2023-11-15 14:37:07 ET
Fastly, Inc. (FSLY)
RBC Capital Markets 2023 Technology, Internet, Media and Telecommunications Conference
November 15, 2023 11:20 AM ET
Company Participants
Todd Nightingale - CEO
Ron Kisling - CFO
Conference Call Participants
Rishi Jaluria - RBC Capital Markets
Presentation
Rishi Jaluria
Welcome back everyone. Thanks so much for joining us. My name is Rishi Jaluria. I cover software here at RBC. I'm delighted to have with me from Fastly, both the CEO, Todd Nightingale; and CFO, Ron Kisling. Thank you guys for being here. Maybe let's just start with a brief overview for the generalists in the room of Fastly, and for both of you what attracted you to the opportunity of Fastly?
Todd Nightingale
Sure. I'll start. For anyone who doesn't know Fastly, Fastly is a Edge Cloud company. Traditionally, Fastly has delivered technology for content delivery, content delivery networks. But in the past few years, that offering has been expanded and really the market moving forward is really about Edge Cloud services. And what that means is that for people who are delivering web experiences, whether that's applications or Web sites or streaming services, they leverage our technology at the edge to make that user experience great. That's our differentiation. We focus on delivering the best end user experience. We partner with our customers to deliver that experience on their behalf, and we like to say that we make the Internet a better place for all experiences are fast, safe, and engaging. That's what Fastly does. We do that largely in the area of content delivery, of security, of edge compute and edge observability. So that's our portfolio and that's the biggest overview. As far as me, I've spent my whole career building the Internet, building networking technology. I was at Cisco before this and other networking companies before that. And I love that, I feel like the Internet is the innovation of our era. Maybe someone will say it's AI now, but I believe it's the Internet. And for me that is -- it's been amazing to have a career working on networking and Internet technology. I believe the next, you know, the next decade of this, it's going to be focused on the end user experience. Every single organization in the world will be defined by what kind of web presence they have, and that's what we deliver at Fastly, and that's why I made the move to Fastly just over a year ago.
Ron Kisling
Yes. I mean, I think similarly as I look at -- I think, the edge is just critical to building, you know, a highly performant, really engaging web presence. And I think as Todd said, you know, that is going to be an important part of the future. And so I think the edge is an exciting place to be. And I think being at Fastly, they have the most performant opportunity, they've got the best platform, I think, at the edge to deliver that performance and speed. And so that was one of the reasons. And then I think just the opportunity to sort of contribute to that and then a growth companies in the valley and helping companies scale through that growth area.
Rishi Jaluria
Yes, awesome. That's a great place to start. Maybe if we think about some of the trends that we've been seeing recently, one of the big ones that jumps out, I think to all of us is consolidation, right? So we've seen Akamai's bought contracts from two companies that have exited the space, there's a public company out there that seems to be going through a little bit of struggles right now. And may maybe what is going on and to what extent are you able to benefit from that consolidation?
Todd Nightingale
Yes, I think it is, it's real. It's happening. We see it. Our largest competitor, Akamai just bought the contracts of two companies, and we see all of those customers entering the market looking for alternatives, which is great. In fact, we were able to even disclose the name of one of them who just recently moved over to Fastly in our last earnings call. I think what's happening is this real transition to an Edge Cloud platform. Being a point provider, whether it's in CDN only or edge compute only, or edge security only, it's no longer sufficient to compete. And we're seeing consolidation towards a handful of Edge Cloud platform vendors. And I guess like, not to mince words, the leaders in that space tend to be ourselves, Akamai and CloudFlare. Akamai comes from a traditional CDN space. We come from a next gen performance CDN space and CloudFlare comes from a security space. And in so many ways, I think we're all finding that it's really this complete platform that's the solution. And players who aren't able to make the leap from point providers to platform players are consolidating. It's a very polite way…
Rishi Jaluria
Yes, that makes sense. Maybe digging a little bit more into competition, you talked about the different foundations of you, Akamai and CloudFlare. Maybe let's expand on that. How should we think about that competitive dynamic, how has it changed over time? And as we think about over the next three to five years, what puts you in a unique position competitively?
