Fastly, Inc. Q4 FY2022 Earnings Call

Good afternoon. My name is David, and I'll be your conference operator today. I'd like to welcome everyone to the Fastly Fourth Quarter 2022 Earnings Conference Call. Thank you. Vern Essi, Investor Relations at Fastly. Please proceed with your conference.

Thank you, and welcome, everyone, to our fourth quarter and full year 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 one 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 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 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 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 6, and the Morgan Stanley Technology Media and Telecom Conference in San Francisco on March 8. And also mark your calendars for our Investor Day, taking place on June 22 at New York Stock Exchange. With that, I'll turn the call over to Todd.

Thanks, Vern. Hi, 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 Ron 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 a $3.3 million take or pay true-up payment materially above a similar $973,000 true-up payment from Q4 of last year. Correcting for these non-recurring payments, our revenue would have 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 Fastly team on closing on 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 remain strong. Our LTM NRR was 119% in the fourth quarter up from 118% in Q3 and our DBNER was 123% in the fourth quarter up from 122% in Q3. Our average enterprise customer spend was $782,000 representing a 3% quarter-over-quarter increase and continues to demonstrate the success of Fastly's 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 add multiple follow-on sales for our Next-Gen WAF Technology. In addition, we have multiple new logo wins for this product as a standalone sale. We anticipate over time having the opportunity to sell these customers our network service delivery, as well as our edge compute and observability features. I'm also excited to share with you that we're gaining traction across multiple verticals. The fourth quarter marked six new logo wins in travel and leisure, a 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 was 2,958, which increased by 33 customers compared to Q3. Enterprise customers totaled 493 in the quarter, an increase of 11 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 at a 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 spent. Excluding the impact of this $2 million payment and the take or pay true-up payment I discussed earlier, our gross margin would have been 57.5% in Q4, increasing 390 basis points from 53.6% in Q3. During the quarter, we continue to drive our durable innovation strategy and release powerful, important technology to our customer base in all of our product lines. A selection of them are listed in our investor supplement for your reference. A few highlights include one, PCI Certification with the Level 1 Service Provider, expanding our e-commerce customer reach and making it easier for e-commerce customers to onboard Fastly. Two, our JavaScript SDK for Compute@Edge, when GA offers unmatched initialization performance further differentiating the ability for Fastly to provide among the fastest load times in the industry. We believe this is a big step forward for developer adoption. Three, our Fastly Next-Gen WAF now supports automated provisioning and management via Terraform for our cloud-based deployment options. And four, as we continue to see advanced Bot and DDoS activity we expanded our Next-Gen WAF advanced rate-limiting rules. Security is top of mind for all of our customers. So we are excited that for the fifth year in a row Fastly's Next-Gen WAF has been recognized as a customer's choice in the Gartner peer insights Voice of the Customer, cloud web application API protection report. Fastly is the only vendor to receive this recognition for all five years. We're especially proud that customers gave Fastly an overall five out of five stars, the highest of any vendor, and 97% said they were 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. We had 15 keynote speakers, including multiple customers at the conference. Videos of most of the conference are now publicly available. Also at Altitude, we’ve relaunched our Open Source and Non-Profit program as Fast Forward with a renewed focus on building community among the builders and maintainers of a faster, safer, and more inclusive internet. Our developer community continues to grow through our edition of Glitch. It has been less than a year since we acquired their team, but the results thus far have been impressive, with over two million developers. That community is already starting to drive our compute roadmap and early adoption. And now I'd like to share my thoughts on my first six months at Fastly. I remain incredibly impressed by this team, and its potential. 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, safe, and engaging. There's tremendous opportunity in Fastly as 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 experience for our developers and for our users. We have a real opportunity to run a high-velocity, low-friction go-to-market motion at Fastly, reaching more customers and onboarding them more efficiently. I'm excited with how the teams have realigned for FY '23 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 divide our edge cloud platform services with reliable billing, simple renewals, and a more complete, simple offer. 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 Fastly. 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. 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 Fastly solutions, and our employees have a real enthusiasm for Fastly's mission. Of course, there's 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 Fastly 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, our focus 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'll 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 that unless otherwise stated, all financial results in my discussion are 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 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 Signal Sciences products was 12% of revenue, a 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 our relatively smaller market share, we've benefited from share gain in an otherwise challenging environment. These 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 remain strong. As Todd stated, we had 2,958 customers at the end of Q4, of which 493 were classified as enterprise; those customers generated in 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, in line with their contribution in Q3. Our enterprise customer average spend grew to $782,000 from $759,000 in the previous quarter, representing 3% expansion in dollars spent. Our strong trailing 12-month net retention rate and growth in average enterprise customer spend demonstrate our continued ability to expand with our largest customers by increasing our share of delivery traffic and adoption of new products and security in our emerging compute business. Our top 10 customers comprise 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 that closely align with Todd's new leadership. We are 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 strengthen Fastly's financial position longer term, but also allow us to drive decreased efficiency in our business, improving 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 2022. 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 margins. As we shared on our Q3 call, we saw a reduction in our bandwidth rates 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 costs. We continue to see benefits or improvements in our network investment capacity planning for more closely match capacity and investment with our traffic patterns and demand. 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 demands 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 '21 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 to $18 million. Our net loss in the fourth quarter was $9.5 million, or $0.08 loss per basic and diluted share compared to a net loss of $11.7 million, or a $0.10 loss per basic and diluted share in Q4 2021. Our adjusted EBITDA for the fourth quarter was negative $91,000, compared to negative $3.5 million in Q4 '21. Turning to the balance sheet, we ended the quarter with approximately $683 million in cash, cash equivalents, marketable securities, and investments, including those classified as long term. Our free cash flow was negative $40 million and reduced sequentially from the third quarters 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 deployment 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, and 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 '23 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 customers 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 a meaningful leverage in our G&A costs in 2023, for these costs have decreased as a percentage of revenue. Given the nature of network traffic drivers in the fourth quarter, including holiday shopping patterns and live sports streaming viewership, historically, our first quarter sees flat to down revenue relative to the fourth quarter, and we expect to see a similar trajectory in 2023. 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 one-time 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 to 100 to 200 basis points from our Q4 gross margin of 57.5%. Adjusted for the aforementioned true-up. 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 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 impact 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 a non-GAAP operating loss of $18 million to $16 million, and the non-GAAP loss per share of $0.12 to $0.08 per share. For the calendar year 2023, we expect revenue in the range of $495 million to $505 million, representing 16% annual growth at the midpoint. We expect the non-GAAP operating loss of $53 million 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 the non-GAAP loss per share of $0.27 to $0.21. 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. 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 in Fastly.

