Fastly, Inc. (FSLY) Earnings Call Transcript & Summary

All right. Good afternoon, everyone. TMT, Day 3, the afternoon session. Super pleased to have the management team for Fastly, Todd Nightingale, CEO; and Ron Kisling, Chief Financial Officer. Thank you both for joining us at the conference. I think just to read some disclosures, so basically www.morganstanley.com/researchdisclosures to get the disclosures. And with that, let's kick off the conversation.

Todd, I wanted to start with just a little bit about yourself, you're roughly 6-plus months into the role. What attracted you to the Fastly opportunity? And then as you took on the role, what was your sort of assessment of the state of the business? What are the things that you thought like things are being executed very well on. And what are some of the things that you wanted to drive further improvement?

Sure. I come from a networking Internet background. My entire career like I've been building the Internet. And looking forward at what the Internet is going to deliver to the world, it's going to be about user experience. The user experience of websites, applications stream. [Audio Gap] That's what's going to matter most when it comes to building. [Audio Gap] The next 10 years. And for me, building networking infrastructure was so exciting because we were bringing that outcome to the world, I think, Fastly and the edge cloud space, really going to be one of the most exciting spaces for the next 10 years and how we deliver that user outcome that's so important. And we really just got like 3-year tutorial through COVID about how every organization from schools and government and businesses across almost every vertical, their success is going to be dependent on the user experience, the digital experiences that they provide. And for me, that just sort of focus the importance on a company like Fastly that delivers that. It's been 6 months. It's been an exciting 6 months. And coming into Fastly, I was just really happy with sort of the innovation velocity. And I was happy with the culture, too. It has been a culture that's really accepted change and focus incredibly well. And I think that's because Fastly culture is so passionate about delivering the mission, making the Internet a better place where every experience is fast, safe and engaging. And as we -- Ron and I are so closely partnered on building a successful, stable business so that we can have a greater impact on the world and deliver that mission more broadly. And the company has really responded to that, and that's been amazing. I've been really touched at how people have embraced that pivot.

To pick up on some of the themes that you just addressed. When I think of Fastly, I think of a company that's an engineering culture that's really focused on delivering the best performance, the best outcome for customers. And that meant sometimes going against the grain, right, in terms of -- we're not just going to go with what has been done before. But if there's a better mousetrap, we will go out and build it even if there may not be -- maybe like sort of an out-of-the-box solution. I wanted to get a sense of whether the philosophy or the operating philosophy within Fastly is changing. And then what I thought was interesting you just launched a 1.0 release supporting JavaScript and computed edge, which took some time. And I wanted to get your perspective on whether this marks sort of an evolution in terms of the company's thinking. Do we have a more, let's say, pragmatic in terms of get out something there that can maybe satiate demand first before we get things spot perfect?

Yes. I think the JavaScript pack is pretty solid. Like I think it's been well accepted and ramping also about that. But I would say the pivot has really been around defining the scope and using that to drive focus. Building a better mousetrap is great, and we pride ourselves on being a performance leader being an innovation leader in edge cloud. But without a real focus on the mission on what the scope of Fastly deliverable outcome is going to be. Sometimes it's hard to make decisions about where to invest. And so we focus and articulated the focus of the company now for the better part of 6 months. We're a user experience company. What we deliver is the best application experience, the best web experience possible. And we do that by delivering technology for an edge cloud that puts our infrastructure as close to the user as possible. It gives us the best opportunity to deliver that experience. And anything that helps web development teams, application development teams deliver a better digital experience over the Internet. That's what we're going. And when we say better, we need fast, safe and engaging, making the Internet a better place where all experiences are fast paced in engaging. If it doesn't fall under that scope, we're not going to build it. Even if our infrastructure is like well positioned, we're going to focus on this one outcome because that's one buyer, and we can leverage one go-to-market team efficiently and it's one infrastructure we can leverage one infrastructure efficiently. And that outcome is something that I think the company is really building a momentum around focusing upon. And the edge compute releases and there have been quite a few actually in just about 6 months. Have been -- I think, about realizing that as continue is an area where we've always sort of prided ourselves in having the most dynamic edge cloud. And by letting our customers now deploy their own bespoke workloads right at the edge, they can deliver a better user experience when it matters most. And that's why we're focusing so much on that right now. I think it's a super exciting space. I've heard some other people talking about it last year. And I think the biggest change culture is focusing on this [Indiscernible].