Todd Nightingale
Akamai's, the traditional vendor, they've been around for many, many years, late nineties, I think. And they've got a ton of deployment around the world and they've got a traditional user base, traditional enterprise sales motion, traditional user base. They made some attempts to expand their offering to include security and security services and recently acquired a company to offer Edge Compute as well. CloudFlare is a traditionally security vendor and they came from a world of DDOS prevention, distributed denial service attack prevention in large place invented that type of solution, just like Akamai invented content delivery. And Fastly, was founded maybe similar timeline to CloudFlare, although, I really am not sure, so don't quote me on that. I know when Fastly was founded, I don't know CloudFlare’s, was really a performance based, user experience based solution starting in CDN but very quickly expanding to edge compute, dynamic CDN and security. I like our position in that competitive market because our core value proposition is end user experience, the user of an app or a Web site streaming service, we partner with our customers to deliver that best experience. And that's what's I think most tied to their outcome. There are customers that are more focused on security or something else, but largely organizations are getting more and more sensitive to user experience. They can track it to their top line, they can track it to their cart conversion, how often they sell tickets to events or travel, how often they succeed in onboarding new users across the board. And that, I think, positions us well to gain market share, both from our competitors but also from a large number of new entrants to the space, people who are looking for better user experience and entering the edge cloud market for the first time.
Rishi Jaluria
Yes, great. Maybe I want to jump into security. So that's been definitely a bright spot over the past couple quarters. Let's start with signal sciences. So that's performed well. What's led to the strength in Signal Sciences and and how do you see the opportunity to expand out the breadth of your portfolio within security?
Todd Nightingale
Yes, great point. In security, we see this fairly frequently as the adversary as the attackers, techniques become more evolved, the preventative technology, the security technology, has to evolve as well. And there's been a WAF market for a long time web application firewall, traditionally served through appliances or software and traditionally based on, like, static rules role management. And for the last few years, we have seen this sort of market shift towards next gen WAF. It can be deployed in traditional ways but also can be deployed to the cloud, rule generation it’s largely dynamic and automated, and in our case, signal based, which gives us very high efficacy. Fastly, two-and-a-half years ago acquired a company called Signal Sciences. You should look up the date, I am not sure I have that exactly right. And my predecessor acquired that company. And I think it was a remarkable move, because it had two amazing criteria. It’s best served by the edge. So it is a core component to an edge cloud platform. And number two is the market trend is all moving from a traditional app to a next gen app, just like we saw in a firewall space from traditional firewalls to next gen firewalls, we are seeing the same thing in this space. It’s becoming much more of a must have and not a nice to have. It is a perfect time to be in this market and it belongs at the edge. It belongs in our portfolio, which is great.
That doesn't mean you don't have hiccups in execution, which can still happen. But I have been happy with the execution of our security team over the last couple of quarters. Part of that is about driving a more cohesive solution within Fastly platform. We have now pushed all Signal Sciences next gen WAF technology onto our infrastructure. So all of the pops, all of our machines around the world that make up the Fastly cloud, they now serve -- they serve content delivery, edge compute, they serve observability, and now they serve security, including next gen WAF. It’s not separate machines, it’s not different infrastructure. You can run Signal Sciences technology right on that thing, I don't have to incur extra special hop costs or anything to deploy it, and it’s a better experience for our customers too. So if you are using CDN and you want to use next gen WAF, you can do that. You don't have to change your architecture. I think there is another gear here for us to do even better in unifying the management plan of that technology and the rest of the Fastly technology. And we have been working on that for the last few months, and I hope to -- we call that the second phase of platform unification. The first phase was unifying the infrastructure and the second phase is unifying the management. We have gotten a lot better but it’s not done yet. And I hope to be really through that at the beginning of next year.
Rishi Jaluria
Great. Maybe let’s ask a couple of macro questions. I will start, are macro trends getting better?
Todd Nightingale
That's a good question. I will tell you, you know what, I have never gotten that question before. I have only been answering these questions for Fastly for a year. No one's asked me are the macro trends getting better, so that's a [Technical Difficulty]. I will tell you this, we are probably not the best people to ask that question, because the macro trends that seemed to hinder some of our competitors, we were largely resilient too. Our customers are using our technology because it’s the highest performance piece, it’s not a nice to have for them. They weren't -- if they wanted to reduce costs in their infrastructure, we couldn't be a target for them. So that was a pretty big piece of it. The biggest pressure that people saw in this area was like in small to medium SMB customers, maybe some of the mid market. We don't have a lot of exposure there. I wish I did have more exposure, and I am working to make our products simpler so we can, but I didn't have a lot of exposure, financial services customers and telco customers, again, if I would had more exposure there, I probably would have seen more. So I didn't see too many headwinds. The only thing we saw was a little bit of elongated deal flow. I don't have any signal that says that's better yet, but I will know more in three months.
