Good day. And welcome to the Akamai Technologies First Quarter 2023 Earnings Conference Call. All participants are in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today's event is being recorded. I would now like to turn the conference over to Tom Barth, Head of Investor Relations. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining Akamai's first quarter 2023 earnings call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer; and Ed McGowan, Akamai's Chief Financial Officer. Please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. The factors include any impact from macroeconomic trends, the integration of any acquisitions and any impact from geopolitical developments. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking statements included in this call represent the company's view on May 9, 2023. Akamai disclaims any obligation to update these statements to reflect new information, future events or circumstances, except as required by law. As a reminder, we will be referring to some non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the Investor Relations section of akamai.com. And with that, let me turn the call over to Tom.

Thanks, Tom, and thank you all for joining us today. I'm pleased to report that despite the challenging macroeconomic environment, Akamai delivered strong results in the first quarter, with both revenue and earnings exceeding the high end of our guidance range. Revenue grew to $916 million, and non-GAAP operating margin expanded to 29% in Q1. Non-GAAP earnings per share was $1.40. In what has been a good start to the year for Akamai, we've continued to invest in the key areas that we expect to drive our future growth while also taking actions to improve margins. As Ed will explain in his portion of the call, we remain focused on returning to our operating margin target of at least 30% as we work to accelerate growth. I'll now say a few words about each of our three main product areas, starting with security. For the first time in Akamai's 25-year history, security represented the largest share of Akamai's revenue in Q1. This marks a significant milestone for Akamai since our expansion into security a decade ago. While we take pride in this achievement, we're focused on accelerating our security revenue growth rate from here, both organically and through disciplined M&A. For example, this past week, we closed our acquisition of Neosec, which complements Akamai's market-leading app and API security portfolio by extending our capabilities in the rapidly growing API security market. Last year saw a record number of web app and API attacks more than double the number in 2021. The rapid rise in API attacks is becoming a critical challenge for enterprises across all verticals and with IDC and Gartner now projecting the API security market to exceed $1 billion by 2027. The company we acquired, Neosec, is a powerful SaaS security platform that leverages AI-based behavioral analytics, unmatched…

Thank you, Tom. Today, I plan to review our Q1 results and provide some color on Q2 and our updated full year 2023 guidance where we increased our expectations for revenue, non-GAAP operating margin and non-GAAP EPS while decreasing our planned CapEx spend for the year. We were very pleased with our strong Q1 results in light of the continued difficult macroeconomic landscape. Total revenue for the first quarter was $916 million, up 1% year-over-year and 4% in constant currency. Security revenue was $406 million and is now our largest business representing 44% of total revenue. In the first quarter, Security revenue grew 6% year-over-year and 9% in constant currency. As a reminder, last year, we had roughly $7 million of upfront license revenue in Q1. If you normalize for this onetime impact, the security growth rate would have been approximately 11% in constant currency. Finally, I was also pleased to see we had a very strong bookings quarter in securities, specifically with our Guardicore segmentation and Lab Solutions. Moving on to Compute. Revenue was $116 million, growing 49% year-over-year as reported and 51% in constant currency. On a combined basis, our Security and Compute product lines represented 57% of total revenue, growing 13% year-over-year and 16% in constant currency. Now on to Delivery. Revenue was $394 million, which declined 11% year-over-year and 9% in constant currency. Delivery continues to provide strategic value in its customer base and generate strong cash flows. I'm optimistic about improving traffic volumes over the past two months and to a lesser extent, the slightly better pricing dynamics we've recently seen in the market. International revenue was $442 million, up 5% year-year and 9% in constant currency, representing 48% of total revenue in Q1. Foreign exchange fluctuations had a positive impact on revenue of $11…

Thank you, we will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Keith Weiss with Morgan Stanley.

Thank you guys for taking the question. And nice quarter. Maybe one top line, on bottom line question. On the top-line side of the equation, you talked to strong bookings performance in the quarter, particularly with Guardicore. Is that a broader security kind of commentary? And maybe part of what kind of sustains kind of your confidence in the double-digit growth throughout the year, perhaps maybe even sort of do we see some acceleration on a go-forward basis based upon that booking. So one is kind of like a perspective on real time what's going on in Security? And then on the better operating margins on a go-forward basis. Can you give us some sense of where the headcount reductions are coming from in that 3% headcount reduction? And when we think about the better margins that you guys are projecting, how much of that comes from this recent round of headcount reductions, how much is just better OpEx controls that you guys exhibited thus far in the year? Thank you.

