reduction in advanced payments of capital equipment and changes in operating cash flows. Third quarter free cash flow reflects the advanced payments of capital equipment of $2 million, capital expenditures of $15 million, which include cash purchases of capital equipment, capitalized internal use software, and payments on financial leases during the quarter. Our cash capital expenditures were approximately 8% of revenue in the third quarter. Our cash and capital expenditures include capitalized internally used software and deployment of prepaid capital equivalents. We continue to expect our cash capital expenditures for calendar year 2022 to be in the range of 10% to 12% of revenue. I will now turn to discuss our outlook for the fourth quarter and the full year 2022. I'd like to remind everybody again that the following statements are based on current expectations as of today and include forward-looking statements. Actual results may differ materially, and we undertake no obligation to update these forward-looking statements in the future, except as required by law. Our fourth quarter and full year 2022 outlook reflects 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 we have today. Historically, our fourth quarter sees strong growth relative to the third quarter, and we see a similar trajectory in 2022. I'd also like to note that given the nature of network traffic drivers in the fourth quarter, revenue is subject to volatility due to a variety of items, including holiday shopping patterns and live sports streaming viewership. As a result, for the fourth quarter, we expect revenue in the range of $112 million to $116 million, representing a 17% annual growth at the midpoint. We expect the non-GAAP operating loss of $18 million to $14 million and a non-GAAP loss per share of $0.15 to $0.11. For the calendar year 2022, we are increasing our prior revenue guidance by $7 million to a range of $425 million to $429 million, representing 21% annual growth at the midpoint. We expect a non-GAAP operating loss of $82 million to $78 million and a non-GAAP loss per share of $0.67 to $0.63, reflecting the impact of increased revenue outlook. And as I discussed above, we now anticipate operating expenses will increase in Q4 relative to the third quarter, and our second half operating expenses will be higher than the first half due to our investments in sales and marketing. Before we open the line for questions, we would like to thank you for your interest and your support in Fastly.

Our first question is from James Fish with Piper Sandler.

Nice bounce back on the top line there. And Todd, welcome to Fastly, looking forward to working with you again. I wanted to start on the sales cycles that you're seeing, particularly for new prospective customers. And obviously, you have some sales and marketing spending going on, but what are you guys seeing with sales cycles on those new prospective customers versus the willingness to consolidate more traffic and security functionality with your existing installed base?

That's a great question, and it's nice to see you again. I appreciate being here. In terms of sales cycle length, we haven't noticed any significant changes recently. However, we have observed some relatively quick sales cycles, particularly with large strategic deals. This is especially true for expansion deals where customers are transitioning from our content delivery services to security and expanding into edge compute. These cycles tend to be much shorter than those for acquiring new logos, which has been beneficial for us as we see growth in those areas. Regarding changes in the sales cycle for new customer logos, we haven't identified any yet, but it's important for us to remain attentive to this.

And then just a follow-up on gross margins. A couple of things. Obviously, some of the colocation companies out there are raising prices just given energy cost increases, particularly in the EMEA region. I guess, how is that impacting your gross margin for the next year or so? Or what are you guys seeing on that end? And at what point should we be through kind of the duplicative sites headwinds that you guys are, I'll say, self-creating?

Yes. We've observed changes in the power sector, particularly in Europe. We are aware of the situation, but we maintain strong relationships with our providers, which will help us manage it. As we grow, we are also improving our pricing. We've successfully reduced our bandwidth costs, and I expect this trend to continue. This effort extends beyond bandwidth as we are currently intensifying our focus on all areas of revenue costs to enhance our margins. This quarter showed excellent results, and I believe we have a significant opportunity to maintain this momentum, which is essential for our success. You will continue to see a strong emphasis on this aspect. We have opportunities with peering and utilizing our infrastructure and network more efficiently to boost our margins, even if we encounter some additional costs related to energy usage. Would you like to add anything?

