Fastly, Inc. (FSLY) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Fastly Signs Definitive Agreement to Acquire Signal Sciences Conference Call. [Operator Instructions] Please be advised that today's call is being recorded. [Operator Instructions] I would now like to turn the call over to your speaker today, Maria Lukens, Vice President of Investor Relations. Please go ahead.

Good morning, everyone, and thanks for joining us in such a short notice. As you've seen by now, we announced the signing of a definitive agreement to acquire Signal Sciences. Joining me today to discuss the transaction are Fastly's CEO, Joshua Bixby; Chief Architect and Executive Chairperson, Artur Bergman; and CFO, Adriel Lares. During this call, we will make forward-looking statements, including statements related to the potential acquisition of Signal Sciences and expected timing of closing and the anticipated benefits of the acquisition to our business 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 more information about the proposed transaction, please see our 8-K that we filed this morning. Please also take a look at our other filings with the SEC, in particular the risk factors, within those filings for a discussion of the factors that could cause our results to differ. Also note, the forward-looking statements on this call are based on information available to us as of today's date. We disclaim any obligation to update any forward-looking statements, except as required by law. Finally, this call is being webcast and will be archived on our website shortly. With that, I'll turn the call over to Joshua.

Thanks, Maria. Hi, everyone, and welcome. We are incredibly excited to announce this proposed acquisition. As you know, we provide innovators with a programmable, reliable and secure edge cloud platform that developers adopt as their own to fuel modern digital experiences and their company's digital transformations. We are built by developers, for developers, and they have been looking to us to provide a unified web and API security solution. The rationale for this deal is quite simple. It significantly broadens our security portfolio with the tool of choice for modern developers, which will further boost the wide and rapid adoption of Fastly's Compute@Edge. The blueprints being developed by our innovative customers using Compute@Edge have critical applications moving to the Edge. When applications move to the Edge, it is imperative that security moves with it. Signal Science is close to modern applications and trusted by modern developers. This acquisition will bring 2 like-minded developer-centric companies together to create a unified offering. Together with Signal Sciences, we will give developers and security teams what they want and faster than we could have done on our own, and this acquisition will also accelerate our path to fulfilling our long-term model. Under the terms of the definitive agreement, Fastly intends to acquire Signal Sciences for approximately $775 million, subject to customary adjustments for transactions of this nature. This includes $200 million in cash and $575 million worth of Fastly common stock, with the number of shares based on a floating exchange ratio subject to a 2-way price collar. This does not include our retention pool of $50 million worth of restricted stock units. We expect to close the acquisition in 2020, subject to certain customary closing conditions, including receipt of required regulatory approvals. Since our founding, almost 10 years ago, we have been focused on providing agility and visibility and limiting the pain of choosing between scale, speed and security. We built a powerful serverless edge cloud platform designed from the ground-up to be programmable and support agile software development. Ours was and is the ideal solution to power the DevOps movement. Today, similar to what challenges Fastly set out to solve 10 years ago, the security market still lacks agility, speed and visibility. Developers are reinventing the way we live, work and play online with fast and highly personalized experiences. They need to deliver these experiences at scale while simultaneously maximizing performance and security. But traditional security tools just aren't suited for that. At the same time, attackers, who are also developers, are taking advantage of these shortcomings. For quite some time, we have recognized the need to extend that agility of the DevOps movement directly into the security world, and finally, giving defenders tools to be more nimble and agile than their attackers. As entire applications are migrating to our edges, in an ever-increasing trend that our Compute@Edge is powering, it has become even more critical that security moves with them. To give developers and security teams what they want and need, we envision a unified security solution to protect web applications and web APIs at the Edge close to users and far from sensitive corporate data and resources. We imagine a solution that detects threats and respond to them, regardless of threat type, and most importantly, makes it simple for developers and security folks to deploy, configure and manage within their development workflows. Together, Signal Sciences and Fastly will fill this need and make our long-held vision a reality. This acquisition enhances our existing investment in security and accelerates our vision of a unified developer-centric platform that marries together delivery, compute and security. As we've envisioned this next-generation solution and thinking about which like-minded innovators might build it with us, it was really important for us to remain true to the culture, values and vision that are at the very heart of Fastly. Enter Signal Sciences. Similar to how Fastly was born from our founders' desire to