Fastly, Inc. (NYSE:FSLY) Q3 2023 Earnings Call Transcript

Fastly, Inc. (NYSE:FSLY) Q3 2023 Earnings Call Transcript November 1, 2023

Fastly, Inc. beats earnings expectations. Reported EPS is $-0.06, expectations were $-0.07.

– : Will Power – Baird Tim Horan – Oppenheimer Rudy Kessinger – D.A. Davidson Fatima Boolani – Citi Tom Blakey – KeyBanc Capital Markets Madeline Brooks – Bank of America

Operator: Ladies and gentlemen, good afternoon. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fastly Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. And I’d now like to turn the conference over to Vernon Essi, Investor Relations at Fastly. Please go ahead.

Vernon Essi: Thank you, and welcome, everyone, to our third quarter 2023 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, product sales, strategy, long-term growth and overall future prospects.

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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 Form 10-K and Form 10-Q filed with the SEC and our third quarter 2023 earnings release and supplement for a discussion of 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 three conferences in the fourth quarter. The RBC Capital Markets 2023 TIMT conference in New York City on November 15th. The D.A. Davidson Technology Summit in New York City on November 16th and the UBS Global Technology Conference in Scottsdale Arizona on November 29th.

With that, I’ll turn the call over to Todd. Todd?

Todd Nightingale: Thanks Vern. Hi everyone and thanks so much for joining us today. First, I will give a quick summary of our financial results and third quarter highlights. And then I will provide an update on our product strategy, go to market and internal transformation before I hand or call off to Ron to discuss our third quarter financial results and guidance in detail. We reported record third quarter revenue of $127.8 million, which grew 18% year-over-year and 4$ quarter-over-quarter. This came in at the very high end of our guidance range driven by strong international traffic. This demonstrates continued momentum in our enterprise customer motion, as we continue to benefit from vendor consolidation and seasonal strengths in streaming activity.

Our customer retention efforts, a hallmark of our customer satisfaction were favorable in the third quarter, Our LTM, and NRR was a 114%, down slightly from Q2. Our DBNER was a 120% in the third quarter down from 123% in Q2 and also slightly down from 122% in Q3 of last year. Our DBNER continues to demonstrate healthy wallet share gains in our customers as we continue to cross-sell more functionality and grow with our customers’ ongoing edge traffic requirements. We’re starting to see some effects of budget tightening by our customers, but we continue to see strength in customer expansion, especially cross product expansion across the board. Our total customer count at third quarter was 3,102 which increased by 30 customers, compared to Q2 and 63 year-over-year.

Enterprise customers totaled 547 in the quarter, a decrease of four from Q2 and an increase of 36 year-over-year. We have four new customers make the enterprise $25,000 threshold in the quarter, number dropped to reflect a sequential decline. As we discussed during our Q1 earnings, our newer enterprise customer count methodology will be slightly more volatile. Our average enterprise customer spend was $858,000, up $40,000 quarter-over-quarter, representing a 5% increase as well as an 11% increase year-over-year. These results point to continued wallet share expansion, as we’ve aligned our customer success teams to be more focused on cross-product adoption. Also, as we work towards platform unification, we begun focusing on our goal of making customer cross-selling, and onboarding as simple as a single click for existing customers.

This will be a huge shift in the usability and the expandability of our platform and help drive customer retention, as well as expansion. I’m excited to share with you that in the third quarter, we acquired Domainr a real-time, DNS API provider. We’ve run on board a small team of highly respected DNS experts and paired with the general availability of Certainly, our certificate authority, we have the opportunity to greatly simplify on boarding to the Fastly platform with security and simplification. In the third quarter, we landed key new logo wins in highly competitive deals. I am personally very excited about Wendy’s a true White House account in a new vertical for Fastly that opens up a major market opportunity As our success in e-commerce grows to include more and more adjacent verticals such as food delivery, travel, and leisure and consumer brands, we see significant potential to accelerate customer acquisition.

Continuing our success in security and privacy proxy implementations, we are excited that Mozilla, adapted Fastly’s oblivious HTTP relay, Fastly now serves three of the top four internet browsers worldwide. On thought leadership, we published our first threat intelligence report, featuring data and insights from Fastly’s network learning exchange, as well as continued posts on Fastly’s technical leadership in the constantly evolving world of DDOS experts. As some of you are aware, a couple of CDM providers are in the process of winding on their services and have sold their remaining customer contracts to our competition. This has created disruptive environment that Fastly is poised to capitalize on, especially as those contracts come up for renewal.

Digital Turbine, a leading digital ad provider is a great example and there are many others already engage Fastly to find higher levels of service and performance at competitive rates. We are committed to helping them find their next strategic partner. If anyone listening recently had their contract sold, please feel free to reach out. We’re seeing this e-commerce expansion internationally as well, closing a top New Zealand grocer and an omni-channel retail fashion house in UK. We saw continued customer acquisition in the travel leisure segment and in the healthcare life sciences. We anticipate continued momentum in these expansion verticals as our sales team is now armed with more reference accounts and pre-built use cases. This momentum significantly tilts the win probability to Fastly and gives us a considerable edge of new customers.