The only thing I'd add, and I think to Todd's point, we're seeing good improvement constantly around bandwidth, managing our CapEx, helping on depreciation. Bandwidth and depreciation are kind of the biggest drivers of our cost of revenue, with colocation being a little bit smaller. So that tends to help against some of the increases we're seeing from the colocation providers.

The next question is from Frank Louthan with Raymond James.

I apologize for the audio issues. It's great to connect with you, Todd. Could you provide us with more details about the tech upgrade and the gross margin? Just to clarify, was the 200 basis points of pressure related to GAAP or non-GAAP? Is there a possibility that this will extend into next year? Also, could you share what you've observed regarding pricing, revenue trends, and how pricing is performing in the current market?

Yes. So I'll start on the 200 basis points in pricing. I think the 200 basis points that we saw in Q2 was sort of a one-time event. The duplication associated with our architecture migration was largely completed in the first half, as we planned. So that's really driving some of the Q3 improvements. And then I think as you look to Q4, you get a little benefit from the revenue accretion you see in Q4, as well as, as we indicated, we saw some improvements in our bandwidth pricing that we'll actually see that benefit for the full quarter in Q4. So that's why what's really the drivers behind the couple of hundred basis point improvement we'll see going into Q4. And then I think on pricing, we really haven't seen any meaningful changes in the quarter, positive or negative compared to the prior quarter.

I think as we look forward, there's a real opportunity for us to sort of continue this trajectory of margin improvement. We are deeply focused on this. One is just around really diligent capacity planning. We've seen some stabilization in the supply chain, maybe not complete, but enough. We are focusing deeply on doing very rigorous capacity planning so that we are deploying our equipment as efficiently as we possibly can. That goes beyond just how much we deploy, but where we deploy it. We're deploying our equipment into the right regions as we predict load. The second is network efficiency. We have a real opportunity as Fastly scales to push more of our bandwidth costs to peering links, which are radically less expensive for us, and that gives us an opportunity to find serious efficiency. And as Fastly continues to scale, that opportunity continues to be available to us. And last, it's really the efficiency of the system. One of the first things that I did when I sort of arrived at Fastly is to work closely with our infra team to understand all the work that's going on just to build the most efficient infrastructure possible, capable of really maintaining a trajectory of margin improvement for the next few quarters. And that's what we plan to do. That's our focus right now.

How important is it for you to achieve EBITDA positive, and what is your expected timeline for this?

I'll tell you that I believe we have a real opportunity to post a far more profitable or far better operating losses next year than this year. It's something that is incredibly top of mind for me and our whole leadership team. In fact, the discussion of deploying every single dollar spent at Fastly to fuel growth, being radically more efficient with our spend, more judicious, and even scrappy with that spend is incredibly top of mind for us because it's not lost on me that we have to improve profitability here and specifically our cash burn. As far as the timing of going to see that turnaround, we're going to try to give you as much information as we can in our next call when we'll be discussing the entire FY '23 plan and guidance. I think that would be the right time for us to give you a further outlook there.

Next question is from James Breen with William Blair.

Can you provide an update on your current capacity in light of the growth you're experiencing? Do you believe maintaining the CapEx range is sensible considering the new products and the growth within your existing customer base? With the improvement in gross margins, to what extent is that due to increased revenue on a fixed cost basis in relation to your network? Looking ahead, what do you foresee as the potential for gross margins as you scale?

Yes. So on the capacity side, I think earlier this year we kind of brought down our expected CapEx from 12% to 14% to 10% to 12% of revenue. I think there are opportunities as we get into next year to continue to see efficiencies around the CapEx side. As we use CapEx more efficiently and continue to make sure we're aligning with traffic expectations, despite what we see is really good growth and expansion within our existing customers.

Regarding capital expenditures, stabilizing the supply chain will assist us in managing CapEx, particularly through improvements in demand planning. Accurately predicting demand will enhance our efficiency in capital deployment, which is crucial. We are heavily focused on enhancing demand planning and maximizing every revenue dollar, including on the CapEx front as well as overall costs. Optimizing our bandwidth is vital, and I want to emphasize that. While CapEx appreciation is significant, bandwidth costs are substantial. Therefore, improving our bandwidth usage, better managing peaks, and optimizing peering will drive our efforts, and we will continue to strengthen this capability over the next few quarters. We are committed to maintaining this positive trajectory. I hesitate to predict how much higher we can go at this moment as I'm still assessing the business, but we will delve into this further when we provide guidance for FY '23 in the next call.

