Fastly, Inc. Q3 FY2024 Earnings Call

Good afternoon. My name is Tamika 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. 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.

Thank you, Vern. Hi, everyone, and thanks for being here. Today, I will discuss our Q3 results and the progress we've made, particularly in increasing revenue outside of our largest customers and improving Fastly's profitability. I will also cover our marketing strategies and technology initiatives, after which Ron will provide a detailed overview of our third quarter financial results and guidance. We reported third quarter revenue of $137.2 million, exceeding our guidance range due to stronger-than-expected performance from some of our larger media clients and a balanced mix of growth outside of our top 10 customers. We recorded an operating loss of $520,000, our best result in over four years and significantly better than our guidance range. This improvement was driven by higher revenue and gross margins, along with cost savings from our quicker-than-anticipated restructuring efforts. I'm pleased to report that Fastly achieved 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. We made significant strides in diversifying our revenue, leading to a more balanced revenue mix as we grew our top line by 7% year-over-year. Our Top 10 customers accounted for 33% of revenue in the third quarter, down from 40% last year and 34% from the previous quarter. This indicates our ongoing progress in diversifying revenue and enhancing our business resilience. Revenue from customers outside our top 10, crucial to our long-term strategy, increased by 20% year-over-year, a significant rise from last quarter's 13%. Last quarter, we referred to this as an inflection point for Fastly. While this transition is gradual, we are already seeing benefits from focusing our investments in product development, customer success, and marketing. We launched a major expansion of our security portfolio, appointed new sales leadership, transitioned to a customized engagement model with our largest multi-vendor clients, and introduced a new self-service platform. We're observing early success in revenue diversification, customer growth, and renewed attention to our largest enterprise clients. There's more to come. These changes will enhance revenue diversification and foster faster, more reliable growth for Fastly. Our customer acquisition initiatives showed solid year-over-year gains in Q3, with our enterprise customer count rising to 576 from 547, marking a 5% year-over-year growth rate. However, it declined by 4% quarter-over-quarter as more customers fell just below our $100,000 run rate definition. We do acknowledge quarterly fluctuations in our enterprise customer count methodology, but we will monitor this closely and aim for growth across our mid-sized accounts. Churn levels returned to normal, remaining flat quarter-over-quarter. Despite the 5% year-over-year growth in our enterprise customer count, we seek to accelerate our growth in this segment in 2025. By the end of Q3, we had 3,638 customers, a net increase of 343 from the previous quarter, translating to a 10% growth rate. We attribute this growth to our new self-service sales approach, which I will elaborate on shortly. Our transition heavily reflects our commitment to technology innovation, which we believe is essential for ongoing success in customer acquisition and market share growth. Fastly's platform is a software-driven edge network providing exceptional delivery, network services, security, compute, and observability. We continue to invest in leading technology and innovation that not only strengthen our platform but also enhance its capabilities for the future of web application development. This functionality empowers our customers to deploy their applications globally. We are confident that our unified platform approach will greatly improve customer retention and create efficiencies in supporting our customers' success. Let me share some key developments regarding our security offerings. We have received positive customer feedback for our bot mitigation solution launched in Q1. This solution, developed entirely within Fastly, appeals to customers due to its simple onboarding and user-friendliness, paving the way for cross-sell and upsell opportunities. Following the successful launch of bot mitigation, we announced the general availability of Fastly's adaptive DDoS protection. This solution automatically safeguards against Layer 7 and other application-level DDoS attacks, enabling frictionless onboarding and implementation at the click of a button. Our history of DDoS protection at Fastly is strong, having partnered with some of the largest and most sophisticated customers in the industry. We are leveraging this intellectual property and productizing it for the broader market, allowing our wider customer base to benefit. Additionally, this solution integrates proprietary auto-adaptive response intelligence. We anticipate that this innovative DDoS solution will serve as a new avenue for acquiring enterprise customers while promoting customer growth and cross-selling. Last quarter, I mentioned launching the beta version of our AI accelerator, an AI proxy designed to deliver performance and cost savings for application builders utilizing large language models. The response from customers has been very positive, and we have expanded LLM support beyond OpenAI to include Google Gemini. We expect the AI accelerator to be generally available for purchase by the end of the year. I am excited to announce this as it indicates our increased innovation pace at Fastly, and I look forward to unveiling more products before the year ends. I will now address the transition in our go-to-market strategies. Since his arrival in Q2, our new CRO, Scott Lovett, has begun transforming our sales approach to secure more new enterprise logos. He is particularly focused on winning new business in security with both new and existing clients. With our new security solutions and his extensive experience, we are optimistic about the prospects ahead. Our go-to-market strategy also emphasizes branding, messaging, and leveraging our expertise through subject matter experts. In Q3, we published the Fastly Threat Insights report, highlighting the latest trends in web application and API security. The report revealed that 91% of cyberattacks targeted multiple customers using mass scanning techniques to exploit vulnerabilities. We also published a survey showing that 59% of IT professionals observed an uptick in bot activity over the past year, with significant incidents costing companies an average of $2.9 million. These findings align with the interest we're witnessing in our security portfolio. We are now in the second year of our packaging initiative, which reflects our commitment to simplicity in product design, pricing, and implementation. Our new self-service model with customizable packages was rolled out last quarter as we initiated our Product-Led Growth efforts at Fastly. These initiatives have led to an increased overall customer count, while also attracting essential developers to the Fastly platform. In Q3, our packaging efforts showed robust growth, with the number of packages sold more than doubling year-over-year. Our new logo packages tripled, accounting for 43% of the packages sold in Q3, compared to 16% a year ago. Lastly, our channel partners are an integral aspect of our go-to-market strategy. In Q3, dealer registrations grew by 33% year-over-year, and year-to-date bookings grew by 46% year-over-year. We foresee more opportunities to leverage our channel partnerships to drive revenue growth moving forward. Now, let me wrap up with our outlook as we approach the end of the year. Reflecting on the past year, we faced unexpected challenges. In 2024, revenue declines from our largest customers prompted us to realign our growth and investment strategies. This led to workforce reductions and a comprehensive transition across all departments at Fastly. I believe we are emerging from these challenging times and turning a corner. Our commitment to cost discipline and financial rigor in pursuing profitability is stronger than ever. This quarter has shown signs of progress that should instill pride in our team, and while more work lies ahead, I am satisfied with the collective efforts over the past three months. As we enter the typically strong fourth quarter, we do not anticipate benefiting from as much sequential growth as in previous years, which is reflected in our Q4 revenue guidance. Although this might seem overly cautious, it is primarily due to the dynamics we've observed at some of our largest accounts over the past three quarters. We believe we've moved beyond the worst of these impacts and have a plan to maintain our position with these large customers while emphasizing healthy revenue growth outside of our largest accounts for essential diversification. I remain optimistic about our prospects in 2025 and continue to believe that our platform advantages position us well to capture a larger share of the world's web application workloads. I will now turn the call over to Ron to discuss the financial details and guidance in detail.

