Fastly, Inc.

Good afternoon. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fastly Third Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, followed by the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the conference over to Maria Lukens, Vice President of Investor Relations. Please go ahead.

Hi, everyone. Thank you for joining our third quarter 2020 earnings call. We have Fastly CEO Joshua Bixby, Chief Architect and Executive Chairperson Archer Bergman, and CFO Adria Larraz with us today. Before they start, I want to remind everybody about the usual format of our call. We published a shareholder letter on our Investor Relations website and with the SEC about an hour ago. We hope everyone's had a chance to read it. Since the letter provides a lot of details, we'll make some brief opening remarks and reserve the rest of the time for your questions. During the call, we will be making forward-looking statements, including statements related to the expected performance of our business, future financial results, strategies, 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. Please take a look at our filings with the SEC, particularly the risk factors within those filings and our Q3 2020 shareholder letter for discussion of the factors that could cause our results to differ. Also note that the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements except as required by law. Also, during the call, we will discuss certain non-GAAP financial measures. reconciliations to the most directly comparable GAAP financial measures are provided in the shareholder letter on our investor relations website. These non-GAAP measures are not intended to be a substitute for our GAAP results. Finally, this call is being webcast and will be archived on our website shortly afterwards. With that, I'll turn the call over to Joshua.

Thanks, Maria. Hi, everyone, and thanks for joining us today. We hope that you're all staying healthy as we continue to navigate through 2020. As we disclosed earlier this month, our third quarter results were impacted by certain customer specific factors that we had not foreseen when we reported our second quarter results and therefore we did not meet the expectations we set. However, despite these challenges, which I will talk about in detail shortly, our underlying business remains strong as demonstrated by our 42% year over year top line growth. Customer demand remains strong. We are proud to have achieved the second highest quarter of new customer ads in our history of being a public company, demonstrating the strength of our business and the continued acceleration of digital transformation. We saw customer wins across multiple verticals, including e-commerce, media and high tech. These companies include one of the largest sportswear and footwear retailers in the U.S. and a national U.S. automotive parts provider. Customer expansion and retention also remained strong with 147% dollar-based net expansion rate and 141% net retention rate on a last 12-month basis, up from 137% and 136% last quarter respectively. In the third quarter, we also saw our highest quarterly new booking attainment this year, which we believe bodes well for future growth. We are thrilled to have closed the acquisition of Signal Sciences which we believe will further bolster our world-class security offerings at a time when security at the edge has never been more critical. And today, as promised, we launched Computed Edge to production. Now, I want to provide some more details on the factors that impacted our results. Outside of a few customers, the business performed as we had forecasted. Certain macro trends over the past two quarters have created extraordinary and, we think, lasting demand for our platform. Our usage-based business model is sensitive to variations in our customers' businesses, which drive us to be customer-focused to help drive stability and increase usage on the platform. At the same time, in Q3, we experienced two distinct challenges that impacted a few key customers, which caused us to miss our original third quarter forecast. One of those was the uncertain regulatory environment surrounding our previously disclosed largest customer, and the other was customer timing impacts. Starting with the regulatory environment, our previously disclosed largest customer, which accounts for 10.8% of our revenue for the nine months ending September 30th, removed a majority of their US and non-US traffic from our platform by the end of the quarter. Based on publicly available information, We believe this global reduction was in response to the potential of a prohibition of US companies being able to work with this customer in any fashion. This clearly impacted Q3, and based on the continued turbulence of the situation, we anticipate the traffic group reduction to continue into Q4 as reflected in our guidance. One of our core values is to focus on our customer, and we intend to fully support this customer unless and until we are prohibited from doing so. We are prepared to accept additional traffic from this customer if conditions enable it to return. However, if it becomes clear that we should no longer support this customer, we believe the reserve capacity for this customer can be reallocated over the medium to long term with a traffic mix that is consistent with our gross margin objectives. Now, moving to the customer timing impacts. In the latter part of Q3, our forecast for new traffic coming onto our network from a few existing customers did not meet our expectations. I'm happy to report that a majority of these timing issues were resolved, and we have now seen this traffic come onto the network. There have been instances, however, where isolated timing issues have persisted due to certain factors, including our evolving understanding of both COVID-19-related travel and data restrictions, In South Asia, the delayed build-outs beyond our expectations and the timing of customer code freezes. We anticipate this traffic to come onto the network and not have a negative impact beyond Q4. Aside from these few customers, positive customer trends drove the quarter's otherwise strong results as highlighted earlier. In addition to these two factors, our Q4 guidance now includes the revenue contribution from Signal Sciences. Specifically, we saw strong renewals expanded market share, and healthy traffic growth. Looking ahead, we remain confident in the future of Fastly, both in the short and long term, while also accounting for the unique uncertainties we face in supporting our previously disclosed largest customer. Before I turn it over to Adriel to discuss the financials and our guidance, I want to provide more details on our product enhancements. We continue to enhance our offering to meet the needs of customers and developers as they shift more components to the edge. As I mentioned at the beginning of the call, we successfully completed our acquisition of Signal Sciences on October 1st, and the integration of their stellar team and products is well underway. Their technology, combined with ours, will form the basis of our upcoming modern unified web application API protection solution, which will power and protect companies at a time when security at the edge has never been more critical. Our customers have already expressed great enthusiasm for this offering, and we are very optimistic about the immediate cross-sell and up-sell opportunities within our combined customer base. In addition to these developments on the security front, with Computed Edge in production, we have already heard from customers that our investments are paying off. We are providing customers serverless compute environments with rock-solid performance and features, allowing developers to create with enhanced speed, agility, and security. With these two core pillars, security and compute, squarely in place and complementing our delivery business, we are now fully executing on our platform vision of providing the most complete edge cloud solution in the market. We are supplying enterprise builders of all kinds, from developers to security operators, with the speed and confidence they need to continue expanding and differentiating. With that, we believe we are exceptionally well positioned in the current enterprise technology environments. delivering multiple powerful solutions tuned for the evolving DevOps workflow at the edge, opening up much broader enterprise customer opportunities. Now, I'll turn it over to Adriel to go over the financials.

