Good day and welcome to the Akamai Technologies Second Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. Now I’d like to turn the call over to Mr. Tom Barth, Head of Investor Relations. Please go ahead, sir.

Thank you, operator. Good afternoon, everyone and thank you for joining Akamai’s second quarter 2022 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 Akamai’s view on August 9, 2022. 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 Akamai delivered strong results in the second quarter despite the ongoing challenges with the global economic environment and slower Internet traffic growth. Q2 revenue was $903 million, up 6% year-over-year and up 9% in constant currency. This result was driven by the continued rapid growth of our security and compute businesses, which when taken together were up 30% in constant currency. These two business lines now account for 54% of our overall revenue. Q2 non-GAAP operating margin was 29%. Q2 non-GAAP EPS was $1.35 per diluted share, down 5% year-over-year, but up 0.5% in constant currency. As Ed will discuss later, EPS was negatively impacted by foreign exchange rates and a higher effective tax rate compared to last year. Free cash flow was very strong at $223 million in Q2 and it accounted for 25% of revenue. We have been leveraging our financial strength to make substantial investments in enterprise security and cloud computing. We have also used some of this cash to buyback additional stock. In the first half of the year, we spent $268 million to repurchase 2.6 million shares. This puts us on track to go beyond what’s needed to offset dilution from employee equity programs this year. I’ll now say a few words about each of our three main lines of business: security, compute and delivery, starting with security. Our Security Solutions generated revenue of $381 million in Q2, up 17% year-over-year and up 21% in constant currency. Growth in security was driven primarily by our app and API security portfolio, which includes our market-leading web app firewall, bot manager, account protector and page integrity manager solutions. Our Zero Trust enterprise security portfolio, led by Guardicore, also performed well in Q2…

Pardon, ladies and gentlemen, we have to interrupt the call at this time. One moment, please.

Okay. Sorry about that, everyone. We are ready to begin the real call. That was the warm up. I apologize again. And what I’d like to do is introduce our CEO, Dr. Tom Leighton. Just standby for a minute. Operator, could you put the call on hold for me? We just had a little trouble with technical difficulties on the phone here.

Yes. Thank you, everyone. We’ll be on hold while you gather your information and get going again. Thank you, everyone. This is the operator. Thank you for holding standing by. We have Mr. Tom Barth, ready to take over again for the call. Please go ahead, sir.

Okay. Thank you, everyone, for your patience today. We’re – again, I apologize for the technical glitch, but we are ready to go. And I’d like to reintroduce our CEO, Dr. Tom Leighton. Tom?

Thanks, Tom and thank you all for joining us today. Sorry about the production snafu there. Anyway, I am very pleased to report that Akamai delivered strong results in the second quarter, with revenue coming in near the high-end of our guidance range and earnings exceeding the high-end of our guidance range by $0.07. Revenue grew to $936 million in Q2, up 4% year-over-year, both as reported and in constant currency. Non-GAAP operating margin was 29% and non-GAAP earnings per share was $1.49, up 10% as reported and up 11% in constant currency. As you can see, and as Ed will explain in his portion of the call, our actions to increase profitability are delivering good results. I’ll now say a few words about each of our three main product areas, starting with security, which is our largest source of revenue. Security revenue grew to $433 million in Q2, up 14% year-over-year, both as reported and in constant currency. The improvement in our security growth rate was driven by multiple products, with especially strong growth for our market-leading segmentation solution. We entered the segmentation market with our acquisition of Guardicore in Q4 of 2021 and we are nearing an annualized revenue run-rate of $100 million. At this scale, segmentation is having a bigger impact on our overall security growth rate. Customers are adopting our segmentation solution to help defend against ransomware and data exfiltration attacks, which have become more frequent and damaging. For example, last quarter, we signed a 3-year $8 million segmentation deal with one of the world’s largest carriers. Large carriers and banks want to protect their consumer data from losses that can damage their brands and trigger large fines from regulators. They also appreciate spending less on legacy firewalls that no longer provide adequate protection. We also…