support a global community knowledge sharing platform Wikia like no existing offering could, Signal Sciences was born to solve an unanswered problem in defending one of the world's largest e-commerce sites, Etsy. The founding teams were early DevOps and DevSecOps trailblazers. Their work in protecting Etsy propelled them to create Signal Sciences, offering a new approach to security to an eager market. They built a developer-first, extremely powerful security platform that provides full protection from the latest web and API security threats. Signal Sciences platform is all the things Fastly loves: User-friendly, fully programmable and able to deliver the best visibility we have seen in any security product. Plus, they see the world the same way we do, focused on the security dimension of DevOps and traditional IT workflows. This powerful integrated new way of providing security will further unlock the innovation and creativity that is powering those who are newly embarking on their digital transformation journey or natively born into the new digital age. To top it off, Signal Sciences has also earned tremendous devotion from its customers, similar to the level of customer loyalty that we prize at Fastly. They have a 99% 5-star reviews on the Gartner Peer Insights review site. So we have every confidence this acquisition will bring enormous value and service to our current and future customers. Signal Sciences' technology rounds out our forthcoming security offering, Secure@Edge, by enhancing our detection and response capabilities to our speed and scale. Signal Sciences and Fastly's DDoS solution complement each other nicely. Fastly's is aimed at protecting against a high volume of attacks and Signal Sciences focuses on detecting and responding to highly advanced attacks. Both are important to customers. So our future offering will combine the best of both solutions. Similarly, with our WAF, Fastly's solution sits at the edge and is extremely fast, which is required for delivery. And with Signal Sciences, we gain smart application protection capabilities. Specifically, from a web application and API security perspective, Signal Sciences' product provides amazing customer value in bot management, account takeover protection, rate limiting, API protection and Web Application Firewall. It also completes the feature set of Fastly's API gateway, and it creates an opportunity for Fastly to protect not just web applications but also secure the core cloud in the future. Our company's vision has always been to provide the primitives and products our customers need to solve their business problems. Even as our security offering expands, we will continue to support our customers when they want to use a third-party security provider by making integration easy and straightforward. We firmly believe in the value of this acquisition for 2 important reasons. The first is ease of integration. Safely integrating new technology at the edge is extremely difficult, but this is exactly what we've built our Compute@Edge framework to do. Originally, we built Compute@Edge's transformative architecture to allow our own developers to safely innovate at the edge a valuable capability that we then extended to our developer customers. Now Compute@Edge will enable us to quickly integrate Signal Sciences' powerful solution into our existing edge platform, reducing risk, increasing value and ensuring global scalability without sacrificing performance. Second, it accelerates adoption of edge computing. Signal Science will help us solve for the emerging web application and API security threats when applications are delivered from the edge. We believe this will accelerate the adoption of edge computing and the movement of more and more code to the edge, creating a flywheel effect for uptake of our Compute@Edge solution. We see a unique and emerging fit between Signal Sciences' technology, the security features we already built and what we imagine Secure@Edge to become. Signal Sciences' business is strong. Their total customer base of 265 customers includes over 60 enterprise customers, of which approximately 70% will be brand-new enterprise customers to Fastly. Signal Sciences has a lot of great customers. As you can see on their website, they have some of the best-known brands, including Duo Security, Datadog, Under Armour, Twilio SendGrid and DoorDash. They also have 5 of the top e-commerce companies, 5 of the largest software companies and many others in the financial services, retail, health care, media and entertainment, manufacturing and educational sectors. Signal Sciences' ability to attract large and highly security-conscious customers proves the value of their offering, and we believe it can further unlock potential for us. Signal Sciences protects over 40,000 applications. They have a Net Promoter Score of more than 80. Signal Sciences had a strong second quarter and ended June 2020 with $28 million of annual recurring revenue, growing at an even faster annual revenue growth rate than what we delivered in Q2 2020. This speaks to how essential and high-end demand Signal Sciences' technology is, especially during this time when so many companies are accelerating their digital transformations. Their gross margin is over 85%, and they have a gross retention rate of over 96%. Clearly, Signal Sciences has built an amazing company with a ton to be proud of. Finally, we are beyond excited and humble to add the talented Signal Sciences team to the Fastly family. They are also becoming our newest shareholders, and we are humbled that they have chosen to join Fastly on our journey to create a more trustworthy Internet. I can't wait to see what we will build together. Now I will hand the call over to Adriel to walk through additional highlights of this transaction.

