Good afternoon. My name is David, I'll be your conference operator today. At this time, I'd like to welcome everyone to the Fastly Fourth Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. If you'd like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you'd like to withdraw your question, press star one once again. Thank you. Vern Essi, Investor Relations at Fastly, please go ahead with your conference.
Thank you, welcome everyone to our fourth quarter and full year 2022 earnings conference call. We have Fastly 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. A replay will be available by dialing 800-770-2030 and referencing conference ID number 7543239 shortly after the conclusion of today's call. A copy of today's earnings press release, related financial tables and investor supplement, all of which are furnished in our 8-K filing today, can be found in the investor relations portion of Fastly's website. During this call, we will make forward-looking statements, including statements related to the expected performance of our business, future financial results, strategy, long-term growth, and overall future prospects.
These statements are subject to known and unknown risks, uncertainties and assumptions that could cause actual results to differ materially from those projected or implied during the call. For further information regarding risk factors for our business, please refer to our most recent quarterly report on Form 10-Q filed with the SEC and our fourth quarter 2022 earnings release and supplement for a discussion of the factors that could cause our results to differ. Please refer in particular to the sections entitled Risk Factors. We encourage you to read these documents. 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 statement except as required by law. 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. Reconciliation to the most directly comparable GAAP financial measures are provided in the earnings release and supplement on our investor relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Before we begin our prepared comments, please note that we will be attending two conferences in the first quarter, the Raymond James 44th Annual Institutional Investor Conference in Orlando on March 6th and the Morgan Stanley Technology, Media and Telecom Conference in San Francisco on March 8th. Also mark your calendars for our Investor Day taking place on June 22nd at the New York Stock Exchange. With that, I'll turn the call over to Todd. Todd?
Thanks, Vern. Hi, everyone, thanks so much for joining us today. First, I will give a quick summary of our financial results and fourth quarter highlights then provide a brief update on our product strategy and go-to-market motion. I will hand the call over to Ron to discuss the fourth quarter and annual financial results and guidance in detail. We reported record fourth quarter revenue of $119.3 million, which grew 22% year-over-year and 10% quarter-over-quarter. Included in this revenue is a $3.3 million take or pay true-up payment, materially above a similar $973,000 true-up payment from Q4 of last year. Correcting for these non-recurring payments, our revenue would have been $116.1 million, growing 20% year-over-year.
We reported 2022 revenue of $433 million, up 22% year-over-year. I'd like to congratulate the Fastly team on closing out a strong Q4. As I said last quarter, I still believe there remains an opportunity for us to outperform this level in 2023 and beyond. Our customer retention and growth engine remains strong. Our LTM NRR was 119% in the fourth quarter, up from 118% in Q3, and our DBNER was 123% in the fourth quarter, up from 122% in Q3. Our average enterprise customer spend was $782,000, representing a 3% quarter-over-quarter increase, and continues to demonstrate the success of Fastly's land and expand approach in strategic accounts.
In the fourth quarter, we saw continued momentum in our portfolio expansion strategy with strong cross-selling activity, just as we discussed last quarter, and had multiple follow-on sales for our Next-Gen WAF technology. In addition, we had multiple new logo wins for this product as standalone sale. We anticipate over time having the opportunity to sell these customers our network service delivery as well as our edge compute and observability features. I'm also excited to share with you that we're gaining traction across multiple verticals. The fourth quarter marked six new logo wins in travel and leisure, a vertical that is more and more focused on the digital user experience. This is highlighted by one of the world's largest corporate travel management platforms moving to Fastly. We complemented this with four new logo wins in healthcare and life sciences, highlighted by our first win at McKesson.
Our total customer count in the fourth quarter was 2,958, which increased by 33 customers compared to Q3. Enterprise customers totaled 493 in the quarter, an increase of 11 compared to Q3. Our gross margin was 57% for the fourth quarter, representing a 340 basis point improvement quarter-over-quarter. I am very pleased with this outcome, I believe it underscores our new cost control rigor and discipline. We found savings with continued increases in peering and improvements in network optimization, coupled with improved hardware maintenance costs. We will continue to be focused on margin improvement through 2023. In the quarter, we were also able to reduce our hardware purchase commitments by over $10 million, reflecting our increased platform efficiency at a cost of $2 million.
This $2 million cancellation charge impacted our cost of revenue this quarter. We believe it will support our margin improvement trajectory moving forward and reduce our cash spend. Excluding the impact of this $2 million payment and the take-or-pay true-up payment I discussed earlier, our gross margin would have been 57.5% in Q4, increasing 390 basis points from 53.6% in Q3. During the quarter, we continued to drive our durable innovation strategy and release powerful, important technology to our customer base in all of our product lines. A selection of them are listed in our investor supplement for your reference. A few highlights include: One, we achieved PCI certification as a Level 1 service provider, expanding our e-commerce customer reach and making it easier for e-commerce customers to onboard Fastly.