Great. I'll take a first pass on these and then turn it over to Ed, and I'll get into more of the details. Yeah, we saw strong bookings and security across the board. It is a challenging environment out there for sure, especially with commits on larger deals. On the other hand, we do see a little bit of a silver lining, especially in the financial vertical, which is large for us. With everything that's going on in the banking sector, there is more concern than ever around security and reliability. And I think the last thing a major financial institution wants to see is some kind of problem now. An outage or some kind of half be successful. And I think that helps us. Akamai is widely recognized as the best when it comes to reliability and in terms of security. And so I think that is also helping us, especially vis-a-vis the competition. We're also pretty excited about Neosec, A lot of very positive conversations early on with customers on top of Guardicore and of course, the whole suite of security products. In terms of margins, the focus of the reduction in force, on the go-to-market side, was really in the management layers and so that we can actually get more feet on the street in services, we can get more people helping customers, particularly in the areas of expertise with Security and Compute. And in some cases, in geographies that we feel are untapped and that we can get more leverage. And with -- I think probably I'll turn it over to Ed now in terms of how this shapes up with all the other things we're doing to improve operational efficiency, Ed?

Yeah, Keith. So we talked about taking a restructuring charge. About half of that was severance related so that the headcount savings and then the other half was -- or roughly half was related to real estate. In terms of thinking about the headcount savings, our payroll is a little over $1 billion. We reduced a little less than 3%. So on an annualized basis, think of that as kind of in the $40 million range, give or take. We'll get about three quarters of the benefit of that this year. In terms of the real estate, we probably saved about 25% to 30% of our current spend. More to go there. I expect we can reduce that probably by a similar amount next year. The big savings to come is going to be in third-party cloud. We did see a reduction this quarter, which was nice. We reduced our spend as we start to optimize and start to move some things over. But that's a big one. That's about $100 million in total spend or a little bit more, and we'll start to see that benefit next year, a little bit more this year, but mostly into next year and into 2025. Team is doing a great job with vendor management, including being able to engineer out certain functions that we may be using a third party for. So I would say it's a combination of things, but just to sort of put it in perspective, that headcount savings is, call it, roughly a little over a point of margin on an annualized basis. That also gives you giving you that sort of kind of run rate payroll number will give you the math necessary to build your models to factor in that annual increase that we give every year in the third quarter.

Also, in terms of the reductions, obviously, we're directing a lot of resources that were on the delivery side of the house into compute. And that, in many cases, is the same person changing what they're doing, but also in this reduction that we're taking, you'll see that effect as well.

Got it. And just to be clear, the lower CapEx intensity, it sounds like that's more efficient sourcing, not any change in the scope of build-out that you guys are expecting for the cloud side of the business?

Yeah. So the way to think about that, Keith, is two things. One, we were able to benefit pretty significantly actually with the pricing reductions in the server pricing. My understanding is that's somewhat of an industry phenomenon, but also just given our buying power, a big chunk of that decline in CapEx was related to that. The other thing that I find pretty exciting is we envisioned when we sort of built the models that we'll be able to integrate with our supply chain to be really tight with our demand and build, meaning not having to overbuild for demand. We've been able to knock down the time that it takes for us to deploy. So the initial builds that we're building out will be a little bit smaller than we originally anticipated because we expected a longer lead time with our supply chain. So now that we've been able to shrink that down we can tighten that up a bit. So those are really the main factors, a little bit of push in terms of a couple of sites that can push into '24, but those two factors are pretty significant. And we're very happy that we're able to deliver that this quickly.

Excellent. That's super helpful, guys. Thank you.

Thank you. And our next question today comes from James Fish of Piper Sandler. Please go ahead.

Hey, guys. Thanks for the question guys. Wanting to build off of Keith a little bit here. Now that you rolled out your objectives for 2023 here, how are you thinking about not just the CapEx intensity for this year as you're starting to kind of get the savings greater than you expected. Is this the right way to think about next year's capital spending? And I think, Tom, you actually had alluded to getting into that long-term 30%. Is there an update on the time frame there?