And just as a follow-up, DBNR was 122 or so, just below where your total growth rate is on the revenue side. What's the opportunity outside of your existing customer base? And think about that from a go-to-market perspective?

Yes. That's great. I mean, of course, we look at the existing customer base with organic growth in the technology we're already delivering and portfolio growth, especially with the early success we're seeing on Compute@Edge and with Security and the Signal Science acquisition. But as far as new logo acquisition goes, we've seen some real progress in the high-tech space, and we're looking at additional verticals where we can really make a concerted fast and wide go-to-market surge in terms of driving new enterprise logos in new verticals. I think with the product packaging improvements that we mentioned, we actually have an opportunity to reach some of the mid-market, especially the high end of the mid-market with a simpler motion, a lower friction motion to onboard new accounts. As we start to get our packaging in order, I think we're going to be able to see some improvement in how well we penetrate, not just large enterprise accounts, but at the high end of the mid-market as well.

The next question is from Sanjit Singh with Morgan Stanley.

It's Matt Wilson, on for Sanjit. Maybe just back to that last one. Can you talk about the opportunity in mid-market through the better packaging? How large is this opportunity? When can it kind of start to show up in financials?

Sure. Look, I think the better packaging really, it's not just a benefit in the mid-market. It gives us opportunity to lower the friction, really increase the velocity of our sales motion, the way we do our billing and invoicing, how customers understand what they bought and use as much of that as possible, really becoming platform users. I think from a packaging point of view, we have the opportunity impact our kind of core existing enterprise motion for sure. I will say, though, as far as mid-market goes, it's absolutely a requirement that we have simpler packaging that can be bought holistically so that you can deploy our content delivery technology with a single SKU, and that SKU can be transacted quickly and easily. This is, I think, really the most important part of that packaging when it comes to mid-market; it unlocks the opportunity for us to bring content delivery through our channel. We've had some early success on the security side of our business, bringing that to the channel, especially from what Fastly's learned from the SigSci acquisition and by building real simple, straightforward packaging for content delivery with the opportunity to bring that to the channel as well. I'm pretty excited about that. As far as sizing it, I think that's a good question, but something we'll probably have to take to the next call as well.

The next question is from Will Power with Baird.

Great. Yes, I appreciate all the color on improving the cost structure. I guess, Todd, one of the questions might be as you think about the cost reduction opportunities and improving cash flow, how do you balance that against also trying to improve revenue growth? It sounds like you have some initiatives there. So I guess what's kind of the confidence level and prioritization there between those two areas?

Yes, that's a great question and is something that’s very important to Ron, myself, and our entire senior team right now. We're focused on making sure that every dollar we spend supports growth while being serious about controlling expenses in the most sensible way. We aim to avoid making drastic cuts that could harm us. We’ve been diligent about eliminating unnecessary expenses in our infrastructure and cost of revenue, as well as on the operating expense side. We're looking to cut costs wherever there's easy wins without compromising growth. From there, we can assess how to balance our spending and growth. There’s a significant opportunity for us to organize ourselves better and ensure that every dollar is utilized efficiently, stepping away from vendors and contracts that do not contribute to our growth. Having been here for about 60 days, I'm still reviewing the details and want to make decisions carefully. The opportunity is there, and we’ll work to achieve this as quickly as possible, aiming to set ourselves up for improved profitability next year while being cautious not to sacrifice growth. I believe we’ll be in a strong position to provide more details in the next earnings call.