Two, our JavaScript SDK for Compute@Edge went GA, offering unmatched initialization performance, further differentiating the ability for Fastly to provide among the fastest load times in the industry. We believe this is a big step forward for developer adoption. Three, our Fastly Next-Gen WAF now supports automated provisioning and management via Terraform for our cloud-based deployment option. Four, as we continue to see advanced bot and DDoS activity, we expanded our Next-Gen WAF advanced rate limiting rules. Security is top of mind for all of our customers, we are excited that for the fifth year in a row, Fastly's Next-Gen WAF has been recognized as a customer's choice in the Gartner Peer Insights Voice of the Customer Cloud Web Application and API Protection Report. Fastly is the only vendor to receive this recognition for all five years.
We're especially proud that customers gave Fastly an overall five out of five stars, the highest of any vendor, and 97% said they are willing to recommend it to others. In keeping with our continued support of our developer community and strong user base, we were happy to bring back our Altitude User Conference live in New York City in November. We had 15 keynote speakers, including multiple customers at the conference. Videos of most of the conference are now publicly available. Also at Altitude, we relaunched our open source and nonprofit program, Fast Forward, with a renewed focus on building community among the builders and maintainers of a faster, safer, and more inclusive internet. Our developer community continues to grow through our addition of Glitch.
It has been less than a year since we acquired their team. The results thus far have been impressive, with over 2 million developers. That community is already starting to drive our Compute roadmap and early adoption. Now I'd like to share my thoughts on my first six months at Fastly. I remain incredibly impressed by this team and its potential. Fastly has an amazing culture and a talented employee base. The team here is passionate about every customer, passionate about the technology we build, and most importantly, passionate about our mission: to make the internet a better place where all experiences are fast, safe, and engaging. There is tremendous opportunity in Fastly as an edge cloud platform, delivering cutting-edge digital experiences for everyone, everywhere.
We believe we have an amazing opportunity to achieve our goal to become a more complete one-stop shop for the edge cloud, delivering a more complete experiences for our developers and for our users. We have a real opportunity to run a high velocity, low friction, go-to-market motion at Fastly, reaching more customers and onboarding them more efficiently. I'm excited with how the teams have realigned for FY 2023 to put the customer first and run a more focused, more efficient sales motion. I've also been pleased that we're making progress to simplify our packaging as we ready our package offerings for the second quarter to streamline customer acquisition and success and provide our edge cloud platform services with reliable billing, simple renewals, and a more complete, simple offer. The progress driving gross margin correction has been amazing.
I'm incredibly impressed by our team, and we remain committed to ongoing gross margin improvements and continue our efforts to make progress in building a more financially stable Fastly. When we look to 2023, we are guiding to 16% revenue growth. There are many uncertainties out there, but I believe Fastly is well positioned to outpace the market. Gaining market share through customer acquisition and portfolio expansion is key to our strategy, and that is exactly where we are aligning our efforts. Additionally, I remain committed to meaningfully reducing our operating losses in 2023, both in percentage and dollar amounts. Let me close by saying I'm very excited about the opportunity here. Our customers have a real passion for Fastly solutions, and our employees have a real enthusiasm for Fastly's mission. Of course, there is plenty of work to come, and I'm excited about the road ahead.
Most of all, I believe digital experiences will redefine the success and drive the mission of almost every organization everywhere. Fastly will have a significant impact on the way digital experiences are built and delivered around the world. I look forward to sharing more with you regarding our progress, our focus on fueling growth, our customer acquisition, and our velocity of innovation in the coming quarters and at our Investor Day in June. Now, to discuss the financial details of the quarter and guidance, I'll turn the call over to Ron. Ron?
Thank you, Todd. Thanks to everyone for joining us today. I will discuss our business metrics and financial results and then review our forward guidance. Note that unless otherwise stated, all financial results in my discussion are non-GAAP based. Total revenue for the fourth quarter increased 22% year-over-year to $119.3 million, exceeding the top end of our guidance of $112 million-$116 million. As Todd explained, included in this revenue amount is a $3.3 million customer take or pay true-up payment. As Todd mentioned earlier, excluding this true-up, our revenue would have been $116.1 million, representing 20% annual growth and 7% sequentially.
In the fourth quarter, revenue from Signal Sciences products was 12% of revenue, a 37% year-over-year increase or a 31% increase excluding the impact of purchase price adjustments related to deferred revenue. Given our relatively smaller market share, we benefited from share gains in an otherwise challenging environment. These dynamics position us well for continued revenue growth into 2023 and beyond. Our trailing 12-month net retention rate was 119%, up slightly from 118% in the prior quarter. We continue to experience very low churn of less than 1%. Our customer retention dynamics remain strong. As Todd stated, we had 2,958 customers at the end of Q4, of which 493 were classified as enterprise.
Those customers with an excess of $100,000 of revenue over the trailing twelve-month. Enterprise customers accounted for 89% of total revenue on a trailing twelve-month basis, in line with their contribution in Q3. Our enterprise customer average spend grew to $782,000 from $759,000 in the previous quarter, representing 3% expansion in dollars spent. Our strong trailing twelve-month net retention rate and growth in average enterprise customer spend demonstrate our continued ability to expand within our largest customers by increasing our share of delivery traffic and adoption of new products in security and in our emerging Compute business. Our top 10 customers comprised 37% of our total revenues in the fourth quarter of 2022, a slight increase to the 36% contribution in the prior quarter.