Thank you, Joshua, and thank you everyone for joining us today. As Joshua noted, we experienced two distinct challenges with a few key customers this past quarter that impacted our results. We believe these issues were unique events and don't change our overall ability to forecast the business going forward. That being said, we're always looking to improve our guidance setting and have incorporated our recent experience into Q4 guidance as detailed below. As mentioned earlier, outside of these few customers, our underlying business remains strong. We generated 71 million in revenue this quarter, representing 42% year-over-year growth. Gap gross margin was 58.5% for the quarter, up from 55.2% in the same quarter last year. Non-GAAP gross margin, which excludes stock-based compensation, was 59.8% for the quarter, demonstrating continued leverage with an improvement of over 370 basis points year over year. As we've said, gross margin will continue to be impacted by the timing of personnel and infrastructure investments, along with the seasonal fluctuations of platform usage by our customers. Despite continuing economic uncertainty, we remain confident in our ability to deliver incremental annual gross margin expansion as we continue to scale and deliver innovative security and edge computing solutions. We also continued our progress towards profitability, generating 0.8 million of adjusted EBITDA compared to a 5 million loss in Q3 2019. Turning to the balance sheet, we ended the third quarter with $472 million in cash, restricted cash, and investments in marketable securities. Note that we used $200 million of this cash at the beginning of Q4 to pay the cash consideration for the Signal Sciences acquisition upon closing. Despite the uncertainty we presently face in the macro environment, as well as the unique challenges we experienced in Q3, we are confident in the future of Fastly and the ongoing demand for our services. As mentioned earlier, we expect to see an impact in Q4 from the regulatory uncertainty and timing issues, and I want to provide some context around what this means and the guidance we have provided. Because of the ongoing fluidity and regulatory uncertainty related to our previously disclosed largest customer, we are only assuming revenue from this customer that we expect to bill in October 2020 in the low end of our Q4 and fiscal year 2020 guidance ranges. While we have no additional insight beyond what is in the public domain for the high end of our Q4 and fiscal year 2020 guidance ranges, we forecasted that the current reduced traffic levels that we observe will remain only through early November. Additionally, for those few customers that have brought on additional traffic to our network since Q3, we are only assuming the currently observed traffic levels at the low end of our guidance. At the high end of our range, we are forecasting increased traffic levels from these customers based on our previous seasonal experience in Q4. Also, because we successfully completed our acquisition of Signal Sciences on October 1, 2020, Our Q4 guidance now includes the revenue contribution from Signal Sciences, which we expect to be approximately $8 million. Lastly, non-GAAP operating loss and non-GAAP net loss per share guidance accounts for the impacts from the customer-specific factors mentioned above, as well as formal Signal Sciences and current vastly higher-end plans. Now, turning to specific numbers for the fourth quarter, we expect revenue of the range of $80 to $84 million, Non-GAAP operating loss in the range of negative 15.2 to negative 11.2 million. And non-GAAP net loss per share in the range of negative 12 cents to negative eight cents. For the full year 2020, we revised our revenue guidance range to 288.2 to 292.2 million from 290 to 300 million. Non-GAAP operating loss range to negative 23.1 to negative 19.1 million from minus 12 to minus 2 million. And non-GAAP net loss per share range to negative 21 cents to negative 17 cents from negative six cents to negative one cent. In closing, we want to express our confidence in the strong fundamentals underlying Fastly's business. We believe we are well positioned to execute and continue our growth. We have a strong company, which has now been further strengthened by our completed acquisition of Signal Sciences which had significant new top line revenue and will be accretive to gross margin scale and growth. We will continue to use our balance sheets to strategically invest in our network. We will also finish building out our new secure at edge offering as well as, as we have successfully done with computed edge, where our deep investments are paying off and allowing us to deliver on our promise of a serverless platform with rock solid performance and features. With that, I'll turn it back over to the operator to take your questions.

