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Edited Transcript of FSLY.N earnings conference call or presentation 8-Aug-19 9:00pm GMT

Q2 2019 Fastly Inc Earnings Call

Aug 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Fastly Inc earnings conference call or presentation Thursday, August 8, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Maria Lukens

Fastly, Inc. - VP of IR

* Artur Bergman

Fastly, Inc. - Founder and CEO

* Adriel Lares

Fastly, Inc. - CFO

* Joshua Bixby

Fastly, Inc. - President

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Conference Call Participants

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* Brad Zelnick

Credit Suisse - Analyst

* Will Power

Robert W. Baird & Company, Inc. - Analyst

* Tal Liani

BofA Merrill Lynch - Analyst

* Jonathan Ho

William Blair & Company - Analyst

* Michael Turits

Raymond James & Associates, Inc. - Analyst

* Tim Horan

Oppenheimer & Co. - Analyst

* Rishi Jaluria

D.A. Davidson & Co. - Analyst

* Jeff Van Rhee

Craig-Hallum Capital Group LLC - Analyst

* Brad Reback

Stifel Nicolaus - Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Jessie and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. (Operator Instructions). Thank you.

I would now like to turn the conference over to Maria Lukens, the Vice President of Investor Relations. Please go ahead.

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Maria Lukens, Fastly, Inc. - VP of IR [2]

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Hi, everyone. Thank you for joining our second-quarter 2019 earnings call. We have Fastly's CEO, Artur Bergman; President, Joshua Bixby; and CFO, Adriel Lares, with us today.

First we would like to outline the format for this and future earnings announcements. We will publish a shareholder letter with our financial results on our Investor Relations website and with the SEC shortly after market close on the day of our earnings release. Since the shareholder letter provides a lot of details, we will begin each call with brief remarks before opening the line for questions. Our hope is that this format will in result be -- have greater transparency and provide a more open dialogue.

We would also like to remind everyone that we will be making forward-looking statements on this call. Today, Fastly will discuss the unaudited financials that were distributed on August 8, 2019.

Certain statements on this call include 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 this call. You should not rely upon them as [predicted] of future events.

All forward-looking statements that are made on this call are based on assumptions and beliefs as of today, and we undertake no obligation to update them. Please refer to our risk factors filed in the final prospectus in connection with our initial public offering, and those to be included in our quarterly report on Form 10-Q.

Also, our discussion today will include non-GAAP financial measures. These non-GAAP measures should be considered in addition to, and not a substitute for, or in isolation from, our GAAP results. A reconciliation of GAAP to non-GAAP measures is included in today's shareholder letter. The shareholder letter and accompanying financial tables can be found on our website at investors.fastly.com.

Finally, this call in its entirety is being webcast and will be archived on our website shortly after the call.

With that, I will turn the call over to Artur.

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Artur Bergman, Fastly, Inc. - Founder and CEO [3]

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Hello, everyone. Thank you, Maria, and think you all for joining us for this call. I want to start with a special thanks to all of our employees, customers, investors, and all the developers around the world who use us for the support, hard work, and -- gotten us to this point. Becoming a public company was a big step for us and we're very happy that we have done that.

We create a trustworthy Internet with some of the best customers in the world. And to do that, we really need the right people on our team. So we strive to be a company full of kind, honest, passionate, and ethical people. And to keep growing at a high rate and sustainable rate, we will continue to maintain that culture. So we have intentionally ground values first and scaled our workforce, services, and customer portfolio purposefully. And I'm proud to say that we've grown with integrity and we will continue to do so.

This afternoon, we issued a shareholder letter with detailed remarks which I encourage everyone to read. On this call, I would like to focus on a few key takeaways from our most recent quarter. We generated $46 million of revenue in Q2, up 34% year-over-year. Our dollar-based net expansion rate was 132%, up from 130% last quarter. Revenue from enterprise customers as a percentage of total last 12 months' revenue increased to 86%, up from 82% year-over-year. Enterprise customer accounts increased to 262, up from 190 year-over-year. We have added to our network and now have 64 POPs online, providing access to 52 terabits per second of global network capacity.

We continue to identify opportunities to drive leverage and expect to maintain our path toward profitability in the years to come. We have built a powerful edge cloud platform that fuels modern digital experiences, allows agile development as close to end users as possible. We really are powering the best of the Internet. Our platform enables high-quality, low-latency delivery of applications, content, security, and edge compute capabilities.

This edge cloud platform is based on three core tenets. Developers must be empowered to innovate. Platforms must innovate ahead of market demands while still being reliable, scalable, and secure. And vendors must provide exceptional flexibility and support. We will continue to increase developer demand for our edge cloud platform.

Our long-term growth strategy is -- will be driven by two key factors: winning new enterprise customers, and expanding usage from existing customers and partners. I believe that our results demonstrate continued success in pursuit of the strategy. And our team remains focused on building upon this momentum.