As I discussed on our Q3 call, we've made a great deal of progress in our financial organization with efforts to closely align with Todd's new leadership. We are seeing benefits in our gross margin and capital deployment plan from engineering efforts that are increasing the efficiency of our platform and cross-functional efforts to simplify our operations and improve our forecasting and review processes. These efforts not only strengthen Fastly's financial position longer term and allow us to drive increased efficiency in our business, but also improve our competitive positioning and our transparency to the investor community. I will now turn to the rest of our financial results for the fourth quarter.
Our gross margin was 57% in the fourth quarter, or 57.5%, excluding the $3.3 million take or pay true-up and the $2 million cancellation fee Todd discussed earlier, compared to 53.6% in the third quarter of 2022. This sequential improvement in gross margin reflects our prior expectations that it would lift in the second half of 2022, primarily due to the results of our efforts to improve our gross margin. As we shared on our Q3 call, we saw a reduction in our bandwidth rates at the end of Q3 that favorably impacted all of the fourth quarter, and we continue to increase the percentage of our peering traffic, which further reduces our bandwidth costs.
We continue to see benefits from improvements in our network investment capacity planning from our closely matched capacity and investment with our traffic patterns and demand. Our efforts to further reduce our existing capital commitments through commitment cancellations Todd spoke about earlier reflect this work to align our capacity investments with expected traffic demands coupled with a meaningful increase in the efficiency of our platform. We also benefited from the seasonal increase in revenue in the fourth quarter, which favorably impacts our utilization of platform overhead costs. Note that our seasonal revenue decline in the first quarter relative to the fourth quarter will have a modest gross margin headwind. I'll expand on this in a moment. Operating expenses were $80 million in the fourth quarter, up 21% over Q4 2021 and up 3% sequentially from the third quarter.
This level of operating expenses, combined with the higher revenue and gross margin achievements, resulted in an operating loss of $12 million, exceeding the high end of our operating loss guidance range of $14 million-$18 million. Our net loss in the fourth quarter was $9.5 million or $0.08 loss per basic and diluted share, compared to a net loss of $11.7 million or a $0.10 loss per basic and diluted share in Q4 2021. Our adjusted EBITDA for the fourth quarter was negative $91,000 compared to negative $3.5 million in Q4 2021. Turning to the balance sheet, we ended the quarter with approximately $683 million in cash equivalents, marketable securities, and investments, including those classified as long term.
Our free cash flow of -$40 million was reduced sequentially from the third quarter's -$44 million. Our cash capital expenditures were approximately 14% of revenue in the fourth quarter and 10% for fiscal year 2022, landing at the low end of our revised outlook shared in Q3 of a range of 10%-12% for the year. Our cash capital expenditures include capitalized internal use software and deployments of prepaid capital equipment. For 2023, we expect our cash capital expenditures to decline further to a range of 6%-8% of revenue. I will now turn to discuss our outlook for the first quarter and the full year 2023. I'd like to remind everyone again that the following statements are based on current expectations as of today and include forward-looking statements.
Actual results may differ materially. We undertake no obligation to update these forward-looking statements in the future, except as required by law. As we look to 2023, our first quarter and full year 2023 outlook reflect our continued ability to deliver strong top-line growth via improved customer acquisition and expansion within our enterprise customers, driven in part by new and enhanced products. Our revenue guidance is based on the visibility that we have today. We expect expense growth for the full year to lag revenue growth and expect a meaningful improvement in our operating losses in 2023 over 2022. More specifically, we are investing in our go-to-market efforts as part of our revenue growth initiatives to continue our expansion in our existing customer and accelerate our new customer acquisition.
We will continue our investments in product and R&D, and as we discussed on our last call, we see meaningful opportunities to drive greater efficiencies in our operations, especially across G&A, and we expect to see meaningful leverage in our G&A costs in 2023 and for these costs to decrease as a percentage of revenue. Given the nature of network traffic drivers in the fourth quarter, including holiday shopping patterns and live sports streaming viewership, historically, our first quarter sees flat to down revenue relative to the fourth quarter, and we expect to see a similar trajectory in 2023. In the first quarter of 2022, this seasonality was favorably impacted by the return of traffic after the Q2 2021 outage. I'd also like to remind you that excluding the one-time take-or-pay true-up in the fourth quarter of 2022, fourth quarter revenues were $116.1 million.
As a result, for the first quarter, we expect revenue in the range of $114 million-$117 million, representing 13% annual growth at the midpoint. As I mentioned earlier, given the seasonality in our business, we expect gross margins in our first quarter to be down 100-200 basis points from our Q4 gross margin of 57.5%, adjusted for the aforementioned true-ups. For the full year, we expect to see continued gross margin accretion and to exit the year with gross margins within striking distance of 60%. We did not see any meaningful changes, positive or negative, to our pricing in the fourth quarter as compared to the prior quarter.
We expect operating expenses will increase in Q1 relative to the fourth quarter of 2022 due to an increase in payroll taxes, which will extend into the second quarter, and the timing of sales events that impact the first quarter. As I mentioned above, we anticipate expense growth for the year to lag revenue growth with a meaningful improvement in our operating losses in 2023 over 2022. We expect a non-GAAP operating loss of $18 million-$16 million and a non-GAAP loss per share of $0.12-$0.08 per share. For calendar year 2023, we expect revenue in a range of $495 million-$505 million, representing 16% annual growth at the midpoint.
