Fastly, Inc. (FSLY) Q3 2024 Earnings Report, Transcript and Summary

Good afternoon. My name is Tamika [ph] and I will be your conference operator today. At this time, I would like to welcome everyone to the Fastly Third Quarter 2024 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] I will now hand today's call over to Vern Essi, Investor Relations at Fastly. Please go ahead, sir.

Thank you and welcome everyone to our third quarter 2024 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 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, product sales, 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 filings with the SEC, including our most recent annual report filed on Form 10-K and quarterly reports filed on Form 10-Q filed with the SEC and our third quarter 2024 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. 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 during the fourth quarter, we will be attending the RBC Capital Markets Global Technology, Internet, Media and Telecommunications Conference in New York on November 19 and the UBS Global Technology and AI Conference in Scottsdale, Arizona on December 4. Now, I'll turn the call over to Todd. Todd?

Thanks, Vern. Hi, everyone and thank you so much for joining us. Today, I will cover our Q3 results and the progress we've made, especially in growing revenue outside of our largest customers and in continuing to improve the profitability of Fastly. I will also discuss our go-to-market and technology initiatives, I will then hand the call over to Ron to discuss our third quarter financial results and our guidance in detail. We reported third quarter revenue of $137.2 million, coming in above the high end of our guidance range due to better-than-expected strength in some of our larger media customers and a balanced mix of share gains outside of our Top 10 customers. We reported an operating loss of $520,000, the best result we have achieved in more than 4 years and materially better than the guidance range. This was the result of higher revenue and gross margins, coupled with the cost benefits from a faster-than-projected execution of our restructuring. I'm also excited to share with you that Fastly reported a net profit of $2.4 million and positive adjusted EBITDA of $13.3 million in the third quarter, both record levels for the company. I'm pleased to share with you the progress we made in diversifying our revenue. This resulted in a more diverse revenue mix in the third quarter as we grew our top line 7% year-over-year. In the third quarter, our Top 10 customers represented 33% of revenue, down from 40% last year and down from 34% quarter-over-quarter. This is a good indicator of continued progress in diversifying our revenue and strengthening our business. Revenue outside of our Top 10 accounts which is key to our strategy and goals for the long-term success in growth at Fastly, grew 20% year-over-year, a significant improvement from last quarter's 13%. Last quarter, we called this an inflection point and a moment of transition for Fastly. While the transition doesn't happen in a single moment, we are already experiencing the benefits of a more focused investment in product, customer success and go to market. Specifically, we released a major expansion to our security portfolio, onboarded new sales leadership, pivoted to a more bespoke engagement model with our largest multivendor customers and launched a new self-service to manage [indiscernible]. We are seeing early progress in our revenue diversification, customer acquisition growth and renewed focus on our largest enterprise customers. There is more to come. These changes will drive revenue diversification and faster, more reliable growth for Fastly. Our customer acquisition efforts showed solid gains year-over-year in the third quarter. Our enterprise customer count was 576 compared to 547, representing a 5% growth rate year-over-year. Quarter-over-quarter, enterprise customer count actually declined 4%. We saw more customers dip just below our $100,000 run rate enterprise definition this quarter. We do see quarterly volatility in our enterprise customer count methodology but we'll be tracking this very carefully and looking to drive growth in all of our midsized accounts. We experienced normal churn levels returned flat quarter-over-quarter. And while we saw a 5% year-over-year growth rate in enterprise customer count we aren't satisfied with this result and hope to accelerate our growth in enterprise customers in 2025. We had 3,638 customers at the end of Q3 and a net increase of 343 quarter-over-quarter for a growth rate of 10%. We believe this is the result of our new self-service sales motions which I will discuss in a moment. Our transition leans heavily into our technology innovation heritage and we believe it is key to the continued success in customer acquisition and wallet share growth. Fastly's platform is a software-driven edge network that offers best-in-class delivery, network services, security, compute and observability. We continue to focus investment in leading technology and innovation that not only solidifies our platform but also extends its features for the future of web application development. The functionality we offer allows our customers to bring their applications to life around the world. We believe that our unified platform approach will significantly enhance our customer retention and create efficiencies for Fastly in supporting our customers' success. Let me share with you some important developments taking place in our security offerings in particular. We continue to experience favorable customer response from bot mitigation since its release in the first quarter. Our bot mitigation solution wholly developed within Fastly, attracts customers