Operator:

Good day and welcome to the Second Quarter 2024 Akamai Technologies Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator instructions]. Please note this event is being recorded. I would now like to turn the conference over to Mark Stoutenberg, Head of Investor Relations. Please go ahead.

Tom Leighton:

Thanks Mark. I'm pleased to report that in the second quarter, Akamai delivered continued strong momentum in compute, strong growth in our security portfolio, steady operating margins and healthy earnings growth on the bottom-line. Second quarter revenue grew to $980 million, up 5% year-over-year as reported and up 6% in constant currency. Non-GAAP operating margin was 29%. Non-GAAP earnings per share was $1.58, up 6% year-over-year and up 9% in constant currency. These results were in line with or above our guidance. Before I provide more color on our performance, I'd like to review how Akamai is evolving as we grow. As most of Akamai first made its name with the invention of content delivery services, and we're still the world's leader in that market today. We stand out for providing the scale and performance required by the world's top brands as we help them deliver reliable, secure and near flawless digital experiences. Recent examples include delivering the Euros football tournament and the summer games in Paris for top broadcasters around the world. As we've said in previous calls, our delivery business has been challenged in recent quarters by macroeconomic and geopolitical headwinds. Our plan for delivery is threefold. First, we will remain disciplined when it comes to the profitability of traffic that we choose to serve. Second, we will continue to leverage our market leadership position and installed base of major enterprises to generate cross selling opportunities. And third, we will continue to take steps to retain our market leadership while also reinvesting most of the cash flow from our delivery product line into the fast growing areas of the business. In Q2, delivery accounted for one third of our revenue, or $329 million. This is quite a change from five years ago when delivery accounted for two thirds of Akamai revenue. The diversification of our revenue across new markets through continuous innovation has long been a core part of Akamai's strategy for long-term profitable revenue growth. A little more than a decade ago, we expanded our business into security with the creation of web app firewall as a cloud service. We did this to meet what we recognized as a growing customer need in a way that was complementary to what Akamai was already doing for customers with delivery. The opportunity was clear to us because we listened to our customers. We created what has proved to be a very successful cloud service for web app firewall. And now, for the first time in Akamai history, security delivered the majority of Akamai's revenue, $499 million in Q2, up 15% year-over-year and up 16% in constant currency. This amounts to an annual run rate of about $2 billion per year. Of course, we greatly expanded our security product set over the years. We now offer market leading solutions for DDoS prevention, Bot management, account and content protection app and API security, and zero trust enterprise security led by our Guardicore segmentation solution. Customer interest in our security solutions is strong and we had many significant wins in Q2. One of the world's largest energy companies became a new zero trust customer with Akamai. One of the top three airlines in the US is moving from a Legacy VPN architecture to a zero trust architecture. With Akamai, we provided Akamai app and API protector to one of the largest providers of HR management software and services in the US and to German retailers Delife, Douglas, Wagner, and Zalando. EFAFLEX, the German maker of high speed industrial doors, purchased our segmentation solution, as did a major stock exchange and a leading cybersecurity company in Latin America. We provided DDoS protection to one of the largest banks in the world and to a government ministry in the Middle east and at one major electric utility in Southeast Asia. We replaced a well known competitor in a five year deal for our web app firewall, DDoS protection, Bot management, account, takeover prevention, and API security. We're especially excited about the most recent additions to our security portfolio. In Q2, we announced our new Akamai Guardicore platform, the first of its kind to enable zero trust security through a fully integrated combination of micro segmentation, zero trust network access, multi factor authentication, DNS firewall, and threat hunting. Its single agent and unified control console, powered by GenAI, are designed to strengthen and simplify enterprise security with broad visibility and granular controls. The new GenAI interface enables our customers operations teams to ask questions in a human language to gain information about their enterprise networks. The new Akamai Guardicore platform reflects our evolution as a security vendor, growing beyond point solutions to a broader and more comprehensive security offering. Customers tell us they want to consolidate security products and tools with vendors they can trust, and we think this will appeal to their needs. In Q2, we also closed the acquisition of no name security as we accelerate our momentum in the fast growing API security market. IDC forecasts this market will grow at a CAGR of 34% to nearly $1 billion by 2027. With no name, we believe that Akamai now has one of the most comprehensive API security solutions in the industry. Within two weeks of the close, Akamai offered no name customers our new Edge connector, an integration with Akamai web app and API protector that works with a click of a button. No name saw a significant increase in closed deals in Q2, including wins at some of the largest banks and insurance companies in North America and at leading software companies in Europe and Asia. We're also beginning to see a good up-sell motion with early no name adopters. For example, one of the largest US healthcare insurers more than doubled their no name contract in Q2 to over $1.7 million annually. About a decade after we entered