At this time, I would like to remind everyone, in order to ask a question, press star and the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Jonathan Ho with William Blair. Your line is open.

Hi, good afternoon. I just wanted to maybe start with the customers that saw the delay in terms of the onboarding. Can you give us a sense of the magnitude of that impact and I guess the confidence level that you have that traffic will be able to come back on time?

Sure. Hey, Jonathan, it's Joshua here. Thank you for the question. We've been looking forward to having this conversation for the last few weeks. I think, as I said, we are really happy to report that In the majority of those situations, that's back and we see it having no impact. We did call out that we do have a few where we do see timing impacts. When you look at those, they're very much related, as I said, to unexpected timing. I think what's really important to remember is this is all net new traffic. This is new traffic that's coming onto the network from customers who love us and want to give us more. This is in the drop-off, obviously, of customer traffic that is there. And if you look at the guidance and the information that Adriel provided in terms of how we're looking at our largest previously disclosed customer, you can really sort of net out where that comes from, given that we remain very confident in the normal Q4 bump that we see and that's reflected in the numbers.

Got it. And then just regarding TikTok, are you in sort of, or your largest customer, are you in sort of active discussions or is this a situation where, you know, there's potentially some impact from elections? I just want to sort of understand how you're thinking about, you know, how we should think about a potential return of traffic, if that's even possible at this point.

Yeah, I mean, it's a very dynamic situation and it's very much driven by an uncertain process. So we don't have clarity on the process. We expect the situation to remain unresolved for a while as it works through. We have the information that's available in the public domain as you do, and I think dynamic is the right way to put it. So I wouldn't want to speculate on that. I think the one thing that's really important for us, given that we are such a customer-focused organization, is that we're standing behind this customer, we're standing with them, and we're here to support them no matter what the situation is so long as we can.

Great, thank you.

Your next question comes from the line of Brad Selman. Your line is open.

Great. Thanks so much, guys. And it's actually good to see the business remains very strong outside of the isolated customer issues. But my question as well, you know, follows the last one about the largest customer. And it seems that they were able to move traffic off of your platform pretty quickly. And I know you've consistently said you don't take on commodity traffic. So can you maybe just give us a sense of what they're using Fastly for and why was it so easy to switch away?

Yeah, it's Joshua here. Brad, it's nice to hear your voice. I think that, you know, what we have said consistently is that we do things at the edge that most of our customers are forced to do from origin. because we are able to bring compute to the edge and because we bring the visibility and control, our customers are able to do things that you can't do with traditional edges that just cache. And so I think organizations have the ability to do the work that we do. It's just at origin. When you do it at origin, it's slow. It potentially could be slower. It doesn't scale as much. Obviously, it's a very different profile on the security side. And so, you know, I think what you see when organizations are forced to move in a certain direction and look at bringing this, you know, high value content that we really thrive in by doing this work for the innovators, there are options, they just, there are trade-offs that are part of those options. And so, you know, I think, as I said earlier, our Our mandate in this process is to stand behind our customer and help them with these processes, any customer that is put in this situation. And so that's really our view on how we look at it. And I think, as we've talked about, in our larger accounts, we have a variety of different traffic profiles that we serve for all of our largest customers that fit into a certain category.

