Fastly, Inc. (FSLY) Presents at Raymond James 44th Annual Institutional Investors Conference (Transcript)

Start Time: 13:40 January 1, 0000 2:13 PM ET

Fastly, Inc. (NYSE:FSLY)

Raymond James 44th Annual Institutional Investors Conference

March 06, 2023, 13:40 PM ET

Company Participants

Ron Kisling - CFO

Vernon Essi - IR

Conference Call Participants

Frank Louthan - Raymond James

Frank Louthan

All right, great. Thanks everybody for being here and joining us on the webcast. Very pleased to have Fastly here with us this year. We have CFO, Ron Kisling; and we have Vern Essi from Investor Relations here today. So let's jump in a little bit, maybe talk to us a little bit about -- tell us a little bit about Fastly, where you are, where you fit in with the other CDNs, and what kind of makes you similar or different with security and so forth?

Yeah.

Ron Kisling

Yes. So as a background, I think we're the world's fastest edge cloud platform. We do that with the software-first approach to delivering content on the Internet, drives a lot more efficient, less hardware intensive than a lot of our competitors who came to the market from very different places over the last decade or two. What that allows us to do is to deliver fast, low latency services. We have a portfolio of security products that provide security at the edge, both web application firewall, DDoS protection, and bot protection.

And we provide service to some of the largest media, consumer and technology companies to enable them to provide robust, personalized experiences to their users. We also offer a compute and observability capabilities that allow personalized experiences at the edge as well as for our customers to see what's going on in terms of their network and get visibility to where issues arise very quickly.

Just a little bit of background on some of the corporate stuff. Last year, we grew 22%, said revenues up 432 million, and saw improvement in our margins, from a cost control perspective, involves managing our operating expenses. And then last September, we welcomed the new CEO, Todd Nightingale, who joined from Cisco. He was their GM of their multibillion dollar network services business.

Frank Louthan

All right, great. So let's dig in a little bit on the network side. People are very familiar with Akamai and how kind of they built that. What is it about your network architecture built on sort of SDN technology and so forth? How does that differentiate you and how difficult is something like that to replicate?

Ron Kisling

Yes. I think the biggest differentiation, and I think a lot of is where we came to this, we started with kind of a software-first mentality. How do we handle the management of traffic, the routing of traffic, the switching to a software mechanism? What that does is it allows us to deliver content with a lot less hardware-intensive environment. It also allows us as we do upgrades to make upgrades across the entire global network as a software upgrade as opposed to swapping out hardware. What that also does is by having that lower hardware intensity means that ultimately, our cost of providing delivery to the edge is a lot lower. And we’ve started to see some of the benefits in the second half of '22 in terms of our margins, where we started to see real meaningful improvement in our margins.

If you look at say, Akamai, for example, who kind of invented this space, if you will, say two decades ago, their initial approach was really around how do we protect your customers' data when you see a big spike in traffic, so you don't bring down their network? And they built a very robust global hardware-centric network. And they do a great reliable job of delivering network and hardware. But it's hardware-centric. And so as you look at those companies in terms of if they want to move to new architecture, rather than it being a software upgrade, that means on a global basis being able to sort of replicate and move through and install a new hardware architecture on a global basis, which is expensive and challenging to do while you keep the network up and running.

Additionally, the other piece that is a big differentiation is our product is very easy to configure. We can get a customer up and running very, very quickly. You can point their website to our server and we begin caching their information. A lot of the more legacy players, it's more of a hardwired system. So also, as you make that change, you also have to deal with migrating all of your customers to that new architecture.

Frank Louthan

So that gets to kind of my next question, what's sort of the sales proposition? So what exactly are customers, what are they buying your product for, what kind of applications are they using your network for?

Ron Kisling

Yes. I think that from a sales cycle perspective, one of the things and it's been our focus is really on the user experience. And I think what's happened over the last couple of years is more and more companies are realizing that that experience at the edge, a fast experience, a personalized experience, actually has a meaningful impact on their business, their retention, and our ability to do that faster is a differentiator. What we found is early on, we were very successful in the large enterprise space by delivering that differentiation. Those were some of the earlier customers to adopt an edge platform strategy.