We expect a non-GAAP operating loss of $53 million-$47 million, reflecting an operating margin of negative 10% at the midpoint compared to an operating margin of negative 18% in 2022. We expect a non-GAAP loss per share of $0.27-$0.21. I'd like to call out that the recent increase in interest rates is resulting in a meaningful increase in our interest income on our cash and investments, and we currently expect to earn approximately $20 million in interest income in 2023. Before we open the line for questions, we'd like to thank you for your interest and your support in Fastly. Operator?
Thank you. At this time, I'd like to remind everyone in order to ask a question, press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. We'll take our first question from Frank Louthan with Raymond James. Your line is now open.
Great. Thank you. Walk us through your path to getting more towards EBITDA positive. Do you think that's something that can happen this year or that's more next year? With that, what are some of the top things where you're finding, the ability to take some cost out of the business? Thank you.
Quickly, I guess if you look at sort of adjusted EBITDA in Q4 of this year, we ended it at about $91,000. You know, I'd say that's fairly, you know, within striking distance of kind of breakeven. I think as we look to, you know, going forward, I think there's a couple of drivers around improving our operating margins. One, as we said, we expect to continue to see, you know, accretion and improvement in our gross margins. We expect that to continue beyond 2023. Our efforts to drive, you know, leverage and operating expenses will continue to bring down, you know, OpEx as a % of revenue. That's generally the trajectory that gives us, you know, high confidence in getting to that breakeven point.
In terms of kind of specific timing, we'll be sharing a lot more in terms of, sort of the timelines and revenue levels where we achieve that metric at our Investor Day, in June. All right, great. Anything specifically you can point to that are some of the major areas where you're finding the cost improvements? Thank you.
I can add a little bit, a little bit there. We have efficiency in the cost of revenue that we're certainly finding in efficiencies on the infrastructure just due to the engineering improvements and also cost reductions on our networking cost because of network optimization efforts as well as contract negotiation. For cost of revenue, we've got a few levers, and we've seen progress. We think we'll be able to continue in that trajectory. Then as far as the OpEx goes, you know, we're starting to see some success in removing duplicative systems that aren't needed across the board. And, you know, we're seeing that on the G&A line, but also to some degree in the go-to-market and the R&D side of the house.
Really being thoughtful about our hiring and really focusing on customer-facing roles and durable innovation engineering roles, primarily.
All right, great. That's very helpful. Thank you.
Thanks.
Next we'll go to Fatima Boolani with Citi. Your line is now open.
Hi, good afternoon. Thank you for taking my questions. Todd, I wanted to go back to something that you mentioned in your prepared remarks as it relates to the vertical diversification that you saw in the quarter. I wanted to get a better and more granular understanding of some of the drivers that are enabling you to more effectively compete in end markets that are maybe newer and not traditional to you, and what type of wallet capture you're seeing. Then a follow-up for Ron, please.
Yeah, for sure. And it's a great question. It's something that we are thinking about quite a bit right now in terms of growing in a more balanced way across all verticals. E-commerce, for example, is a place where we have focused in the past. We've seen lots of success, but there are a ton of verticals where a real focus on the digital experience, whether it be through the website or through applications and apps, I think is driving interest in Fastly. For sure on the content delivery side, which enables a lower latency, more engaging experience. I think the edge compute side and the ease with which our security platform can be onboarded for the developer experience is making a difference there too. Travel and leisure is a great example.
Traditional retailer, I think is another great target for us. Starting to see it in healthcare, to me, is incredibly, it's an incredibly positive signal. I think the healthcare industry pretty much across the board is looking at this more and more and what that patient experience really looks like. We have a real opportunity with, you know, our emerging edge compute portfolio coupled with our network service content delivery side of our house, I think, to have a huge impact there. As far as the wallet share part of your question goes, to be honest, I think we're really scratching the surface right now.
We have a huge opportunity to take these customers that are just starting, the ones we mentioned earlier, and expand a broader and broader set of our portfolio there in a land expand motion. Also really, I think, using these as lighthouse accounts to penetrate those verticals more.
I appreciate that detail, Todd. Ron, for you, just on some of the one-time impacts in the quarter. You really fleshed out for us the true ups. I'm curious from an event standpoint, if you can quantify what the World Cup might have done to the business, and then the Super Bowl and, you know, anything else we should be mindful of as it relates to the sequential compares, you know, from some of these one-time events. Just as a related matter, I know customer concentration did tick up. Was that, you know, in any particular vertical or end market that drove that? Do you expect that customer concentration level to increase as you continue to focus on penetrating the install base? That's it for me. Thank you.
Good question. You know, we don't get into, you know, specific traffic levels around sort of specific events. I think, you know, the way to look at it is if you kind of look at the seasonality change between sort of, you know, Q3, Q4, you know, and across the quarters, that'll give you some indication of, you know, some of the traffic increases. What we particularly see in Q4 is, you know, as you note, a number of, you know, live sports events occur in the fourth quarter as well as seasonal shopping patterns. That's been a pattern that's been pretty consistent, you know, on the past couple of years. I think as we look to. The second part of your question on.
Customer concentration.
I nstall base.
Just the customer concentration, where that should trend from here.