Yes, I mean, I think on the first part of the question, I come back to what Todd said in terms of seeing fairly short sales cycles in terms of customers quickly adopting either additional delivery or even more importantly, additional products around security or compute, where we're starting to actually see some traction in those areas. I think that expansion is one area that we saw in the quarter driving some of the increased growth, particularly around the timing trajectory of when customers took on that additional business. In terms of the macro headwind, I think to date, I sort of come back to what's been driving the business thus far: expansion with our existing customers, where we've actually seen maybe even less friction in expanding on existing customers. Given our relative market share, market share gains have sort of helped us against any macro headwinds that we see. Ultimately, I think the service that we do is pretty key to customers. If you look at the dynamics of whether it's M&E or shopping, I think you see opportunities for that traffic to continue to grow.

The next question is from Fatima Boolani with Citigroup.

This is Mark, on for Fatima. Todd, congrats on the first few months in the role, and it's great to see top-line raises on 2022. But just on the operating margin points coming down a point on the sales and marketing investments, is there any specific areas there that are really driving the lion's share of the investments or just a function of the opportunity ahead that you could call out? Can we get a sense of how much incremental investments may be needed just going beyond 2022, just given your initiatives?

Sure. Yes, I can speak to that. Look, on the sales marketing side, we've tried to focus any incremental investment on carriers. And that's been sort of a religion here, focusing on covering as many accounts as possible with the strongest possible teams. Really, quota carriers and the account executive in SE roles, that’s where we focus any incremental spend. As far as looking at the projections beyond FY '22, I think it will be a little bit early for me to make the call on it. I recognize that this is a question that keeps coming up. We are deeply concerned about it, especially the operating loss side of the house, and it's absolutely the area where my whole team right now is engaged in our planning for next year. I want to be just as judicious as I possibly can to put that strategic plan and budget plan together before we talk about it publicly.

Got it. Maybe just a follow-up on that. Just going to 2023, there are probably meaningful opportunities to reduce operating losses. Any areas of low-hanging fruit outside of the gross margin levels that perhaps you didn't expect?

I believe there are clear opportunities to improve efficiency by addressing duplicative systems. We've already identified this in a few areas, particularly in our cost of revenue, which will enhance our margins. There's also potential for savings in our operating expenses. We can streamline our processes to find efficiencies, particularly in how fast our teams can work with fewer external contracts or support. Transitioning our sales approach to a packaged system should lead to a more straightforward operation that requires fewer resources. This will be crucial for improving our profitability next year and will also support our scaling efforts over the next three to five years.

The next question is from Justin Re with Craig Hallam. I believe there is an opportunity for us to enhance efficiencies in our systems and improve how swiftly our teams can function with reduced reliance on outside contracts or support. By simplifying our approach and transitioning our standard sales process to a packaged system, we aim to streamline operations and require fewer resources. This will be crucial for driving our profitability next year and will be essential as we plan to scale in the next three to five years.

This is Daniel on for Jeff. Just a quick question for me. You mentioned quota carriers. Can you just refresh us on where the sales heads are at right now in terms of count? And just update us on what you're thinking in terms of count moving forward?

That's a great question. I don't have the numbers right in front of me, and I don't want to quote something either.

We'll have to get back to you on the exact numbers. So I don't want to give you a number that's closed.

Yes. Yes. All right. Well, just a second question there for you, Todd. A lot of conversations on the call about margins understandably so. But just kind of wondering as you're entering or you're looking at the opportunities facing the company, what other areas are a focus of emphasis for you as you're looking at potential changes and things you're interested in as you’re stepping in?

Yes. Look, I think the cost control is an opportunity for sure top on my mind. Improving the margins, I think it's a huge opportunity we have, the ability to deploy technology and resources to improve the margins, which is great too. But I think as far as the opportunity goes, it really is around driving growth for us. We have the opportunity to drive organic growth, both within the technology or employee and portfolio expansion. We have local acquisition along a line of expanding from one vertical to the next, but also driving beyond the enterprise account set. We’ve got a real opportunity to look at driving growth in a very significant way, even beyond those dimensions, geographic expansion as well. For us, trying to balance, like there's a huge opportunity in managing these different dimensions of growth and really focusing ourselves on the areas and the opportunities for growth where we have the best investment leverage.