And I think as we look forward, the areas where there's opportunity is some of the smaller customers aren’t as aware of Fastly and have not yet sort of adopted our product. And as we look to '22, one of the things we're doing is we're taking our product and packaging. And we're simplifying that into packages that include delivery, the security you need to deploy for a fixed price. And we see that as an opportunity to engage with that next level of customer. It's also an opportunity for us to leverage the channel in delivering our delivery product to their customers.

Frank Louthan

Okay, great. So you recovered pretty well in last couple of years, you started right at the infamous network outage.

Ron Kisling

I think it was interviewing Joshua the day that the outage happened.

Frank Louthan

Yes. So again, recovered very nicely from that. What's different about the company now? And what have you learned from that experience versus what was going on?

Ron Kisling

Yes, I think two things. One of the things that was a real asset to the company when we had the outage was our really strong customer service and reputation we had with our customers. And so when the outage happened, we were very transparent about what happened. Over 90% of our customers brought traffic back within the month. And our largest customer brought back traffic over the next two or three quarters to where their traffic now exceeds what it was sort of pre-outage. But I think what we learned was a number of things in terms of building network resiliency.

And again, with this sort of software-first network, we can make these updates on a global basis by updating the software. And so we certainly were able to build in more safeguards into the network. Outages are things that happen. But we are able to automate and create less opportunity for those to occur. And as I said, leveraging your customer service and our transparency was really important when we went through that outage that we had in 2021.

Frank Louthan

All right, great. And so with that, we now have a new CEO. Talk to us a little bit about that leadership under Todd, what can we expect to see differently? What is he bringing to the organization as it matures and so forth? And how should we think about that?

Ron Kisling

Yes. I think first and foremost, Todd has really hit the ground running. I think his experience leading the networking business at Cisco really gave him a really strong background, both from a technology perspective but also in terms of how the market works and how customers look at the industry. So he came in and very quickly is focused around three areas. On the product side, his focus is around building platform unification. We have a delivery component. We have a security portfolio. We have compute and we have observability. Bringing those into sort of a single management console, a single pane of glass so that it is much easier, a better experience for our consumers, also easy for them to add and adopt new products, if they're all on the same management platform, is one of the initiatives that we're launching this year.

The other piece is the pricing and packaging that I spoke about earlier, which is again packaging up our delivery with the security that customers want to deploy in a configuration that they can deploy without a lot of thought, and being able to add in compute for a predictable monthly cost, which has been one of the impediments is if we turn this on, we don't know what it's going to cost. And launching that in the first half of this year as a way to accelerate new customer acquisition, reach a segment of customers that we haven't reached today, and really enable the channel motion that we've seen work very well on our web application firewall, but we haven't been able to do on the delivery side.

And then on the go-to-market side, again, sort of leveraging that pricing and packaging around reorganizing the sales team to have very linear alignment between the rep all the way through to customer service around customer segments. And then lastly, sort of the operational rigor you would expect someone from an established company like Cisco around being efficient. You saw that in terms of our outlook for this year, really running the business on an efficient basis looking for where there's opportunities for savings and extreme discipline around what we're targeting in terms of OpEx to actually achieve those results.

Frank Louthan

So to follow up on that, when you upgrade things, this single pane of glass and so forth, how does that get deployed or is that just new customers? Does everybody get it at once? And then how do you educate the customers? And then you say you've got the sales sort of segmented by that. Is that by vertical? Is it by dollar spend per month, or how do you have that?

Ron Kisling

Yes. So I think on the first question, be available to all customers. I think the deployment is going to depend on their customers' personal situation, where they are in their cycles. Some customers have blackout dates, depends on what components they're using. If they're only using one component, it's certainly less of a benefit than if you're using the portfolio but obviously we want to get everybody on it so it makes it easier to adopt other components of the portfolio. On the second question in terms of --

Frank Louthan

You mentioned that the sales is organized. Is it by vertical? What is it really --?

Ron Kisling

It’s really more by -- we have a regional, but it's really by size in terms of focusing on really the large enterprise customers, channel support and the midmarket.

Frank Louthan

All right, great. So last year you came out with your guidance and did very well, exceeded that. What does it take this year to get to more of the high end of the range of the guidance? What’s sort of baked into your assumptions there?

Ron Kisling

I’ll level set, and that's a question I always get is how did you come up with your guidance? I think it’s important that we set our guidance based on what our forecast is, the visibility that we have today, and we have -- a big piece of our business is usage base, so that visibility at the beginning of the year is always a little bit challenging. We have a very robust engagement with our customers to come up with that forecast. But it really reflects the number that we have confidence in today that we can achieve.