We will continue to invest in our edge cloud platform. We want to make it faster, more secure, and more flexible for our customers and developers. For example, we have our new edge cloud developer tools released this week that make it faster and safer for developers to discover, test, customize, and deploy edge cloud solutions with pre-tested, pre-baked solutions. We believe this will drive continued growth throughout the third quarter and the remainder of the year.

We're encouraged by recent progress. We're excited about our future. We look forward to sharing our progress with you for many quarters.

And Adriel, Joshua, and I would like to reserve the rest of this time for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Brad Zelnick, Credit Suisse.

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Brad Zelnick, Credit Suisse - Analyst [2]

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Congratulations on an initial quarter here as a public company. Great to see the strong results. I guess maybe just for starters, if I look at your cost of goods in the quarter, it was, at least percentage-wise, a little bit higher than we were expecting. And you commented in the letter and in your remarks that you are investing ahead of an expected strong second half.

But could you maybe just unpack your cost of goods? And if we look at them by their various components and then we look to your largest competitor in CDN, I know that they are talking a lot about capital investments ahead of an expected surge in OTT traffic.

Is that -- if we think of your business in terms of traffic mix in what it is that you're pursuing, are you going after that same opportunity? And how should we think about the mix of traffic on the platform? Thanks.

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Adriel Lares, Fastly, Inc. - CFO [3]

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Thanks, Brad. Hey, it's Adriel here, and thanks for joining us on the call; and again, happy to be here. So I think one way to think about it is -- we've talked about this before -- is we're building basically ahead of the second half. And from an allocation standpoint, we were allocating much of this CapEx ahead of time. From a percentage standpoint of, one, percentage of CapEx (inaudible) to total revenue, I still feel comfortable with where we will get sort of a 10% of revenue as a percentage of -- CapEx as a percentage of total revenue over the long run. And then this year, we're going to continue to make progress in that vein.

Some of the challenges here is we're -- we make these strategic bets around the world. And in terms of what we've seen in previous years, usually the first half of the year is where you'll see CapEx percentage of revenue higher than the second half; because normally, the second half, we've now made those -- we've signed up those contracts from a booking standpoint and you see the ramp over time.

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Brad Zelnick, Credit Suisse - Analyst [4]

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Thanks, Adriel. And if I could just follow up with another question. At the time of the IPO, at least a portion of the proceeds were intended to invest in building out your go-to-market. Can you maybe just give us an update? I know it's only been a couple, few months or what have you, but in terms of the progress in hiring, I mean the enterprise customer growth seems to be very strong. Was it 36% or 38%?

But from the leading indicators that you look to terms of the productivity and the ramp that you're seeing some of these hires, how do you feel you're doing relative to expectations?

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Adriel Lares, Fastly, Inc. - CFO [5]

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Yes, on the hiring front, I think we are on our expectations of where we wanted to be. We've gotten folks into sales and marketing, especially in the demand generation and account-based marketing initiatives. And so from that standpoint, I feel like we're on our expectations. In terms of the progress that we've made so far, you're right; it is a bit early.

But I'll let Joshua comment a little bit further on that.

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Joshua Bixby, Fastly, Inc. - President [6]

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Sure. Thank you, Adriel. Brad, thanks for joining. I think as we've talked about, this is an area that we have historically underinvested in. We are a company that has grown through word-of-mouth, for the most part. And we know that that's an area that -- with the proceeds of the IPO and with our intentions long-term of continuing the strong growth, we have to invest in.

It has been what feels like a very short two months since the IPO timeline, but we've made good progress. As Adriel said, we're on track from a headcount perspective. On the marketing, we're on track on the spend perspective. Now, these are large enterprise deals; so as you know, they do take time to work their way through. But all signs indicate really positive results from our investments thus far, but it is early.

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Brad Zelnick, Credit Suisse - Analyst [7]

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Awesome. And at the risk of being greedy, I just want to slip in one more for Artur. To us, perhaps the most exciting future opportunity is in edge compute. And with a lot of the capabilities that you most recently announced, Artur, can you maybe just talk about some of the excitement, maybe some of the leading use cases, and the confidence that you have in more and more compute and programmatic complexity actually occurring out at the edge? Thanks so much.

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Artur Bergman, Fastly, Inc. - Founder and CEO [8]

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Thank you. I mean, the demand for use cases of the edge compute kind of environment where you can do just more, ranges -- it's pretty wide. A lot of it has to do with personalization, content filtering, applying different rules at the edge for different users, so you can see this, I can see this; aggregating data from IoT devices so that you don't have to communicate all the way back to a data center, you can actually do most of the edge and then feed the data back. There are mapping companies that I've talked to that want to be much more creative in how they package the maps that you want to get.