We'll take our first question from Frank Louthan at Raymond James. Your line is now open.

Great, thank you. So, walk us through your path to getting more towards EBITDA positive, you think that's something that can happen this year? That's more next year? And then with that, what are some of the top things where you're finding the ability to take costs down in the business? Thank you.

So quickly, I guess if you look at sort of adjusted EBITDA in Q4 of this year, we ended up at about $91,000. So, I'd say that's fairly within striking distance of breakeven. I think, as we look to going forward, there are 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. We expect that to continue beyond 2023 and our efforts to drive leverage and operating expenses, will continue to bring down OpEx as a percent of revenues. So that's generally the trajectory that gives us high confidence in getting to that breakeven point. In terms of specific timing, we'll be sharing a lot more in terms of the timelines and revenue levels where we achieved that metric at our Investor Day in June.

All right, great. And anything specifically you can point to as the major areas where you're finding the cost improvements? Thank you.

I can add a little bit there. We have efficiency in the cost of revenue that we're certainly finding in efficiencies on the infrastructure, just due to the engineering improvements, and also cost reductions, our networking costs, because of our documentation efforts as well as contract negotiation. 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're starting to see some success in removing duplicative systems that aren't needed across the board. And we're seeing that on the G&A line, but also, to some degree in the go-to-market and the R&D side of the house, and really being thoughtful about our hiring and really focusing on customer-facing roles and durable innovation engineering roles primarily.