Rishi Jaluria
Yes, no, absolutely. I mean, on the last earnings call, you did talk about some budget tightening that you had started to see. What's changed that you're seeing that now and you weren't seeing it a couple quarters ago?
Todd Nightingale
I should be asking you man. No, for the last three or four quarters, I've gotten this question in each earnings call about what are we seeing from the macro, my competitors are seeing these effects and slowing the growth and we're not seeing that. Our sales motion, we feel like has gotten more efficient. Maybe we are seeing a little and we're just beating it with better execution, but I'm not seeing it. I haven't been seeing it. This past quarter, I saw a little bit of deal elongation. I track -- just to give you it a hundred percent verbatim, I'm always tracking top 10, top 20 deals for any given quarter. My sales team wants to book the deal. They're credited on the booking, especially new customer acquisition booking, and they've been pretty reliable. If they say it's going to book it books, that's happened pretty, pretty close every quarter. And this past quarter, we had three or four deals that slipped. They all booked by now but they did slip. And that's a real data point. I knew I would get that question in the earnings call, so I answered it upfront.
Rishi Jaluria
I appreciate, it's always good to be more transparent than less transparent. I appreciate that. Alright, you talked about being more efficient with your sales motion. One thing that you've talked about since taking over the CEO reigns is maybe going back to some of the PLG roots of Fastly. Can you maybe expand a little bit on the strategy there? What you can do to kind of regain that edge that you used to have maybe and can you you talk about down market, right, you're not as successful as you'd like to be? So I'd love to hear a little bit more about that.
Todd Nightingale
I never saw the PLG roots of Fastly. So I'm not the best person. We're going to get our Arthur, our Founder, back up here next time around and he'll answer that question. But he should answer the same question. But here's what I have seen. We had a real opportunity to optimize the efficiency of our go-to market in a sales [indiscernible]. And we've done a pretty good job of that. We've been able to drive customer acquisition and revenue growth without having to expand and constantly expand the size of our sales spend. In fact, we've been able to increase our sales headcount without necessarily increasing our spend that much, because there was so much efficiency to be gained. We had extra layers of management in the organization, extra SaaS platforms that we didn't need or weren't using. We had inefficient compensation plans, et cetera. So it's just about business rigor that’s part of it. As far as the PLG goes -- motion goes, I can't comment on getting back to our roots, but I can comment on this. Fastly, as it was growing up in the early days, even found a lot of success with large sophisticated customers. And because of that built our go-to-market engine for that type of customers, which customers doesn't require PLG motion and because of that, we don't have a healthy one right now and we need one, not necessarily to pick up like customers that are going to spend $20 a month on a credit card, but to make it easier for all customers, especially the commercial and mid-market customers, making it easier for them to onboard. Even if they do it with the help of a sales team, it should still be simpler and we have a lot of room to grow there. I'm super excited about the progress so far. We just demoed easy onboarding at our conference a couple months ago and we put a link to that demo in the earnings supplement.
Rishi Jaluria
Great. I want to talk edge computing now. You know, this is something that I think you had said you expect to start to actually show up in the model next year. Maybe can you walk us through, number one, help us understand the differentiation between edge computing and what we think about central cloud? And number two, what's giving you confidence that would -- it will actually start to show up in numbers over the near term?
Todd Nightingale
I think I said 25…
Rishi Jaluria
Sorry, that's my mistake…
Todd Nightingale
I maybe 24, I like your optimism. You've got -- if you think about how content is delivered, if you have to go -- if you request content from a Web site, it has to go all the way back to a central cloud, like where that Web site is at AWS, you'll get your content, but it'll be slow. And for that reason, people deploy in a content delivery network. Traditionally, people who are building these applications, they have to compromise between personalization and dynamic content that's just for you and/or static content that is the same for everyone. The static content can be delivered at the edge on a platform like Fastly and very quickly. And the performance user experience is awesome, but if it's super personalized content, which might be far more valuable, well that will have to go back to the core, because they need to look up information about you and they need to look up all this data about like what's available and then decide how to make your Web site more personal. This is incredibly true for like media when they're recommending what to watch next. I see that every night or e-commerce when they're deciding what products to recommend. It's true in high tech when they're trying to turn around live events for SaaS reliability, whatever it is. By taking some of that compute that would be at the core and moving it to the edge, you can get the best of both worlds. You can get fast and personalized without compromise. And we see more and more customers, especially customers who are particularly performance sensitive. They want the best, fastest user experience, taking some strategic workloads from the core and moving them to the edge and getting enormous improvement in performance without having to compromise personalization and dynamic content. That's really the value of edge compute.