These are all use cases that we perhaps could have developed in the past, but they are very specific -- some customers in the actual product use case. And we are seeing a lot of demand for customers to just go off and do that final bit of customization on their own.

We're also driven the GraphQL evolving standards around how to interact between clients and servers so that you can really assemble API requests at the edge; also drives the kind of demand for this.

And then I think last but not least, once you can deploy more code that does more that the edge, you can start evolving security introspection functionality that's very customized for your application and try and prevent attacks as far away from your data centers or your clouds as possible.

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Brad Zelnick, Credit Suisse - Analyst [9]

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Awesome. Thanks so much, guys.

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Operator [10]

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Will Power, Baird.

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Will Power, Robert W. Baird & Company, Inc. - Analyst [11]

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Thanks for taking the question, and all the allocated time here. Let me first just start from a high-level perspective. As you look at the strong year-over-year growth, the dollar-based net expansion rate improvement sequentially, I wonder if you could just talk from a high level as to what the key drivers are. I know video has been a key driver, live video. Maybe just help us break apart what those key secular themes have been that's driving that revenue growth.

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Joshua Bixby, Fastly, Inc. - President [12]

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Sure. Hey, Will, it's Joshua. Thanks for the question. There are a number of them. I would start certainly with edge compute and security. I mean, as Artur said, we continue to evolve edge compute, but we are by far the leader in that space and we continue to see incredible innovation. We came out, as Artur said, with the developer library that really is a collection of tools that help continue to push our strong leadership on the edge solutions space. So people are coming to us because they know that they can do more at the edge and they want that, and that is continuing to drive growth.

We continue to see, as we've talked about the past, a strong connection between our growth and the security needs of our customers. So we continue to see underlying growth in the security space, which if you look at the market in general, that should be no surprise. I think we're also seeing a strong demand in the live video, the higher-value side of that market, which is driving that.

I think as we start seeing edge compute, security, and the OTT growth, as well as some of the really nice tailwinds around 5G and other things that are coming forward, we're seeing a lot of important growth vectors. And I would say it's across those ones, for sure.

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Will Power, Robert W. Baird & Company, Inc. - Analyst [13]

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Okay, great. All right. And then maybe for Adriel, just to maybe come back to the earlier gross margin commentary. I wonder if you can just comment on what you're seeing competitively out there, whether there's been any meaningful shifts in the pricing environment, if that's contributed any of the weakness? It sounds like, again, it's more about investing in front of the second half.

And then I guess as part of that, how do we think about the gross margin outlook from here? Is that something that should tick up a little bit in the second half? And any thoughts, then, over the next couple of years from here?

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Adriel Lares, Fastly, Inc. - CFO [14]

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Yes, thanks, Will. I think to the second part of your question, yes, you should see some upticks for the second half. And in general, I'm comfortable in delivering gross margin leverage on the year-on-year basis. We talked previously in the past that our primary goal right now is to evangelize the Fastly solution, talk about edge compute, talk about all the benefits that you have coming onto Fastly platform.

And from our standpoint, we're not leading with price, but we certainly don't want to lose on price. There's too much opportunity out there. And we know that once a customer comes onboard to Fastly, we have our 98% retention rate, we've got our strong DBNER, and we want to take advantage of just bringing a customer onboard.

So we'll -- but there is the normal seasonality that we experience, which Q2 is no different, where we're getting ready to build ahead of time for the second half of the year. And so you should see leverage, both in gross margin and, as well, as in operating leverage over that time frame.

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Will Power, Robert W. Baird & Company, Inc. - Analyst [15]

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Okay, great. Thank you all.

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Operator [16]

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Tal Liani, Bank of America Merrill Lynch.

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Tal Liani, BofA Merrill Lynch - Analyst [17]

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Was there anything that changed since you went public until now that drove gross margin roughly 200 basis points below what you just told us a few weeks ago? Trying to understand the gross margin part.

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Adriel Lares, Fastly, Inc. - CFO [18]

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Yes, sure. One of the biggest differences just from Q1 to Q2 is Q1, as we talked about on the road show, had a particularly strong February which we, up until this point in the Company's history, we hadn't quote-unquote broadcast that particular sporting event in the past. And we had actually built CapEx-wise in Q4 of last year ahead of that period of time. And so we had the benefit of that one-time sporting event, which didn't replicate -- the football season doesn't go into Q2. So that provided us a bit of a bump.

But from a -- if you think about it, from a year-on-year basis, over a 12-month time frame, you actually do see gross margin going up on a year-on-year, 12 month basis. And so we should continue to see that trend over time.

But seasonally you have another factor in Q2. You have two 30-day months, so you have a little bit shorter amount of days for revenue. And so most of those pressures in Q2 -- I mean, that explains really the quarter-on-quarter contraction in gross margin. But overall, in terms of where I think gross margin will be from a longer-term perspective, I'm still confident in.