Yeah. Yeah. I think we'll see some fluctuation in it. I think as we continue to accelerate new customer acquisition, you know, I expect it to remain relatively stable. It's gonna move around a few percentage points as we continue to see expansion within our largest customers. That expansion rate within enterprise customers is one of the motions that we do particularly well. But I would expect it's gonna move around a little bit, but I don't see any major, either increase in it, or decrease prospectively. Thank you.
Okay. Next we'll go to Sanjit Singh with Morgan Stanley. Your line is now open.
Yeah, thank you for taking the questions. I wanted to get the team's perspective on, you know, the factors that can ultimately drive gross margin. I think you mentioned on your prepared remarks, Rob, that pricing was neither a tailwind nor a headwind. You guys took the trade-off to reduce your purchase commitment. I'm trying to get a sense of, you know, ultimately in getting a path to 60%, what sort of needs to happen? Is it a better pricing environment? Is, you know, a higher mix of flash? Does edge compute needs to come online?
As you sort of draw that picture for us, you know, getting, to 60% and hopefully north of that over time, what are the sort of things that we're looking to execute upon?
Yeah, that's a great question. On the gross margin side, you know, getting to 60%, I think it's a good milestone and something we're looking at closely. I think you're right to mention, ramping up the compute business faster would, I think, have a tendency to help in that area. Also a mix change that would shift towards security would help. Even under current, even with the current mix, we're targeting that goal of getting to within striking distance of 60%. Whether the mix changes or not, we're gonna drive towards that effectively through increased efficiency in the infrastructure. That comes from building out the technology that delivers that, which is a big part of it. It comes from cost controls and managing our spend effectively.
It also comes from better and more sophisticated demand planning. Our teams have really focused there so that we're not deploying equipment that we won't need, and that makes a big difference, which is exactly what motivated our focusing on, you know, getting rid of some of these purchase commitments to kind of lay the groundwork for better margins in the future.
That makes perfect sense. It's encouraging to hear. Rob, one quick question on the guidance. Heard you loud and clear on, like, the seasonality in Q1, in particular, sort of taking into account, the true up factors in Q4. When I sort of look at the full year guide, it does imply, you know, stronger growth generally, in the back half of the year against compares that, at least by my model, look a little bit tougher. Just wanted to get your perspective on that potential stronger growth in the second half against, tougher compares.
It's a good question. I think if you look at kind of the midpoint of Q1 guidance and the midpoint of the year, there is, you know, some acceleration that we anticipate as we move through the year despite some of the more challenging, you know, comparisons that we have, you know, in the second half. I think there's a couple drivers. One, I think last year, Q1, you know, we saw a return of a lot of traffic coming back from the outage that we had in the year before. It makes Q1 a particularly challenging compare because we typically do see some seasonality down, and we didn't see that last year.
I think as we move through this year, what we've seen is in building off of the really strong expansion motion that we saw across our customers, as we continue to add new customers in the second half of this year, those as they ramp their traffic and we increase our expansion effort in those, start to really take place, you know, as you move through the second, third, and fourth quarters of the year.
Understood. Thank you very much.
Next, we'll go to James Breen with William Blair. Your line is open.
Thanks for taking the question. Can you talk a little bit about the network and the CapEx side? It was 14%, I think you said for the full year, and I think you said 68% for 2023. Just talking about, you know, where you are in terms of network evolution and spending on that over the next couple of years as you see increased revenue on the network side.
Yeah. Just to clarify on the CapEx. You know, the percent of revenue while it was 14% in the fourth quarter, CapEx for the full year was 10% of revenue. It was down from what we had guided at the beginning of the year. As we move into next year, you know, based on a lot of the efficiencies that Todd spoke about, in terms of platform efficiency, we see that capital intensity coming down further, to where in 2023, we would expect CapEx to be somewhere between 6% and 8% of revenue.
How are you able to do that in terms of taking some of those absolute dollars down?
You know, I think one of it is, you know, there's probably two particular drivers around the efficiency. One is just the engineering work around the hardware that makes our hardware more efficient, and so we can manage more traffic through the same amount of hardware, which allows us to accommodate additional capacity without expanding our capital equipment. The other piece is, you know, engineering efforts to better manage the use of our bandwidth, being able to automatically route traffic to, you know, to lower cost bandwidth rates, increase our peering percentages. Those would be the biggest drivers that allow our platform to become more efficient, reduce the amount of CapEx that we have to add, and reduce our bandwidth costs as traffic increases.
I'll just add that scale helps. As we grow, we have more opportunities to scale and the engineering work needed to drive these types of platform efficiencies, the ROI on those become more and more attractive for us to deploy resources. You know, scale kind of helps us drive these efficiencies, which we're starting to see in that gross margin number. Great. Thanks.
Next, we'll go to Tim Horan with Oppenheimer. Your line's open.
Thanks, guys. To clarify the 6%-8% CapEx, do you think that's more permanent kind of going forward or, you know, this is just another maybe a one-time true up this year?
I think just to, I guess, clarify, the 6%-8% of revenue CapEx is kind of what we expect for next year. This year was about 10%. We do see capital intensity coming down in 2023 on the increased efficiency that we spoke about. You know, I think as you look beyond that, you know, I certainly don't expect it to increase. I think there's the opportunities to maybe move towards the lower end of that range. A lot of that's gonna tie to, you know, how traffic ramps in the future. You know, we should continue to see, you know, meaningful increased efficiency in our use of CapEx. I would say next year is a good guide to that trend.