All right, great. That's very helpful. Thank you.

Hi, good afternoon. Thank you for taking my questions. Todd, 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 more non-traditional to you, and what type of wallet capture you're seeing? And then I had a follow-up.

Yes, it's definitely a great question. We are currently focused on achieving balanced growth across all verticals. For instance, we've had a significant emphasis on e-commerce in the past and have experienced considerable success there, but there are many other verticals where enhancing the digital experience through our website and applications is crucial. This focus is certainly generating interest in Fastly, particularly in content delivery, which allows for lower latency and a more engaging user experience. Additionally, our edge compute capabilities and the simplicity of onboarding our security platform are making a noticeable impact. Travel and leisure is one example, and traditional retail is another strong target for us. We are also seeing positive developments in healthcare, as the industry increasingly evaluates the patient experience. We have a significant opportunity with our emerging Edge Compute portfolio alongside our network services and content delivery to make a substantial difference in this sector. Regarding wallet share, I believe we are only beginning to tap into our potential. There is a vast opportunity to expand our relationships with customers who are just starting out and utilize these as examples to deepen our penetration into various verticals.

I appreciate that detail, Todd. Ron, for you just on some of the one-time impacts in the quarter. So you really flushed out for us the true-ups. But I'm curious from an event standpoint, if you can quantify what the World Cup might have done to the business, and then the Super Bowl, and anything else we should be mindful of as it relates to the sequential compares from some of these one-time events. And then just as a related matter, I know customer concentration did pick up. So was that in any particular vertical or end market that drove that? And do you expect that customer concentration level to increase as you continue to focus on penetrating the install base? That's it for me? Thank you.

Yes, it's a good question. So we don't get into your specific traffic levels around sort of specific events. I think the way to look at it is if you kind of look at the seasonality change between sort of Q3 and Q4 across the quarters, that will give you some indication of some of the traffic increases. What we're particularly seeing 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, over the past couple of years. I think as we look to the second part of your question, on customer concentration, I think we'll see some fluctuation in it. I think as we continue to accelerate new customer acquisition, we are expected 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 to move around a little bit, but I don't see any major either increase in it or decrease prospectively.

Thank you.

Yes, thank you for taking the questions. And I wanted to get the team's perspective on the factors that can ultimately drive gross margin. I think you mentioned in your prepared remarks around that pricing was neither a tailwind nor a headwind, you guys took the trade-off to reduce your purchase commitment. So I'm trying to get a sense of ultimately in getting a path to 60%, what sort of needs to happen, is it a better pricing environment, is it a higher mix of fast compute? As you sort of draw the picture for us, getting to 60% and hopefully north of that over time. What are the sort of things that we're looking to execute upon?

Yes, that's a great question. So on the gross margin side, getting to 50% I think is a good milestone and something we're looking at closely. I think you're right to mention, ramping up the compute business faster would I think have had a tendency to help in that area, and also a mix change that would shift toward security would help. But even under current, even with the current mix, we're targeting that goal of getting within striking distance of 60%. So whether mix changes or not, we're going to drive towards that through effectively increasing 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. Our teams have really focused there, so that we're not deploying the equipment that we won't need. And that makes a big difference, which is exactly what motivated our focusing on getting rid of some of these purchase commitments to kind of lay the groundwork for better margins in the future.

That makes perfect sense. It's encouraging to hear. Ron, a real quick question on the guidance. So I heard you loud and clear on the seasonality in Q1 and the timing of events, but when I sort of look at the full year guidance, does it imply stronger growth generally in the back half of the year against compares that, at least by my model, look a little bit tougher? I just wanted to get your perspective on that potential stronger growth in the second half against tougher compares.

Yes, it's a good question. 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 there's a couple of drivers one, I think last year, Q1, we 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 I think as we move through this year, what we've seen is, building off of the really strong expansion motion that we saw across our customers, as we've continued to add new customers in the second half of this year, those as they ramp their traffic, and we increase our expansion effort, and those start to really take place as you move through the second, third, and fourth quarters of the year.