As these new verticals ramp, a diversified traffic load will provide Fastly with smoother network and compute demand, providing better infrastructure utilization, leading to future margin improvements. Our gross margin was 55.9% for the third quarter, representing a 17 basis point decline, quarter-over-quarter, but a 230 basis point increase year-over-year. I am pleased with the team’s efforts controlling our variable cost of revenue and continuing to get more from our infrastructure footprint. For the second quarter in the row, we saw outsize increases in international traffic, which did cause a short-term margin headwind. As with last quarter, these will open up opportunities for us to peer more and negotiate a bandwidth cost to lower our total cost of revenue for the future.

Our operating expenses were $84 million in the quarter, coming in lower than anticipated. Financial discipline and rigor continues to have behavioral results here. Note this result also reflects heavy sales and marketing spend due to one-time events and fees. I’m also pleased that we posted another positive adjusted EBITDA quarter making this our second quarter in a row. Positive EBITDA should be a normal occurrence moving forward, but you’ll excuse my enthusiasm just this one last time. Ron will explain our outlook and guidance in more detail. But as you can tell from our OpEx spend, we are readying our model to leverage revenue growth and improve our cash flow for next year. During the quarter, we continued to drive our durable innovation engine strategy and have delivered several key pieces of functionality in the market.

You can see these in our supplement including KV Store, Shipping GA, which enables more powerful edge applications through very high performance of reads and writes of key data at the edge. GraphQL inspection expands Fatly’s API security offering. Certainly going GA establishes, a Fastly certificate authority to provide domain validated TLF certificates and improve the security, and reliability of our customer sites. And our Goal Compiler SDK provides edge compute developers with a key capability for a highly requested language. During the quarter, we hosted Altitude, our user conference in New York City drawing hundreds of worldwide attendees. Most attendees were customers and prospects, but there were also industry and investor analysts in attendance.

I was extremely pleased with the event. It was very well received. Some of the sessions have been viewed thousands of times online following our social media coverage. One of the highlights was a demo of simplified service creation, our new onboarding workflow and dashboard. This demo was so powerful because it showcased Fastly’s new ability to provision a global website for best-in-class low latency user experience worldwide, all in 90 seconds. This combination of power and simplicity is near and dear to my heart. And I believe it’s key to rapidly increasing customer acquisition at Fastly. Please give it a look if you have a chance. It’s bookmarked in our Events page and in our supplement. There’s also been great progress with our packaging motion.

We initiate this motion a little less than a year ago and closed our first handful of packaging customers in the first quarter of 2023. Since then, the growth has accelerated and in the third quarter the number of customers that signed packaging deals more than doubled quarter-over-quarter. Almost half the package is sold to-date have been computing related with almost a third of the customers buying a standalone compute-only package. In terms of the overall number of packages sold, more than 25% of our package deals are platform wins with multiple product lines included demonstrating the ability for packaging to help us drive our platform strategy and expand our offerings beyond CDN. This data gives us great insight into where we can see our efforts and we plan to continue to drive a single platform cross-selling motion across our customer base.

I first thought about this opportunity as Ron will explain in just a moment this is having a favorable impact on our RPO as well. Moving on to our channel partner development, we are seeing great progress here. Our 2023 deal registration is already triple that of 2022. You’ll recall that during our Investor Day in late June, Brett shared with you that we had 33 partners globally engaged. Today that number totals 55. Our revenue contribution has grown more than 50% in 2023 year-to-date, when compared to all of 2022. And we expect to see this trend continue into 2024. So far, I’m pleased with the progress we’re making in 2023. And this is reflected in our updated projections for the year. We raised our annual guidance for both revenue and operating margin and we’ll strive to find ways to outperform that guidance through strong innovation velocity, strategically lowering the friction of our go to market efforts and streamlining our employee experience.

Fastly partners with our customers to deliver the best possible end-user experience. This focus uniquely positions us where these market needs intersect the edge cloud. And there is an enormous opportunity in that intersection. The future user experience is fast, safe and engaging without compromise. Organizations been too much time building best-in-class digital experiences only to see the value of that effort lost by having to compromise between performance, safety and personalization. This represents a clear architectural opportunity for Fastly. The solution has to be built on the edge and it has to leverage all the benefits of a best-in-class edge cloud platform, fast, safe and engaging without compromise. This is Fastly. Thank you so much.

And now to discuss the financial details of the quarter and guidance, I’ll turn the call over the Ron. Ron?

Ron Kisling: Thank you, Todd, and thanks everyone for joining us today. I’ll discuss our business metric 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 third quarter increased 18% year-over-year to $127.8 million, coming in at the top end of our guidance of $125 million to $128 million. Revenue from Signal Sciences products was 14% of revenue, a 33% year-over-year increase or a 31% increase, excluding the impact of purchase price adjustments related to deferred revenue. Also, note that we calculate growth rate off of the actual results with the percentage of revenue rounded to the nearest whole percent.

In the third quarter, we saw traffic expansion at our major customers, as well as strong upsell and cross-sell activity. Our trailing 12-month net retention rate was 114%, down from 116% in the prior quarter and 118% in the year ago quarter. We continue to experience very low turn and our customer retention dynamics remained strong. Turning to RPO, as I discussed last quarter, our consumption-based revenue model is now being augmented with predictable revenue packages. For the third quarter, our RPO was $248 million, up 7% from $231 million in the second quarter of 2023 and up 43% from $173 million in the third quarter of 2022. As Todd shared, we had 3,102 customers at the end of Q3, of which 547 were classified as enterprise, a net, decrease of 4 compared to an increase of 11 in the second quarter.