You know, I think really over moving from sort of 14, excuse me, 21 to where we are today, we've gone from about 14% to around 6%-8% next year. You know, meaningful movement there.
Got it. Thank you. On Compute@Edge, can you just maybe talk a little bit more about customer interest and competitive differentiation and, you know, how meaningful is it for customers in terms of both latency and cost and how differentiated are you? In the same vein, can you just talk about the potential for AI to run on top of this infrastructure at a high level? Thanks.
Sure. That's a great question. Something that's super top of mind for us here. Compute@Edge for us is I think it's incredibly important because in addition to being, I think, super interesting technology, it's really an extension of Fastly's core value proposition, delivering the fastest, safest, most engaging user experience. That speed, that engaging application performance, while the content delivery and network service portfolio helps deliver that in really significant ways. In a lot of ways, the next step, the next natural evolution is Compute@Edge and driving some of these processes all the way to the edge as close to the user as possible. We've seen a lot of folks looking carefully around metrics of time to interactivity on websites and applications. That I think is super interesting stat.
Some of our most sophisticated customers are focusing deeply on that and so do we. Content delivery helps deliver that, but edge compute can make a huge, huge difference. And it has been. We see it in both on the website and the app side, for people who care deeply about that, and e-commerce is certainly an area where that's incredibly important. But we're seeing it in tech, we're seeing it in other verticals as well. As far as sort of how our differentiation, how we see our differentiation in that space, I'll tell you, I think this is an area where being developer-led is incredibly important. And you see that in some of the technology announcements in our supplement.
I think it's incredibly important because developers are moving workloads to the edge. They're driving towards these performance goals, and they need to have confidence that a computer-based platform is gonna be there to serve them, to serve developers in the future. It's what motivated our Glitch acquisition. We're getting huge amount of feedback and input there. It's what's driving our roadmap for platform support, language support, I should say, such as like the JavaScript launch we mentioned, and even automation toolkits like Terraform support.
Do you think the impact of AI is a major driver of growth potentially for this product?
You know, yeah, sorry, I missed that part. Yeah, it's an interesting question. I would say sort of our growth trajectory isn't dependent on that. It's an interesting idea. It might wind up mattering how much GPU you start deploying out at the edge, instead of traditional CPUs. For us right now, we're focused on more traditional workloads.
Thank you.
Next, we'll go to James Fish with Piper Sandler. Your line's open.
Hey, this is Quinton on for James Fish. Thanks for taking our question. You know, looking first at the security side of the business, you know, this is a focus for a lot of investors. You know, the team really looked inorganically the last time it really tried to level up kind of the Fastly portfolio. Can you talk about how you're balancing organic and inorganic opportunities in the security platform and maybe what opportunities are available for Fastly to take on from the security side?
Sure. Absolutely. When it comes to the security space, it's an enormously diverse market, we're really focused on web application security. The Signal Sciences acquisition represented that inorganic move to bring in an entire component and really operating business and partner motion around Next-Gen WAF. We're looking at now really bolstering that Signal Sciences portfolio with DDoS protection and more advanced and more managed DDoS protection for our customers, as well as bot protection. That really kind of fulfilling this vision of a deep focus on web application security. Never say never, you know, in at least in those areas, we're really looking at organic innovation from the Fastly team.
The Fastly platform team has been doing advanced DDoS protection since practically inception. It's an amazing opportunity for us to bring more insights, more management, more visibility to our customers in our security platform. You know, on the bot side, we see a ton of interest from customers there. We've done interesting partnerships there. Again, I think we'll be looking at organic innovation in that space. The Signal Sciences acquisition represented a really sort of strategic product line acquisition for Fastly. I think right now there's nothing like that on the horizon for us. We're really looking and focusing on organic innovation.
Got it. Helpful. Then Ron, maybe for you on the guide. You know, what are you implying here from a macro standpoint, to kind of get to the numbers you're laying out for 2023? Do we need to see any sort of improvement kind of in the back half of the year from an underlying macro, or is this kind of baking in things are remaining the same from here? Thank you.
Yeah. It largely assumes that things moved, or the economy's broadly the way it is now. You know, our growth is really predicated on market share gains and expansion within our existing customers. Given our relative market share, you know, while we're not 100% immune from the macro economy, the key driver is gonna be share gains. We've assumed, you know, similar environment to what we have today, but that's not the biggest driver to our growth in 2023.
Got it. Thank you.
We'll go to Rich Hilliker with Credit Suisse. Your line's open.
Hey, guys. Thanks for taking my questions. Todd, I was wondering if you can update us on your near-term intention to leverage peering and the path towards that. Ron, maybe on that same topic, how should we think about peering playing into the 2023 versus 2024 margin story?
I'm so sorry, Rich. You broke up just a little bit. Could you ask that question again?
Absolutely. Can you hear me better this time?
Absolutely.
Much better.
Yes. Thank you.
Okay, great. So Todd, first for you, I was wondering if you can update us on the near-term intention and really path towards leveraging peering. I know you've talked about that in the past. Then Ron, on that same topic, I was wondering if you can give us a sense of how we should think about peering contributing to the margin progression in 2023 as opposed to 2024.