So wondering how that -- the evolution and focus can maybe map to the evolution in sort of your go-to-market and the markets you're sort of pursuing. So traditionally, historically, Fastly has been focused at the blue chip customers, large enterprise. And I want to get your percent whether there's an opportunity to move and address some of the longer-tail. And what kind of muscle would you have to build to execute on that and sort of that -- sort of market positioning.

Yes. That's a great question. Actually, I got -- we got a bunch of questions about that before my very first earnings call, and I've only been in the seat like 6 weeks.

We're a tough bunch. Sorry about that.

Maybe 8 weeks. And I still believe what I said there. I think there's -- Fastly has an enormous set of licensed customers right now. It's a gift like huge strategic accounts that are in so many ways, demonstrating the ways that edge cloud can be used to drive better user experience, better security, better application reliability, better performance. But there is a real opportunity for us to start penetrating the rest of the market beyond those [indiscernible] especially like media and journalism, tax, health care, travel, et cetera. And I think we do have that opportunity, but it takes a different muscle. And a big step forward in building that muscle, the packaging efforts that we're going through right now. One thing we hear from mid-market quite a bit is it feels a little risky to buy -- to architect Fastly into their infrastructure, pure utility building model where they're going to have -- they have to kind of project how much they're going to have. So by delivering packages that are all-in from a functionality perspective and we're doing that per module network services, security, edge compute. And by giving them a reliable packaging, reliable building, reliable discounting, they have a very predictable way to onboard to get started. And that -- those packages are going to launch in Q2. We're already seeing some early successes on that. And I think that's the first step in building that muscle around the mid-market. And there's a secondary effect there, which I think will help us drive the mid-market penetration as well, which is -- this type of package with an all-in functionality, reliable building a SaaS-like deal. It allows us to unlock the channel with much greater velocity and that's important to the channels that help us [Indiscernible] systems integration channel, especially with the [Indiscernible] side to help us reach some more of the market [indiscernible].

Right. And maybe like bring it back down to some of the financials and [Indiscernible] Ron into the conversation. The big theme, I think, for the past 2 quarters is the improvement in trajectory in gross margins after about a year of gross margin degradation. You've seen the gross margins come up sort of to the high 50s. In terms of the mission statement to get back to 60%, what is it going to take to get there? And ultimately, what do you see as sort of the longer-term trajectory for gross margins going forward?

Yes. The biggest motion on gross margin is really improvement and the [Indiscernible] really sort of managing the cost by the way.. Our biggest costs are around bandwidth and our server deployment. And what we've done really over the last year was [indiscernible] planning around [Indiscernible] online or capacity [Indiscernible] traffic. In addition, [indiscernible] increased efficiency on our servers allows us to run a lot more traffic to same hardware that we did the same year. [Indiscernible] pricing as well as increasing the [Indiscernible] on the bandwidth side, have all used our top of revenue [Indiscernible] gross margin accretion. Those efforts are ongoing. I think a good example is going into the year as we spoke about our [Indiscernible] for servers [indiscernible] the year with a CapEx target [ 12.3% ]. We ended 2022 at 10% [indiscernible] manage that, and our outlook for '23 is in that 6% to 8%. So that gives you an idea of the progress we've made around efficiency and [Indiscernible]. So we look to what's possible. I think a couple of data points. One, if you can look back at what you saw in 2020 where we saw the gross margins [Indiscernible]. I think the current mix [Indiscernible], if we look to '23, I think the year [indiscernible]. I think there's further opportunity beyond that [indiscernible] we saw that in 2020. Beyond that, we kind of look to [Indiscernible], as we continue to see the growth segment of our portfolio maturing as [indiscernible] bigger [indiscernible] overall revenue base, those are [Indiscernible] gross margins that drive further [Indiscernible] gross margin on what I would just [indiscernible].