As a reminder, we changed our calculation of enterprise customers this year to customers with an annualized revenue run rate of $100,000 or $25,000 in the current quarter, which results in more quarter-to-quarter volatility than the previous 12 months trailing $100,000 definition. Using our prior methodology, enterprise customer count increase by 10 customers in the third quarter to 530, compared to an increase of six in the prior quarter. Enterprise customers accounted for 92% of total revenue on an annualized basis in both Q3 and Q2 and enterprise customer average spend was 858,000, up 5% from 818,000 in the previous quarter and up 11% from 771,000 in Q3 of last year. Our top 10 customers comprise 40% of our total revenues in the third quarter of 2023, an increase from the 37% contribution in Q2 2023, reflecting in part the impact of vendor consolidation and expansion of our traffic at some of our largest customers, which also drove one customer to account for 12% of revenue in the third quarter.

I’ll now turn to the rest of our financial results for the third quarter. Our gross margin was 55.9%, compared to 56.6% in the second quarter of 2023, slightly above our expectation of 100 basis point sequential decline. We saw increased bandwidth costs from higher than expected growth in traffic from customers outside the US and EU, which was partially offset by reductions in our other variable and fixed cost of revenue. As we’ve discussed in 2022, we implemented new and more robust network capacity planning to better align network capacity investments with our expected traffic demands. These steps have driven significant reductions to our cash CapEx investment as a percentage of revenue, which declined from 14% in 2021 to a current range of 6% to 8%.

As part of this capacity planning, we identified approximately $4.3 million of hardware, software and related commitment, primarily acquired or committed to in 2021 that are in excess of our requirements. We recorded an impairment charge for $4.3 million in Q3 to reserve for this excess equipment and commitment. We excluded the impact of this charge in our non-GAAP results. Operating expenses were $84 million in the third quarter, an 8% increase compared to Q3 2022 and up 9% sequentially from the second quarter. A portion of this growth was a tax benefit of $3.4 million recorded in the second quarter that did not recur in Q3 and one-time marketing expenses related to events and fees in addition to our normal investments in R&D and sales and marketing.

The benefits from our continued focus on cost discipline and financial rigor offset these investments resulting in OpEx coming in slightly below our expectations. This favorability, combined with revenue at the upper end of our guidance range and gross margin slightly ahead of expectations resulted in an operating loss of $12.6 million, exceeding the high end of our operating loss guidance range of $15 million to 13 million. Our net loss in the third quarter was $8 million, or a $0.06 loss per basic and diluted share, compared to a net loss of $16.8 million and $0.14 loss per basic and diluted share in Q3 2022. I am pleased to report that our adjusted EBITDA was positive in the third quarter coming in at $0.7 million, compared to negative $9.1 million in Q3 2022.

Turning to the balance sheet, we ended the quarter with approximately $461 million in cash, cash equivalents, marketable securities and investments, including those classified as long term. Our free cash flow for the third quarter was negative $19 million from positive $7.8 million in the second quarter. This decrease was primarily driven by changes in working capital and lower operating margins as compared to Q2, which benefited from the aforementioned non-recurring sales and use tax refund of $3.4 million. Our cash capital expenditures were approximately 4% of revenue in the third quarter below the low end of our outlook of 6% to 8% of revenue for 2023. We expect to accelerate the purchase of certain hardware in the fourth quarter for deployment in 2024, which will drive our annual CapEx for 2023 as a percentage of revenue to the high end of our 6% to 8% range.

As this demonstrates, we expect to continue to see quarterly fluctuations in the timing of our capital expenditures, but for them to align with our range on an annual basis. As a reminder, our cash capital expenditures include capitalized internal use software. I will now discuss our outlook for the fourth quarter and 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 material. We undertake no obligation to update these forward looking statements in the future except as required by law. Our fourth quarter and full year 2023 outlook reflects our continued ability to deliver strong top-line growth via improved customer acquisition, upsell and cross-sell expansion in our existing customers driven in part by new and enhanced products.

Our revenue guidance is based on the visibility that we have today. Historically, our revenue experience is sequential growth in the second half that accelerates into the fourth quarter. For the fourth quarter, we expect revenue in the range of $137 million to $141 million, representing 16% annual growth and 9% sequential growth at the midpoint. As we shared on our previous calls, we saw some increase in price declines in the first half as a result of winning additional traffic from a major customer. As we entered the second half of 2023, we experienced increased traffic in the international markets where we saw favorable pricing. As a result, our pricing trajectory was more favorable than this normal course and we expect that to continue to the remainder of 2023.

And recall that normal reductions in our bandwidth cost and ongoing network optimization, combined with increasing traffic into our fixed cost base typically offset our pricing declines. Looking more closely into these dynamics on the cost side. In the second half of 2023, we saw a larger increase than previously expected in traffic from customers outside the US and EU markets. Within these markets, our bandwidth cost today are higher than those in the US and EU markets and it had a modest adverse impact on our gross margins. While this increased traffic gives us the opportunity to renegotiate our bandwidth rate and increase peering reducing costs for all customers in these regions, it will have a modest near-term impact on growth margins while we complete these negotiations.