Thank you, Joshua, and thank you, everyone, for joining us today. I share Joshua's enthusiasm about the addition of Signal Sciences' security product portfolio to our platform, which I know will only enhance the attractiveness of our customer offerings. From a financial perspective, Signal Sciences adds immediate top line growth, scale and gross margin accretion. On our Q2 2020 earnings call, I talked about how we are well positioned to execute on our growth strategy, and Signal Sciences will further enhance our ability to drive revenue growth. We believe the expanded technology capability that Joshua outlined will help us win new customers. We also believe that these capabilities will drive increased consumption of Fastly's current platform offerings, including our Compute@Edge solution. Specifically, our work with Signal Sciences to date shows that there is a tremendous opportunity to attract existing Signal Sciences' customers to Fastly's platform while also increasing our existing customer base's usage at Fastly's new security capabilities. Security continues to be a focal point for all customers, and this transaction better positions us to win the growing number of customers who see security as a critical component of the decision-making process. In sum, this transaction will allow us to drive revenue growth by accelerating our account penetration, acquiring new customers and bringing additional value to existing customers from both companies. The rapidly growing base of recurring revenue we are adding to Signal Sciences' security software also has an attractive gross margin of over 85%. The addition of this new revenue stream will enhance and accelerate the margin expansion path we have been focused on here at Fastly. With this growth, and gross margin accretion, we also expect an accelerated path to our long-term model with continued improvement across our P&L. We remain focused on driving operating leverage and go-to-market efficiency without compromising growth. Also, much like Fastly, Signal Sciences brings a highly skilled team and customer-focused culture with strong recurring relationships, both with industry-leading retention and expansion rates. We will not be providing any updates to our Q3 or full year 2020 guidance at this point. We intend to close the acquisition in 2020. And on our third quarter 2020 earnings call, we plan to provide Q4 and updated full year 2020 guidance that reflects the combined company's operating plan. In closing, as Joshua articulated, we strongly believe in the tremendous strategic value of this acquisition, which we are confident will enhance our ability to drive sustainable, long-term growth. Signal Sciences significantly broadens our security offering and positions us well to continue to execute on our road map to profitability. Signal Sciences' shared focus on the developer and on the security dimension of DevOps aligns perfectly with our Secure@Edge vision and dramatically accelerates our ability to realize that opportunity. As our focus on innovation continues, we are thrilled to welcome Signal Sciences' high quality talent, which includes 150 security-minded team members to help us continue executing on our product strategy and road map. Thanks to both companies' shared customer-focused DNA, we believe there will be a natural synergy and dynamic working relationship between our teams. Simply put, both companies build products to solve our customers' problems and are devoted to serving those customers. And with that, I'd like to open up the call for questions.

[Operator Instructions] Your first question comes from the line of Brad Zelnick with Crédit Suisse.

Great. Congratulations to all of you all around. I mean this combination to me seems like -- as natural as peanut butter and jelly, if you will. I've got 2 questions. Maybe first for starters. I recall part of the value proposition for Signal Sciences had been in its ability to provide customers with protection across CDNs and across different clouds. And you mentioned 30% overlap in the customer base. How should we think about the mix of underlying platforms that their customers are using? And I could see the opportunity that you mentioned to bring some of their customers on to Fastly. But are there any potential dissynergies that you can see out of the gate?