Makes total sense. And maybe just stick on the topic of financials and sort of particularly the outlook, which is quite solid, I think sort of targeting mid-teens growth. Can you give us the underlying assumptions behind the outlook with respect to some of the macro headwinds that all software companies are seeing? And then particularly, does imply some acceleration, I think, in the back half and what gives you the confidence to see that better growth in the second half?

Yes. So I think as we started the year [indiscernible] the full year, our approach similar to last year, which is [indiscernible]. We continue to evolve in that process. Really good visibility to have [Indiscernible], which reflected that around fiscal year. I think if you look [Indiscernible] risk [Indiscernible] around the [Indiscernible] platform implications. The pricing, tax implication launch in the second quarter. Those -- we really factor in a large sort of increase in that. So we see a very sophisticated [indiscernible]. We see the channel do some very successful [indiscernible] in 2023, best opportunity to drive [indiscernible] revenue in terms of the forecast or guidance you laid out [indiscernible]. I think if you look at the macro economy in terms of headwinds, I think it come back to kind of what's their growth driver over the past couple of years. And that [indiscernible] rather than overall growth in internet traffic. Well, that's the [indiscernible]. And so we expect that cost to continue and continuing to drive market share growth, expansion within our existing customers both in terms of [indiscernible] upsell [Indiscernible] our product portfolio as well as gaining additional [Indiscernible] based on that user experience, which Todd spoke about earlier. So I think those are some of the dynamics when you look at the economy. I think if you start to see some big headwinds, [indiscernible] driver, you can see an extended sales cycles. At the same time, as customers are looking for opportunities to reduce cost and be more efficient, our end user experience combined with very ease of management, it would allow them to deliver their opportunity at lower cost. So that could actually be an opportunity for us.

Okay. A potential tailwind there. And then zooming out in terms of the sort of longer-term view in terms of the targets previously and it was probably a different environment at that time, but you guys talked about getting to $1 billion of revenue in 2025. [ 10x-ing ] the security revenue over that period. Do you feel like those targets are still relevant? Or is that something we should reassess for later and sort of pushed further out?

I think the $1 billion target certainly is relevant to us. And largely because scale does matter in our business, we can run more efficiently. Our gross margin is going to improve [Indiscernible]. Scale helps us drive leverage. And so scaling is important I certainly am targeting $1 billion [Indiscernible] revenue one day. I think 2025 sounds ambitious -- so I'd hold that. I don't hold that target of the 2025 target, but I certainly see it as a vision. I do believe that -- and this has been true ever since we've made the Signal Science acquisition, we're going to see security driving growth, outpacing Fastly growth and driving growth. In fact, we think of our network service content delivery business as our core business, our security business as a growth business and then edge compute and our observability as our incubation businesses. And so certainly, we're going to see outsized growth coming from the security space. So getting to 10x from the original acquisition date, I certainly believe we will hit that just again in time line.

Yes. That makes sense. So let's just pick up from your comments here on security. Can you frame out for us how many customers are taking Fastly security products today? And what can happen on the Single Sciences front to drive greater adoption within the base?

Sure. We don't disclose individual customer [Indiscernible] but I'll say this, with the purchase of Single Sciences, I think that really codified security as a separate and really growth driving product I think for Fastly. So that was a seminal moment for us. And now we're really building that as a separate product line with a value proposition that doesn't just apply to the application and web developers, whether [Indiscernible] and security and compliance team as well, which has been a win for us. We see not just the notion of sort of upselling that technology to existing Fastly customers. But we have seen quite a bit of net new customer acquisition from the security space and then giving you the opportunity to cross-sell into some of the more content delivery here at [Indiscernible] space. One thing that I think though, is interesting is there's a ton of portfolio completion opportunity on the security side. We see enormous opportunity on API security, where we've always had a lot of investments, but there's tons and tons of interest right now and really especially [indiscernible]. There's still a lot of room on DDoS as well. And so there's a lot of components that I think can be brought to bear that we have in development right now that are going to help bolster the security portfolio beyond the next-gen [Indiscernible]. In fact, we really look at that security portfolio holistically, not separately as sort of what goes to Signal Sciences [Indiscernible].