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 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 2024 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, an $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 one-time revenue true-ups in the fourth quarter compared to the one-time $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 reflects 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 costs 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.

Your first question is from the line of James Fish with Piper Sandler.

Congratulations on achieving net income profitability this quarter. I think everyone is curious about the competitive landscape, especially with one of your competitors declaring bankruptcy. Todd, we discussed this at our conference. What are you seeing in terms of opportunities arising from this situation, particularly since that competitor had significant, overlapping customers? What strategies are you implementing to capture additional market share following their bankruptcy?

Yes. I think it's making the market an 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 on security innovation and I'm sure you see there's certainly a surge here with two big releases in the last two quarters. We focused that not just on security efficacy but on 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 have far too little penetration on the cross-sell opportunity.

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

It seems that the recent increase in the business was more of a one-time event. Could you explain what factors were driving the media business this quarter? Are there any aspects that could potentially be replicated? Additionally, regarding the restructuring efforts, can you share where you've seen early successes? Are you still tracking the same overall cost savings, or have you discovered new ones? Is it possible that we've achieved some savings sooner than we anticipated?

We observed better-than-expected revenue from our top accounts. You are correct in noting that we are being cautious about projecting too much from these results into future quarters. It's important for us to acknowledge the volatility in this area and ensure that our revenue projections are accurate. A significant aspect of the growth rate and revenue results in Q3 is that we experienced a 20% year-over-year growth outside of the Top 10 accounts. We are beginning to gain momentum as we transition to target a larger market, acquire customers beyond the media sector, and build a more diversified and reliable business, which will enable us to achieve more predictable growth. This shift is closely tied to our emphasis on diversification and long-term sustainable growth. Regarding cost savings, we have been focusing on cost control, operational efficiency, and discipline for quite some time now, yielding consistent improvements. Our restructuring efforts were executed more quickly and efficiently than anticipated, contributing significantly to our better than expected operational expenses. Ron, do you have any additional input on this?

No, I think that's a good overview 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. When you mentioned acquiring business outside of media, can you describe some of those workloads and the data associated with them? Are they primarily software-based? Additionally, do you see these as new opportunities with significant growth potential, or are they just incidental business?