What's exciting about that is that architecture is something that all of our customers are already doing. They already use it for content delivery, so why not put dynamic content edge compute there? They're already storing their data in our cloud, great. They're going to use this. It gives them so much more power, it makes them more powerful in important ways. And one of the most important ways is they can run their inference model, their AI model at the edge as well. Personalized content is a great example. This is all of the content that's available, let's say from a newspaper, from a media company, that's static content, but there's a small amount of personal data about you or they think they know what you might be interested in and they can use an inference model to make that recommendation. They can run that at the edge to get the best possible performance. So running those AI models at the edge is like it's an emerging area right now, but tons of our customers are working on that on the Fastly platform right now. It’s super interesting and I think we're only going to see more of it. And I also will tell you it's not lost on anyone that if you're a good platform for that, you might get a lot of eyeballs. There's other workloads they could move to the edge too and probably that will hit the revenue line item sooner.
Rishi Jaluria
Okay, that’s really helpful. Since we brought up gen AI, maybe want to go a little bit deeper and ask you what's an interesting gen AI use case that you're thinking about that no one's really talking about right now?
Todd Nightingale
I like the contact recommendation. But I'll tell you the reality of this is I want to be clear, some of my competition is ramped up on like competing with central clouds. We don't do that at Fastly. We believe in a multi cloud architecture. They are supposed to be a core with big data structures and large processing capability and an edge. And people who use the core and the edge architecture, they are the ones who are getting the best of both worlds. So I don't compete with AWS and GCP in those areas. In fact, we partner with them. The models will be trained at the core. It takes a lot more processing, a lot more storage to do that. And there is no downside. Train the model in AWS and GCP. Then when you deploy the model to actually run for the user, if it’s latency sensitive, if it’s direct customer engagement like content recommendation, product recommendation, customer support chatbot where user interaction is important, those use cases running at the edge, that's what's exciting to me. I think those are also areas where it is not nearly as distant as future as AI writing novels or building the next great skyscraper. These are things that are much more tangible and realistic in the near term and are best deployed at the edge.
Rishi Jaluria
Yes. Got it, that's really helpful. All right. Ron, I am going to ask you some margin questions now. I haven't forgotten about that. So you have been showing some real margin expansion and good trajectory there, which is great to see. Maybe number one, can you talk about what have been some of the drivers, be it on the operation for financial discipline side to get there? And number two, what is a glide path from here to get to, first, free cash flow breakeven and then eventually healthy profitability look like?
Ron Kisling
Sure. Yes. So I think we talked a little bit about the financial rigor. But I think first and foremost was really looking at our gross margin profile. A lot of that came down to just a lack foundational business forecasting in terms of what the demand was and building out our infrastructure without that visibility. And so one of the first things that we did about two years ago was really build that visibility that, one, gave us more predictability on revenue but also, we will use that data around our business planning, our infrastructure planning and investment levels to align that much more with our traffic levels. And with that work and then a focus on margins around managing our bandwidth and costs, we saw a meaningful improvement in our gross margins. And we think that that trajectory, there is still room to continue to do that as we diversify across verticals, as we continue to increase our volume that gives opportunities for better rates and peering, and we continue to appreciate. We saw a little bit of headwinds over the last quarter or two as we saw our traffic patterns with increased traffic internationally. We see a little bit higher pricing but lower margins because the traffic was a little bit low. The benefit of seeing that higher traffic is we can go back to those providers, negotiate better rates, increase our peering, then ultimately build a more efficient network on a global basis. So that's been one of the first drivers.