looking for simple onboarding and ease of use, opening the door for continued opportunities for cross-sell and upsell. Fast following on the heels of our successful launch of bot mitigation, we announced the general availability of Fastly's adaptive DDoS protection on the platform. This solution provides automatic protection from Layer 7 and other application-level DDoS attacks. Our platform enables frictionless onboarding and implementation of this solution with just the click of a button. We've had a long heritage of DDoS protection at Fastly partnering with some of the largest, most sophisticated customers in the industry. We are tapping into this intellectual property and productizing it to address the entire market so that our broader customer base can benefit. Additionally, this solution allows us to layer proprietary auto adaptive response intelligence within the offer. We believe this innovative DDoS release is a new enterprise customer acquisition vector for Fastly in addition to driving customer growth and cross-sell opportunities. Last quarter, I shared with you that we launched the beta version of our AI accelerator, an AI proxy capable of delivering performance and cost savings to application builders leveraging large language models. The interest and response has been very favorable from our customers and we've added LLM support beyond OpenAI to include Google Gemini as well. We expect AI accelerator will be generally available for purchase by the end of the year. and I'm excited to make this announcement as it demonstrates the increase of innovation velocity at Fastly and I look forward to announcing more product launches before year-end. I'll now discuss the transition taking place within our go-to-market efforts. Since joining us in the second quarter, our new CRO, Scott Lovett, has taken the first steps towards driving transformation within the sales order to close more new enterprise logos. He's particularly focused on driving wins in security with new and existing customers. And with our new security offerings and deep experience in this space, we're excited about the opportunities ahead. Beyond sales, our go-to-market success is also the culmination of branding, messaging and sharing our expertise with subject matter experts. In the third quarter, we released the Fastly Threat Insights report, providing the latest attack trends across the web application and API security landscape. The report found that 91% of cyberattacks targeted multiple customers using mass scanning techniques to exploit vulnerabilities. We also released the results of our new survey, bought wars, how bad bots are hurting businesses. which revealed 59% of IT professionals reported an increase in [indiscernible] over the past year with significant incidents costing companies an average of $2.9 million. These results seem closely in line with the interest we're seeing in our security portfolio and our new security offers. We are now in the second year of our packaging efforts which truly demonstrates our focus on simplicity, not just in our product but in pricing and our ease of implementation. Our new self-service model with mix and match packages was rolled out last quarter, kicking off our initial PLG efforts at Fastly. These efforts have resulted in growing our overall customer count while also attracting critical developers to the fasting platform. In the third quarter, our packaging efforts demonstrated strong growth and we more than doubled the number of packages sold year-over-year. Our new logo packages tripled and represented 43% of the packages sold in the third quarter compared to 16% a year ago. Lastly, our channel partners rounded out our go-to-market efforts. In the third quarter, our dealer registrations grew 33% year-over-year and our year-to-date bookings grew 46% year-over-year. We anticipate more opportunities to leverage our channel and drive top line growth as we move forward. Now, let me conclude with the discussion on our outlook as we close out the year. Looking back one year ago, we did not foresee all the challenges we faced. In 2024, we suffered revenue declines from our largest customers and this, in turn, prompted us to realign our growth strategy and our investment strategy. Ultimately, we implemented a workforce reduction and overall transition that impacted every department of Fastly. I believe we are pulling through these difficult times and we are turning a corner. The cost discipline and financial rigor on our drive towards profitability growth has never been better. We've shown signs of progress this quarter that should make the team proud -- and though there's more work on the horizon, I'm pleased with the efforts across the board over these past 3 months. Heading into the fourth quarter, typically very seasonally strong we do not believe we will be benefiting from as much of the typical sequential lift we've experienced in prior years and this is reflected in our fourth quarter revenue guidance. While this could be dismissed as conservatism on our part, it is more the result of what we have shared over the past 3 quarters with the dynamics we are seeing taking place at some of these largest accounts. We do believe that we've moved past the worst of these impacts and have a strategy in place to keep our strong position at these very large accounts while also focusing heavily on healthy revenue growth outside of our largest customers, driving important revenue diversification. I'm very optimistic on [indiscernible] prospects in 2025 and continue to believe our inherent platform advantages afford us the opportunity to capture more share of the world's web application workloads. And now to discuss the financial details of the quarter and guidance in detail, I will turn the call over to Ron.