Thanks for taking the question. Can you talk a little bit about the network and the CapEx side? It was 14%. I think you said for the full year. And I think you said 6% to 8% for 2023. Just talking about where you are in terms of network evolution and spending on that over the next couple of years, as you see increased revenue on that platform?

Yes, so just to clarify on the CapEx, as a percent of revenue, we while this 14% in the fourth quarter, CapEx for the full year was 10% of revenue. It was down from what we had guided beginning of the year. And as we move into next year, we'll base a lot of efficiencies that Todd spoke about on our platform efficiency, we see that capital intensity coming down further to where in 2023 we would expect CapEx to be somewhere between 6% and 8% of revenue.

And how are you able to do that taking some of those absolute dollars down?

I think one of it is, there's 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 to better manage the use of our bandwidth. Being able to automatically route traffic to lower costs, bandwidth rates, and 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 your 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. The ROI on those become more and more attractive for us to deploy resources. And so, scale kind of helps us drive these efficiencies, which we're starting to see in that gross margin number.

Thanks, guys. And to clarify the 6% to 8% CapEx, do you think that's more permanent kind of going forward? Or there's just another one maybe one-time true-up this year?

I want to clarify that we expect capital expenditures as a percentage of revenue to be around 6% to 8% next year, compared to about 10% this year. We anticipate decreased capital intensity in 2023 due to the improved efficiency we discussed. Looking further ahead, I don't expect capital expenditures to increase, and there may be opportunities to approach the lower end of that range. This will largely depend on future traffic growth. We should continue to see significant efficiency improvements in our capital expenditures, and I believe next year will be indicative of that trend. Notably, we've reduced our capital expenditures from about 14% to the projected 6% to 8% next year, which is a significant shift. Compute@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 costs, then, how differentiated are you? And in the same vein, can you just talk about the potential for AI to run on top of this infrastructure at a high level? Thanks. Sure, that's an excellent question and something we are very focused on. Compute@Edge is critical for us because it not only represents fascinating technology but also enhances Fastly's core value proposition by enabling the fastest, safest, and most engaging user experiences. The speed and application performance we provide, along with our content delivery and network services, play a significant role in achieving this. The natural next step in our evolution is Compute@Edge, which brings processes as close to the user as possible. Many of our sophisticated customers are carefully examining metrics like time to interactivity on websites and applications. This focus on interactivity is crucial, especially in e-commerce, where it can make a substantial difference. We're also observing this trend across various other sectors. Our differentiation in this space is essential, and being developer-led plays a significant role. You can see this reflected in some of our technology announcements. Developers are increasingly moving workloads to the edge and aiming for performance goals, needing assurance that the Compute@Edge platform will be reliable for their future needs. This was a key motivation behind our Glitch acquisition, and we are receiving valuable feedback that informs our roadmap, including platform and language support, such as our recent JavaScript launch and automation tools like Terraform support. Yes, sorry. I missed that part. It's an interesting question. I would say sort of our growth trajectory isn't dependent on that. But there's an interesting, it's an interesting idea. It might wind up mattering, how much GPU you start deploying out at the edge of traditional CPUs, but for us right now, we're focused on more traditional workloads.

Hey, this is Quentin on for Jim Fish. Thanks for taking our question. Looking first at the security side of the business, this is a focus for a lot of investors. And the team really looked inorganically the last time it really tried to level up kind of the Fastly portfolio. Can you talk about how you're balancing organic and inorganic opportunities in the security platform and maybe what opportunities are available for Fastly to take on from the security side?