I think the second driver, a lot of it is financial rigor, but it is also planning our resources, our headcount around aligning around what our goals are and focusing that. Todd spoke about looking at the org structure. We were able to eliminate a layer of management of the sales organization to pay for more direct salespeople, those efforts are ongoing. And I think the ability to continue to grow our expenses, while investing in engineering and go-to-market at a lower rate than revenue is sustainable. And so, as you look at that trajectory, we have seen a nice trajectory in our free cash flow. If you go back to kind of the middle of 2022, we saw probably an average of about $40 million negative free cash flow. The last two quarters averaged about $6 million. And at the Investor Day, we shared that we expected to be cash flow breakeven in 2024 next year, we still see cash flow breakeven in 2024. And I think the dynamics of cash flow are really improving our operating margins, which will improve our cash flow from operations. We have also in that same time period, some of that is the forecasting around investments, taking our capital expenditures down from back in ‘21, 12% to 14% of revenue to 6% to 8%. And so those expanded operating cash flows will cover our CapEx and drive positive cash flow as we move beyond ‘24.
Rishi Jaluria
Yes, got it. Really helpful. I guess when we think about, maybe going on the gross margin piece. Is there like a mix shift dynamic that as edge computing becomes a bigger part of the business security, that should all be higher gross margin as well and then that mix shift dynamic will help you over the next three to five years?
Ron Kisling
Yes, I think there's two dynamics around mix that can help drive our gross margins. Certainly, you know, security and computer opportunities to get additional payments for the same traffic, compute runs on, the servers where the traffic is one bandwidth, so it more efficiently uses our overall network. The other thing is Todd talked about we grew from enterprise basis early on, particularly in streaming and publishing, that tends to have a concentration of traffic usually in the evenings. As we expand our presence in other verticals that have different time sequences such as tech or travel, where most of that traffic's in the middle of the day, we're using underutilized traffic, underutilized hardware, and margins on that business are dramatically higher. And so by balancing out the verticals, we can see a significant contribution to margins as well.
Rishi Jaluria
Yes, got it. All right. When we think now about some of the strength that you're seeing with your largest customers, because you continue to grow there. I guess number one, what's been the driver of that strength? And number two, I guess why should we not be too worried about customer concentration given we all remember what happened, was it two, three years ago with Fastly's then largest customer?
Todd Nightingale
Yes, I'll get started. The customer concentration, I worry about it. I think it's fair, it's fair to worry about that. And I'm never going to let that worry get in the way of generating as much revenue as I can, right? So if we have large sophisticated customers who are doing deep analysis and measuring what the best possible solution is, the most performance solution, the most cost effective solution, and they decide to go from having five vendors in this space down to two, I'm never going to say no to that. And that's what we're seeing, right, vendor consolidation in the space. Maybe that's the biggest effect we saw with the macro was some of our big customers deciding to use only two vendors instead of five or six, because they didn't want to manage multiple accounts. But customer acquisition is the key. Our business will continue to get healthier as the number of customers increase, as we track customer acquisition and number of customers very carefully. And the only way to a more diversified set of customers that is healthy for us is through customer acquisition, and that's what we're focused on. You see the packaging, partner, community growth, customer acquisition and deal registration, the diversification of the portfolio largely designed to drive success in that area.
Rishi Jaluria
All right. I'll close out with a compound question, and I probably should have left a little bit more time, but we'll try to blitz through this. What's the biggest decision that you two will have to make as a management team over the next three years? And what is the single biggest item that excites you about the future of Fastly?
Todd Nightingale
The thing that excites me is the platform play. The most exciting thing about my QBRs right now is platform customers. We track platform customers in how many of our customers are using more than one product lines, specifically at a reasonable percentage, more than 5%, more than 10% of their revenues on product line two, because it's the platform that wins deals. Like the best cloud storage company can't compete with AWS and we saw this play out in central clouds. AWS and GCP and Azure, they have the best cloud platform and it's only by offering multiple high value solutions on one customer experience where you deliver that. And to me that is the thing that's most exciting to me and I track it every quarter. It's lovely. It warms my heart. The biggest decision that we'll have to make next year -- the biggest decision that Ron has to make is how to buy more debt faster. But I think it's balancing the investment. Ron and I spend enormous amount of our time talking about balancing. We we're like, look, we're trying to like control all of our costs and G&A. And we have -- we did a lot of progress this year. I think we have more to do. But balancing our investments in which of these product areas of these four areas and what go to market dimensions, we're definitely on the channel side, but there will be a little bit of regional expansion, there will be a little bit of customer vertical penetration. The biggest decisions we're going to make, where do we put the most fuel on fire.
Rishi Jaluria
Alright. It's a great place to jump off. Thank you so much guys. Really appreciate.
Question-and-Answer Session
End of Q&A
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Fastly, Inc. (FSLY) RBC Capital Markets 2023 Technology, Internet, Media and Telecommunications Conference (Transcript)