We continue to be very disciplined in our network investment and cost of revenues, which contributed to our third quarter gross margins being approximately 30 basis points better than we initially expected. For the fourth quarter, we now anticipate, our gross margins will increase approximately 100 basis points relative to the third quarter, plus or minus 50 basis points. As we mentioned previously, our Q3 operating loss was moderately better than our earlier expectations, as our continued cost controls offset increased seasonal spending in marketing. For the fourth quarter, we will see the benefit of increased revenue as we continue our cost control efforts. As a result, for the force quarter, we expect our non-GAAP operating loss to decrease by approximately $3 million to $7 million to $10 million to $6 million and our non-GAAP loss to be $0.5 to $0.01 per share.

We reported nominally positive EBITDA in our third quarter and expect our adjusted EBITDA creating positive and to improve materially in the fourth quarter. For calendar year 2023, we are raising the midpoint of our revenue guidance from a range of $500 million to $510 million to a range of $505 million to $509 million. This increase represents 17% annual growth at the midpoint. We expect our non-GAAP operating loss to improve to a range a $44 million to $40 million, reflecting an operating margin of negative 8% at the midpoint, which compares favorably to our prior guide of negative 9% at the midpoint and our operating margin of negative 18% in 2022. We expect our non-GAAP net loss per share to improve to $0.23 to $0.19, reflecting the improvement in our operating loss expectations, compared to our prior range of a net loss per share of $0.27 to $0.21 and we expect our adjusted EBITDA for calendar year 2023 to be positive, compared to negative $32.9 million in 2022.

Before we open the line for questions, we’d like to thank you for your interest in your support in Fastly. Operator?

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Q&A Session

Operator: [Operator Instructions] We will take our first question from Frank Louthan with Raymond James. Your line is open.

Frank Louthan: Great. Thank you. Just following up on the guidance, any change to the longer term metrics you gave at the Analyst Day, particularly the free cash flow guide from 2024? And then to follow up on the OpEx declines how much further can that – can we see that decline and what sort of good run rate for that going forward? Thanks.

Todd Nightingale : Yeah. I think if you look at the sort of outlook, particularly with respect to cash flow, that we gave back on the Investor Day that exact – that is still intact if we look toward 2024, our cash flow basis, we would look to be break even-ish on a cash basis.

Ron Kisling: On the OpEx side, I’m pretty happy with the cost control across the company right now. But I’ll tell you, we’ve got, we still have some significant benefits here. I mean, it takes a while to unravel long-term SaaS contracts and commitments. We’re still seeing that. We’re still reaping the benefits there and we’ve done I think a pretty good job of putting business model rubrics in place to control the headcount, that control the operating models for our teams. So that, going forward, we don’t expect OpEx to grow nearly as fast as the top-line. And I think that’s going to be the key for us.

Frank Louthan: All right, great. All right. Thank you.

Operator: And we’ll take our next question From Jonathan Ho with William Blair. Your line is open.

Jonathan Ho: Hi, good morning, good afternoon. Just wanted to get a little bit more color on what you’re seeing in terms of the spending environment and some of the budget tightening? That’s the first question.

Todd Nightingale : Yes, it’s super interesting. We’re seeing we see budget tightening in some of our accounts that leads to that can lead to vendor consolidation. They don’t want to manage as many vendors. That tends to be good news for us, because, as the performance leader in almost all of those deals they tend to want Fastly to be part of their solution even if they stick with a multi-vendor play. There are some cases where we’ve seen deals taking a little longer to close as more approval of our needed. I think that might be the nature of the current economic environment that we’re in and we haven’t seen those deals dissolve. We’ve seen them take a slightly longer than usual. What we’re tracking that very carefully. Kind of, I might have a little bit more interesting information next quarter on it. But we haven’t we haven’t really been too worried about it so far. But we’re noticing something.

Jonathan Ho: Got it. And just as a follow-up, how should we think about where you’re growing in terms of the international markets? Is there a way for you to maybe help us understand what markets these are, these are specific vertical that you’re seeing traction internationally? And how long is it sort of takes for some of these contracting negotiations to take? Thank you.

Todd Nightingale : Sure. We see – we’ve been pushing on our international go to market for sure, and that drives local business with local traffic in those expanding regions for us. But what is interesting and what is causing some of our model to shift a tiny bit, is we’ve got large multinationals who are successfully penetrating new regions themselves, and they’re using Fastly to partner to deliver that that content. We see it in media largely. And I think it’s really good news. It’s helping us grow into those markets and modernize our infrastructure and our or I should say, mature our infrastructure and that’s what these to those contract negotiations. Because with more traffic, we’re able to negotiate and peer more effectively in those regions and then improves the margin for all of our traffic in that region not just the multinationals, but the local traffic, as well.

It can take us a little bit quarter, but more likely probably six months. It doesn’t take a full year generally speaking because those contracts have a much tighter turning on renegotiations.

Operator: We will take our next question from James Fish with Piper Sandler. Your line is open.