Okay, maybe a follow-up, I don't know, perhaps for Adriel or yourself. Despite the customer-specific issues in Q3, it seems like traffic growth continued to be durable. So as we think about calendar 21 and beyond, how do you think about the rate at which traffic can grow from elevated levels here and how an eventual global reopening may impact your business?

Yeah, I mean, I think we're not in a position yet to speculate on 21. I can tell you that you know, we are in the early stages of this. If you think about our market penetration into our core customer, into the core customers and the core verticals that we're in, we're still, you know, small single digits. And in some of the large customers that we already have, you know, we don't have the majority of their wallet share. And so I think if you just look through a very simple lens, we are in a position where we are investing. We are, we feel this is early. We think the opportunity when you layer in not only the, the delivery business, which we obviously are a leader in, but now our continued leadership in the compute business and the security business, there are a lot more than 300-odd enterprise customers in the world. We're talking tens of thousands. And so we really look at this as being in the early stages of this. So I don't think they're – I think the question about where the Internet goes and how traffic increases is one vector, but the way I'd really look at it from our perspective is just how early we are and how huge the opportunity is in front of us.

Fantastic. Thank you so much for the thoughtful answers, and I wish you all to stay well. Thank you. Thank you.

Your next question is from Robert Magic with Raymond James. Your line is open.

Great, thanks. Following up on the prior questions and understand that you have limited details, but on the topic of your largest customer, are they moving traffic as a temporary measure to avoid any disruption to potential US ban? Or in the event of no ban, could this be more of a permanent shift in their CDN strategy?

Yeah, Robert, thank you for the question. I think, you know, this is a very dynamic situation. I come back to that. You know, I think if you think about the timeline over the last few months since we last spoke, a lot has changed, a lot that we thought was going to happen may not happen. So I think, I'm not sure, we are in certainly no position to have any proprietary insight into any of this situation. I think what we would say in general is it's very dynamic. We don't have clarity on the process and we expect the situation to remain unresolved for a period of time. So I don't I don't have any more insight in terms of what that looks like. I think from the publicly available information that we see, it is very clear that it is important for any customer in this position to be able to continue to serve their customers if and when certain vendors are prohibited.

And if I can, can you help us understand your strategy in managing the reserve capacity for this largest customer? At what point will you allocate that capacity to other customers? And what gives you the confidence that you can backfill that traffic with traffic that meets your gross margin objectives on potentially short notice?

Sure. So I talked about a medium and long term in terms of thinking about how we can shift that. And I think... we have confidence based on the relationships that we have. As we talked about previously, we have great relationships with our customers and we feel that that's a strong possibility for us. Obviously, until we start doing it, we won't know the exact results of that. And I think from a strategy perspective, given the uncertainty and how dynamic the situation is, we feel it is very much in our interest to remain consistent you know, steadfastly behind this customer, given the timing. I think the answer will be when we believe we should start that process in earnest. You know, we will, but that's based on the information that we have and the uncertainty in the process. That's not where we're at right now.

Great, thanks, and I appreciate the call you've given us today.

The next question comes from the line of Brad Reback with Steeple. Your line is open.

Great. Thanks very much. Joshua, in the investor letter, you talk about some meaningful commitments from U.S. media conglomerates producing what it says, higher profit renewals. Could you dig into that a little bit? Is that expanded pricing for existing functionality or did they take additional product down to improve the process? Thanks.

Yeah, thanks, Brad. You're seeing both. I mean, I think, you know, as we migrate into a multi-product business and really engage with that, I think you're starting to see some of the first, you know, it's starting to see continued growth in that area. I think what you're also seeing, which is, you know, something we've talked about in the past, which is there's obviously a commodity market here in the high volume. If you think about where we really focus, it's in the high quality. And I think now more than ever, those who care deeply about their quality, that's paying off. And so when you look at the vendors, when you look at the platforms that are really excelling, I think you'll see a correlation between how fast they are, how consistent they are, and that is a unique value proposition for us. We're also seeing in a lot of those instances, and I think this is important, is because we are so good at what we do, we're able to offload the central cloud from a lot of traffic. And so as your central cloud costs go down when you bring in a modern, intelligent edge cloud, you also see a really significant payback there. So I think you're seeing a combination of the ROI showing up. You're seeing a combination of the unique value proposition that we provide. You're also seeing the adoption of multiple products. And I think across All of those vectors, if you add them all up, that's really where you're seeing really impressive results there.