Certainly. In the security sector, which is a highly diverse market, we are concentrating on web application security. The acquisition of single sign-on represents our strategic move to integrate a key component and enhance our business and collaboration around Next-Gen WAF. We are now focusing on strengthening the Signal Sciences portfolio with advanced and managed DDoS protection for our customers, alongside enhanced threat protection. This aligns with our vision of a strong emphasis on web application security. While we are open to possibilities, our current focus is on organic innovation from the Fastly team. The Fastly platform team has been providing advanced DDoS protection since the beginning, giving us an excellent opportunity to offer greater insights, management, and visibility to our clients through our security platform. Additionally, we are seeing considerable interest from customers in the bot area, and we have pursued some exciting partnerships. However, we will concentrate on organic innovation in this domain as well. The single sign-on acquisition was our first strategic product line acquisition, but at this time, we are focused on fostering organic innovation without any such acquisitions on the immediate horizon.

Got it helpful. And then Ron, maybe for you on the guide? What are you implying here from a macro standpoint, to kind of get to the numbers you're laying out for '23? 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 economic environment broadly stays 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.

Hey, guys, thanks for taking my questions. Todd, I was wondering if you can update us on your near-term intention to leverage peering and the path towards that. And then Ron, maybe on that same topic, how should we think about peering playing into the '23 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?

Absolutely. Thank you.

Okay, great. So Todd, first for you. I was wondering if you can update us on the near-term intention and your path towards leveraging peering. I know you've talked about that in the past. And then Ron, 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 '23 as opposed to '24?

Yes, great question. Something our infra team thinks about a lot. 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, and improves our current core value proposition by decreasing network distance, putting Fastly’s costs closer to the user, which is amazing. It also drives lower networking costs in our cost of revenue. And so for us, finding the strategically 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 something that we do focus on quite a bit.

Yes, I think as you look to peering, one of the things that Todd said earlier is, obviously as we scale, there's an opportunity to increase the amount of peering that we do, which brings down our bandwidth costs. We've said bandwidth is about a third of our costs. The drivers are going to be peering and will be a more efficient use of overall bandwidth, which I believe will drive increased efficiency in our platform from bandwidth costs in '24. So as you look at where we exit, I think there's an opportunity to continue to see accretion in gross margins into '24. Driven from the cost structure side of things. The other piece is capital intensity. 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 of '23 into '24. But obviously, bandwidth is a big one. It's the single biggest cost.

Great. So maybe the next question here, changing gears, packaging has been a clear focus. If I'm not mistaken, I think you mentioned you'd be ready for Q2 and some of the changes to drive simplification. I'm wondering, Todd, how does that sales playbook change relative to that packaging evolution? And how are you positioned to leverage those and all that hard work you've been doing to mobilize those changes? Thanks.

Oh, I love a packaging question. I think there's just an incredible opportunity, both sort of internal pathway 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, security, edge compute, or observability. These are the four 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 to onboard. And that's something we'll be tracking very carefully. It also provides well, other benefits to customers, like reliable billing, simple renewals, etc. It also provides, importantly, a more channel-friendly option of simple skews with straightforward pricing and discounting, etc., that can just move through not just our go-to-market, but our systems integration and MSP channel partners go-to-market more efficiently.

Wonderful. Thanks so much for taking my questions, guys. Nice to see some good resilience and a path to better margins. Maybe two questions, if I may. First, as we've talked about the developer ecosystem, and I know like it's accelerated with the acquisition of Glitch. Maybe I'd love to talk a little bit more about going down the PLG strategy, some of the efforts you want to make to maybe return to your roots, and what I guess what steps need to be taken to actually gain that traction? And what sort of impacts you think that could actually have on your margins and sales efficiency going forward? And then I got a follow-up.

Yes, great questions. I think we've been very thoughtful about PLG in these first couple quarters that I've been here, specifically, really on building out products, support for motions that allow our teams to move more efficiently and for customers and users to be able to self-serve more. Specifically, we focused a lot on 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 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 products support for fully automated free trials. That's really just one example. The packages, I think, give us another opportunity to lower the friction that enables us to operationalize that sort of platform-wide free trial instead of individual product or feature by feature free trials. And maybe that's just a good example of how we see product-led growth evolving at Fastly. Not fighting against our sales and partner team, but really helping fuel and drive that enterprise sales motion. I think that we have perhaps the biggest area where we expect to see a real impact right away is in that mid-market commercial account, where having fully automated motion and bringing in the right Fastly resources when needed, to smooth the land-and-expand play can really make a difference.