The next is from Tom Blakey with KeyBanc Capital Markets.

I find your comments on expanding with existing customers interesting. Could you elaborate on those statements regarding penetration rates? Are you referring to any specific customers or just generally? Additionally, is there potential for growth by capturing market share from established CDN and security vendors? I have a follow-up question after that.

Sure. Yes. I think when it comes to logo acquisitions, we are largely looking at picking up share, no doubt about it. In some cases, that means actually transitioning customers over from another CDN provider or being their first CDN provider, both cases really focused on picking up share and growing our market share in the CDN space is an enormous part of our focus, no doubt about it. But it's important to remember that Fastly, while we deliver CDN, is really edge cloud. And that's edge-cloud platform is our offering, which is why there's just been an enormous opportunity for us to do portfolio expansion with existing accounts. Expansion from content delivery to security, especially in this space, has been an incredibly powerful force right now, especially because the industry is focused on WAF right now. The Web Application Firewall is becoming more and more the fact of standard and the requirement for application developers or website developers. It's a great and growing market. We're focused on that expansion. That's really a growth portion of our portfolio. When we look at edge compute, I think of that a lot in terms of incubation, an incubation business. Something that was really a pleasant surprise when I got here is to see how mature that business has gotten in such a short time. We've had very significant deals in edge compute and customers who were content delivery customers who are actually going to be spending more in edge compute next year than on content. I think that's a motion that we can replicate, and it’s an important one because app developers, especially, are looking at how dynamic, real-time their applications can be pushing that compute to the edge has a huge opportunity to deliver that outcome for them. So we're very bullish on that opportunity, and that's something we are really deeply focused on.

Some interesting comments about expanding on existing customers. I was wondering if you could clarify some of those statements regarding penetration rates. Can you provide insights on any customers generally or any specific ones? Additionally, is there potential for expansion by gaining market share from existing CDN and security vendors? I have a follow-up after that.

Yes. So this is Ron. On the commitments, what we did, I think going into really the pandemic when we realized there were going to be supply chain issues, we basically made commitments with the number of our suppliers to lock in a certain supply of equipment. That supply of equipment, we're taking delivery on that as we need to deploy it in line with those traffic patterns. From a cost perspective, and we did talk about last quarter that we did make some payments associated with these prepayments, but we haven't taken delivery of the equipment. We start taking depreciation only when we take title and deploy this. We're going to deploy this in line with our build plans that are aligned very tightly with what that demand is. When we see the demand, the equipment is available, and that's when we actually start taking title to the equipment and reflecting the cost of that in our gross margins. With those cash commitments, it positioned us really well to meet the increasing demand, and still allows us to deploy in line with expected traffic patterns.

Ron, could you provide any insights into the overall capacity utilization rate in relation to the company's gross margin structure? Is this a geographical issue? You mentioned deploying more equipment with demand, and while I'm not trying to pin you down for a specific number, I would appreciate your thoughts.

It's a good question. The challenge lies in the fact that utilization can differ significantly based on geography and the timing within the quarter. There is some seasonality in our business, meaning you need to prepare for the demand expected in the fourth quarter. Capacity needs to be in place to handle that anticipated demand. So, you allocate a portion of that capacity. Additionally, as we've mentioned before, when we expand, especially in new regions, the initial deployment often operates below our typical or desired utilization as it is set up to take advantage of specific opportunities. As traffic in that area increases, we can improve utilization. The utilization impact stems from both the traffic levels we are observing and the areas where we are extending our global platform.

We have no further questions at this time. I'll turn it over to Todd Nightingale for any closing remarks.

Thanks so much. Thanks, everyone. Before we close the call, I want to take an opportunity just to thank all of our customers, employees, our partners, and our investors. Fastly remains as committed as ever to making the Internet a better place where all experiences are fast, engaging, and safe. Moving forward, we remain focused on execution, on bringing lasting growth to our business, and delivering value to all shareholders. Thank you all. Thanks so much for the time today.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.