the security market, we again expanded Akamai's future opportunity by developing a much broader offering in cloud computing. As many of Akamai has offered function as a service in our edge platform. For many years, this kind of edge computing has been used by thousands of our customers, and it is deeply integrated into our delivery and security services. But our customers asked for more. They wanted us to offer full stack cloud computing so that they could run their VMs and containers on the Akamai platform. And they wanted us to do it in a way that would be more efficient and less costly than comparable offerings provided by the hyperscalers. They wanted Akamai to do this because they were already delivering and securing their sites and apps on our platform. They liked our track record of reliability, and they knew they could trust Akamai to be a good partner. Many of them also liked the fact that we don't compete against them. Unlike the hyperscalers, adding cloud computing to our portfolio also makes good sense for Akamai. In addition to satisfying customer demand, we can reap the advantages from offering customers delivery, security and compute on the same platform. The synergies include improved performance, seamless integration and other operational efficiencies, bundling for cross selling and strong customer retention, increased margins for all of our services, deepening relationships with carrier networks, capacity to quickly detect and stop massive cyberattacks at the edge, unmatched visibility into enormous volumes of traffic and the security insights and threat intelligence that we gain as a result. If you step back and look at how the marketplace has evolved, you can see how the hyperscalers have worked to achieve a similar suite of offerings, although they've taken a different route to get there. They started with cloud computing and infrastructure as a service and then moved into security and delivery, validating our view that there is synergy in offering customers all three together. he hyperscalers also have a more centralized architecture, while Akamai has the world's most distributed cloud platform, with more than 4100 points of presence in over 700 cities across 130 countries. We believe that being more distributed provides customers with better performance, better economics and greater reliability. As we reported in our last earnings call, the initial response from customers to our new cloud offering has been very encouraging. The strong early momentum that we achieved in Q one continued in Q2, with compute revenue growing to $151 million, up 23% year-over-year and up 24% in constant currency. New compute customers added in Q2 include one of the world's best known media and entertainment brands based here in the US, the European cybersecurity company Sekoia.io, Clara Video, the video brand of the biggest Telco in Latin America, MwareTV, a technology platform for IPTV and OTT services and a cable satellite IPTV provider that reaches almost half the households in Australia. Customers are also leveraging our ISV partners, which we call qualified compute partners, to run low latency workloads on our compute platform. These include solutions for observability into workload behavior, cybersecurity and large scale events where the need to store very large sets of data makes Akamaya more attractive and cost effective option than competitors. Our media customers can now take advantage of a full suite of media workflow offerings on Akamai connected cloud, which provides valuable synergy with our delivery platform for more efficient image manipulation, decisioning and video transcoding. And with Akamai's latest qualified compute partner and customer Yospace, media companies around the globe can leverage their advanced ad tech and ad strategies at scale across the Akamai connected cloud. Customers are also building new apps on our platform where low latency data distribution and processing provides a better user experience for their customers at significantly reduced cost. One customer is training and testing the machine learning engines that power their security scanning product. Another is building an AI powered Chatbot application to improve their customer experience and streamline operations with intelligent, conversational customer engagement. Such AI powered applications are increasingly popular with recent advances in large language models. Akamai is also a very large user of our new cloud solution. As a result of migrating most of our own apps from the hyperscalers to Akamai connected cloud, we're seeing better performance and greatly reduce cost. In fact, we expect to reduce our spending on third party clouds to less than a third of what it would have been this year had we stayed on the hyperscalers, saving us well over $100 million in annual OpEx. It sure feels good not writing a nine figure check to your competitors every year, and this is a feeling that we look forward to providing to our large enterprise customers. In summary, Akamai has undergone a fundamental transformation. We transformed from a content delivery pioneer into the cloud company that powers and protects life online. Compute and security now generate two thirds of our revenue, and we believe that they provide Akamai with excellent potential for future growth and profitability. And we've achieved this transformation while successfully maintaining robust margins. Because both of our fast growing product areas, our large security portfolio, and our rapidly growing cloud computing portfolio, are built upon and enabled by the foundation of our business, our highly efficient and massively distributed delivery platform. Our near term operating margin goal remains 30%, and we see potential margin upside over time as the fast growing areas of the business expand our profitability. Looking back at the first half of 2024. We're pleased by our strong performance in security and compute. Looking ahead, we're very excited about our potential for future growth as we integrate noname and as our fast growing compute offerings continue to gain traction with customers. Now I'll turn the call over to Ed for more on our Q2 results and our outlook for Q3 and the full year. Ed?