In that number though, if you look at where there's opportunities for overachievement, particularly around the pricing and packaging, if we see an accelerated adoption both by our customers or by the channel with their customers, that's an opportunity for upside, because we didn't factor in a significant uplift from that in the first year of launch. So that's probably the biggest opportunity. I think when you look at -- we get a lot of questions about the macro economy and the impact on guidance. We're not immune from the macro economy.

But if you look at our growth rates today, it's largely been driven by market share gains. We’re relatively small in the space. And so even if the broad market is not growing, we're able to gain market share and show growth. Additionally, the efficiency of our network gives us an opportunity as companies are looking to be more efficient, looking to provide the best possible experience to get as much market share or revenue from their customers. That also could be a lever to actually drive more adoption of our network.

Frank Louthan

All right, great. And then looking at your different product segments, what's driving pricing this year? What's the outlook for pricing in the major segments?

Ron Kisling

Yes. When it comes to delivery, we've really seen a stabilization in terms of pricing over the last, say, 18 months since I've been here in terms of pricing from maybe what we've seen before. So we've seen fairly small decreases typically when customers do an annual contract at the end, that contract are some rerate, but it's relatively small. Those tend to be in line with the efficiencies we see in terms of our costs going down. From Moore's law, we see dropping in the price of hardware. We saw bandwidth costs going down every year. We just recently, at the end of Q3, renegotiated our bandwidth costs, so they tend to move pretty much in tandem.

Frank Louthan

Okay, great. So there's always the rise of self provisioning on the delivery side, the major content providers all are in a lot of the same data centers you're in and so forth. So how do you defend against that? How do you make relevant with them and continue to have them to use your services versus building it themselves?

Ron Kisling

Yes. I think first and foremost, we look at the risk of someone self deploying similar to sort of any other competitor, and it's really amount of what value are we adding? Can we add a faster efficient network? We have a complete suite portfolio of security products. We have compute and observability. And so that being built on the software-first and that efficiency allows us to compete very favorably in terms of a cost.

We can leverage our learnings and technology developments and ongoing improvements in efficiency across all of our customers. And so it's really a matter of adding or reflecting better value. And we believe that we can do that the same way we've done it in terms of our competitive wins. It's really that same motion in terms of whether you self deploy or utilize Fastly, and we think we're very well positioned to offer a comprehensive solution that competes favorably from a security speed and cost perspective.

Frank Louthan

So related to that, what are some examples of types of content or applications that are really well suited for you that customers seek you out for? And then what are maybe some that they don't, that you don't do as well, or you're not as well designed for?

Ron Kisling

Yes, I think if you look to date, and a lot of it may mirror customers who have really recognized the need for that strong user experience. If you look at the media space, protecting the brand and delivering content reliably is really important to those customers. On the commerce side, differentiation in terms of faster page loads or better recommendations has a meaningful impact on cart abandonment and overall return from your website. And so we've seen very strong early success in those spaces.

We're starting to see -- we announced some wins in the travel industry. And I think more and more companies in other industries are going to start to realize the benefits of having a fast, robust, personalized experience on the web. And I think while it's been the largest companies today, I think that drive to more immersive experiences is you're going to start to see more and more companies move to the edge that aren't there today. Today, it's been the larger companies. That's where we've had success. But I think over time, you will absolutely see smaller companies also come to the edge so that they have a competitive, personalized, fast experience for their customers.

Vernon Essi

And I think one thing to add to that is, as you go down the path of our roadmap, the computed edge, putting compute resources at the edge will bring a lot more market opportunities in different areas. Last year, we had a very interesting win with New Relic to help them work on their observability solution for software customers on their end. And it's just an example that probably two years prior, we may not have thought of this being a use case, but there are industries very random for computed edge.

People would immediately think gaming is a big opportunity, which it is, but then there's things like say process control at a factory automation level. A computer vision is another huge example of that. So I think you're going to see a lot of applications like that that we play really well into. We just haven't had that go-to-market motion, if you will, to address it.

Frank Louthan

So you mentioned edge, and that's probably one of the most often spoken words at conferences like this in this area, what does edge mean to you? And what are you doing to sell that? And what are customers coming to you for?