Thank you, Todd and thank you, everyone, for joining us today. I'll discuss our financial results and business metrics before turning to our forward guidance. Note that unless otherwise stated, all financial results in my discussion are non-GAAP based. Revenue for the third quarter increased 7% year-over-year to $137.2 million, coming in well ahead of the midpoint of our guidance of $130 million to $134 million. Network Services revenue grew 5% year-over-year to $107.4 million and security revenue grew 12% year-over-year to $26.2 million. Lastly, our Other segment which represents our emerging products category grew 85% year-over-year to $3.6 million, driven primarily by compute. In the third quarter, we saw better-than-expected strength in live sports and gaming with a balanced mix of share gains outside of our Top 10 customers, offsetting traffic headwinds at certain of our largest customers that we've previously discussed. Our Top 10 customers comprised 33% of our total revenues in the third quarter of 2024 compared to 34% in Q2 2024, reflecting the impact of the revenue decline from some of our largest customers and our strategy of targeting a more diverse customer base. Also, no customer accounted for more than 10% of revenue in the third quarter. Revenue from customers outside of our Top 10 customers grew 20% year-over-year. Our continued focus on customer acquisition has resulted in revenue expansion outside of our Top 10 customers. expanding our wallet share into the broader enterprise customer segment. Our trailing 12-month net retention rate was 105% and down from 110% in the prior quarter and down from 114% in the year ago quarter. This decline is primarily due to the revenue declines in some of our largest customers and we anticipate this will continue to be a headwind on to our LTM NRR through the remainder of 2024. At the end of the third quarter, our RPO was $235 million, up 6% from $223 million in the second quarter 2024 and down 5% from $248 million in the third quarter of 2023. This increase is primarily due to contract renewals with our larger customers and increasing adoption of our packaging products which are sold on a subscription or SaaS basis. This was offset by other larger customers working through the remaining obligations over their contract terms. As Todd mentioned, we had 576 enterprise customers at the end of Q3, a net decrease of 25 compared to an increase of 24 in the second quarter. On a year-over-year basis, enterprise customer count increased 5%. The Enterprise customers accounted for 92% of total revenue on an annualized basis in Q3 compared to 91% in Q2. Enterprise customer average spend was $880,000, up 9% from $804,000 in the previous quarter and up 3% from $858,000 in Q3 of last year. I will now turn to the rest of our financial results for the third quarter. Our gross margin was 57.7% compared to 58.5% in the second quarter of 2020 and up 180 basis points from 55.9% in Q3 2023 as we benefited from better utilization on our fixed costs on higher-than-expected revenue offset to a lesser extent by increased bandwidth and transit costs on higher traffic. Our incremental gross margin hit a record 79% on a trailing 12-month basis compared to 73% in the third quarter of 2023, reflecting continued efforts on reducing our cost of revenue in an otherwise challenging top line environment. Operating expenses were $79.6 million in the third quarter, better than our expectations. Lower employee costs related to the recent restructuring and a reduction in hiring accounted for a majority of the upside. This represents a 5% decrease in operating expenses compared to Q3 2023 and a decrease of 12% sequentially from the second quarter. This better-than-expected favorability in our operating expenses, combined with better-than-expected gross profit resulted in an operating loss of $0.5 million in the third quarter beating our operating loss guidance range of $12 million to $8 million. In the third quarter, we reported a net income of $2.4 million or income of $0.02 per diluted share compared to a net loss of $8 million or a loss of $0.06 per basic and diluted share in Q3 2023. Our adjusted EBITDA was positive in the third quarter, coming in at $13.3 million compared to $0.7 million in Q3 2023. As Todd mentioned, I'm pleased to highlight that both net income and adjusted EBITDA set quarterly records for Fastly. Turning to our balance sheet. We ended the quarter with approximately $308 million in cash, cash equivalents, marketable securities and investments, including those classified as long term. Our free cash flow for the quarter was negative $7.1 million of $11.4 million sequential improvement from negative $18.5 million in the second quarter. This improvement was primarily driven by an increase in our cash from operations to positive $5 million. compared to negative $4.9 million in the second quarter. Our cash capital expenditures were approximately 9% of revenue in the third quarter coming in at the lower end of our guidance of 9% to 10% of revenue we shared on our Q2 call. As a reminder, our cash capital expenditures include capitalized internal use software. For 2024, we anticipate our cash CapEx will be approximately 9% to 10% of revenue. I will now discuss our outlook for the fourth quarter and full year 2024. 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 and we undertake no obligation to update these forward-looking statements in the future, except as required by law. As Todd shared in his remarks, while we are seeing growth in new customer acquisition which we believe will lead to further revenue expansion longer term, we are facing an unexpectedly challenging environment of revenue declines from some of our largest customers continuing throughout the course of 2024, adversely impacting our revenue growth. Our revenue guidance reflects these dynamics in our business and is based on the visibility we have today. We expect somewhat flat to modest sequential growth in Q4 revenues compared to Q3 due to lower revenue at some of our largest customers. For the fourth quarter, we expect revenue in the range of $136 million to $140 million, representing flattish annual growth. Note, we do not expect to experience any onetime revenue true-ups in the fourth quarter compared to the onetime $2.8 million and $3.3 million revenue amounts we recorded in the fourth quarter of 2023 and 2022, respectively. We continue to be very disciplined in our network investment and cost of revenues which contributed to our third quarter gross margins being approximately 70 basis points better than we initially expected. For the fourth quarter, we anticipate our gross margin will decrease approximately 150 basis points relative to the third quarter, plus or minus 50 basis points. This sequential decline in gross margin is primarily due to increased bandwidth and colocation deployment costs associated with increased traffic in international regions. We anticipate our fourth quarter operating expenses will be flat to modestly up from third quarter levels. Guidance for our fourth quarter operating results reflect the impact of the sequential decrease in gross margin and the beneficial impact of lower operating expenses. As a result, for the fourth quarter, we expect a non-GAAP operating loss of $5 million to $1 million and a non-GAAP net loss of $0.02 per share to a non-GAAP net income of $0.02 per share. For calendar year 2024, we expect revenue in the range of $539 million to $543 million, reflecting annual growth of 7% at the midpoint. We expect to continue to see gross margin improvement in 2024 compared to 2023 as we leverage cost on incremental yet lower revenue growth. We anticipate our 2024 gross margins will improve by approximately 70 basis points, plus or minus 50 basis points relative to 2023. As a result, we expect our non-GAAP operating loss to be in the range of $28 million to $24 million, reflecting an operating margin of negative 4.8% at the midpoint, an improvement of approximately 29% in dollar terms. Over 2023 operating loss margin of 7.2%. We expect our non-GAAP net loss per share to improve to $0.12 to $0.08, reflecting the improvement in our operating loss expectations. And we expect free cash flow to be in the range of negative $40 million to $30 million in 2024 compared to negative $59 million in 2023. Before we open the line for questions, we'd like to thank you for your interest and your support in Fastly. Operator?