Thank you, Tom. Today, I plan to review our Q2 results and provide some color on Q3, along with our increased full year 2023 guidance. I’m pleased that Q2 was another strong and very profitable quarter. I’ll have more to say about our double-digit EPS growth in a moment. First, let’s discuss revenue. Total revenue for the second quarter was $936 million, up 4% year-over-year. In the second quarter, Security revenue was $433 million, growing 14% year-over-year. As Tom mentioned, security revenue was driven by strong demand for our WAC, slot management and segmentation solutions. Moving to compute. Revenue was $123 million, growing 16% year-over-year as reported and 17% in constant currency. On a combined basis, our security and compute product lines represented 59% of total revenue growing 14% year-over-year and 15% in constant currency. Shifting to delivery. Revenue was $380 million, declining 9% year-over-year as reported and 8% in constant currency. International revenue was $456 million, up 7% year-over-year and 8% in constant currency and now represents approximately half of our total revenue. Foreign exchange fluctuations were flat on a sequential basis and negative $6 million on a year-over-year basis. Moving now to profitability. Non-GAAP net income was $228 million or $1.49 of earnings per diluted share, up 10% year-over-year and up 11% in constant currency. The strong EPS results exceeded the high end of our guidance range by $0.07 and were driven primarily by higher revenues, saving from savings from the head count actions we took earlier in the second quarter and continued progress on our cost savings initiatives. As a reminder, those cost savings initiatives include third-party cloud savings, rationalization of our real estate costs, depreciation expense and other operating costs associated with lower CapEx related to our delivery business, disciplined spending with vendors and tighter travel…

Thank you. [Operator Instructions] First question will be from James Fish, Piper Sandler. Please go ahead.

Hi, guys. Congrats on the quarter and the security [indiscernible]. And speaking of security, how should we think about the bookings heading into Q3 for this segment or the bookings related to us? And really, the crux of my question is – just trying to understand the sustainability here and understanding we’re raising by 2 points for the full year. Just kind of give some color around the confidence for the year is really what I’m asking.

Hey, Jim, thanks for the question. This is Ed. I’ll take that one. So I would say we had two back-to-back very strong quarters of bookings. So that was very encouraging. And we also saw strength and if I look at my sequential growth quarter-over-quarter, we actually saw all three major product lines accelerate. So we saw growth in API and protection segmentation was very strong. Guardicore was extremely strong in the quarter. And even the infrastructure business still has some hangover effect from the Kilmet attacks we saw earlier on. So all those product lines grew sequentially quarter-over-quarter. In terms of the customer penetration, if I go back to Q4 and look at where we are now, we saw about a 2.5% increase in customers buying a security product up to about 75.5%. So we’re seeing great penetration in the installed base. just one other sound by for you. We now have about 700 customers who are buying four or more products in security. So we’re seeing really good strength with new customer additions, bookings across all product lines. And then just another thing on segmentation. When we’re seeing renewals with segmentation, we’re seeing those renew very favorably and generally with expansion orders included.

Helpful. And then, Tom, maybe for you on the compute side. How are you guys looking to invest behind the GPU as a service side of Linode. Is this something your customers, particularly your large media customers are looking to deploy with you or do you see that as more reserve for the hyperscalers and so you’re going to be more focused on that AI inference opportunity. Thanks, guys.

Yes. We do support GPUs today. It’s not our primary focus and that’s just a financial decision. I would say gaming is more where you’d see that with our big media customers doing video and media workflow, CPUs are just fine. And much more economical and attractive there. In terms of AI, I think over time, probably that migrates – at least in terms of the inference engines, migrates to CPU as well. And I think that, over time, as we talked about, probably something you want to be doing at the edge. But we’re fully capable of supporting GPUs. We do that some today, really based on demand from our customer base and financials.

Thank you. Next question will be from Keith Weiss, Morgan Stanley. Please go ahead.