Yeah, great question, something our info team thinks about a lot. You know, peering is an incredibly powerful tool for us because it actually has two positive impacts. First and foremost, it improves the user experience, drives lower latency, performance for applications and websites. It improves our kind of core value proposition by in network distance, putting Fastly's POPs closer to the user, which is amazing. It also drives lower networking costs in our cost of revenue. For us, finding the, you know, strategically the best places to add peering, it's really a win-win for us on both sides of the house. How often do you get to lower costs and improve the offering at the same time? Yeah, something that we do focus on quite a bit.
Yeah. I think as you look to peering, I think one of the things that Todd said earlier is obviously as we scale, there's an opportunity to increase the amount of peering that we do, which brings down our bandwidth costs. You know, we've said bandwidth is about a third of our costs, the drivers there are gonna be peering, and they're gonna be more efficient use of overall bandwidth, which will drive, I believe, increased efficiency in our platform for bandwidth costs in 2024. As you look at where we exit, I think there's an opportunity to continue to see accretion in gross margins into 2024, driven from the cost structure side of things.
The other piece is, you know, capital intensity, and I think the efforts we've spoken about in terms of making our hardware more efficient, allowing us to run more traffic through the same amount of traffic also is a tailwind that allows us to continue to show accretion in gross margins off of 2023 into 2024. Obviously bandwidth is a big one. It's the single biggest cost. Co-lo depreciation, those three are probably, you know, two-thirds of our overall cost of revenues.
Great. Maybe the next question here, I'm changing gears. You know, packaging has been a clear focus and, you know, if I'm not mistaken, I think you mentioned you'd be ready for Q2 in some of the changes to drive simplification. I'm wondering, you know, Todd, how does the sales playbook change relative to that packaging evolution, and how are you positioned to kind of leverage those and all that hard work you've been doing to kind of mobilize those changes? Thanks.
Oh, I love a packaging question. Yeah. I think there's just an incredible opportunity both for internal at Fastly and externally. Internally, packaging helps us operate more quickly. It gives us offers for the market that are designed to be inclusive of everything that a typical customer would need, whether that's in network service, in security, in edge compute, and observability. Those are the four areas that we're really looking to launch packaging in Q2. Externally, I think it just provides a much easier motion, especially for mid-market customers to onboard, and that's something we'll be tracking very carefully.
It also provides other benefits to customers like reliable billing, simple renewals, et cetera. It also importantly, it provides a more channel-friendly option of simple SKUs with straightforward pricing and discounting, et cetera, that can just move through not just our go-to-market, but our systems integration and MSP channel partners, go-to-market more efficiently.
Thanks, guys.
Okay. Thanks for the question.
Next we'll go to Rishi Jaluria with RBC. Your line's open.
Wonderful. Thanks so much for taking my questions, guys. Nice to see some good resilience and a path to better margins. Maybe two questions, if I may. First, you know, as we talk about the developer ecosystem, and I know that gets accelerated with the acquisition of Glitch, maybe I'd love to talk a little bit more about going down, you know, the PLG strategy, some of the efforts you wanna make to maybe return to your roots as I may kind of think about it. You know, and what...
I guess what steps need to be taken to actually get that traction, and what sort of impacts do you think that could actually have on your margins and sales efficiency going forward? Then I've got a follow-up.
Great questions also. I think, you know, we've been very thoughtful about PLG in these first couple quarters that I've been here, specifically really on building out product support for motions that allow our teams to move more efficiently and for customers and users, to be able to self-serve more. Specifically, you know, we focused a lot on automating our free trial motion and making it so that customers who are at Fastly can start that expand motion in a real product led product led growth style, and that our go-to-market teams can help engage and help, you know, smooth the way as we go. I think there's a huge opportunity here, especially as we focus right now on free trials and how the product support for fully automated free trials can help.
That's really just one example. The packages, I think, give us another opportunity to really lower the friction, be able to operationalize that sort of platform-wide free trial instead of individual product or feature-by-feature free trials. Maybe that's just a good example of sort of how we see product-led growth evolving at Fastly, not fighting against our sales and partner team, but really helping fuel and drive that enterprise sales motion. I think that we have maybe the biggest area where this where we expect to see real impact right away is in that mid-market commercial account, where having a fully automated motion and having the ability to kind of bring in the right Fastly resources when needed to smooth the land-and-expand play, can really make a difference. Yeah.
Far as supporting margins, I always believe, you know, mid-market business is good for margins, good for customer retention, so I like that.
All right. Wonderful. That's really helpful. Just one financial question. So nice to see, you know, improving margins, the guidance talking about margins improving, you know, more significantly from here. You know, at the end of the day, right, cash flow is what's ultimately gonna matter. I guess two pieces. How should we be thinking about cash conversion for 2023? Maybe more importantly, what's kind of the glide path to get from here to, you know, being free cash or break even or even starting to generate cash? Thanks.
I think, you know, I'll leverage off of some of the comments we made about some of the opportunities in the business to improve from an operating, you know, margin, and bringing that to sort of break even. As you look to 2023 and 2024, there's a couple of sort of significant tailwinds. During 2022, we spoke a lot about some of the prepayments we made toward capital equipment. A portion of that 6%-8% of CapEx that we're going to deploy in 2023, we paid for in 2022. Our, you know, cash deployments for equipment should be down materially.