James Fish: Hey guys. Nice quarter here. Todd, maybe for you, channel partner deal registration of three times year-to-date. Can you just talk about what those channel partners are leading with between delivery that tends to be more self-serve versus security understanding? You gave some of those metrics there and really the crux is kind of what kind of economics you’re seeing versus the traditional Fastly model? And then I’ve got a follow-up for Ron.

Todd Nightingale : Yes, no worries. Our partner community has largely, historically been around the security business and we’re starting to see that branch out from just security to them being able to operate across the portfolio, which is awesome. And that’s been a big help, especially new partners that we’re bringing on board, they are capable of operating and in some cases have much broader expertise. And that’s why for me, the jump of partners in the program up to 55 really matters. I think that is a broadening of the expertise of our partner community. And I think will also help customers to engage with those partners on board faster which is an important metric to our business. And the other thing is just on the geographic side.

We’ve got our traditional partner program for the revamp was really heavily focused in the US. We are seeing it start to ramp up outside of the US and that’s helping quite a bit. And I should say the partnership with the cloud providers helps that move a little faster. In some cases, it’s easier for partners to onboard because they’re all the operating to a cloud marketplace, and that is a nice synergy for them. And it’s valuable for us, as well as it lowers our operating costs it.

James Fish: Got it. I am not surprised to see the top 10 up, just you guys own the relationships with those top 10 customers and it’s a bit of double-edged sword especially as you think about the history of this space. So I guess how are you guys trying to mitigate some of that risk around those top 10 customers? Are you looking to sign those customers for longer contracts? And also Ron, any puts and takes on ‘24 to think about understanding, you’re not going to guide Q4 for specifically, but especially as we start to think about how this packing can kind of impact growth rates moving forward? Thanks.

Ron Kisling : Yeah, I’d say, I’m proud with the growth in the top 10 accounts. And we take that very seriously as the largest, the most sophisticated users of this tech they trust Fastly and they’re leaning into the platform more and more strategically, which is a good thing. The only way that I look to combat that is through enterprise customer acquisition, and especially large strategic customers. I have, we love engaging with those large customers. I’ve no interest in doing anything, but growing those accounts as fast as we can, and adding more and more technology to those partnerships. But it’s a long-term litigation that has to come through customer acquisition especially differentiated vertical customer acquisition, and that’s why we’re so focused on that.

That’s why we mentioned some of the expansion verticals especially e-commerce expansion verticals that we’re focused on. I think, looking into ‘24 and we haven’t really shared our ‘24 guidance. We talked a little bit about some of the cash flow expectations at our investor Day. We will share that as we’ve historically done on our Q4 call in February. I think what I would say is I think we’re excited about the progress to-date. We continue to believe on our ability to outperform the market continuing into 2024.

James Fish: All right guys.

Ron Kisling : Thanks.

Operator: We will take our next question from Rishi Jaluria with RBC Capital Markets. Your line is open.

Richard Poland: Hey. This is Richard Poland on for Rishi Jaluria. Thanks for taking my question. So, I guess first one. Just any sense for how much of that top 10 account expansion was on the traffic side versus, cross-sell of the broader portfolio maybe getting more security products in there? Any color around kind of the breakdown of that?

Todd Nightingale : It is a good question. We don’t disclose this, although we do track it. The peak in international traffic that came from those large multinationals, that’s largely traffic expansion. But there are new use cases being added with those folks all the time. It’s hard for us to disclose details on that. Maybe we’ll look and see if there’s something that that we can share in a longer term. Anything you’d add there?

Ron Kisling : I mean, the one I would add, I think as you look at that growth, I mean, vendor consolidation that we saw at one of our largest customers clearly was a contributor in that concentration. I think, as Todd said earlier, I think as we look forward to the benefits from some of the sales and marketing, the packaging in the channel of that accelerates new customer acquisition. That should be a counter motion to the expansion. We know we’re going to continue to see, particularly our largest customers that you see in that top 10 number.

Richard Poland: Thank you. That’s very helpful. And then just a quick follow-up on the security portfolio. I think, if I recall correctly, the Bot management solution was still in beta as of last quarter. So any update there on just kind of how the progress of the expansion of security portfolio is going? Thanks.

Todd Nightingale : Yeah that’s great. Our bot product is, we have like a very large number of folks on the beta. It’s going limited availability this quarter. I hope to actually to be able to close some deals on this quarter and then GA in the first half. We got amazing success. I’ve been really happy with how many customers have leaned in to the beta, and are helping us really co-develop that solution, and got one more feature to check off and it’ll become available to customers and into our sales teams to start closing deals. So, I’m super excited about that. We’re also looking at a couple of other important areas on the security side. A productization – the potential productization I should say, deeper DDOS analytics, visualization and services, as well as deeper feature set in API security.

It’s become really clear to us that the buyer in this space that’s looking for strategic edge partner in CDN security, edge compute et cetera, they’re looking for a suite of security suite that includes bot DDOS, next-gen and whack, and API security. And we plan on pushing hard on all of those components.

Richard Poland: Got it. Very helpful, Todd. Thank you.

Operator: We will take our next question, from Will Power with Baird. Your line is open.