Yeah. Let me take a first pass at this. This year is when we're doing the initial build-out for compute and obviously very substantial. And future years will depend on how fast we sell the capacity that we're building out now. And so if we're able to sell that quickly, then there would be more CapEx spend next year. If it takes us longer to fill that capacity, then you would see CapEx be much less next year. So it really depends on how rapidly we get uptake on the initial build-out that we're doing. And on the 30%, we're not issuing a specific time line there. But obviously, we're having, I think, really good success in our efficiency and we're taking actions to improve margins. And so we'd like to get back to 30% and beyond just as quickly as we can, subject to making the investments for future growth. And I'm very optimistic about our ability to do that. Ed, was there something you'd like to add there?

No, I think that covered it, Tom.

Great. And just a follow-up on the security side as well. It sounds like you guys are pointing to this being the kind of trough in growth. But as you think about network security offerings, in particular, including the Zero Trust overall portfolio not just Guardicore, how do you feel about your go-to-market -- how your go-to-market is aligned with selling these types of solutions that tend to go through indirect sources that really are MSPs that you guys have historically been lined up with? Thanks, guys.

Yeah, I do think we should see improvement in security growth from here. And particularly now that we're adding API security into the mix, I think the channel is really important for us and it's something we're putting a lot of effort into it, especially on the enterprise security side. For example, Guardicore is all through the channel, very successful partnerships, and it's something we'll be focused on with API security as well.

Thank you. And our next question today comes from Jonathan Ho with William Blair. Please go ahead.

Hi, there. I just wanted to understand a little bit better about maybe your confidence level around the macro environment, what you're seeing out there? And why you're not potentially taking a more conservative stance. I think you said that your expected macro to remain consistent.

Well, I think our guidance does reflect or the current situation and our view, we're not assuming that the macro environment will improve. And so I do think we are taking a reasonably conservative view going forward. We are very happy with the strong start to the year on several fronts as we talked about. Ed, would you like to say a little bit more about that?

Yeah, sure. I mean in terms of some of the negatives that you're seeing, obviously, sales cycles are a little bit longer. We are seeing difficulty with adding new customers with the exception of Guardicore. Tom alluded to the fact that Guardicore brought a pretty good channel organization with them, and we're seeing pretty good new logo acquisition there. So that's probably the exception to that rule. We're seeing some pricing pressure from some verticals, we are seeing, I mentioned, better pricing environment for some of the higher media delivery business. Inflation obviously causes some challenges. We've seen some bankruptcies in the retail space and a couple in the financial services. None that's overly material. And as I said, we're not anticipating things to get worse. If things did get worse, potentially we'd see a little bit more of that. On the Pro side, we are seeing lower turnover of employees, faster time to hire, which isn't much of a surprise. With rates going up and we have cash interest rates are better for us from a reinvestment perspective, the dollar is slightly weaker. That may -- as the dollar gets weaker that helps our benefits. And then also just from the vendor side, just continued focus on pushing vendors for better pricing and things like that. So it's a mixed environment, obviously, a challenging environment. I think we're navigating through it pretty well. And we've built in what we thought we could achieve based on what we see today.

On the silver lining side, as we get our compute offering, prepared to take on major mission-critical enterprise workloads, there is the potential that because we can do it less expensively, particularly for applications involving large amounts of data and delivery of data that, that could be a net benefit for us competitively in a time when companies are looking to cut costs. And is something a lot of our customers have told us, particularly customers with large volumes of data that they need to cut the cloud expense. And I think we'll be in a position to help them do that. And as I mentioned earlier, at a time like this when there's a lot of concern in the financial sector, Akamai's reliability and security, it really becomes paramount. And that's helpful to help mitigate the impacts of a difficult macroeconomic environment.

Excellent. And then just as a quick follow-up. In terms of the delivery business, I think you talked about some favorable trends around the traffic side. Can you talk about what you're seeing in terms of those improvements and maybe the sustainability of that as we think about, again, the delivery traffic? Thank you.

Yes. About March, really of last year is when we really saw traffic growth take a hit, part because of the economy as a whole, part because of the war in Ukraine, and now we're lapping that. And so when you look at the year-over-year rates, indeed, they did start improving in March. And so we're optimistic about that and hope to see that be more sustainable just because you have a more reasonable compare. Ed, do you want to add more color on that?