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Tal Liani, BofA Merrill Lynch - Analyst [19]

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Got it. Okay. The other question is: anything change in the revenue trajectory versus what you thought before? Or does it (technical difficulty)?

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Adriel Lares, Fastly, Inc. - CFO [20]

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Everything, at least from what I can see right now, still seems to be on course. We're continuing to win the deals that we need to go win, get the [POCs], and we need to get out there. It's -- we're still, I think, relatively a small player in terms of the number of deals that we're in. If anything, we're just not in enough parties to actually go and try to compete for that business, which is why we are ramping up sales and marketing now and into the end of the year.

And part of the balancing act that we're trying to do is grow revenue, grow share, while also delivering a discipline in leverage as well. So I think we're still continuing to do that. And at least, at this point, nothing has changed in terms of what I think we'll actually be able to go deliver.

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Tal Liani, BofA Merrill Lynch - Analyst [21]

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Great. Thank you.

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Operator [22]

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Jonathan Ho, William Blair.

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Jonathan Ho, William Blair & Company - Analyst [23]

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I just wanted to start out with some of your comments around the streaming business. Can you maybe provide a little bit more color on what drove the strength there? And if there's any marquee events, does that -- what does that mean for maybe future opportunities?

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Adriel Lares, Fastly, Inc. - CFO [24]

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I'll speak a little bit to that way -- I look at it from a finance standpoint, and then I'll see if Artur or Joshua have any sort of follow-up comments on that.

From my standpoint, I'd look at some of the marquee events, especially in Q1. And some of them, similar maybe some episodes in Q2 that came to a series end that I can't talk too much about; but, nevertheless, the -- effectively all the different providers there who -- they know who all the different edge providers can be and which ones are succeeding.

And the more that we win, they become beacons, if you will, of reference points for, wow, they can deliver this. They can deliver time to first view of sub-x or consistency of stream without interruption. All of that really does make a difference. And it enables our future -- our current and our future sellers to go out and win more of this business; which then gives me, from a finance standpoint, more confidence from a forecasting standpoint to, in this case, give the guidance that we are giving for Q3 as well as for Q4 -- sorry, as well as for the rest of the year.

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Artur Bergman, Fastly, Inc. - Founder and CEO [25]

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I think on the importance of these events, is absolutely a signal that we are now a player that can handle a very, very large event. And that's important not only because of the OTT events, but also when you go talk to large enterprise or commerce customers, because they know how large these events are. So for them, suddenly -- if you can handle the largest sporting event in the US, I just don't need to worry at all that you can handle my traffic. And so there is a very strong tailwind that that helps with.

And on the OTT side, we focus on the live streaming. And our underlying technology platform -- with the modern software-defined network, how we've architected it -- we are very, very well suited for the kind of traffic that live streams are. And there's a lot other traffic like that -- API calls during election, for example -- where a lot of people are just trying to get the same object. And that's -- we are really, really good at delivering that with a very, very consistent quality.

And as the OTT providers on live, especially in sports, are trying to get the delay from glass down short, [very] shorter -- we have a customer who is aiming for 500 milliseconds delay -- that consistency in the delivery at really high volume is key to them. So, platform-wise, we're very well suited to it. And it really helps us in all parts of the business to be able to say that we can deliver these events. Thank you.

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Jonathan Ho, William Blair & Company - Analyst [26]

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Got it. And then just as a follow-up, I just wanted to understand if you are seeing any shifts in the competitive environment. I know there's a few competitors that had outages during the quarter, but is there anything there or any opportunities that that creates?

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Joshua Bixby, Fastly, Inc. - President [27]

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Yes, great question, Jonathan. We have not seen significant changes in that. As you know, we're in the enterprise. As you see, the number of enterprise customers and the size of our deals. There were certainly outages in the small and medium CDN side of the business. But we continue to be laser-focused on the largest and those that aspire -- largest customers and those that aspire to be. And that targets directly in the legacy CDN space, and that environment hasn't changed at all.

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Jonathan Ho, William Blair & Company - Analyst [28]

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Thank you.

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Operator [29]

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Michael Turits, Raymond James.

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Michael Turits, Raymond James & Associates, Inc. - Analyst [30]

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First, Adriel, on CapEx, you came in higher on CapEx this quarter than was in our model. Wondering if there's a change in the outlook or prospects for the year on CapEx.

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Adriel Lares, Fastly, Inc. - CFO [31]

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Yes. Hey, Michael. From a year's standpoint, I still think CapEx as a percentage of revenue should be at or near where we were in 2018. And so we're still targeting that. As you can see, some of our investments in Q2 were much more timing-related as we think about what we see in our pipe in terms of our customers that we believe are going to be ramping up, which is reflected in our guidance. So nothing over a year or longer time frame has changed in that regard. It just might have been more timing from a quarter -- Q3 to Q2 basis.