Excellent. Thank you very much.

Your next question comes from the line of Rishi Javaria with DA Davidson. Your line is open.

Hey, guys. Thanks for taking my questions. Two here. First, just drilling down into the Q3 results, you know, if we look at, kind of do the math, right, absent the headwinds from your largest customer, revenue still declined sequentially about half a million dollars. In the shareholder letter, you talk about how, you know, there's some shortfall related to new traffic. So maybe can you help give us color on why even absent the largest customer headwinds, you still saw a sequential decline. Was that just a function of traffic itself being down sequentially? Was there some pricing stuff? And I think, you know, squaring out also away with the fact that your DBNER was really strong and even better than Q2. And then I've got to follow up.

Sure. Adriel, you want to take the first one?

Sure. Hey, Rishi. Yeah, it's definitely really much more a function of the timing of some of the, as we disclosed in the letter, there's a few key customers that were bringing on additional traffic you know, onto the network. And for sort of the completion of reasons associated with bringing that on, there was just a bit of a delay. And the majority of those situations, it's onto the network today. And we've, you know, we've forecasted, you know, quite rightly conservatively in terms of what it looks like for Q4. At the same time, we're also bringing in the seasonality with Q4 that we've experienced historically. So that you can see some respect to sequential up from Q4 over Q3 at the midpoint at those levels. And I think from our standpoint, we're still feeling pretty good about sort of our long-term prospects, why you still see the investments that we're making across the business, as you've seen as our non-gov operating loss profile. So from that standpoint, I think we're still feeling pretty good. Okay, great.

I'd also add to that that Q2 was obviously a very difficult time for all of us as the lockdowns came in. And so I think if you normalize this, you'd be seeing normal increases in line with what we'd expect from a seasonality perspective.

Yeah, that's totally fair and definitely appreciates. The conservatism and Q4 guidance, definitely, in my opinion, the right thing to do. And then I just wanted to drill a little bit more into the DBNER. And I know they're not 100% apples to apples, right? But DBNER was 147%. NRR on a trillion 12-month basis was 141%. And again, acknowledging they're calculated slightly differently. That does imply, though, that your churn on a trillion 12-month basis was about 6% versus Last quarter, if we do that similar sort of math, it was a lot lower, probably close to one and a half. And I imagine revenue from your largest customer in spite of Q3 was probably still up on a trailing 12-month basis. So can you help us square A if that's the right way of thinking about things or if the numbers are just calculated so differently that that comparison is meaningless and B, if there was in fact elevated churn in Q3 relative to Q2? Thanks.

Sure. Adriel, why don't you take that one, please?

Yeah, I think, you know, on both of those metrics, as you know, they're sort of backwards driven. That is, you know, they're trailing 12 months and the Devner perspective excludes churn and then in the revenue retention, even on the trailing 12-month metrics. So I think what that really, that's really what speaks of is really the comparison as you include Q3 from last year versus Q3 from this year, sort of working backwards. I don't see anything unusual from that standpoint. In fact, I think the key thing to take away is that despite, you know, sort of the sort of unprecedented nature of the current disruptions with our previously disclosed largest customer, that that was still a decently good metric, which I think sort of exposed well to the overall growth rate you saw year on year on the 42%. So I think it's much more of an output than it is necessarily an input. All right. Got it. That's helpful. Thank you, guys.

Thank you.

Your next question comes from the line of Jeff VanRage with Craig Hallam. Your line is open.

Great. Thanks for taking my questions. A few for me. Hey, guys. Hey, Joshua. Signal Sciences, maybe if you could spend a minute there, just you talked a bit about the cross-sell, up-sell. What opportunity have you had to go out and validate that cross-sell, up-sell from sort of the execution standpoint, common touch points, common buyer, Just talk about the ability, one, that's helped you validate the cross-sell, up-sell, and two, Signal Science's EPS impact in Q4, if you can color that in.