I wanted to follow-up on the security question in the security business. We got a reacceleration this quarter. And I just want to understand like some of the drivers behind that, whether you’re seeing a better spend environment. It sounded like the bookings were pretty solid. Is it sort of sales execution? Or are you seeing sort of like newer offerings like Guardicore sort of reach material scale to drive that sort of dollar growth on a year-over-year basis. I was wondering if you could sort of unpack the strength in security and what it could portend for future quarters.

Yes. Ed talked to that somewhat. Let me just give some additional color there. It’s still a challenging spend environment in general. So that – I would have said that’s changed a lot. We are getting strong sales execution. And security is really important. And as we’ve talked about before, in this environment, financial institutions, they just can’t afford to have a glitch. And this is where our reliability really helps and stands out against the competition. They can’t afford to get hacked. And again, we stand out there because we have the market-leading solutions for web app, firewall and for bot management. And with Guardicore, really seeing strong growth, as Ed talked about. And I think what we’re seeing in the marketplace is there’s good tailwinds there. Particularly now you have Gen AI and already the tools are out there, the variance of that to produce more malignant bots to morph malware so it’s harder to detect. You can train the bots pretty easily to get around a lot of the firewall defenses. And so I think what you’re going to see is even more penetration of the traditional defenses. And at that point, what you really need is Guardicore to identify when you are penetrated and where and to proactively block the spread. So I think you’re going to see more demand for segmentation is really the critical defense going forward. So strong – as Ed talked about, strong execution and performance across all three pillars. And then you look to the future, API security is going to be, I think, a very important market for us. Very early days but I think really critical. So it’s really pleasing to see the momentum that we’ve been building in the first half of the year with security and that can, I think, help drive us forward.

I appreciate the thoughts, Tom. And just as a follow-up, sort of toggling to the delivery business. Just want to get an update, and you guys have talked about this before, but I just want to get an update on sort of the operating principles and the operating philosophy around the delivery business with respect to sort of managing for sort of revenue share versus harvesting for profit to fund investments in the compute business given the ambitious road map you have there? What sort of the right way we think that you guys are going to strike that balance between those two objectives?

Yes. It really comes down to price and profitability. And as we’ve talked about, we have turned down business that is very spiky, and we don’t get what we think paid enough to do it. And so we’ve left that to others to take. And meanwhile, growing the highly profitable delivery business, the core business there. And I think we are starting to see some positive signs there. Traffic growth is not where it was before the pandemic, but getting better. We’re seeing some acceleration there, which is good. Price declines, I’d say, softening a little bit here. And so I’m optimistic that over the next 1 to 2 years, we should see more of a stabilization of that business. Still price pressure, but I’m pleased with the progress we’re making there and strong cash generation.

Thank you for the details, Tom. I appreciate it.

Thank you. Next question will be from Ray McDonough of Guggenheim Securities. Please go ahead.

Great. Thanks for taking my question. Tom, maybe just to stay on the security side of things. Last quarter, you mentioned actions you were taking on the go-to-market side in security. And you mentioned execution as part of the driver of security reacceleration. But I’m wondering if you could provide more color on the sort of go-to-market changes that might be working here. And we’ve been hearing that Akamai has been more successful in engaging traditional security resellers recently. Has that helped drive an acceleration of growth here at all? Or is that still too early and maybe a contributor into the future?

Our partners are very important for security sales. In fact, some of our products are partner only, for example, segmentation. And very pleased to just recently announced a partnership with WWT, that will be bundling in our solutions for segmentation and API security. And that kind of partnership is obviously very helpful for us in driving a lot of the improved execution. We also have dedicated resources for some of the newer and more advanced security services like segmentation. And I think that helps with sales. And we’re seeing customers – new customers to Akamai, which is great and also upselling our solutions into the existing base. And as Ed noted, now 700 customers buying four different security solutions. And Ed, do you want to add anything to that?