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Michael Turits, Raymond James & Associates, Inc. - Analyst [32]

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Okay. And then a question on programmability, which is obviously being where you guys have been winning share. Maybe an update in two respects. One, in terms of your product roadmap there for advancing programmability. And secondly, your assessment of the competitive landscape in terms of whether or not others in the space are making any changes that will change your competitive advantage.

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Artur Bergman, Fastly, Inc. - Founder and CEO [33]

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Hi, Artur here. Thank you. On the product roadmap innovation side, we're investing heavily into a technology called WebAssembly, which is driven by us and a couple of large companies to create a safe and secure environment to run code. Initially it was to run code safely and securely on your desktop. And we have adapted that for server-side use and are involved heavily into the ecosystem, the WebAssembly ecosystem, to make that run very well on the servers and evangelize it. And one of the key things with it is that it frees us up to allow many different programming languages, and so customers can use a wide variety of those.

We have -- to help the adoption of this, we have open sourced a tool called Lucet, and that's part of our commitment to this technology and just help drive usage of it across developer base. We are very, very excited. One of the cool aspects of this technology is that every single request that we get from a customer, for an end user, will run essentially like -- well, equivalent to its own sandbox.

And so we can really offer a high degree of safety and security for our users, both for eventual potential attackers or if they have problems internally, we can help them detect that and mitigate that. So that's on the R&D side.

And on the competitive side, I'll hand over to Joshua.

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Joshua Bixby, Fastly, Inc. - President [34]

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Sure, thank you. The competitive landscape hasn't changed dramatically. I think we're definitely seeing, particularly from the legacy CDN players, a lot more developer-friendly overtures. So we're seeing a lot of marketing story arcs. But fundamentally our customers referred to the legacy providers and the anti-cloud, because you have to get professional services and engage on a non developer friendly platform.

So we have not seen any dramatic changes in the competitive landscape in the enterprise space, other than some marketing information that's come out. But competitively, we remain the dominant edge cloud and the only one today that really allows you to build the type of programmability that a modern developer needs.

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Michael Turits, Raymond James & Associates, Inc. - Analyst [35]

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Okay. Thanks, everybody.

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Operator [36]

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Tim Horan, Oppenheimer.

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Tim Horan, Oppenheimer & Co. - Analyst [37]

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Any particular customer segment or maybe any other more color on applications that are growing faster than what you've seen in the past? Or yes, any color on that would be great.

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Joshua Bixby, Fastly, Inc. - President [38]

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Joshua here. Thanks for the question, Tim. I wouldn't say that we've seen a dramatic shift in the overall base at all. We continue to see strong growth across the core verticals. If you think about areas like e-commerce, travel, high-tech, we continue to see a lot of really big brands who often are in a time of digital transformation. And that is often one of the precursors that brings us in.

So we'll see examples -- like Ticketmaster is a great example, where we've -- over the history of that business, as they have evolved their platform, they built us in early and are able to re-platform, which really is less of a shifting out of a vendor and more shifting in a platform. We see that type of evolution in a lot of those core verticals. High-tech follows that same pattern.

I think on the platform side, we continue to see growth. As we've talked about in the past, we believe very strongly that the way into the SMB market, the most efficient path is through platform vendors where we sell to one vendor and they are able to sell to hundreds of thousands of customers.

And we continue to see strong growth, but I wouldn't say it's anything outside of the historical norm. They are all growing. And I think the edge delivery and programmability continues to anchor, along with the security use cases.

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Tim Horan, Oppenheimer & Co. - Analyst [39]

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And maybe just a touch more color on edge compute. I know you are saying you are well, well ahead of your peers, and it clearly appears to be the case. And is WebAssembly an example of this, where you do need the programmability at the -- or developers need the programmability and other features and functionality, especially in this new toolbox that you've rolled out.

And I guess, given that this is a brand-new market, do you have a sense of what percentage of revenue that can ultimately get to? And maybe what it is now, even? I know it's very small now, but yes, any more color would be great.

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Artur Bergman, Fastly, Inc. - Founder and CEO [40]

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I think -- it's hard to say that percentage of revenue. But a large amount of our customers, to a certain degree, use our edge compute capability. And so, quite often, not very much; but it is accelerating. And I think we'll continue to see that accelerating over time. And the use cases are really -- as Joshua said earlier, really diverse.

What I find really interesting is even if you take something that's ostensibly sounds kind of -- why would it need edge compute? So OTC live streaming. Well, it turns out that if you can personalize ads and do real-time ad insertion at the edge, that's the most efficient place to do it, the fastest way to do it, and it can drive more revenue to you because you're not showing everyone the same ad. To do efficient ad insertion for each individual user, you need edge compute capability. So we are seeing it advance functionality across a lot of different -- most areas of the business.