Ron Kisling

I think when we look at edge, it really is just sort of a differentiation from the central cloud in terms of bringing content security, compute close to the user. By close to the user, it's really located close to the Internet points of presence, that's how you achieve it, but having that data close to the user so you really get that fast experience. One of the things that I think is central to being really successful at the edge is being able to really cache data from the central cloud and decache or deploy that out very efficiently, because that has a big impact on ingress and egress costs as well as how fast your experiences are. And that's one thing where I think we offer a meaningfully differentiated experience that plays out in terms of faster response, lower costs for our customers, and efficient use of the network.

Frank Louthan

And do you -- are you in the right locations? You did a big upgrade last year in a lot of your data centers. Do you need to be further in different places or can you solve all these products you’re talking about where your network is currently deployed?

Ron Kisling

So if you look at our network deployment today, I think across most of the world, we're deployed where we need to be to support Europe, the Americas, and the IQ [ph]. There are some locations that are hard to serve where we don't have the presence we would need to have a strong local presence, Taiwan being an example. Akamai has a much more global network in some of those very hard to reach locations. Today, we cover a very big piece of the market. And as we grow, we will be stepping into more and more markets over time as the demand plays out.

Frank Louthan

Okay. So let's shift gears a little bit and talk about security offering, tell us about what you offer there, and how that fits in with your overall network capabilities and so forth?

Ron Kisling

I think first and foremost, we're focused on the security that you really need as an edge cloud provider. What is that security portfolio? And generally that portfolio consists of a web application firewall, Denial of Service protection, or DDoS, and bot protection. And so we offer products across all of those. Our web application firewall is best in class. It's maybe the only web application firewall that is run more than 90% of the time in blocking mode, not just reporting mode.

It's an exceptionally good product. It came from our Signal Sciences acquisition a few years ago, and it's now been integrated into our edge platform. On the DDoS, we actually have a really good technology around Denial of Service protection. We need to package that more completely to make it easier for customers to deploy. We also offer a bot product in one of the -- that's an area where we are working to continue to enhance and improve our bot detection this year.

Frank Louthan

Great. So do you feel like you have the parts that you need? What else are you looking for? And is this more of a build versus buy kind of -- how do you think about adding those other features that you might need?

Ron Kisling

Yes, that's a good question. If you look at sort of the core technology across the critical security that we have, we have the technology that we need. We don't need to go out and buy or bring in new technology. It's really a lot of packaging or filling in some additional areas around those products. Similarly when you look at kind of our emerging product lines, compute, again, we have the technology to roll that out. That is being sold. We're starting to see a really exciting sort of uptick. It’s nascent revenues today. And similarly, as we start to roll observability, that's an internal development.

Frank Louthan

Okay. So when you're out in the marketplace and you win in the security, what is driving that? What is sort of the reason you're winning over your competitors? Why are they taking your product?

Ron Kisling

Yes, I think the best case to sort of look at that would be on a web application firewall where there is just a meaningful performance difference in terms of not flagging sort of false positives. And so we see really great adoption of our web application firewall. We have our web application firewall running in companies that are running a different delivery network, one of our competitors' delivery networks. And I'd say that's probably the biggest example where we see strength. I would say across the other products, we tend to run them on our own platform with our own delivery.

Frank Louthan

Okay. And so where does the sales force fit into that as far as getting more traction on the security side of things?

Ron Kisling

Yes, there's really two pieces to it. I think first and foremost, on the delivery side, security is part of every sort of conversation. If people are looking to deploy delivery or have delivery and they're looking to expand, having core security, particularly if it's on the same platform, one of the things those companies are looking at being more efficient is they're looking closely at their cost structures. Having that built into the platform versus having to integrate multiple security products is a cost savings. And so it's important that we have that portfolio on the platform.

As we look to sell, a lot of times it is looking at -- we follow leads in terms of security opportunities. As I said, we frequently sold our WAF. The other element of really driving sales across security is, we do have a good channel motion around our web application firewall today, with a channel selling that independent of its delivery. Our pricing and packaging, what we want to do is we want to enable that channel to not just be able to sell security, but to also be able to sell delivery into our customers.

Frank Louthan

So it's always kind of curious I think for your investors as well, you mentioned that you have a customer that's using your WAF and they're not using your CDN. To what extent are these sold separately, sold together? And to what extent does a security customer get pulled in to buy the CDN or vice versa?