Brad, it's Joshua. Certainly, we are as excited as it sounds like you are about this. I think that part of what we've seen here is this incredible synergy. And as you know, we have a whole slew of products that sit behind other CDNs. We've got our cloud optimizer, we have our media shield, we have a number of products. And so we actually see this as an additional opportunity and additional synergy rather than dissynergy. I think that we are seeing opportunities here where security and edge are coming together. And one of the biggest motivations for us in all of this was just how important this is going to be, as I said in the remarks around bringing Compute@Edge to applications that are moving to the edge. And I think that's a really important element of this. So we actually -- because we sit in many cases, in multiple locations, not just at the edge, but in this really interesting additional tier, both the optimizer tier and the shielding tier, we see these as opportunities. What our customers are asking us is to be a neutral third-party where they can bring their security, their logging, all the visibility they need and everything that is required because we are moving into a multi-cloud world. There's no question that, that's what our customers want. And they want that ability to have the control to deliver load balance content to those clouds and work with them. And for certain types of customers, they also are looking for a multi-edge world that applies to certain verticals more than it does to others, but we actually see all of that as a really significant opportunity.

Got it. That makes perfect sense. And maybe just a comment, if you can, on the tech integration. Specifically, what -- I mean really compelling gross margins that you shared with us for Signal Sciences. What infrastructure are they running on today? And how do you envision that migrating on to your infrastructure over time?

Sure. Let me answer the first part of that, and I'd like to hand that off to Artur because he's been very intimately involved in some of that planning. I think at a high level, we see a tremendous synergy here. And I think one of the things that we absolutely see is how important Compute@Edge is in this. And I alluded to that earlier as well, but I think a key point here is we built Compute@Edge to take this incredible -- incredibly powerful, globally scaled performance platform and build application logic on it. And that's not just for our customers. It's also for us. And so if you look at this deal and other future opportunities for us, we now have this platform that has gone through this rigorous testing that is being worked on by some of the largest companies in the world, as we speak, and it's showing this incredible promise. So part of what's so exciting is leveraging the promise we've made outside the company, inside the company, which makes this easier. But I'll hand this off to Artur to give you a bit of a better sort of story arc around the actual technology and integration.

Great. So the -- there are a bunch of different products that Signal Sciences have, and we're going to work through especially how that integration works. But at a high level, they're -- if you take their cloud WAF products or the part of the product that they have with their customers right now, the idea is to take that and run it on top of the Compute@Edge platform. And as Joshua mentioned, it really is the fact that we have this Compute@Edge platform that makes me and the team really confident that this integration will be smooth and really just running on top of the infrastructure that we have for the customers who are currently using cloud WAF and for new customers on the shared platform.

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

Great. I guess I'd echo my congratulations, seems like a really nice strategic fit. I wondered -- I guess a couple of additional questions. So it sounds like a number of new growth areas within securities. As you think about the $28 million ARR, any further color you're able to provide on the breakdown of the key drivers of that? I mean it sounds like they had terrific revenue growth in Q2. I guess I'd be interested in kind of key drivers behind that and how concentrated the growth is versus broad-based across their portfolio. And I guess just kind of along those lines, I'd just be curious to kind of get your sense for what the applications are that you're most excited about that they're bringing to the table that you'll integrate over time here?

Sure. Let me take this sort of broad question and then hand it off to Adriel to give you a little more perspective on the revenue side. But I think you're seeing it the same way we are. This is incredibly unique. If you look at their strengths, and I talked about this in our earnings call last quarter, that we're really seeing companies being divided very quickly into those that are necessary in this wave of digital transformation and those that aren't. And I think the fact that Signal Sciences had such incredible growth in Q2 in one of the hardest quarters, as we know, on history, certainly modern history for companies, it tells you a lot about the incredible importance that they bring. And I think that importance is tied exactly to the same themes as we've seen in our own business, which is, as companies look to digitally transform, they are looking to the innovative businesses out there who have already done transformation. I mean they're testing their eyes around their industries. And I think what is particularly exciting about this company is the number of enterprise customers that they have. When you look at the maturity of the business, what is particularly impressive to us is how many enterprise customers they have and the quality of those customers. So what that tells you is they've been able to work through a lot of the challenges. It's hard to get into financial institutions. It's hard to get into top e-commerce stores and do that at a massive scale. One of the great synergies that we have with them is the story of coming from a customer, right? When you're at a customer and you're extremely frustrated about what exists, you rethink the problem through a different lens. And, I think, one of the things that we've seen is just a different way of thinking. This is a group that wants to empower developers. They believe in developers. They want tools to be easy to use, not require a tremendous amount of tuning, and work right out of the gate. So I think from a general sense, we were -- we see real strength in the enterprise, financial services. We see real strength in traditional industries that have very high standards and that require extremely rigorous, both scale and compliance. So that's something that allows us to take our global scale and our global customers, and I'm very excited about what those opportunities will bring. I will pass it on to Adriel to give you a little bit more color on the revenue in terms of distribution. So Adriel, I think we have some of that information.