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Tim Horan, Oppenheimer & Co. - Analyst [41]

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That's very helpful.

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Operator [42]

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Rishi Jaluria, Davidson.

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Rishi Jaluria, D.A. Davidson & Co. - Analyst [43]

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First wanted to start off by asking about international. Wanted to see what your traction there looks like. We did see the announcement recently about you expanding your Australia presence. So I think any color you could give in terms of international traction, be it with local companies out there or with just the international parts of American companies, I think that would be helpful. Then I've got a follow-up.

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Artur Bergman, Fastly, Inc. - Founder and CEO [44]

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The international we told you about is we classify the traffic based on where it happens. But for revenue, we attribute that to wherever the customer is based. So the growth that we're seeing when we talk about international numbers in the roadshow is from customers in those regions.

And we're seeing that the strategy of being that we enter a region for our existing customers -- that's how we have the justification to build a physical presence. And as we build those networks up, we start getting local customers who notice this network and want to work with us. And once we have a mass of those, that's when we start investing people into actually selling into those markets.

And we have -- we have had really good success with this. International is accelerating, and we're going to keep on. As you said, Australia, where we have a really fantastic network, being with four POPs in Australia, two POPs in New Zealand. And so we think that's a large untapped market.

Europe is behind the US when it comes to digital transformation. And so what we're taking and doing here is very much applicable around the world. And since they are a little bit behind, like we're actually really well positioned to help them.

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Adriel Lares, Fastly, Inc. - CFO [45]

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And Rishi, it's Adriel. Just a quick follow-up. So the actual revenue contributed internationally in terms of just where the billing locations are was 30% in Q2.

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Rishi Jaluria, D.A. Davidson & Co. - Analyst [46]

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Thanks, guys. That was helpful. And then I just wanted to ask a little bit about the gaming opportunity. Like, we've had some of your competitors out there talking about capitalizing on gaming opportunity and maybe (technical difficulty) things like live streaming, which is probably at the intersection of gaming and OTT, and even on these cloud gaming platforms down the line.

Would love to get a sense from you how are you thinking about the gaming opportunity, and is that something that you think you can probably capitalize on that secular tailwind. Thanks.

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Artur Bergman, Fastly, Inc. - Founder and CEO [47]

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I think -- this is Artur. Thank you. I think it's definitely -- it is a large growth area. And as the gaming companies also are adapting to an online world in a way where it's not just downloading a game and moving to more modern architectures, we do see a lot of opportunity around delivering part of the game experience, delivering the APIs around it, delivering metadata, and doing -- enhancing that with edge compute to give personalized experiences through those games.

We have some really good gaming customers. And we do believe that there is a large growth area for us, and that the evolution of the edge computing platform fits really well with that.

We also do help the live streaming of games. And going back to my comment earlier about the time from glass, latency sensitivity, that's an area in e-sports where they really want to be as close as possible. And being 15, 20 seconds behind is not acceptable. So we have customers in that segment.

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Rishi Jaluria, D.A. Davidson & Co. - Analyst [48]

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Great, that's helpful. Thank you.

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Operator [49]

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[Jaysic Rico], Citi.

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Unidentified Analyst [50]

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I wanted to return to the question of CapEx and maybe to the sources of the CapEx spend. Because in the entirety of 2018, you spent around $19 million. And just in the first half of this year, you spent $21 million in CapEx. And in the most recent quarter, it was $12 million.

So I was wondering, could you help us un-bucket the sources, the kinds of projects that you are invested in, especially in Q2, that contributed towards this larger number.

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Adriel Lares, Fastly, Inc. - CFO [51]

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Sure. So as I mentioned earlier, as a percentage of revenue, I do expect over time that that should get to about 10% of revenue overall in CapEx, and that's inclusive of around 2% of software capitalization. So as a percentage of revenue in 2018, we were probably sitting somewhere around 13%. And so I think we'll probably land somewhere in that range in 2019.

Keep in mind that in 2018, 2018 benefited a bit from a big investment we did in 2017. And there was a large investment we did across the network to upgrade, I believe, the protocol in terms of -- we went from a 10 to a 100 gig Internet -- either 100 gig Internet ports in the back, which really upgraded the entire network. Which that alone in terms of doing that with the Fastly network, I would find would be a real challenge for any other provider to do that. So if you sort of streamline those two years, it would average out a little bit more smoothly versus the bump that we did in 2017.

But returning back to your question, there was again a bit of a front-loading in the first half of 2019. But I still expect for the second half of the year, you won't see nearly that amount of CapEx in the second half of the year.

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Unidentified Analyst [52]

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Just turning to the nature of projects, was this due to geographical expansion? What were you invested in?