Yes, probably. And sort of my follow-up question in terms of going out to market and being confident in the portfolio of capabilities in your security portfolio, what's sort of the status [ check ] across Those dimensions, obviously, Next-Gen WAF, you're there on DDoS. Sort of maybe just walk us through API, anti-bot protection, DDoS. Where is it today? Where is it going to be 6 months, 12 months down the road?

Sure. I think Next-Gen WAF, we feel comfortable that we have a technology advantage across the market there. And it's a lot of the reason people take a look at Fastly security, which is great. I mean that's, I think, why that acquisition was so important. It's also incredibly -- it's really incredibly complementary to folks who are using Fastly on the content side, which is great. There's one real exception there from a road map completion point of view, and that is unifying the platform, unifying the management plan. It is still not a single pane of glass that really could lower the friction of a land-and-expand motion where if you're already a content delivery customer Fastly with a click of a button, you can enable Next-Gen WAF. That doesn't exist today. It's still 2 separate management plans. And so the work to do full platform unification is underway, has been for a few months. I hope that we'll be shipping that late this year. And that, I think, will accelerate the land-and-expand motion in a big way. But other than that, on Next-Gen WAF from a functionality point of view, I'd say it's 10 out of 10. From a DDoS point of view, I'd probably give us 8 out of 10. Fastly has been delivering best-in-class DDoS basically since inception. It's table stakes to do what we do on the content side. But we haven't done a great job productizing it separately for customers who aren't on our platform who want better telemetry and more sophisticated analytics around DDoS protection. And so we are working on productizing DDoS. And you just saw we just launched a managed service around DDoS and application security to help bolster that and complete that portfolio on that side. For bot protection, we mostly deliver that through partnership today. We have a ton of R&D going in there. I'd say it's still very early days for us. So we're -- we have a ways to go. And on the API side, we've had a -- there's a lot of deployment around API protection, especially on the DDoS side, but there's a lot more to do. And that space is evolving very, very quickly. Web application protection, we hear about that from customers. There's a lot of different solutions with different types of tech in the market right now. And I believe that we're investing there as well because we believe that will be increasingly important.

So sort of round out the conversation on product and product strategy. I want to talk a little bit about the Fanout and Glitch acquisitions. What did those bring to the table? Like what is it -- what capabilities it bring to bear? How do you see that sort of impacting the business over the next few years?

Yes. I think Fanout was a pretty straightforward acquihire and a technology tuck-in to help bolster the API technology across the board. So that was pretty straightforward. Glitch on the other hand, is super, super interesting. Glitch is the developer community that's really driven around education and developer awareness. And it's doing 2 really big things right now. It's driving our edge compute road map. We pride ourselves on being developer-led and really letting the developer community at large drive that road map. It's what informed the JavaScript prioritizing JavaScript and language support, what's helped inform prioritizing distributed edge storage technology. It's been remarkable. And maybe that makes us more pragmatic to your first question. So like -- yes, I take that point. But that's been incredibly valuable. And I think that was the core value proposition upon which the acquisition was made. But the second thing now is we're starting to see developer conversions and leveraging the Glitch community to start creating early customer acquisition for the edge compute space, especially. And it's early days on that front, but I see that as a potential headwind moving forward for sure, especially on customer acquisition. I mean, we need developer customer acquisition to start to build that expertise of developers preferring the Fastly platform. And as they move from job to job as they tackle more and more user experience problems, they turn to Fastly to solve those problems.

Let's bring back the conversation to the edge opportunity, which in some of your early responses to my questions, you continue to seem to have an optimistic view about the edge cloud. So could you just frame us or sort of give us an update on how you're looking at the edge cloud opportunity from the Fastly perspective? And how should we start thinking about the time line? Because I think across [Indiscernible], we've been talking about it for quite some time, it's been -- taken a minute to materialize. So what's sort of the updated view on the time line?

When you say edge cloud, you mean edge compute?