[Operator Instructions] Your first question is from the line of James Fish with Piper Sandler.

Congrats on getting the business here to net income profitability in the quarter overall. Look, I think everybody is wondering here about the competitive environment with one of your competitors going bankrupt. And Todd, you and I talked about that at our conference. But -- what are you guys seeing in terms of that opportunity in particular, especially given -- that entity had very large customers, even some overlapping customers. What programs are you putting in place to try to gain further wallet share with that bankruptcy [ph]?

Yes. I think it's making the market like a super interesting place right now and there's definitely potential upside here. We've seen some accounts that have, in fact, shifted traffic towards Fastly and that's largely the overlapping accounts where the transition is straightforward. But largely, I think of this as a significant opportunity in 2025. I think that's where we're going to see big shifts in that area in particular. Maybe just a slightly wider lens. I think it also underscores the importance of a platform strategy here of building a very complete offering with strength, not just in network services but security and compute and observability as well. And that's where we're seeing a lot of the momentum in our business and I think it's going to help us transition these customers over to a more complete offer. So for us, we've seen a little bit of that so far but I think the majority of the upside opportunity for us is probably in '25.

Got it. And then maybe on the packaging side and security piece specifically, what's the penetration or attach rate of security to customers generally at this point? And specifically, as well within your web delivery customers where that may be a little bit easier to cross-sell? What's the low-hanging fruit that Scott has here?

Yes. It's super top of mind. We don't disclose the particular number here but I would tell you, I think our cross-sell penetration is still very low. I think there's a lot, a lot of opportunity. And that's exactly why we've focused the security innovation and I'm sure you see there's certainly a surge here with 2 big releases in the last 2 quarters. We focused that not just on security efficacy but an ease of deployment and true simplicity in the platforms that customers who are existing content delivery customers can onboard best-in-class DDoS or bot mitigation or our WAF even with a click of a button. And we're really targeting the product and platform innovation area here to drive this cross-sell where I believe we are far, far -- we have far too little penetration on the cross-sell opportunity.

Your next question is from the line of Frank Lau with Raymond James.

So it seems like the bump in the business here was a little bit more onetime in nature. You're a little cautious that it was. Can you give us an idea of what was kind of driving that media business in the quarter? And any thoughts about what possibly could be replicable. And then on the efforts you've made on the restructuring. Can you walk us through where you've seen success there early on -- are you tracking to the same overall cost savings or you found some new? Is it going to be a little bit higher? Or we just capture that a little sooner than we thought.

Sure. We saw some better than projected revenue in those top accounts. And I think you're right to say we are -- we're being very careful not to project too much from those results into the out quarters. And I think that's important. We know there's volatility there and we want to be really sure that we are projecting the correct -- that we're giving you the correct revenue projection moving forward. But I think that like the part of the growth rate and the revenue result in Q3, that's really important is that we saw 20% year-over-year growth outside of the Top 10. We're seeing momentum starting to build in this transition towards approaching the larger market, acquiring customers outside of media and driving a more diversified, a more reliable business and therefore, more projectable and reliable growth rate moving forward on that diversified business. And there's no doubt that this transition has a lot to do with that focus on diversification and focus on long-term reliable growth. As far as the cost savings, largely, we've been pushing cost control and operational efficiency and rigor for a long time. and we've had pretty consistent results in making improvements there. But our restructuring, we were able to do a little bit earlier, a little bit faster and more efficiently than we believe than we believe possible. And that drove a big chunk of the beat on the OpEx side to our projection. Ron, anything on [ph]?

No, I think it's -- I think that's a good [indiscernible] on the traffic. And again, we saw some favorability in the spending just based on the execution of the restructuring that basically is going to drive about a $14 million savings versus our original plan in 2024.