Yeah. The only thing I would add, I did touch a little bit on just slightly better pricing environment, which makes sense given the volumes. They're still not back to pre-pandemic levels, better than what we saw last year. Also, we've seen in some accounts, some larger accounts, some vendor consolidation, and we've been a benefactor of that, which makes sense. Some customers will have four or five CDNs that can get to be pretty expensive. Sometimes they build up teams. They have technology they use for load balancing and things like that. So as they consolidate vendors. And a lot of us have volume-based tiered pricing, so you can take advantage of lower unit economics as you consolidate to one or two vendors. So that's been a positive trend for us. It's another reason why we've seen a little bit of an uptick in traffic.

Thank you.

Thank you. And our next question comes from Frank Louthan with Raymond James. Please go ahead.

Hey, guys. This is Rob on for Frank. So who do you run into in the marketplace now for compute specifically? And how would you guys evaluate the outlook for that business in particular going forward? And what's driving that outlook primarily?

Yes, the hyperscalers and also do it yourselves. And I think the outlook for us is positive. We're not trying to take 30% market share. It's a $100 billion, $200 billion market. But we do think we can be very competitive for certain kinds of applications, particularly in the verticals where we do a lot of business, the media vertical, entertainment obviously, video, gaming, commerce. And that's because those customers, they know us, they like us, they use us for the delivery and security. And I think we're in a position to offer them a very compelling capability in terms of better performance and a lower price point. So we'll see. But so far, I think we're very pleased with what we've been hearing for customers, making good progress, getting our connected cloud platform built out, upgrading Lino to really take on large-scale mission-critical enterprise workloads.

Great. Thank you.

Thank you. And our next question today comes from Rudy Kessinger with D.A. Davidson. Please go ahead.

Hey, great. Thanks for taking my questions. Just want to double click maybe on security. You said Guardicore $7 million of license revenue Q1 last year. Was there any license revenue for Guardicore this Q1 this year?

Yeah. No, nothing material. No.

Yeah. Okay. Got it. And then maybe just a follow-up on delivery, certainly stronger revenue performance than we expected. Is there -- I guess, was there anything in the quarter you talked about maybe some customers consolidating from four or five vendors, maybe to three. Anything in particular in the quarter that would give you hope that delivery maybe you could potentially turn that back to a, I don't know, say, a flat or maybe only a 3%-5% decline in business as opposed to a 10%-ish decline in business as we've seen over the last few quarters?

Yeah. That's obviously continued traffic growth. I think if we get back to kind of pre-pandemic levels, that's certainly going to help. We've done a pretty good job on pricing, especially with the larger customers in the old web verticals, especially commerce, we're still seeing some pricing pressure there. So really, it's a combination. But I'd say the stronger traffic growth is going to be the main thing. As we get into Q2 and Q3, we've got slightly easier compare you recall last year, we had significant renewals in our top-10. We have renewals all the time, but that was an unusual year for that. So the double-digit declines, I wouldn't expect that certainly next quarter or the quarter after that. And in Q4 is always the toughest quarter to call, but things will get -- should get a little bit better from a year-over-year compare standpoint. But in terms of getting to sort of flat or even plus or minus a point, you're going to need to see stronger traffic growth than what we're seeing now.

Got it. Fair enough. Thank you.

Thank you. And our next question today comes from Ray McDonough with Guggenheim. Please go ahead.

Great, thanks for taking the questions. Tom, maybe first for you. Another question around security go-to-market. I know you touched on the focus on the channel. But you did mention you were also redeploying go-to-market resources within the security group as well. Can you talk more specifically to the changes made in that organization? And is there any early results to point to from those changes that give you confidence that you will be able to reaccelerate growth here in the rest of 2023?

Well, we're just taking the actions as we speak. So nothing to see directly from that yet. I would say they're in three areas. One is less investment in management and more in, say, feet on the street. The next would be more focused on security and compute and getting the right expertise in front of the customer, and that would be in presales and also in services. And then the third is a shift in resources to some of the, I would say, undertapped geographies, where we think there's the potential for a lot of growth. So I think all three are very helpful. And then, of course, channels, particularly for our enterprise security solutions, where that's, I think, a much -- a better way of doing it. For our established web app firewall, we do have a significant channel's presence but also a significant direct presence. And we expect to start seeing the benefits here towards the end of the year as we hire the new resources in these areas.