Edge compute, yes. That's right.

I think about edge compute as a component to the solution. So the outcome that matters here is user experience. And we pride ourselves on having the most dynamic edge cloud possible. And we've been delivering that through content delivery with extremely flexible, extremely dynamic content delivery that allows for all kinds of advanced features at the edge. But eventually, in order to really realize that dream, in order to make it usable across a massive expansive set of use cases. You sort of -- you have to unlock the ability to run bespoke customer written workloads right at the edge. And that allows you to move from dynamic content delivery to true edge compute. The way I see that, and I think this differs from some of our competition. This is not about trying to compete directly with central cloud like [ IS ] services like AWS and GCP, it's a complementary architecture. The reality is core infrastructure as a service, core compute workloads they're running in AWS, running in GCP or Azure, there's very little reason for people to migrate those off most of them. But there are a set of workloads that by deploying them at the edge, you can radically change that user experience, latency-sensitive, data sensitive workloads can change the user experience by pushing just a small portion of workloads and storage to the edge. And that's where it matters, and that's where we see customer interest. So when it comes to like personalization, especially recommendation engines in e-commerce and media, when we look at the high tech, like conservability and DevOps, the ability to do ultra low latency response times for IoT or any kind of monitoring, putting those workloads at the edge can deliver a completely different user experience. And maybe the best example of this would be in gaming. The user experience for gaming is so latency sensitive that gamers talk about what their latency is. Bragging if they have the right like cable modem. You can radically change the latency in gaming by pushing the operational game workloads to the edge. And it's that kind of user experience. I think so many industries are moving towards having a more responsive, more engaging user experience will have the opportunity to change your business model, change how frequently you convert shopping carts, how frequently people stay engaged on a media stream, et cetera, how quickly you do ad personalization, ad placement, et cetera. And that isn't going to -- that's not about competing with AWS. That's about building a multi-cloud architecture that delivers the best-in-class user experience.

It makes a ton of sense. I want to go off to the audience and see if they have any questions for the Fastly team. You can just raise your hand, we'll get you a microphone. All right. No questions. So...

It's because your questions are so great.

Yes. I got ChatGPT to write them for me, so -- so let's just maybe -- I want to bring the conversation back to where we started. And going back to your personal background, and being a long-time executive at Cisco. And when I started my career in Wall Street, I was working on Cisco and I've seen all kinds of competitive threats to Cisco, and they've really been like a tested company that's sustained over decades. What in your Cisco experience you think really suits you well in terms of taking Fastly to the next era?

Maybe there's 3 things that I guess I -- like found incredibly useful. One being the sort of durable innovation model. Cisco has a core business and has for decades now, but they're always -- Cisco is always reaching for that next generation of technology. They maintain innovation at scale. And I mean, you see -- I think [ Chuck ] is like a case study, an innovation scale. And even at the Fastly scale, I think it's so important to think about durable innovation. That's why we're really focusing on this concept of a core business, a growth business and always reaching for incubation businesses that will become the next growth engine 3 years, 5 years from now. It's why we have completely different targets in our incubation space for compute and observability there around customer acquisition and growth engine and the core engine that's about revenue growth and revenue upside. That's been incredibly useful. The second one would be scalable go-to-market. Fastly is at a moment in time where we really need to build to scale. We need to be building Fastly right now to operate at the $1 billion, $2 billion space. And that means shedding some of the growing pains and building an operating model that is built to be repeatable and scalable and efficient. And yes, at least in my experience, no one does that better. I mean, Cisco is built to scale in so many ways. And last would be the technology. I mean, at the end of the day, Fastly is operating. We operate a global network. Our business is dependent on best-in-class networking technology. And I guess it's just nice that -- nice for me that I know something about that. I spent my whole life building out Internet technology and now getting to be a little bit on the other side of that to really be deploying it and operationalizing that. It is -- it's also been amazing experience.

With that, thank you so much, Todd and Ron for giving us the update on Fastly. Really enjoyed the conversation.

Thank you.

Thank you.

Thank you. Cheers. Thanks everyone. Thank you.