Great. And when you mentioned getting business outside of media, can you characterize what are some of those workloads and what does that data look like that you're getting? Is it more software-based -- and then what's -- is it -- are these new opportunities that you think have a long growth rate? Or is it just where you just happen to business [ph].

Yes, for sure. I think, number one, it's a lot of new logo acquisition and that drives a very, very healthy growth rate in the couple of years as there is a more accelerated motion or, I should say, expand motion in the first 24 months on the platform. It's definitely a business that is more diversified across the portfolio than the media business. Outside of media, there's much more spend in security, compute, observability across the board and we're starting to see those results outside of media which I think is really, really healthy for the business. It will help us drive margins. It will help us balance workloads across our infrastructure and a multi-portfolio customer is stickier, they enjoy platform leverage that makes their teams and their developers more loyal to the platform and more powerful within their own organization. So we are really excited about.

Your next question is from the line of Sanjit Singh with Morgan Stanley.

Nice to see getting back to a nice cadence [ph]. I guess my overarching question, Todd, is, is there like a mix between Top 10 and non-top 10 that would essentially signal growth returning to the business. It sounds like the Top 10 business seem to be getting worse but when I look at your Q4 guide, we're looking for about flat year-over-year growth, so probably more sort of your growth headwinds on [indiscernible]. And so is it like sort of getting that mix down to 25%, 20% because it looks like your non-top 10 customers are growing healthily in the double digits. So any thoughts there on like were those kind of 2 lines crossed where that sort of fits out reasonable growth.

Yes. I think it's a good question, something we think about a lot. I believe that the growth rate, overall, is going to be more and more dominated by this longer tail of customers and it's why I'm tracking so carefully the nonmedia growth rate and in the public disclosure, the non-top 10 growth rate. And as that concentration reduces then we're going to index more and more on it. I think getting to 30% is going to be a pretty significant momentum time for us. And I think that really will be a healthy place to be. But to be honest, I think it's only upside and diversification. We've seen so much success in diversifying our business and we're going to keep at it not just diversifying our revenue across the customer base. But increasingly, in 2025, you're going to see us pushing really hard on the security side of our portfolio as well.

Maybe you can just follow up here on the security side. So more updates to next-generation WAF, more updates to the bot management capabilities. Where are we in sort of driving that stronger sort of security sales motion? I'm sure sort of interplay with the momentum you're seeing with partners but what is sort of your outlook for security growth over the next couple of quarters?

Yes. It's certainly top of mind not just from XL but for Scott, our new CRO, comes from a security background. And as we look to the restructuring that we just did. And really, the path forward, especially as we start 2025, we are deeply focused on sort of pairing the R&D investment with real go-to-market focus in security. And so, I really -- I believe 2025 security is going to be a very, very top of mind. -- area, not just in the R&D side, not just on the product line side but across the board. I think there's a ton, a ton of upside here. We've got -- and it was mentioned in the first question, -- we have a lot of untapped potential in the cross-sell. I'm seeing really good momentum in our security sales motion when it comes to new logo acquisition. And we have -- especially with the recent product developments, we have a really amazing opportunity to use security more and more as a way to onboard new customers to the platform for the first time and start to actually land and expand those customers into delivery and network services.

Your next question is from the line of Will Power with Baird.

Okay, great. Todd, maybe just coming back to the media side, just to clarify a bit for me. I mean it looked like in Q3, your Top 10 customers were actually pretty stable with Q2 which has the surface encouraging. I'm sure the price maybe some cross currents within that. And yes, it sounds like you're still spending some headwinds seasonally in Q4 and maybe there's some conservatism in there but still some questions. So I guess I'm just -- but it also sounded like you kind of think you got the worst behind you so I'm just trying to understand what underpins the confidence around the visibility that the worst is behind you given some of these headwinds in Q4. Maybe you can just help triangulate that for me?

Yes. I mean I think we have now a strategy that is certainly more dependent on the business outside of media and we've seen this big shift from 40% all the way down to now 33% in just a few quarters. That's certainly helping us build better projection, have more confidence in the growth rate. And in the fullness of time, help us build a better, more -- higher and more reliable the growth rate for the company. As far as the media business goes, we did see our higher-touch customer engagement model that we put in place when we started to see these headwinds a few quarters ago. we have seen really two, I think, significant benefits here. One is we've been able to serve these customers better by demonstrating better performance than the rest of the market, more reliability, better ease of doing business which is so important. And with that better customer engagement, better executive engagement, I think we have better projections for that business. But that business has changed a little bit. We're hoping that things like the Agio situation will help fuel that business, that part of our business back to growth. And we think we've ever been in a better position but we don't have visibility to a big return to growth in Q4 and that's what's baked into our projection. That being said, this higher touch customer success motion has also given us, I think, a much better projection of that business. A better way to predict it and measure it and get telemetry from across the systems, the business, the Internet, et cetera and what's happening here. And so this sort of better engagement and hopefully, a faster return to growth for our media business but also a better projection and better building of our revenue model moving forward.