Yes, we do. Thanks, Joshua. As Joshua mentioned, there's really good alignment in terms of the enterprise as we've defined it those customers that [ generate ] over $100,000 over a 12-month period relative to Fastly. They're -- if you think about their 63 [ of ] 265, it's about a little bit 20%. We're sort of little bit below that, around 15% of our enterprise versus our total customers. So they're very much focused on sort of that higher end which -- I mean it aligns quite nicely with us. In terms of sort of the most recent growth, definitely feels like it's a bit broad-based. And they've been able to do that sort of broad-based growth also without too much customer concentration. So for them, they have no single customer that's greater than 5%. But their top 20 customers account for 35% of their total revenue. So I think there is a sort of a similar alignment. And I think given the fact that we talked about on our last earnings call that for Q2, the innovators are the ones growing through the pandemic, I think they're sort of experiencing sort of a similar phenomenon.

Your next question comes from the line of Rishi Jaluria with D.A. Davidson.

Really exciting to see this acquisition. 2 on my end. I mean the first, with any sort of a deal like this, there's always the build-versus-buy question. So maybe if you could walk us through kind of the thought process on why it made sense to bring in outside technology and then have to do this integration versus trying to build it in-house? And then on -- actually, let's start with that, and then I'll have a follow-up.

Sure. I think it's rare that you see such a complementary story. We've worked, as you know, extensively and are extremely proud of our security products. And what we saw in this was the ability to complement what we've built with what they've built. So I think the digital transformation that we've experienced in the last 4 months necessitates an acceleration across the board for any company that's in these -- this category of serving innovators and doing it at just this incredible scale. So in the same way as digital transformation has accelerated, we need to continue to accelerate our work. And this was just a beautiful opportunity to do that with the cultural synergies that we talked about, the history of thinking of customers differently, the incredible devotion of their customer base and then being able to buy something that has the financial -- incredibly attractive financial picture. So it seemed -- when you get these opportunities, which come very rarely, with a team that believes so much in the emergent quality of this, and, I think, that's one thing that has made this very exciting. We have a team in Signal Sciences who wants to be shareholders of Fastly. They are excited about the emergent quality of 1 plus 1 equals 3. And it's not about their customers and our customers entirely because, of course, as we've talked about, we are in the early stages of this. I mean we only have 300 enterprise customers. There are thousands, tens of thousands out there, all who need to be liberated and who need to have visibility into what's going on, control into what's going on, programmability, performance. This is a world that is just changing so quickly in front of our eyes. So this is really, for me and for us, a story of just dramatic acceleration in our business and in the needs of our customers, and therefore, this just -- this was a no-brainer.

Got it. That's helpful. And then just with the broader security portfolio that you're now going to have post the acquisition closing, how does that -- how do you change or adapt your go-to-market? Do you start to have kind of a more -- in certain cases, a more security-first approach where you're landing with security? Maybe any color around how you expect that to shape out would be helpful.