No, I think you covered it. We’ve made a lot of the investments already. So there’s not a big investment needed in the sales overlay functions. Very happy with that. As a matter of fact, lot of the new customer acquisition is coming from Guardicore. And they’re actually getting penetration in some verticals that aren’t traditionally strong. Like this quarter, we saw some wins in education, state and local government, manufacturing and pharmaceutical places that typically are a very big web properties that are typical CDN customers. So I think we’re seeing really good execution across all the parts of security, direct sales, the overlay teams in the channel.

Great. That makes sense. Maybe as a follow-up, Ed, I know Guardicore and some of your other businesses, there could be some upfront license deals that could contribute in any given quarter. Was there anything to call out from an upfront license recognition in the quarter in security, in particular, that might not be repeatable that we should just know about? And is there any renewals that might be coming up in the back half of the year that we should be aware of?

Yes. So nothing material this quarter, a couple of million bucks, but nothing material. It’s over a couple of points, I call it out, so nothing there to call out. One thing I will say, though, with the licensing we do with Guardicore in particular. It’s term licenses, so it’s generally 2 to 3 years typically. And those license deals were new and one of the comments I made earlier is that we are seeing very strong renewals. So when those license deals come up, we are seeing renewals typically with expansion orders, which is really encouraging. So you have somebody who’s renewing and then adding on more protection across their internal infrastructure. But nothing to call out this quarter.

Great. Thanks for the color.

Thank you. Next question will be from Frank Louthan, Raymond James. Please go ahead.

Great. Thank you. On the delivery business, can you talk to us about any impact you think you might see from the writer strike. Do you think is that factoring any of that in the decline? And then just comment on the sort of the sequential change in the business there. What’s sort of the outlook there for the rest of the year? Thanks.

Hey, Brian, this is Ed. From the registry, I wouldn’t anticipate any major impact from that, certainly not hearing anything from our customers there. Obviously, that potentially impact new releases, which you could take a couple of years to get out. But not seeing anything there. And in terms of the second part of the question, what are some of the fundamentals and what we’re seeing. As Tom talked about, we are seeing traffic growth rates improve. It’s going up a couple of points a quarter. Pricing is still a bit challenging and some of the old web performance verticals in commerce and a little bit in travel as well. But we are seeing with the larger customers, big media, traditional media customers pricing starting to abate a bit there still pricing declines were not nearly as steep. So, I think its profit continues to improve and we obviously have Q4 coming up in a few months, will be in Q4, and that always tends to be a generally strong quarter for the Internet as kids go back to school and new gaming consoles are sold and connected devices and all that stuff, and it also tends to be pretty popular with new TV series and sports and whatnot that we are optimistic that traffic should continue to improve. And as Tom talked about, hopefully, we get this business back to stable in the next year or so.

Alright. Great. Are you seeing any more vendor consolidation like we saw earlier this year with some of the larger media companies?

There is one probably, real notable one that went from five vendors down to two, and we were a leading provider there and did pick up some additional shares. So, we want the ones who won there, but nothing really notable this quarter. That happened, I think at the end of last quarter.

Okay. Great. Thank you.

Thank you. Next question will be from Mark Murphy, JPMorgan. Please go ahead.

Hi. This is RD on for Mark Murphy. Thanks for taking the question and congrats on the quarter. Start off, you mentioned earlier that you expect to see stabilization in the delivery market over the next couple of years. Can you just describe what trends you are seeing that kind of leads you to think that?

Sure, I will take this Tom, if you want to add something. So, I think it’s really in the delivery business, it comes down to pricing and traffic growth rates. Now, we are starting to see traffic growth rates improve and also comps become a little bit easier. The other thing is we talked about moving away from some of the peak year business, what that will do is improve the profitability. So, the delivery business to us is a really strategic asset for us, right. It enables us to get really great economics, which will help our cloud business delivery function of cloud in a lot of ways. Also for our security business, which enables us to get the reach and the scale and the data for security. So, it’s obviously a very strategic business. But in terms of like the stabilization, I would say we are seeing pricing moderate, especially with the larger customers, which is a good sign, traffic improving a bit, and if that continues, we should be back to hopefully a stable plus or minus a couple of points would be great. But I think one thing that the macroeconomic environment is causing a little bit of churn, if you will, or challenges in some of the traditional web verticals like commerce. So, that’s going to have to work itself out as well. So, that may take a year or so for that to work its way out. But I think as we see traffic growth and pricing stabilize a bit more, we should be in pretty good shape.