Okay. And then maybe just, I guess, one other follow-on. I mean, you touched on this a bit but nice to see that actually even improved growth, I guess, in your customers outside the Top 10. Any common variables to call out there, either particular verticals you're doing well in or particular use cases that are helping drive the success there, both in terms of revenue and in terms of new customer adds which I know the enterprise number was down the overall ads looked good.

Yes. I think the biggest trend I've seen this is a little anecdotal but the biggest trend I've seen is certainly that new customers are coming to fast, especially outside of media, looking for a complete edge solution. Network services and delivery, security, observability and edge compute. And as we've filled out the last couple of pieces in our security portfolio, we're starting to see, I think, a lot more serious engagement on those new logos and finding more success in bringing them on board. So to me, the big trend I've seen here is finishing our security portfolio has helped us build a more complete portfolio and these new customers, that's what they're looking for. They're looking for a solution [ph].

Your next question is from the line of Timothy Horan with Oppenheimer.

Sorry, guys. I think you said large customers are working through their obligations. I mean, do you have much visibility when those obligations are over, where you're at on relative pricing basis. And will those customers or a time line on that and maybe what's the visibility? I know you've been answering this a bit on retaining our customers and -- but I guess related to this, the whole CDN space has been under a lot of pressure. Is it volumes are coming in lower than expected? Or are the hyperscalers gaining share or other new entrants like where is the kind of -- why has the revenue been disappointing for the whole industry? And I guess, with your large customers, I know you've been talking about it but just a little bit more color on those applications, they have.

Yes. In terms of the obligations, we have really good visibility to when the contracts come up for renewal. And particularly with our largest customers with our increased engagement at senior levels, we have much better visibility into what their pricing expectations are, what drives their decisions around care. What I would say, as we've sort of shared in the past, is that we don't have a concentration of renewals in any particular quarter. They generally are kind of spread out across the year. So we have renewals in each of those quarters. that results in a little less sort of a single impact from when we see those contracts at new pricing. But I think we have much better visibility in terms of what those adjustments might be at contract date. We certainly have good visibility to win those contracts come up for renewal.

Yes. Just looking at it through the lens of the whole market, I think we are seeing -- we are seeing a little bit of a change here. There's been consolidation and there's fewer players in the space and even fewer if you look at it from really full service edge platform players. And I think I think that has the opportunity to make the pricing environment healthier in '25 than we saw in '24. And I guess a little optimistic that, that's exactly what we're going to see.

And then, just one question on the AI accelerator. Can you talk about how much you improved latency on your platform and reduce cost or any color around that from what you've experienced so far?

Yes. AI Accelerator basically brings the power of the [indiscernible] platform to LLM style solutions. And -- the -- I think there's a video of me doing this demo. But the reality there is using a public Lncloud, the deliquency on relatively trivial question, can be 5 or 6 seconds or more. And that doesn't always feel like the most human experience. There's no reason that every single 1 of those requests has to go all the way back to our central cloud. And we can provide fast speed of response here and bring those requests times well below a second, while at the same time, lowering the total cost of the solution to the development teams building that type of LLM based use case. And the most common is like a support chatbot use case with a very, very easy developer onboarding a single line of code. Customers can leverage the power of our semantic match, the power of the Fastly cash and at the same time, lower their total cost of delivering the solution. It's awesome. I've gotten great response from customers in the beta and I'm really excited to launch into general availability this quarter.

Your next question is from the line of Jeff Van Rhee with Craig Hallum.

Maybe on the enterprise customer count, just a little clarification. I know the non-top 10 was up 20% year-over-year. So generally, other than the Top 10, very good quarter. The overall sequential drop -- can you talk about the pattern of that drop? I would have expected, given the strength of the non-top 10 that you wouldn't have that many fall below your $100,000 threshold in the quarter. Any other color there you can share?

I'll tell you, I shared that concern, so I did dig into those numbers quite a bit. I did not -- what I was trying to be very sensitive to is if we saw any sort of increase in customer churn which I did not see or even customers on their way to churn. But we do have a lot of customers that will swing above or below the number. When you look at -- in the disclosures when you look at the average dollar spent by enterprise customers and the total amount spent by all of the non-top 10 customers, I think it tells the same story. We saw -- we saw some folks drift below that $25,000 per quarter threshold and that's what showed up in the numbers. It's not a result that I love to be honest and we're going to be pushing very, very hard to make sure that we are driving growth in every single account, including those midsized commercial/enterprise accounts. to make sure that, that number is really reliably growing every quarter.

That's helpful. And then I guess, Ron, on the financials, I think the guide for FCF last quarter was minus 10% to 20%. And I think if I heard right, you said minus 30% to 40% here. So the treatment to message across the board was stability is sort of in line with what you thought coming into the quarter but that 1 ticked lower. Just talk about what happened there?

