Fastly, Inc. (New York Stock Exchange: FSLY) has been in flux for about two years, and the addition of new CEO Todd Nightingale last quarter marks a complete revamp of the entire management team. In my previous article, I described his quarter 2Q22 as disappointing, which appears to be the case for its quarter 3Q22. However, I appreciate new CEO Todd’s candor in acknowledging existing problems and, unlike CEO Joshua Bixby, he is committed to reducing operating losses going forward.
3Q22 revenue exceeded guidance, growing 25% year over year. Unlike previous quarters, management did not disclose Signal Science’s revenue. According to management, this growth is driven by cross-selling in Signal Science and Compute@Edge. While this growth looks decent, how have you fared in other areas?
Continuous struggle to acquire customers
Fastly’s struggle to acquire customers continues as they only added 20 new non-business customers and 11 business customers this quarter. During the 3Q22 earnings call, management also attested that revenue growth is driven by existing expenses and the sales cycle hasn’t changed for new customer onboarding:
“…As far as new customer logo sales cycle changes, I haven’t seen any yet, but I think it’s a good thing we’re keeping an eye on…what’s been driving business so far is the expansion with our existing customers where In fact, I’ve seen maybe even less friction and expansion with existing customers.”
Additionally, management made efforts to simplify its product offerings to reduce sales friction:
“And I will focus on: number 1, simplifying our product packaging. This will allow our customers to understand the ‘purchase’ of our technology more effectively, and our team will be able to operate with less friction.”
While business customers are at the core of Fastly’s operation, the growth rate of its business customers is nothing short of disappointing. Also, your business is driven by a land-and-expand strategy, I’d say the growth of your non-business customers is just as important. And there seems to be a problem of adapting the product to the market, since they have not found any success with landing non-business clients.
This weak sales operation is also evident by its poor sales efficiency, as its sales and marketing (“S&M”) expenses as a proportion of total revenues continue to be very high.
High operating losses and worrying negative free cash flow margin
Fastly’s continued struggle to acquire customers and its high operating expenses are evident in operating losses, as its operating margin remains in the 60% range. CEO Todd acknowledged this during the quarter:
“…we have a real opportunity to post a much more profitable or much better operating loss next year than this year…that’s incredibly important to me and our entire leadership team…the discussion of how to spend every dollar spent at Fastly’s to fuel growth, being radically more efficient with our spending, more judicious and even rudimentary with that spending is incredibly top of mind for us because it’s not lost on me that we have to improve profitability here and specifically our cash consumption. .”
Throughout the earnings call, management reiterated the focus on cutting operating losses numerous times, and analysts also hammered home the theme of profitability. In my opinion, this should have been the core focus under the leadership of the previous CEO, Joshua Bixby.
Earlier, I also discussed the high share-based compensation (“SBC”) expense Fastly incurs, which accounts for a large portion of its total revenue. Since it is a non-cash expense, software companies tend to add SBC back to cash flow operation (“CFO”) and exclude it from non-GAAP metrics such as Adjusted EBITDA, thus which I personally do not agree with, and Aswath Damodaran also has managed the matter of doing it.
Adding the SBC back to the CFO gives us a negative free cash flow (“FCF”) margin of 71% for the quarter. This is extremely concerning, as they are rapidly burning through cash at the expense of the weak sales operation, which is destroying shareholder value. Let’s also not forget that $704 million of senior convertible notes due March 2026 are on the balance sheet, which is 3.3 years from today.
Fastly had a pretty disappointing quarter overall. While CEO Todd has acknowledged these issues, it remains to be seen whether material improvements will be made in the coming quarters. While I appreciate the candid comments from management, I won’t place too much emphasis on them. There is still a lot of uncertainty in terms of investments at the moment due to the lack of a clear path to profitability, and the Fastly turnaround will take longer due to the need to address product market fit and sales execution issues.
What are your thoughts about the quarter? Let me know in the comments section below.