Sure. I mean, I think our go-to-market remains this dual motion that we've talked about previously, where we have developers and security developers who find us and love us, and then we have a top-down executive motion because we are working at such large companies who have such high and strict requirements. And so one of the attributes that is very attractive to us was that there was a similar motion. I mean a motion that really speaks to devotion, users who love you, usage -- the ability to leverage a usage-based model. So you win, we win and earning that business every day. And those are attributes that Signal Sciences has built into their most recent platform and that we are very excited about. I think from a security market perspective, and I alluded to this as well, but we get a whole suite of products, including the ability to get really close to applications. And so when you look at account takeover, you look at RASP, what you're seeing is our ability to look and watch what's happening in applications, and remember, those applications are moving to us. And so when you talk about what -- where security can expand beyond this, obviously, today, the web and the API security is very important. But what we've also talked about in the past is that our customers don't just have applications that are just facing the public, for example. They don't just have applications where they're -- they have -- for every large website, they've got many, many applications that sit in their business that are running that drive the business. And so there's a tremendous opportunity to look at additional markets and, as we said, start looking at securing the core as well. Obviously, that's in the future, but I do think that there's a really nice opportunity there for us as we expand. So similar go-to-market motion, as we see today, which, I think, also dramatically derisked this for us.

Your next question comes from the line of James Fish with Piper Sandler.

Congrats on the acquisition this morning. Joshua, you had mentioned the combined offerings and time. Any sense to the timing of when they will be available on the DDoS and WAF side? And just to clarify, Adriel, how should we think about the Signal Sciences' model in terms of SaaS, term license or usage base?

Sure. Let me start quickly. We're not -- today, we've got to close. We have a regulatory approval that we need to go through. So we're not yet in a place where I think we're going to give time lines on this. I think, as Adriel said, at our next earnings call, we'll be giving an update in terms of time line. So I think that's probably the best time to give you an update in terms of when -- the timing of it. But certainly, it is in our interest and Signal Sciences' interest, but more importantly, in our customers' interest to have this go as quickly as it can, and that's certainly our goal. Adriel, why don't you take the next one?

Yes, Jim. Yes, on the -- on sort of the contract side, the traditional sort of SaaS contract, so there is some usage-based components to it. And I think those are the things we'll also evaluate once we get past close about how we would sort of merge that with what we're doing here at Fastly.

Got it. And just one last one for me. Any understanding as to how competitive, if there was competition in sort of the buying process, given the multiple paid here?

Yes, certainly can't speak to that. I think from our perspective, I've had the opportunity over the last year or more to get to know Andrew and to build that relationship. And this is something that -- as we've talked about, this is an organization that's extremely mission driven, values driven. And one of the things that aligned deeply was the fact that this is yet another step on this journey for them. We have 3 founders who feel a deep passion to bring human -- humanity and value to the people that are out protecting us. And they don't see that as being over. So I do think that the cultural side, the fact that they've chosen to become shareholders of our business speaks a lot to the value proposition that we were able to bring in this. And I'm extremely proud that, that's the choice they made.

[Operator Instructions] Your next question comes from the line of Walter Pritchard with Citi.

2 questions for Adriel. One, maybe just to put it into context, you could help with the security revenue. What is your security revenue today as a percentage? And sort of how do you see that building into the future? And then just a follow-up on, what do you expect to disclose going forward on the revenue here on Signal Sciences?

Walter, yes, we haven't disclosed the security revenue for Fastly, primarily because it's been bundled with our products in the past. So from our standpoint, we don't [ quite have ] a comparison there. In terms of the future, you'll see pro forma stuff, and so you'll be able to see Signal Sciences broken out as we get further beyond once we're sort of integrated, I think we'll have to sort of look at it at that point. But from our standpoint, we're pretty excited just sort of see the overall growth in sort of the security products and revenue that Signal Sciences is going to bring. And clearly, also, as we've talked about in the past, as we sort of think about our sort of longer-term gross margin path for us, this is certainly going to be a great feather in the cap for us to sort of bring that and allow us to sort of bring higher-margin business over the longer run.

There are no further questions. I'll now turn the call back over to Joshua Bixby for closing remarks.

Thank you. Before we sign off, I'd love to just say thank you to all our employees, customers, partners, investors. All of you continue to contribute to our ongoing success and growth, and we remain deeply grateful. I'd also like to thank the folks at Signal Sciences. They have been incredible to work with through this process, and I can't wait to start building great value for our customers together. We look forward to connecting with many of you in the future, and we are confident -- extremely confident about our future and look forward to sharing more. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.