Will Power : Okay. Great. Thanks. Yeah, I guess a couple, maybe just starting on competition. I mean, you kind of noted and I guess we’ve seen a couple of smaller players selling off contracts. And I guess, exiting the business I just wanted more broadly kind of what you’re seeing from a pricing environment, recently in the US it sounds like you know international pricing is helping probably overall. But just think any kind of color as to kind of how the competitive environment is looking today?

Ron Kisling : Yeah, I think you’re from a pricing perspective, as we said the international mix, we do have slightly favorable pricing relative to kind of the major markets in the US and EU. And that really provided if you some strengths, kind of in the quarter-to-quarter pricing. I see here in US, the trend has been generally in line with our long-term trend. We did have some deceleration in the first half from the vendor consolidation and I would say, outside of that international or if you look at it by market, it’s generally been returned to more of those long-term trends. We haven’t seen any acceleration. And we still see, a good pricing environment. I think this one across the industry.

Will Power : Okay. And then, I guess, Ron, on just on the on the gross margin comments. It sounds like some headwinds just given the international traffic in Q4. But how would you kind of frame up how to think about gross margin progression next year? I mean, I know you generally been expecting it to rise, but how quickly do you get kind of international kind of behind you and back kind of maybe on the targets where you were?

Ron Kisling : Yeah, I think if you look at kind of that timeline, I think, the, the medium to long-term gross margin dynamics are still intact and I think the 80% gross margin that we had mentioned at the Investor Day in that medium to long-term are intact incremental gross margins are intact. I think, if you look at that gross – incremental gross margins that we’ve seen in the last four quarters have been above 60% compared to the teens kind of in early 2020. I think as we go through that contract negotiations, that’s probably a couple of quarters work. I think we generally in 2024 address most of those headwinds and get back to that medium to long-term or the larger targets that we’ve laid out previously.

Will Power : Okay. Thank you.

Operator: We will take our next question from Tim Horan with Oppenheimer. Your line is open.

Tim Horan: Thanks guys. Can you talk a little bit about some products what customers are using it for? And why they are they using you? And any color when it kind of starts to move the revenue needle? Thanks.

Todd Nightingale : Hey sorry. We missed the first part of that. Could you repeat the questions?

Tim Horan: Yeah, I apologize. Can you talk about which compute products your customers are using? And what are they using it for? And why are they using it guys? And when you got moving the needle?

Todd Nightingale : Yeah, great question. The customer that we track, our compute business on customer acquisition, people tend to come to Fastly, because we are really delivering freedom to developers especially with the technology called Labs, and that allows them to compile their own language and run it on the Fastly platform. You saw, there’s a release I think it’s in the supplement of our Go SDK and I think that that gives you a real sense of supporting languages that developers are – that are top of mind for developers and gives them the freedom to go and build serverless components at the edge. The second thing is, people come to Fastly to deliver use cases that are already proven out, and that’s a big deal especially around personalization, shopping cart management, content recommendation, et cetera.

That’s been really a big push there. And from a vertical point of view, there’s a very strong focus from high tech companies who are – they kind of be the most sophisticated. They tend to get be able to get a lot out of it very quickly, especially with pretty mature documentation and developer enablement from Fastly and part thanks to the acquisition. And I think that’s what brings folks to the Fastly program. It’s really an organic developer first motion. I plan on tracking this business largely in customer acquisition through next year, as it’s still truly an incubation, but I think we’re going to start to see it hit the – in some material way, hit the revenue line and I hope it tail end of ‘24 and ’25, but we’ll see.

Tim Horan: Great. And can we just give us some kind of revenue breakdown now if possible, like on media delivery, your application delivery or you know any other color would be would be great?

Ron Kisling: Yeah. We haven’t provided that breakdown between media and other delivery across the verticals in our revenue breakdown. Sorry about that.

Tim Horan: Thanks.

Operator: We will take our next question from Rudy Kessinger with D.A. Davidson. Your line is open.

Rudy Kessinger: Hey, great. Thanks for taking my questions, guys. I guess, just with those smaller CDM players exiting the business in the quarter, did you pick up any material business from this smaller players that exit?

Ron Kisling: We do pick up, we’ve seen a few already move over and we’ve got a quite a few additionally already in the pipeline. Those folks have contracts. And so what really, I think, I think the real pattern here is that as their contracts come due, they tend to stick their head up and, and make a new vendor selection. That’s a really good news for us. We thought with Digital Turbine those guys pretty sophisticated group, they were able to move quickly. I’m hoping that we’re going to see more of that really in Q4 and Q1 on the new customer acquisition front.

Rudy Kessinger: Got it. And then, just general traffic growth trends across the board. Anything to call any material changes as just how general traffic – traffic growth trending.

Todd Nightingale : The traffic trend is pretty had been sort of interesting. There have been a lot of interesting events. We are starting to see the seasonal sporting event trends. We even saw some peaks from content drops, some of the streaming platforms. I think it’s fairly close to what we were expecting with the addition of some of the international – some addition, some additional volume on the international front.

Ron Kisling: Yeah. And we’re guiding to the normal potential update we start to see as we exit Q3. We are continuing to see this year.

Rudy Kessinger: Got it. Great. Thanks for taking my questions and congrats on the numbers.

Todd Nightingale : Thanks.