Yes. I think -- in the quarter, we did see a little better cash flow from operations. We did also, as we know our CapEx was around 9% in the quarter. And so a lot of those puts and takes. The other thing that we did have relative to free cash flow impact was the impact of sort of the restructuring in the quarter which when we prior to the restructuring, we didn't have that in our calculations but we'll say more than that by the time we wrap up the year with the $14 million of the OpEx savings.

Okay. And maybe just last for me then. The conclusion to not count on a seasonal uptick here in Q4. can you just talk about anecdotally or quantitatively just how you came to that conclusion? Just curious what evidence built you to assume that other than I know you guys just want to keep the expectations down in conservatism. But any color there would be great.

Yes. I mean I think a couple of things. I think as we go into Q4, we did see some increased strength in our largest customers across gaming and some live sports. I think we some of those largest customers were going to see somewhat lower revenue. We also see an absence of some of the true-ups that we saw in the last couple of years that contributed to that seasonal uptick in the fourth quarter. And so when we bring those 2 together on top of the higher revenue we saw in Q3, we ended up with relatively flattish Q3 to Q4 revenue outlook. And note that those true-ups impact not only revenue but also gross margin, Jeff.

Your next question is from the line of Rishi Jaluria with RBC Capital Markets.

This is Chris [ph] for Rishi Jaluria. I was wondering if you could give us an update on the efforts to of revenue within the Top 10 customer cohort. But from the standpoint of mix shift and selling more security and other services into those customers, so that way you aren't as reliant on the delivery business.

It's top of mind. And as we look at how we are approaching those Top 10 customers in a new way, we have everything on the table. The portfolio expansion is certainly a big one. But we do know that their spend is primarily going to be in delivery by the very nature of their business. That doesn't mean that the stickiness can't come from bespoke compute offering and we saw a pretty good results there across the business on the compute side and certainly on the security side. We are seeing a lot of security event activity in the media space. And so, I think there is more opportunity for us to gain that stickiness from security even if the bulk of our revenue continues to come from media. But I'd tell you, I think we are still at the beginning of that journey, largely. Like I don't think we've reached every -- we haven't reached our full capacity and diversifying the portfolio there. And again, in '25, security is going to be a huge part of our focus. -- and I think that will include the media.

Got it. Just one other one. How should we think about the mix of securities revenue increasing? And what is embedded into Q4 guidance?

The -- yes, as far as the security mix went in Q3, I think we can do a lot better than that, to be honest. I wasn't to complete the result. And of course, the effects of these product launches that came in this quarter and during Q3 and in Q2. We haven't seen that start to show up in the revenue yet. And certainly, we haven't seen the full effect of our new sales leadership here. I think we can do significantly better than that. And it will be a big, big focus for the company in 2025.

Yes. The only thing I'd add, I think is all I think to Todd's point, I think you'll really see the bigger impact as we get into 2025 with recent releases and the efforts that Scott is putting into the go-to-market efforts.

Your next question is from the line of Madeline Brooks with Bank of America.

This is [indiscernible] on for Madeline Brooks of Bank of America. I've two questions for you but I'll start with the first one. My first question is, was the strength in 3Q expected or unexpected especially with the recovery you noted in the few large customers? And then can you talk about the sustainability of these trends? Were there any one-offs such as the Olympics that contributed to this outperformance?

Yes. I think we did see better-than-expected results in the third quarter as we worked through the quarter. I think where we saw strength was we did see some strength from live sporting events, including global events where they end up medallions. But we also saw spring in gaming, a lot of that's tied to release timing and so we saw better strength there than we anticipated going into the quarter. And then as Todd mentioned earlier, share gains outside of the Top 10, that growth was -- we expected to see an acceleration. We mentioned that on the Q2 call but that acceleration was a little stronger than we had anticipated going into the quarter.

Yes, we posted 13% year-over-year growth outside the Top 10 in Q2 and shifting that to 20% in Q3. again, this transformation and real focus on diversification of our revenue. I think we're starting to see results there and that's going to lead to more long-term sustainable growth for the company.

Perfect. And then, just looking at -- you guys see breaking out your network service security and other revenue which is basically compute. And I know you talked about this in the last few questions but could you maybe talk about and possibly quantify what we will see mix of revenue shift over time. We see like network services has gone from like 81% to now 78%. When we start to see more of that deceleration there with an increase in security? Or how should we be thinking about this a year from now or going into 2025.

Yes. Look, I believe -- I don't want any of our business growth to decelerate. I want every product line to accelerate for sure. But I think the pattern of further diversification of the revenue across the product lines is exactly what you're going to see. And I certainly believe in the fullness of time, we'll see that network services revenue come well below 70% and even lower than 2/3. That is certainly possible in this market. And I think as time goes on, we're going to see more and more diversification and perhaps more and more product lines as well.

Your next question is from the line of Rudy Kessinger with D.A. Davidson.