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. 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 seems 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. 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 two 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 non-media 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 clearly a priority for both XL and our new Chief Revenue Officer Scott, who has a security background. As we move forward after our recent restructuring, especially looking ahead to 2025, we are concentrating on aligning our research and development investments with a strong go-to-market strategy in security. I truly believe that security will be a primary focus area in 2025, not just in terms of R&D and product lines but throughout the organization. There is a significant amount of potential here. As mentioned in the first question, we have a lot of untapped opportunities for cross-selling. I'm witnessing strong momentum in our security sales efforts, particularly in acquiring new customers. With our recent product developments, we have a fantastic chance to leverage security as a means to attract new customers to our platform and to successfully expand those customers into our delivery and network services.

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

Okay, great. Todd, can you clarify the media side for me? It seemed like in Q3, your Top 10 customers remained quite stable compared to Q2, which is encouraging. I understand there may be some challenges within that. It sounds like you're still facing some seasonal headwinds in Q4 and there may be some conservatism involved, but I still have some questions. It also seems like you believe the worst is behind you. I'm trying to understand what gives you confidence that things will improve despite the challenges in Q4. Can you help clarify 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 reliable 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 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, etc. and what's happening here. And so this sort of better engagement hopefully will drive a faster return to growth for our media business but also a better projection and better building of our revenue model moving forward.

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

Sorry, I think you mentioned that large customers are working through their obligations. Do you have any visibility on when those obligations will be fulfilled and your position regarding pricing? Will you have a timeline for those customers? I know you've touched on customer retention, but with the CDN space facing significant pressure, are volumes coming in lower than expected, or are hyperscalers gaining market share? What explains the disappointing revenue across the industry? Additionally, could you provide more details about the applications your large customers are using?

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 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, which results in a little less 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 when those contracts come up for renewal.

Yes. Just looking at it through the lens of the whole market, I think we are seeing a little bit of a change here. There's been consolidation and there are fewer players in the space, and even fewer if you look at it from really full service edge platform players. And I think that has the opportunity to make the pricing environment healthier in '25 than we saw in '24. I'm 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 costs or any color around that from what you've experienced so far?

Yes. AI Accelerator basically brings the power of the Fastly platform to LLM style solutions. I think there's a video of me doing this demo. But the reality there is using a public cloud, the latency on relatively trivial questions 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 one of those requests has to go all the way back to our central cloud. And we can provide a fast speed of response here and bring those request 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. The most common is like a support chatbot use case with very easy developer onboarding, a single line of code. Customers can leverage the power of our semantic match, the power of the Fastly cache, 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.

I would like some clarification on the enterprise customer count. I know that the non-top 10 customer segment grew 20% year-over-year, which indicates a strong quarter outside of the top 10. However, I noticed an overall sequential decline. Could you explain the reasons behind this drop? Given the strength of the non-top 10, I wouldn't expect many to fall below your $100,000 threshold this quarter. Any additional insights would be appreciated.

I understand your concern and I investigated those numbers thoroughly. I was particularly careful not to notice any increase in customer churn, which I did not find, nor did I see any customers on the brink of churning. However, we do have many customers whose spending fluctuates above or below our metrics. When examining the average spending by enterprise customers alongside the total expenditure from non-top 10 customers, it conveys a similar narrative. We did see some customers dip below the $25,000 per quarter mark, which is reflected in the numbers. It's not an outcome I am pleased with, and we will be diligently working to ensure we stimulate growth in every account, including those midsized commercial and enterprise accounts, to guarantee that this figure consistently increases each 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 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 expect 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. When we bring those two 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.

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

This is Chris for Rishi Jaluria. I was wondering if you could give us an update on the efforts to improve 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. 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 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. I don't think we've 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 security mix in Q3, I think we can do a lot better than that, to be honest. I wasn't too pleased with 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 to Todd's point, 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 Madeline Brooks from Bank of America. I have two questions for you, but I'll start with the first. Was the strength in Q3 anticipated or surprising, especially considering the recovery you mentioned with a few large customers? Additionally, could you discuss the sustainability of these trends? Were there any one-time events, like the Olympics, that influenced this outperformance?

Yes, we experienced better-than-expected results in the third quarter as the quarter progressed. We noticed particular strength in live sporting events, including global events that featured medals. Additionally, we found strong performance in gaming, which was largely influenced by release timing, leading to better results than we had anticipated. As Todd mentioned earlier, we also gained market share outside of the Top 10, and the acceleration in that growth was stronger than we expected 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.

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