Yes. And the only thing I would add is that in this environment with higher interest rates and money is harder to get, there is a little less enthusiasm for investment in the lots of CDNs out there that are losing money. And as Ed noted, Akamai is a unique position that we generate a lot of cash from our delivery business. We are the market leader, we do it better than anybody. And the smaller companies that were okay losing money before, well, that’s not so easy to do now. And so I think that does help maybe the overall environment a little bit, and we will see how that plays out over the next year or 2 years.

That’s very insightful. Thank you. And then with regards to Guardicore, it seems like you guys are having a bit of momentum on that front. Any changes in the competitive landscape win rates, anything along those lines?

Yes, it’s gotten more favorable for us. Our lead over the competition has widened as we’ve made a lot of investments in Guardicore to improve its capabilities. And so now we are recognized by the analyst community is the market leader by a wide margin. And that’s very good timing because that capability is an increasing need with major institutions. So, I think the competitive environment has become more favorable for us because of the work we have done to make it a great product.

Got it. Thank you. I will step back in the queue.

Thank you. Next question will be coming from Rishi Jaluria of RBC. Please go ahead.

Hi. Wonderful. Thanks so much for taking my questions guys. Nice to see the security reacceleration this quarter. I had a two-part question I wanted to ask about the compute business. First, can you talk a little bit about how some of your product investment in terms of getting Linode to be enterprise scale and to be truly competitive with the likes of either AWS and Azure, I think it got features and functionality like Kubernetes, for example, how those efforts are going? And maybe what learnings you have had as you have been migrating your own cloud spend onto that platform. And the second part, and Tom, you kind of hinted a little bit at this earlier, right? But let me look at what the hyperscale cloud vendors are saying, they are seeing a big uptick in demand right now as a result of generative AI workloads. And how do you think about your ability to capture some of those generative AI workloads as companies are thinking increasingly about adopting their generative AI strategy? And maybe are there additional investments you need to make in Linode to be able to capture some sort of some share of it? Thank you.

Yes. Great questions. And we are making really good progress with Linode, Kubernetes. And really, it’s about scale, and we talked about that. The build-out will be up to a couple of dozen core locations by the end of the year with a ton more capacity than we had before. Object storage and the new architecture there, much more capacity and capability. The certifications, we now have PCI compliance for our use, so we can run bot manager on it with market-leading bot management solution. We have 300 customers now using that solution on Akamai connected cloud instead of a third-party cloud. And that does take advantage of deep learning technology. So already, we have those capabilities, you have to support that on Akamai’s cloud. I think overall, with the timeline, the way we think about it, by the end of this year, we should be in a position to start taking on more serious bookings or bookings with large customers for really important applications. We have a couple already using it and then start generating more revenue next year from major applications. Now, in terms of competing with the hyperscalers, we are not going to be fully competitive for every application. And we don’t have to be. It’s a $200 billion a year market, growing 15%. And we are targeting a subset of that market, primarily initially vertical media and gaming, followed by commerce after that, where in particular applications where performance matters. So, the application is being used in some way by end users or business partners, where you maybe want to have that application running closer, so it has better performance. Where scalability, rapid scalability matters and cost, especially for the applications that involve moving data around or have a lot of hits. And you see that…

Wonderful. Really helpful. Thank you so much.

Thank you. Next question will be from Rudy Kessinger, D.A. Davidson. Please go ahead.

Hey great. Thanks for taking the questions. Just – I know a lot of questions have been asked on security. Can you share the Guardicore growth rate? What kind of growth are you seeing in that business?