Ron Kisling: Thank you.

Operator: We will take our next question from Fatima Boolani with Citi. Your line is open.

Fatima Boolani: Hi, good afternoon. Thank you for taking my questions. Ron, maybe these are for you. First thing, over the course of this year, you all have been very intentional about managing your install base and start pruning the less economical or lower LTV type customers in your base. And that’s been pretty obvious. I’m curious if you can comment on if you’re sort of through the halfway point or towards the end of that process such that we can start seeing some more robust growth in that metric? And then just a quick follow-up on some of the contract negotiations, that you are foreshadowing for next year?

Ron Kisling: Sorry. Just to clarify, when you say, pruning customers in the LTV type of, what do you mean?

Fatima Boolani: Just in terms of, managing the install base for higher quality customers, just wanted to get a sense of, how far down the path are you that your current install base is, high value high, penetration opportunity, versus, some of the customers that you might have particular ways with over the course of the year? I just wanted to get a sense of where you are in that process and is that mostly sort of done – are you done pruning?

Ron Kisling: Got it. But – I’d just clarify that. We haven’t pruned any customers intentionally and largely the way that our business runs and the way our infrastructure is built and is able to organically serve customers, I think it’s pretty hard. I mean it’s very rare that we would find a customer that would be not a great fit. When we occasionally had a – I need to prune a customer. The only times I can think of that happening are on terms of use and community guidelines. The infrastructure at Fastly allows for us to have very efficient delivery, especially very efficient delivery of incremental traffic. And so we don’t – we haven’t done any pruning. I absolutely don’t intend to. I do believe we have an opportunity to increase the margin by changing the traffic, a signature of our total customer base.

But the only way that we’re – the only thing we’re pursuing to do that is, focusing on differentiating the verticals that we serve. So, that the traffic flow will be more balanced across type of day, as well as the type of traffic load and working hard to drive our customer acquisition motion into regions where we’ve got, where we have good infrastructure to be able to serve. And so, as far as improving the traffic mix on the platform, we certainly do that. We certainly have shifted our focus, but it’s all of that focuses on the customer acquisition side. Not on the on the pruning side.

Fatima Boolani: Understood, I appreciate that. And Ron, I appreciate you are in the planning phases of 2024 right now. But some of the contract negotiations that you’re again foreshadowing for 2024 that you’re going to be addressing. Can you give us a little bit of a flavor as to help bake these body of contracts is going to be, any high level thoughts on if these contracts may be concentrated with some of your largest customers? And any seasonality commentary at high level you can share with us, that would be really great as we think about the next year.

Ron Kisling: Yeah, I mean, I think you’re starting with the seasonality. I think, what we’re certainly seeing this year is fairly consistent seasonal patterns, as we work through Q3, we started see an increase in traffic. We expect us to continue to see that accelerate in Q4, I think it’s reflected in our guidance. I think as you look to 2024 from seasonality, I think, again, we expect that the typical seasonal patterns to continue. Q1 typically is flat to down a few percentage points. We would expect that to continue into 2024. I think as you look to kind of your customer acquisition, I think again, there’s really two motions that we have that are driving that. There’s the expansion and the cross-selling opportunity in our largest customers.

And we continue to be really successful at that, particularly when we see vendor consolidation and there is multiple vendors. We – because of our performance gained share and are able to cross-sell additional products into those customers. And then, our new customer acquisition engine with a lot of the work we’re doing across packages as well as the channel, we really expect that to sort of drive acceleration and new customers in 2024. So I think you’re going to see most of those motions driving the performance of 2024. Most expansion motion, which we’ve consistently done well, and the new activity is really driving acceleration of new customer.

Operator: We’ll take our next question from Tom Blakey with KeyBanc Capital Markets. Your line is open.

Tom Blakey : Hey guys. Thanks for being here. I just – perfect setup there Ron, in terms of the channel you discussed some highlights in your press release this morning or this afternoon. Any color Todd, you want to provide for us to can talk, check the sustainability here? What are the biggest changes that you’ve implemented in terms of this dynamic growth here? You’re seeing of late. I have a follow through.

Ron Kisling: Yeah, I think, look, it is still early. So I hope to have hundreds of partners driving business for Fastly and more importantly, delivering services that allow our customers to move more quickly to adopt Fastly technology more rapidly. I’d say from a trend point of view, I just think it’s an underserved space. There’s a lot of systems integrators with high software specialty. They’re working very closely with teams that are building out digital experiences and they haven’t had the ability to partner closely with a edge cloud provider, especially a performance leader in CDN. And so, we’ve had good receptions to this new partner program. We will be looking and reviewing it for next year to see ways to make it better.

But so far, for me the trends are what I want to see. This is moving in the right direction, but I would say for sure, partner acquisition and dealer velocity are trending in the right direction. But for sure, we are planning to ramp them hard in 2024.

Tom Blakey : Does that include just quick follow-up before I ask for other questions? Does that include like enterprise caliber customers? And what are the – why is this kind of growth unique to Fastly? And what are the incentives. I am sorry. Just a lot of growth here and a big opportunity and typically CDN doesn’t benefit from the channel.