Ron, I'm curious, in Q4, if you could maybe just on the revenue guide, maybe break out a bit between the Top 10 and non-top 10? I know last quarter, -- like you said, you expected the non-top 10 to accelerate. It looks like it accelerated a bit more. I guess the prior commentary suggested in my head Top 10 customer revenue declines to about 30% in Q4. Is that still the expectation? Or is it a bit lower, a bit higher just based on what you saw in Q3.

Yes. I mean without specifically quantifying, I think we do expect to see some additional headwinds with certain of our largest customers going into Q4. It's reflected in our guidance. That likely will bring down that concentration a little bit below what we saw in the third quarter. And I think what we will see is continued strong growth relative to maybe what we've seen in Q2 and Q3 continue into the fourth quarter.

Okay. And at this point in time, I guess, do you feel like Q4 is the likely less contraction in the Top 10 revenue or maybe potentially some more in the first half of next year. And then on gross margins, even if I adjust for the 90 basis point benefit that you had in Q4 last year, still, you're guiding to about 200 basis points of a decline or compression in your gross margins in Q4 this year. Could you just maybe unpack that a bit? What's driving it? And just how should we think about gross margins into 2025?

Yes. I think in your first question, I think we do believe we move past kind of the worst some of the impacts from our largest customers. We certainly have dramatically improved our visibility to their behavior. But there's still going to be some headwinds going into Q4 but I think we're nearing the end of -- those headwinds and declines we've seen amongst a subset of our largest customers. I think we've got a good strategy to keep a very strong position which we have with those customers. and continue to see healthy growth outside of these largest customers. On gross margin, I think to your point, the other dynamic on top of some of those onetime benefits is really the investment that we're seeing to drive increased bandwidth and [indiscernible] deployments really associated with increased international traffic. -- is one of the headwinds and then we're seeing increased international traffic which today typically has lower gross margins because our volumes are lower there. Although as we continue to grow that there's an opportunity for us to bring those international gross margins more in line with what we see in our major markets.

Your next question is from the line of Fatima Boolani with Citi.

Todd, can you speak to the composition of the Top 10 customers today versus a year ago? I can appreciate that you've been very, very hard at work to diversify away from this group and have done a good job kind of growing outside of that. But just curious if you can give us some color on what the composition of that Top 10 today is versus a year ago? And then I have a follow-up as well, please.

Sure. It tends to be very media heavy. That doesn't just mean streaming video but it could mean folks in the gaming space in the bulk download space at 1 time or another. And some of those organizations have a digital business as well attack that might look more like traditional [indiscernible] but of course, the is often the same account.

Got it. Ron, you were kind of alluding to this and you've kind of discussed a number of factors around ongoing headwinds but the magnitude of some of those headwinds may be shrinking as we progress through into 4th quarter and maybe to start of next year. But when I specifically think about the net retention rate compression, when and where should we see this troughing out as it relates to what type of visibility you have in the business, if you can give us some kind of clues or some help or some guardrails on when we should trough out on the net retention rate compression trends.

Yes. I mean -- yes, it's a good question. I think as we move into next year and as I said, I think a lot of the headwinds from the large customers are behind us. Given that the NRR has gone on the LTM basis, that's going to move or slow kind of the growth out of where we see LTE and NRR. So I would expect that we would see some expansion as you move into sort of middle of the year and second half as you see some of the headwinds that we saw in 2024 drop off the LTM calculation.

Our final question will come from the line of Jonathan Ho with William Blair.

This is Jared [ph] on for Jonathan Ho. I'd like to go back to the security business. And just to get some additional color on where you're maybe seeing some more success? And then on the flip side, where you potentially slow just in terms of type of customer or any specific products?

Yes. I think the -- there's been a lot of success, especially around the last part of our security portfolio where I really believe we have a technology advantage across the board. The efficacy of that product really a cut above and it leads our users to be able to run it in full blocking mode and get really the full value, not just the alerting and the platform. We've seen a lot of loyalty there. And over the last year or so, we've really moved all of that technology to be fully enabled on the fast platform so that the power of our edge and infrastructure is now deployed there. along with DDoS and Bob a very complete solution. So I think that unification of the platform is driving a lot of our confidence here and then the way I see customers engaging with that WAF technology and now the add-on and adaptive to DDoS prevention [ph] feel really good. I think it has the biggest upside outside of media, especially in verticals like e-commerce, hospitality, travel, logistics, et cetera, fintech and it has a real potential for us is this untapped penetration to our existing delivery customers. And so I think there's just a lot of upside in security. That's why it's going to be such an important focus for us in '25.

I will now hand the call back over to CEO, Todd Nightingale.

Thank you so much. I want to thank our employees, customers, partners and our investors. We remain focused on execution on bringing long-lasting growth to our business and delivering value to all of our shareholders. Thank you so much for your time and your attention today.

This concludes today's call. Thank you for joining. You may now disconnect your lines.