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Adriel Lares, Fastly, Inc. - CFO [53]

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Yes. There's a bit of it in Q2 with a much more APAC expansion in terms of -- as our customers, in some respects, pull us there to serve traffic in those areas. Then it allows us to actually sell into those areas more prospectively.

But in general, it was overall traffic growth, signals that we were receiving from regions like APAC and EMEA; but as well as just overall signals we were receiving in terms of bookings, in terms of overall traffic growth.

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Unidentified Analyst [54]

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Just maybe as a last question, because what this brings me is probably one of the key questions on people's minds right now. And that's you do compete against very well geographically diversified, albeit [clumsy] incumbents. And the question becomes, does this level of CapEx spend become really a semipermanent part of your strategy as you are entering this new stage of competition that reaches across geographies?

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Adriel Lares, Fastly, Inc. - CFO [55]

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I think if I understand your question correctly, given where we're competing would -- are we seeing that this is driving CapEx dollars as a percentage of revenue -- putting it as a percentage of total revenue here. Would that change the guidance, at least the perception of where we would go in the future? And the answer is no.

I think that what we're beginning to realize and what you'll see overall in gross margin is many of the investments that are needed to get us to a point of scale, especially in a lot of the fixed cost areas that incrementally are unrelated to bandwidth and some of the servers that are deployed worldwide, we do a lot of catch-up to get for enhancing 24 by 7 support, customer support, technical account managers, et cetera, et cetera.

As we grow, we will get scale on this and we realize scale in those areas. But that is what drove a bit of the impact in Q2, as well as the preparation for the second half of the year. But there's nothing at least that I've seen so far that moves me off of our efficiency in terms of where we need to be, long run, as a -- in terms of CapEx of percentage of revenue sort of around 10%.

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Unidentified Analyst [56]

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Okay, thanks very much, Adriel.

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Operator [57]

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Jeff Van Rhee, Craig-Hallum.

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Jeff Van Rhee, Craig-Hallum Capital Group LLC - Analyst [58]

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Just a couple for me. I think in terms of the pipeline, maybe you guys just spend a minute and expand a bit more there. I'd be curious if you see any variability in terms of what's working through the pipe. Obviously you've had some very large, high-profile events. Are you seeing that result in a very notable shift in, say, deal sizes in the pipe? Use cases, verticals, et cetera, just maybe a little more color in terms of any variance of what's coming to the pipe.

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Adriel Lares, Fastly, Inc. - CFO [59]

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I'll take a stab at it first just from a finance standpoint. I think some of the -- in general, when we're bringing on a customer of any size, I think it's really more of the opportunities that are getting bigger. But in general, customers who come onboard, there is a ramp period. So you will see a ramp period and that hasn't changed. But I think the size of the opportunity in terms of what we actually are being invited to take on is increasing in terms of the names of those opportunities. And the scale of those opportunities certainly is growing.

In addition to that, as we expand our solution into areas that then make our solution more attractive for areas like e-commerce or financial services, and many of those areas are dependent on having qualifications like SOC 2 or PCI or security offerings such as web application firewall -- as we add more and enhance our solutions, we're able to win those faster and ultimately ramp those faster.

But in general, nothing has changed other than the size and the scope, which is incrementally changed. I didn't see anything significantly different, although I will say we probably got a lot more inbounds post- our little event in Q1. But that's my perspective.

Joshua, if you have some two cents on your side.

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Joshua Bixby, Fastly, Inc. - President [60]

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No. The only thing I would add is that the publicity around the IPO was also very helpful. We're certainly seeing larger deals, and some change to how that pipe moves in the sense that people can look at us and they can see our financial position, and that has certainly helped.

But we are seeing some larger deals. We're definitely, I think, seeing the potential to see, at least over the long-term, some of those timelines come down in terms of the sales cycle. But as Adriel said, we're not seeing a dramatic shift in any underlying vertical, per se.

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Jeff Van Rhee, Craig-Hallum Capital Group LLC - Analyst [61]

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Got it. Fair enough. And then I think in terms of the business in the quarter, any variance with respect to the usage versus committed percentages? And then one other housekeeper on the DBNER: just a little -- maybe an update on your thinking about that nice uptick in the quarter, thoughts next 12 to 24 months in terms of how you think that trends.

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Adriel Lares, Fastly, Inc. - CFO [62]

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Sure. It's Adriel here. I'll take the second part of your question first. So on DBNER, we talked a bit about, over time, that will likely come down. And all of our teammates here at Fastly, we focus on delivering just the best of service to our customers. We feel like we have innovated a lot with partners like Slack, when we are offer Slack support for many of our customers.

And from our standpoint, to the extent that we keep doing that, we feel like that puts upward pressure on DBNER. And the extent that we can, with a typical account manager, show and educate our customers on all the solutions and the possibility that you can in terms of moving traffic over to us.