Ron Kisling

Well, I'd say certainly amongst our delivery customers, we have really high adoption of our security products. We have had certainly instances where a customer not running our delivery is running our firewall. And we do gain some of the delivery business. What it really -- it gets back to our overall expand motion. If we can get into a customer and they can see the quality of our customer support, how easy our products are to use, and how effective they are, it's very easy to get them to try to adopt additional products. And as they do those and try them, then we see the expand motion where we get a bigger share of the traffic or a bigger share of their business in a particular area.

Vernon Essi

Yes, I think it is important to be clear on point here too though. Our security solution has unseated packaged portfolio motions from other companies. So we've been able to segregate that out and win that business and hopefully over time deliver -- win the delivery side of that business as well.

Frank Louthan

Okay, great. Anybody in the audience have any questions? All right. Maybe talk to us a little bit about capital priorities for the year. Last year one of them was that the upgrades in all the data centers. How should we think about capital priorities for you?

Ron Kisling

Yes. One of the things that, as I said earlier, our architecture allows us to be less capital intensive. And certainly if you go back over the last couple of years, we've had an expansion motion and built out quite a bit of capacity. We've done a much better job of sort of planning that going forward, sort of integrating our build plans with our sales forecast. And so what we've seen is decline in that capital intensity. So we sort of entered 2022 with an expectation that our cash spending on CapEx would be 12% to 14% of revenue.

If we got to kind of midyear, and a lot of the processes we put in place around planning came in to effect, we reduced that to 10% to 12% and ended the year at about 10%. For 2023, we've adjusted that and we believe that we'll be spending between 6% and 8%. So we've seen a meaningful reduction in terms of the CapEx that we need. So that's really bringing it in line with sort of the capital intensity of what our network needs to run. And that’s not always a driver of improving our gross margins, but as we get more efficient in CapEx, it's a tailwind to our cash flow.

Frank Louthan

So the 6% to 8% is kind of run rate.

Ron Kisling

I think in the near to medium term, yes.

Frank Louthan

And talk to us about profitability and getting -- achieving those kind of goals, where is that in the guide and how do we see getting EBITDA positive moving forward?

Ron Kisling

I think that's a big priority for Fastly. It was one -- when I joined was how do we move from -- and we've done a really good job historically kind of growing expenses in line with revenue -- how do we get leverage in the business? That path, as you look to 2023, we see two things, which is we see meaningful improvement in our gross margins. You saw that in the second half of this year. As we move into 2023, we expect to see sequential growth. We expect to exit the year within striking distance of 60% gross margins.

And then as you look at our OpEx, while we're focusing -- we're very focused investment in sales and marketing around quota-carrying sales reps, overall, we're driving leverage in the business. And so in '23, we're moving from an operating loss that's 18% of revenue down to 10% in '23, and expect to continue that meaningful improvement in our operating losses going forward, to get to profitability. And then the cash movement, because of the efficiency we see in CapEx, I expect our progress on cash flow to be even more meaningful than what we're seeing in terms of our progress on our operating losses.

Frank Louthan

And what are some of the areas that you found to take some of the costs out of the business?

Ron Kisling

Yes. I think in the OpEx side, a lot of it is good discipline and hygiene. We put in place a, I’m going to call, robust purchasing process where we're actively negotiating with vendors. We have visibility to what our spend is. We've taken a review of one of the things if you don't have good control is it's very easy for department managers to adopt SaaS solutions. It's a great selling opportunity if you're in sales.

But really taking a look at those SaaS applications where we have duplicate applications, looking at key areas where maybe we have multiple applications serving a certain function and replacing those with a single application that not only do they drive savings in terms of third party costs, but they allow us to be a lot more efficient in terms of our own internal resources, meaning we need less people to manage a certain process.

Frank Louthan

Okay, great. Any questions from the audience? All right, just real quick at the end, what do you think is sort of the most misunderstood about the story and think investors should really dig into?

Ron Kisling

Yes, I think historically we've not done I think the best job of explaining our differentiation to our customers and to the market in terms of how meaningful our software-first network is, what impact it can do in terms of providing faster, more robust experiences, and with execution, what that can drive in terms of long-term gross margin accretion.

Question-and-Answer Session

Frank Louthan

Okay, great. Well, thanks everybody for being here. Appreciate it. Thanks, Ron and Vern.

Ron Kisling

Thank you.