Sure. I'll take the cross-sell, up-sell, and I'll hand the EPS question off to Adriel's Joshua here. Jeff, thanks for the question. I think one of the amazing attributes of working with the innovators of the Internet is and acknowledging that we are building an innovator's toolkit is that we have this unique perspective into what other tools are put in the toolkit. So before this process even kicked off with Signal Sciences, we knew, you know, because of the choices that our customers were making, we knew exactly, you know, what the buyers were looking at, how they were looking at the problem, what they loved. And as we went through our most innovative customers and those that are truly on this path of digital transformation, pioneering this path. They were already down the road, either as customers or who already looked at it. So I think what's exciting about working within this same tribe, ultimately, is the ability that we come into that conversation with a bit of an advantage. I think the other advantage is we already, you know, there was already a way for our products to work together before we even walked into this because of all the mutual customers and the conversations we've had Now, admittedly, the scale is different, but we had seen it already at enterprise scale. So, you know, those conversations have seemed, in the early days, and again, we're only a few weeks into this, very natural. They're already conversations that we had been having. You know, a customer would come to us and say, hey, we're integrating with Signal Sciences. We need you to work closely with them. So I feel like being in the toolbox of innovators, like, and Signal Sciences was there, too. It just gives us a huge advantage. So, you know, overall, we're seeing... tremendous interest. We're seeing a lot of interest on both sides. So existing SignalScience's customers that haven't thought about delivery in this way because people start this path of going down agile platforms in different formats. Some people started on the security front, and that's part of what we're really excited about is capturing that. Some people started on the delivery front. But what both of those paths lead to is the understanding that you need control and visibility, that the platform has to feel and act like your own, and as a builder, you have to trust that you can build on it. And what we saw in Signal Sciences and what has been confirmed, not only in our diligence, but as I say, through our customers' lenses for the last four years, is that. So very optimistic, a tremendous amount of enthusiasm at this point. Adriel, on the EPS question.

Yeah, and Jeff, I can take the second part of that question. I'll sort of abstract it up just a little bit, which is I think from given that we're still early into the integration phase of signal sciences, I think that sort of the estimated burn impact on a non-gap operating loss perspective is about 4 to 5 million. So if you think about the non-gap operating loss, that kind of gives you a sense of sort of the magnitude of impact in Q4 now that signal sciences is part of this. Got it.

Very helpful. And then just if I could briefly back to the customer timing, the few customers primarily. Sounds like it's really central to a few. I mean, it sounds like there might have been more than a few, but really comes down to a couple. Just want to validate that. And then with respect to those few customers, was there any other commonality? Are these common, you know, similar type customers, similar use cases? Can you tell us anything else about what was common or not common about those kind of few main customers that led to that shortfall?

Yeah, I mean, these are all unique customer-specific issues. There's no significant commonality, no thread that you can pull either industry or even, you know, what led to the timing-related issues. And as you say, this is a small number of customers. So, you know, just happy to report the majority are back to exactly what we had expected and are billing and that the few remaining won't have an impact beyond Q4. But nothing that would draw attention a link between them or speak to any pattern.

Got it. Fair enough. Thanks so much. Appreciate it.

Thank you.

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

Okay, great. Yeah, thanks. And thanks for all the disclosures. I think a lot of my questions on the customer challenges have probably been answered. Let me maybe switch gears on signal sciences. I think you're guiding to $8 million of revenue in the quarter. Is that principally based on the existing run rate from that business? Are you assuming anything in terms of cross-sells, up-sells to kind of get to that figure? And any early flavor as to how we should think about growth expectations for that segment as we move into next year? Sure. Adriel, why don't you take that one?

Hey, Will. It's Adriel. Thanks for the question. Yeah, we're actually, for that sort of number that we put out, we're not assuming really any sort of additional sort of in-quarter contributions at this point. I think we're trying to be a bit conservative here. So you can think about that stuff coming kind of directly from the balance sheet that we sort of already had when we came, when they came into it. But we are, it is growing quite nicely. As we mentioned when we first, we announced the transaction there in Q2, they're growing faster than we were. So I think from our standpoint, we're really excited about sort of the future impacts of this as we think about future years together. And, you know, we're still early in the process of trying to figure out where the you know, the cross-sell and up-sell opportunities are not only for our customers, but also, you know, SuperScience's customers that we want to sort of introduce, you know, Fastly delivery to and Computed Edge to. So at this point, you know, we're just excited about the prospects going forward.

Okay. And maybe a margin question, if I can. I know in the shareholder letter, maybe even the prepared remarks, like Adriel, you alluded to ongoing kind of puts and takes and gross margins and potential different impacts. Maybe just to kind of make sure we're on the right page going into Q4. Any thoughts as to how we should think about gross margins, you know, positives and negatives at the end of the quarter? And how does Signal Sciences, you know, influence that?