Hey, Rudy, this is Ed. About 60% year-over-year. And as Tom talked about, we should be at a $100 million run rate very, very soon. I would be surprised if we don’t get there next quarter.

Great. That is very impressive. As it relates to compute, 17% year-over-year constant currency that’s fully organic figure this quarter as you have lapped that acquisition. The guide implies depending how you model the sequential is maybe 1 to 2 points of acceleration by year-end. I guess just how is the pipeline building for Linode as you get some of these sites online? And when should we expect to see more material growth acceleration? Just what are your growth aspirations there in terms of maybe 2024?

Yes. So when you talk about Linode, almost all of the revenue there is in their traditional business, developers, small, medium enterprises, low-ARPU customers. That business was a little over $100 million a year when we bought it growing in the teens. It’s growing a little bit faster now, but it’s not – that’s not the game changer. And why we bought Linode was to be able to use it as the base to create a service for major enterprises with mission-critical applications, very high ARPU accounts. And today, the revenue there, we have actually signed up a few important cases, customers. And so we do have revenue there now, but it’s small in the millions of dollars. And so but that’s where the growth comes from and that’s – we are trying to get 1% of the $200 billion market, so over a period of time to go from a few million to a couple of billions. We don’t have a timeframe on that yet, but we are trying to do that as quickly as we can. But that’s where the real growth comes from and it starts from a very small portion of our roughly $0.5 billion compute business today.

That’s helpful. Thank you.

Operator, this is Tom Barth and it’s time for one more question.

Thank you. Our last question will be from Amit Daryanani of Evercore. Please go ahead.

Yes. Thanks for taking my question. I guess maybe to start on the security side, can you just touch about – as you see the acceleration that’s happening there, is that skewing more from new customers or expansion of existing customers, just any clear that would be helpful and then was there any licensing revenues that help you with Guardicore in June?

Hey, Amit, this is Ed. So as I talked about earlier, there was really no material license revenue in the quarter. And as I said, I’d call it anything, if it’s a couple of points of growth or anything like that. So nothing to report there. In terms of the new customers and existing we are seeing, as I talked about, a pretty good expansion in the existing installed base, both with just pure penetration rates up a couple of points in the last two quarters to – as I look at customers buying multiple products. I mentioned earlier, we have over 700 customers now buying four products. So the majority of the revenue growth is coming from the installed base buying more, but I’m very encouraged with the new logo acquisition, especially with what we’re seeing in Guardicore. Very encouraging to see them be able to attract new customers and verticals that were typically not very strong in. So again, mostly from the installed base in terms of buying more products, which is great, but it’s very encouraging on the new logo acquisition as well.

Got it. And then if I can just follow-up on one thing. I think you talked about full year operating margins being around 29%. That’s about what you have in the first half of the year as well. But that would imply that sales will accelerate in H2 versus H1 from a dollar basis, but operating margins don’t go up. So maybe I am missing this, but what’s the offset? Is it the merit increases or is there other offers to consider in terms of why aren’t we seeing better operating leverage in the back half of the year?

Yes. So two things there, one is the merit increases you called out. But also the depreciation picks up quite a bit because of the CapEx in the first half of the year. So those are really the two main drivers. But I’m pretty pleased with what we’ve been able to accomplish on the margin front, making huge investments in the business and acquisition, the big investments we’re making in compute and to be able to deliver 29% operating margin for the year is pretty impressive and then to deliver – be able to raise EPS guidance. Very pleased with the team. I think everybody has pitched in and done a great job. So happy with that and pleased to see – is able to maintain the 29% margin despite the fact that there’s increased depreciation and merit increases. .

Perfect. That’s helpful. Thank you.

Thank you, Amit and thank you everyone. In closing, we will be presenting at several investor conferences and road shows throughout the rest of the third quarter. Details of these can be found on the Investor Relations section at akamai.com. Thank you for joining us and all of us here at Akamai wish you and yours a wonderful rest of the summer. Have a nice evening.

Conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.