Then I think as we continue to drive margins and efficiency in the business, you know, we believe that there is a significant opportunity to improve the cash flows from working capital and bring that along with the improvements in our operating margin. I think as we look to some of the specifics of, you know, you can look at kind of the progress we've made on kind of adjusted EBITDA, but, you know, an Investor Day will provide a lot more granularity in terms of sort of the timelines and again, kind of revenue levels at which we get to kind of a cash flow break even.
You know, in addition to the efficiency we see in the operating margins, there's efficiency, you know, in our cash going into 2023 that are, you know, meaningful tailwinds to cash flow usage.
All right. Wonderful. Thank you.
Thank you.
We'll go to Jeff Van Rhee with Craig-Hallum. Your line's open.
Yeah, great. Just a couple from me. I think, you know, on the go-to-market improvements, it sounds like the packaging you see is a big catalyst, maybe that's the answer. When I look at the enterprise customer, additions, relatively flat for a handful of quarters now. How do you think about that number in particular when we should think about an uptick?
Yeah, that's a good question. you know, our enterprise customer count has been growing kind of slow and steadily. We measure that in the rear, so $100K revenue over the last four quarters. It's a little bit of a trailing statistic for us. This sort of slow and steady growth, I'm expecting to kind of hope to accelerate slowly over time and not find a big, huge pop all at once. perhaps the driving force this, I think packaging would be one, but maybe something else would be platform unification.
By unifying our platform, I think we're making it a lot easier for our customers to start with one product line and expand into the next, into the next because it's all being built now on one unified user experience, unified developer experience. That will, by doing that, help ease our expand motion, drive a more strategic relationship with our customers as they become sort of multi-portfolio users, and help them cross that threshold, that 25,000 a quarter threshold. But again, I think in terms of like, are we gonna see a big pop in that number? No. I hope to accelerate that, the growth in that number just as we accelerate the rest of our revenue line.
Yep. Got it. You counted on taking share. You know, in terms of the competitive landscape, if you want to clarify, who are you taking share from? Then just in terms of that land, you comment on the platform unification, how has that initial use case or initial capability/pain point changed, in terms of, you know, the reason you're landing in the first place?
Yeah, that's a great question. I don't really wanna name, directly name competitors, but I'm sure you can, I'm sure you can guess. When we look at content delivery, we're picking up share, and I believe we have an opportunity to pick up share specifically by focusing on user experience. Fastly, we're not a CDN company or a cloud security company or an edge compute company. We're focused on being a cloud platform company that delivers user experience outcome, leveraging all of this together. This idea of platform unification, this idea of building a more complete offering for our customers, that is the differentiation that we hope to use to deliver a better user experience for everyone.
That is the differentiation I think that's gonna drive market share gains for us, a true focus on user experience, fast, safe, and engaging digital experiences.
Okay. Got it. Thank you.
Thanks.
We have time for one final question. We'll go to Rudy Kessinger with D.A. Davidson. Your line's open.
Hey, great. thanks for squeezing me in here. just want to clarify on the quarter, the $3.3 million in true-up. Did you have any Like, in the original guide you gave, was there any expectation that you would get any of that in the quarter or no?
I think going into to the guide, I think there was an expectation that we would have some true-up. I think what we saw in the quarter in terms of the level of overachievement was, you know, the magnitude of that as well as overall traffic patterns. We saw a really good expansion with an existing customer over the course of the quarter, as well that actually drove overachievement in the quarter.
Okay. Got it. On the guide for 2023, you know, just curious if you could give any more specifics with respect to, you know, the assumptions on growth for Signal Sciences or security versus CDN and compute. Just any breakdown you could share there?
Yeah. I mean, we haven't, you know, broken out. I think what I would sort of generally speak to is, you know, we have seen security or Signal Sciences reported being a faster-growing element. Security is certainly important. I think the other piece is, you know, compute is also a faster grower, although starting at, you know, fairly nascent levels. Those are gonna be the higher growth items. I would say security is probably the one of the magnitude that's a key contributor to the growth. We're also gonna see growth in, you know, core traffic, both from new customers, but also we're seeing in some of our largest customers, you know, continuing to gain, you know, traffic share within some of those largest customers based on that user experience. You know, we see growth across that.
I think one way to frame it, as Todd sort of framed it, is, you know, we have the core business, if you will, which is, you know, growing nicely. We have really the growth engine, which is security. We have sort of the, you know, the incubation stuff, you know, compute that's probably moving, you know, from that, you know, in the near term kind of into that growth engine, and continue to have new things in compute that, will grow into part of the growth drivers.
Anything further, Rudy?
No. That's it for me. Great. Thank you.
Okay. I'll turn the call back over to Todd Nightingale for any additional or closing remarks.
No. Thanks so much, everyone. Amazing questions today. Before we close the call, I wanna thank our employees, customers, partners, and investors. We remain as committed as ever to making the Internet a better place where all experiences are fast, safe, and engaging. Moving forward, we remain focused on execution, bringing lasting growth to our business, and delivering value to our shareholders. Thank you so much and thank you so much for the time today.
This concludes today's conference call. You may now disconnect.