As far as supporting margins, I always believe mid-market businesses are good for margins and good for customer retention. So I like that.

All right; wonderful, that's really helpful. One financial question. So nice to see improving margins, the guidance talking about margins improving more significantly from here. But at the end of the day, 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 break-even or even starting to generate cash? Thanks.

So I think, you know, I'll leverage off some of the comments we made about some of the opportunities in the business to improve from an operating margin. Bringing that to breakeven. As you look at '23 and '24, there's a couple of significant tailwinds. During '22, we spoke a lot about some of the prepayments we made toward capital equipment. 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 deployments for equipment should be down materially. And then I think, alternatively, as we continue to drive margins and efficiency in the business, we believe that there is a significant opportunity to improve 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 the progress we've made on adjusted EBITDA, but at Investor Day we will provide a lot more granularity in terms of timelines, and again, kind of revenue levels at which we get to cash flow breakeven. But in addition to the efficiency we see in operating margins, there are efficiencies in our cash going into '23 that are meaningful tailwinds to cash flow usage.

Yes, great. Just a couple for me, I think on the go-to-market improvements, it sounds like the packaging you see as a big catalyst. And maybe that's the answer. But when I look at the enterprise customer additions, it seems 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 has been growing kind of slow and steadily. We measure that in arrears. So 100k revenue over the last four quarters. It's a little bit of a trailing statistic for us. But I think this sort of slow and steady growth; I mean, that's what I'm expecting to kind of hope to accelerate slowly over time and not find a big huge pop all at once. Perhaps the driving force, this repackaging would be one, but maybe something else will be platform unification. By unifying our platform, I think we're making it 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. That will, by doing that, help ease our expand motion and drive a more strategic relationship with our customers as they become sort of multi-portfolio users and help them cross that threshold that 25k a quarter threshold. But again, I think in terms of like, are we going to see a big pop in that number? No, I hope to accelerate the growth in that number just as we accelerate the rest of our revenue line.

Yes. 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 a platform unification? How has that initial use case or initial capability/pain point changed in terms of the reason you're landing in the first place?

Yes, that's a great question. I don't really want to recreate competitors. I'm sure you can guess when we look at content delivery, we're picking up share, and I believe we have an opportunity to pick up share, specifically by focusing on user experience. Fastly, we're not a CDN company, or a 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. The idea of platform unification that we are building a more complete offering for our customers. That is the differentiation that we hope to use to deliver a better user experience for everyone. A true focus on user experience provides fast, safe, and engaging digital experiences.

Great, thanks for squeezing me in here. So I'm clarifying the quarters, the $3.3 million in true-ups; did you have any expectations looking into your guidance? Was there any expectation that you would get any of that in the quarter or no?

Yes, I think going into the guidance, 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 overachievement was the magnitude of that as well as overall traffic pattern; we saw a really good expansion with an existing customer over the course of the quarter, as well, that actually drove overachievement in the quarter.

Okay, got it. And then on the guide for '23, I'm just curious if you could give any more specifics with respect to the assumptions on growth for Signal 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 Sciences reported being a faster-growing element; security's certainly important. I think the other piece is, compute is also a faster grower, although it starts from fairly nascent levels. Those are going to be the higher growth items; I would say security is probably one of the key contributors to the growth. But we're also sort of seeing growth in core traffic, both from new customers but also we're seeing in some of our largest customers, continuing to gain traffic share based on that user experience. So we see growth across that; I think one way to frame it, as Pawns sort of framed it is 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 into that growth engine; we continue to have new things in compute that will grow into part of the growth drivers. Anything further, Rudy?

No, that's it for me. Great, thank you.

Thanks so much, everyone. Many of you had questions 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 a better place where all experiences are fast, safe, 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, and thank you for your time today.

This concludes today's conference call. You may now disconnect.