So we think those are all upward pressures. Although at the same time I'm -- as a finance person, I'm well aware of the law of large numbers and the challenges associated with that. So I was very happy to see the uptake quarter over quarter in DBNER. But again, I think it's one of the things we work on 24 by 7, all the time. But I can't sort of -- nothing has changed my tune about eventually we'll see some attrition there. But at least, so far, we're focused on keeping that as high as we can.

In terms of your first question, nothing changed from a split standpoint, commit versus usage over the commits. Still around 50-50 and I don't expect that to change too much to the future. And if it does change significantly, we'll certainly let you know.

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Jeff Van Rhee, Craig-Hallum Capital Group LLC - Analyst [63]

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Yes, great. And last one for me then, I'll -- just on the sales reps, where are you now, rep-count wise? And then -- I mean, you obviously came into the year and out of the IPO looking to add a lot of capacity. Are you finding the heads? Are you finding the pace? Are you onboarding them at the pace? Just maybe a little more color about the sales adds, the ability to find them, and any -- it may be a little early to get a sense of incremental ramp, but any thoughts on ramp as well?

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Adriel Lares, Fastly, Inc. - CFO [64]

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Yes. I think as you can see from our total headcount at 544 at the end of Q2, in general everything is going the way that we expect it to. And we still have a target rep count somewhere around 60 by the end of the year, and we still feel like we're on track to hit that number. So from that standpoint, I still feel like things are in line with what we expect.

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Jeff Van Rhee, Craig-Hallum Capital Group LLC - Analyst [65]

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Fair enough. Thanks.

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Operator [66]

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Brad Reback, Stifel.

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Brad Reback, Stifel Nicolaus - Analyst [67]

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So many of mine have been asked. But maybe on the pricing front: Adriel, as you look at longer-dated customers, as they come up for renewal, what have been the pricing trends there? Thanks.

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Adriel Lares, Fastly, Inc. - CFO [68]

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Thanks, Brad. Nothing has changed too much on that front. There are still situations where, if a customer is coming up for renewal -- and I sort of generally think about our business as we're still an evangelical sale -- but given the fact that our DBNER is 132%, and that encapsulates renewals into that metric -- so I still feel like we're doing a good job there. And so from our standpoint, it still takes a lot of work. And the way that we can reduce pressure on renewals is to continue to not talk to a customer at renewal time but continue to deliver great service and great support throughout the year. So from that standpoint, nothing unusual has changed in Q2 as it relates to that.

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Brad Reback, Stifel Nicolaus - Analyst [69]

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Great. Thanks very much.

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Operator [70]

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(Operator Instructions). Michael Turits, Raymond James.

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Michael Turits, Raymond James & Associates, Inc. - Analyst [71]

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So maybe you explained this and I missed it, I'm sorry, but -- so, are you saying, Adriel, that in the end COGS is about where you would have expected it for the full year and this is just a pull-forward sort of like a CapEx? Or COGS is going to end up higher than expected for the year? And if so, why is COGS higher but CapEx is not? What's the difference in where you need to invest?

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Adriel Lares, Fastly, Inc. - CFO [72]

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I think it's former. But I would replace COGS with CapEx in the sense that overall CapEx, on an absolute and as a percentage basis, given where we've given guidance, should be about where we expect. It's really more of a pull-forward to that. As you -- again, if you pull the CapEx forward and you start the depreciation at that time, so there may be -- what we're assuming there is that over time as the depreciation starts to kick in, COGS as a percentage should still hit the numbers that we want to deliver overall gross margin leverage year on year.

So think about 2019, we should be able to deliver gross margin leverage relative to 2018. And what you see in Q2 specifically is gross margin was up year on year. What you saw the difference there being is that Q1 to Q2, you didn't have that one event in Q1. And then as we get ready for Q2, it sort of depressed it a little bit before we get to the second half.

Does that answer your question?

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Michael Turits, Raymond James & Associates, Inc. - Analyst [73]

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Sort of. I was just wondering if COGS as an absolute number ends up higher for the year. And, if so, is that just because you push CapEx forward and you are depreciating earlier? Or because your expenditures outside of depreciation in COGS are higher?

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Adriel Lares, Fastly, Inc. - CFO [74]

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If COGS is going to be up on an absolute basis, it's because revenue should be driving that up as well. And the reason we're then investing in CapEx ahead of time is because we expect the revenue to continue to grow.

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Michael Turits, Raymond James & Associates, Inc. - Analyst [75]

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All right. Okay, thanks.

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Operator [76]

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There are no further questions. I turn the call back to the presenters for any closing remarks.

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Adriel Lares, Fastly, Inc. - CFO [77]

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This is Adriel. I want to thank everybody for joining us on our first public conference call. We look forward to seeing you all out on the road. We're going to be at the KeyBanc conference on Monday, and we look forward to seeing you out on the road.

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Operator [78]

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