Yeah, I'll go in sort of reverse order, which is, you know, with Signal Sciences, you know, this is an attractive security software-as-a-service model-based business. So their gross margins are in sort of the 80-plus percent range, which is fantastic and I think really shows the value that Signal Sciences brings to their customers and now our customers. So I think that's going to have a nice uplift just from the standpoint of the mix of within the current business from Fastly today. And that's some of the things that I've spoken about before, which is, you know, our security and competitive edge businesses don't have bandwidth as a big cost component to it. So by that very nature, it's a nice up-up to what we have today. Historically, you know, prior to Signal Sciences being part of Fastly, our Q4, which is where we drove Fastly, leverage in our annual and on an annual basis. So I think that trend should continue, but I think right now it makes it a little bit more likely given that signal sciences is now part of Fastly.

Okay, great. Thank you.

Thank you.

Your next question comes from the line of Timothy Horne with Oppenheimer. Your line is open.

Hi, guys. Two questions. One, maybe give us a little bit of color what's going on with your license-based revenue versus usage-based, maybe, you know, any kind of mix or change in mix. And secondly, I think you added six terabits of capacity this quarter, but CapEx is up quite a bit. I know last year in the fourth quarter you were adding 16, and it's kind of trending down, you know, kind of since then. Just maybe what's going on with the capacity with the increased CapEx. Thanks.

Sure. Adriel, you want to go on both of those?

Absolutely. Hey, Tim, I'll go in reverse order again. On the CapEx side, as we've seen before in the past, annually now, sometimes the CapEx that you see that we report will bounce up and down. But I've always talked about within a particular year, we should be, and especially in 2020, we should be around the sort of 13 to 14%, which I still think is likely to be the case. Our long-term model that we were sort of looking to get to by year five post the IPO, we want to get to sort of 10%. Clearly, 2019, we were just a hair below 10%. Um, and I suggested in 2020 that we're going to be more like, uh, 2018, which is where we're still investing. And I think this year, um, we'll, we'll still hit those numbers. And so I think, uh, you know, one particular quarter may sort of, um, uh, make you think otherwise, but I still feel that overall on the annual basis, once you sum it all up, we should be in that sort of 13 to 14% range from a capacity standpoint. And then, um, on the former question, um, the license, uh, base versus usage. I don't know that it's changed too much at this point, given what we've disclosed in the past. So at this point, I can't, I think it's much more about the timing of invoices more than anything else. But yeah, I wouldn't read too much into that.

Adrian, sorry, my question on the CapEx. I think you guys added six terabits of capacity this quarter. If you went back, you know, three, four quarters ago, you were adding like 16. It seems to be a pretty big slowdown in the capacity you're adding.

Oh, sorry. When I think about capacity, I was thinking you were mentioning CapEx physical infrastructure as opposed to bandwidth from that perspective. And so I don't know that there's too much more in that. I think it's much more about just where we see and as we've done before in the past is we're often building ahead of the typical holiday season that is in the Q4. And so that sort of followed a pattern we've done previously before.

Tim, there's also a dynamic here that when you buy, get the servers, get them in, you're trying to time the bandwidth side of this so that you're incurring those costs when the traffic's there. So these things don't always go hand in hand in terms of sort of when the servers are there and when the bandwidth is there. Imagine those are actually different contracts, different vendors. So there is a bit of an arc in terms of how we augment existing services Pops where you don't have to necessarily augment the bandwidth so those are not over over time they'll they'll they'll map, but in in shorter periods of time, you might not see the map and I think that's what you're seeing in this quarter as well, specifically because so much of the capex has gone into augmentation.

Thank you. Again, if you would like to ask a question press star and the number one on your telephone keypad. Your next question comes from the line of James Fish with Piper Sandler. Your line is open.

Hey, guys. I want to go back to Will's question. Is there any way to think about the impact to Signal Science's revenue and gross margins as you move it towards a usage-based model via security at edge?

Let me start with that, and then I'll pass it off to Adriel. I think one of the things that our customers are asking us for in certain segments is more consistency in their billings. And so I think you're going to see two phenomenons come out. One of them is you are going to see us continue, obviously, a strong push in the usage-based business model for large subsets of our customers, and we'll be bringing Signal Sciences along for that. I think we're also learning from Signal Sciences and from our customers that there is a certain subset of customer here that really likes the consistency of what they're bringing. And I think one of the things that I'm really excited about with this merging of our two sort of cultures is we're learning a lot about how that looks with this builder audience and how we can really take advantage of both. So I think what you're going to see is a bit of both. And, you know, overall, I think that's good for customers, particularly those that want a predictable bill month in, month out.