Ron Kisling: Yeah. And I really think that our effect of just the way the first few entered into this product space have operated. I think, looking at the market now, there’s so much software spend that’s already going through the cloud market place. There is systems integration, know how to operate that and operationalize deals big and small through those systems and direct to vendors. And we offer both options. For me, there’s one other twist, which is the ability that flexibility in that channel program matters. These – our channel partners can operate in the traditional channel sales motion, but also in an agency model. That flexibility matters. And the way that we’ve operationalize that I think is important. We’re also engaging with partners who are really on the technology consulting side for the first time.

And those engagements although it’s early days, I think have a lot of potential upside, as well. And those are like technology consultants largely. But, I guess, my point of view, and I think this will play out in the next 12 months is that this is just an underserved part of the market. And by focusing here, we have an opportunity to gain the attention of the channel.

Tom Blakey : Very, very helpful. And then, Ron on that 50% channel revenue growth, is all the requisite questions there, over what period of time, what percentage of revenue here? Even if it’s a range where you kind of expect that to head in the coming year or two? That’d be helpful. Thanks guys.

Ron Kisling: This is about the channel growth?

Tom Blakey : Well, you talk about revenue channel growth. Just what period of time is that and…

Ron Kisling: It’s program to-date year-over-year.

Tom Blakey : Okay, where are we in terms of a percentage of revenue where do you expect that to go? Todd kind of spoke positively there as that obviously going to increase just to give us something like level as – helps yet.

Todd Nightingale: So I think what I said, we haven’t given the specific percentage of revenue, but we do expect it to continue to grow as a percentage of revenue. I think in terms of really gaining traction and being a contributor, we see that really gaining traction in 2024 a lot of the work, sign ups and deals happen this year. We expect to see that grow – as a contributor grow overall revenue in 2024.

Tom Blakey : Great. Thank you.

Operator: And we’ll take our final questions from Madeline Brooks with Bank of America. Your line is open.

Madeline Brooks: Thank you. Thanks so much for taking the question. Just a quick one for me here. It looks like from an edge compute standpoint, got a lot of positive signals with the packaging motion. So just want to marry that quickly to the budget comments and the landscape you guys are seeing with the slight weakness. And just want to know and apologies, if this has been asked I mean there’s a few calls, but why do you think of paying Fastly now versus other companies earlier? And can you call out any specific areas of impacted more versus less? Thanks so much.

Ron Kisling: Sure. On the compute side, I feel like the momentum is really good for us right now. I feel like, you do me a critical amount of features and functionality before developers can really reach different outcomes that they care about, learning their services at higher cost, dramatically improving performance and user experience, being able to build sustainable solutions and pull the appropriate workloads from their core into an edge serverless environment that will have the kind of performance and kind of user experience improvement that they want. And I think we’re getting – we are starting to hit our stride, which is great. I think we have opportunity here on the product side, as well. And not to – but I think we can simplify our offering and make it even easier for our customers to onboard and understand all the components there.

So, I’m not trying to that, we’ve arrived. We’re going to be on this journey for quite a while. Your second question was around the belt tightening comment in the opening, is that correct.

Madeline Brooks: Yes, it’s correct.

Ron Kisling: Yeah, I guess, we may have briefly mentioned it already. I think, what we’re seeing as our customers’ budgets feel a little pinch to them. That certainly drives vendor consolidation that tends to be good thing for us as the performance leader we tend to fair well in those engagements. We do, see a little bit of slowness in the deals as vendor changes when customers are leaving some of our competitors that come into Fastly changes in contracts are just getting more scrutiny, requiring more sign-ups and that can delay some deals. So we’ve seen a few deals that have taken a little longer to close than we’d like. But we’ll see. I think I mentioned this earlier, like, I think we might have a more of a complete perspective of that next quarter. Yeah.

Madeline Brooks: Got it. I am sorry Just to quickly clarify that, Todd, so, it fair to say a deal type you want to get it? But close rates have remained stable throughout the quarter.

Todd Nightingale : Yeah. Well, we track a few – we track very carefully key deals in the quarter and we saw a few of them slip a few weeks, Nothing material. I mean, some of these are six months engagements. So we saw them slip a few weeks. And that, yeah, that’s what is largely due to additional approvals that are needed. I’d say it’s anecdotal, but we’ll be tracking it closely. So I might have better day for you next year. Next quarter.

Madeline Brooks: Got it. Thanks so much next quarter.

Todd Nightingale : Great.

Operator: And that concludes our question and answer session. I will now turn the call back to Mr. Todd Nightingale for closing remarks.

Todd Nightingale : Well, thank you so much. I do want to take a minute to thank our employees, our customers, partners and investors. And moving forward, we will continue to remain focused on executions, bringing lasting growth to our business, and delivering value to our shareholders. I’d like to close by saying how excited I am about the road ahead. Of course, there’s plenty of work to do, but I believe digital experiences will drive the mission and to find the success of almost every organization everywhere in Fastly, while the significant impact on the way digital experiences are built and delivered around the world. Our customers have a real passion for Fastly’s solutions and employees have a real enthusiasm for our mission to make the Internet a better place where all experiences are fast, safe and engaging. Thank you so much for the time today.

Operator: Ladies and gentlemen, this concludes today’s call and we thank you for your participation. You may now disconnect.