That makes sense. And then maybe just a follow-up for you on Linode. I believe you've kind of outlined an expansion of 14 core datacenters by the end of the year and 50 distributed sites, I believe. Is that still the case? And maybe just following up on one of your comments earlier, can you talk about how much smaller the Compute footprints are this year, if it's a magnitude of size? And how comfortable you feel in terms of the lead times to add capacity if the macro environment or demand turns more quickly than you expect?

Yeah. Why don't I start with the last part first. So in terms of the timing, I think we've got it down to probably 60 to 90 days, I think we can add capacity pretty quickly. We're building up -- working with our suppliers. We've had long-term relationships, structuring deals with them to be able to very quickly get our hands on equipment and building up some inventory and that sort of thing. So we feel pretty good about that. So I think -- and also these sales cycles are not immediate, right? So there's usually a trial period and that sort of thing, starting the conversations now. So it's not like CDNs where you can shift overnight, just move traffic within a day or two. So we will have good lead times there. In terms of the actual size, I just say they're small, I don't have a specific number to throw out. We're on track to deliver all of our core sites. There's a couple coming online in Q2 and a bunch coming online in Q3, no change there. As far as the distributed sites, we will be building out a bunch of those. I don't have an updated figure for you. Some of them may push. Those are much smaller in terms of of CapEx. So that really doesn't have a major impact on CapEx. Each one of those sites are relatively small, so it's not going to have a material impact. But in terms of what we're seeing with the supply chain, we feel pretty good. We've done a lot of work, great hats off to the team. They've done a fantastic job working with our suppliers to be able to really tighten things up, and you can see that in the updated guidance.

Great. Appreciate the color.

Our next question today comes from Amit Daryanani with Evercore. Please go ahead.

Hi, this is Lauren on for Amit. So just to kind of double-click into buybacks and how you guys are thinking about the second half of the year after a fairly aggressive first quarter? That would be great.

Yeah. Our policy and strategy really hasn't changed. And that includes -- there's times when we do buyback more shares that are needed to offset dilution from employee equity programs. And those are opportunistic. And in Q1, we felt there was a substantial opportunity to buyback more than the usual allotment. And of course, we have a programmatic buyback that buys back more when the stock price is lower and buys back less when the stock price is higher. And so when the stock goes lower, the programmatic or automatic buying also increases. And as you know, the stock price was lower through a lot of Q1. So there's really no fundamental change in strategy. Prior to this year, over the last 10 years, we've bought back an extra 1% a year over and above the equity program dilution offset. Obviously, Q1 was more than that. So there's not a specific change in strategy that would say we're going to buyback what we did in Q1 every quarter. So no change in strategy.

Got it. Thank you.

Thank you. And our next question today comes from Mark Murphy at JPMorgan. Please go ahead.

This is [Indiscernible] on for Mark Murphy. Thanks for taking the call, and congrats on the quarter. Maybe just on compute. I think in the past, you've mentioned that the node hasn't faced the same optimization headwinds that the hyperscalers have. Curious if anything's changed on that front?

Sorry, as in faced what headwinds?

Sorry, the same optimization headwinds that the hyperscalers have been calling out the last few quarters?

Yes, I think Linode is really in a very traditional, Linode a very different market and much more affordable and really not servicing the major enterprises. Major enterprises, at least the customers that we talk to are very worried about the rapidly growing cloud costs. And that's something that I think we're in a position to help them with as we get our infrastructure built out and get it ready to take on mission-critical workloads.

Great. Thank you so much for that additional color. I'll leave then and pass back to the operator.

Thank you. And ladies and gentlemen, we have no further questions at this time.

Okay. Well, thank you, operator, and thank you, everyone. In closing, we will be presenting at several investor conferences and road shows throughout the rest of the second quarter. Details of these can be found in the Investor Relations section of akamai.com. Thank you for joining us, and all of us here at Akamai wish continued good health to you and yours. Have a nice evening.

Thank you. Ladies and gentlemen, this concludes today's conference call. And we thank you all for attending today's presentation. You may now disconnect your lines. And have a wonderful day.