Hey, Jim, it's Adriel here. And I'm actually going to build on that concept of predictability, because one of the things that, you know, historically, fastly, was about 50% sort of, you know, contracts, quote-unquote, committed versus 50% usage above those commit. If you actually just mix in Signal Sciences with the way that they build today and the way that they work with their customers, that actually pushes up, quote-unquote, that sort of the committed and or fixed portion of our revenue almost closer to 60% as opposed to 50-50. So I think from my perspective, there's a lot we can learn from how Signal Sciences has done things and how they work with their customers. And there's certainly... I think some attractiveness to that from a financial predictability standpoint. So certainly we're going to keep looking at that. We haven't made a determination yet about how we're going to do that and how much we're going to blend those products in a more usage-based model. But it is certainly something we're going to look at.

And then on the enterprise net ads, is that just a factor of kind of being the newer vendor on the street here against the incumbents and just sticking with a little bit of a status quo? Because it was only nine again this quarter. And Adriel, is there any way to think about how many customers, specifically enterprise customers, that Signal Sciences will add?

Let me start with the first one, Jim, and then I'll hand it off to Adriel for the latter. I think that what we said last quarter still applies, which is we're really happy about those that expanded or added into this category. But given the way that we calculate this, which is looking back in the mirror over 12 months, what you're seeing is now a second full quarter of COVID-related impacts to some of the verticals that have been impacted. Now, thankfully, you know, for our business, that was a very small percentage of our business, but you're still seeing that work its way through. And so we're, you know, if you were to look at the total ads, you know, not the net, you would see that there's strong, there's strength there. And I think we'll see another, you know, one more quarter of where that works through the system. But overall, we're happy with that number, given the situation. Adriel, you can go on the second one.

Yeah, thanks, Joshua. And Jim, actually, when we disclosed the acquisition announcement, I think we disclosed about 70% of those 60-plus Signal Sciences customers are expected to be likely enterprise customers. So if you do the math, they're about around 40%. At this point, it's hard to historically, we haven't been able to figure out how much of those enterprise customers are going to come from our current base. But at least from a signal sciences perspective, hopefully that gives you some sense of what, you know, ballpark estimate of what we hope to add, at least in Q4.

Makes sense. Appreciate the extra color, guys. Thank you.

Your next question comes from the line of Walter Pritchard with Citi. Your line is open. Thank you.

Hi, thanks. Just a question for you on how we should think about Q4, Q1 seasonality. That's typical there. You have some M&A coming in. In this Q4, you have some other factors you've talked about. Just relative to past years, what color can you give us as we start to think about next year? Pedro?

Yeah, I think we're going to reserve sort of talking about next year until we get to that point, because I kind of want to see how signal sciences works within FASLI, especially from a selling motion perspective. into Q4. I mean, historically, Fastly has been, you know, on an annual basis, Q4 in a normal year, again, non-COVID-related, Q4 has been sort of our stronger growth from Q3 to Q4. And typically, you sort of are sort of flattish Q4 to Q1, and then it's, again, flattish again until you hit the Q4 again in the following year. So at this point, you know, hopefully when we're sort of out of COVID and post-COVID, you get to sort of a more regular growth But we are really interested to sort of see in terms of what, you know, growth opportunities do exist with signal sciences. But I want to sort of wait until we get through Q4 to sort of comment on that.

Okay, got it. And then just maybe one more question on the largest customer. Was there a commit part on that one as well that's still in there in the revenue coming through? Or was that customer primarily transactional traffic based? Adriel?

Yeah, Josh, I can take that one. Yeah, traditionally with our Princess Coast largest customer, it was a relatively low commit. So from that standpoint, this is traffic that they chose to keep on us, at least through whatever we have through October. And that's what we currently are built into the lower end of our range.

Okay, great. Thank you.

There are no further questions at this time. Mr. Bixby, I turn the call back over to you for closing remarks.

Thank you. Before we sign off, I want to say thank you to our employees, customers, partners, and investors. Our shared vision has got us to where we are today. We're proud of the role we play in providing mission-critical services to meet the needs of our customers in this moment and in the future. We look forward to connecting with many of you and hope to virtually see most of you at the upcoming Stiefel, Needham, Credit Suisse, and Wells Fargo conferences. Thank you. Stay healthy.

This concludes today's conference call. You may now disconnect.