Operator:

We will now begin the question-and-answer session. [Operator instructions]. The first question today comes from Patrick Colville with Scotiabank. Please go ahead.

Tom Leighton:

Yes, great question. And I got to say, we were very pleased to see the rapid early adoption. that's a capability that we really just started selling in earnest this year. We had some very early adopters towards the end of last year. And, if we can get up to $100 million ARR by the end of the year, which we think we're going to do, that's great, for the first year of the product, and then we'll see where we are at the beginning. Next year, we'll give guidance in February for the year in compute, but we're very optimistic about strong growth in compute driven by the enterprise customers and our new capability. There's an enormous market there, obviously, and so we're really looking forward into tapping into that.

Tom Leighton:

Yes, I don't think what we're seeing today persists over the long term. traffic, I think, will grow, continue to grow maybe at a little bit of a slower rate, than it did certainly during the COVID times. But, delivery, I believe, is here to stay. We are intent on remaining the market leader by a good margin. It's a very profitable business for us. We're very careful about that. We're very efficient in what we do. And it's very synergistic, with our security web app firewall business and our emerging compute business. So I don't see these headwinds persisting over the long term. There are geopolitical considerations that we're worried about, for next year. But I don't think this is a long-term phenomenon. And in any case, given the very fast growth of our security and compute product lines, they've nearly trickled in revenue over the last five years. So now where they're two thirds of our revenue overall, I think the, what you see with delivery, with sometimes challenges, sometimes good, it has a lot less impact on the overall growth rate as we go forward. Ed, do you have anything you want to add to that?

Operator:

The next question comes from Keith Weiss with Morgan family. Please go ahead.

Ed McGowan:

No, Keith? Yes. So we included no name in our guidance last quarter as well. So there's nothing that's changed. If anything, the business has gotten a little bit better. So our guidance has come up a bit to reflect that.

Tom Leighton:

Well, Yes, the saving, operating savings we're getting, as Ed said, we've been plowing that back into the business by and large so that we can invest in growth. There's more savings to come there, but we really get the upward pressure on margins, the beneficial tailwinds on margins as the mix shift continues. As we add compute customers, that is good margin for us. And it's accretive security as we add customers there, it's accretive. Now, as Ed noted that today with the new security products, initially they're dilutive, but as we grow the revenue there, every customer we add, every deal we sign improves margins. So that over time, 30% is our goal, we're very close to that today, but over time, we think we have good potential to grow beyond that.

John DiFucci:

Thank you. I have a question on Guardicore. So, segmentation broadly seems like it's becoming more relevant in the market. Customers are more accepting of it. It's no longer like a new thing, and it has been for a while, and you guys have been there, and you bought God of a couple of years ago, but frankly, it seems like an essential component to a zero trust environment. Not everybody has it. So can you talk a little bit more about how about this business, but really about your Akamai Guardicore Zero trust platform that you just launched a few months ago, and how that sort of fits in the ecosystem of some of an enterprise when they need to protect all their assets to establish that zero trust environment. Because it always seemed to me that this was essential, like I said, for zero trust. I guess if you can also, in addition to the technologies and what else it fits in with, can you also hit on your channel efforts regarding this platform? Because I know this is sold through the channel. I think, Ed, you said this before, but it seems like a really sophisticated solution. It's not just you're buying a firewall for somebody or something like that. If you can just talk a little bit about how. I know it's only, it's early, but how that's working through the channel?

John DiFucci:

And if I could, Tom, because that all makes a ton of sense to me. But it also raises the question, like, what are people -- what do they do? What are the alternatives? Like I'm familiar with Illumio and as another company, I've seen called Truxport but like you said, like people don't lot of enterprises don't even have segmentation implemented. So a lot of do, but a lot don't. And so what are the -- are there other things that we're just -- that I'm just missing like I don't know, is Palo buy the whole Palo platform. Are they just saying, you don't need it? Or we have something that kind of does it? Like I'm just trying to -- because the opportunity is just seems really big here?

Operator:

The next question comes from Mark Murphy with JPMorgan. Please go ahead. Thank you very much.

Ed McGowan:

Mark, yes, not much of a change. The dollar moved around quite a bit during the quarter, up and down, but it's pretty much exactly the same. So for the full year, it's about $40. I gave the guidance already in the quarter in terms of the impact quarter-over-quarter and for year-over-year, but it's still about the same, just around 40 for the full year.

Tom Leighton:

Yes. Great question. I would say today, AI workload is probably a small fraction of the ARR. I think over time, potential for growth there. As we talked about useful in security, applications, chatbots, tailoring content for commerce companies, ad targeting, recommendation engines. I would say that the models are smaller because they're more focused. The giant models sort of are used to learn everything, your chat GPT, you can ask it any question at all, have it try to be knowledgeable about everything. Those are giant models and we're not really targeting that business. But for our customer base, they tend to be a lot more focused on what they're trying to do. Maybe it's a commerce site, maybe it's an ad site, maybe it's a security company. And they don't need to learn the whole world to really provide value. In fact, we see that with our own solution with the Akamai Guardicore platform with the control interface, powered by Gen AI. Really, it's a very specific application, which means that you don't need the gigantic model to really provide the value. And that means it doesn't have to run on this giant suite of GPUs, it can run just great on our platform, which has GPUs but primarily CPU-based, which gives us much better ROI. And that works great for what our customers are looking to do in terms of their AI applications.

Madeline Brooks:

Hi team, thanks for taking my questions. I want to continue on the discussion of Connected Cloud and you mentioned some nice wins in enterprise outside of your traditional CDN customers. But I guess I just wanted to double click on that and kind of get a little bit of color. What are those customers for nonmedia, non-e-commerce. What are the use cases that those customers are finding from Connected Cloud? And if you could just help us break out to growth of those customers maybe versus growth of your more traditional customers? Are they growing around the same in terms of their adoption of Connected Cloud?

Operator:

The next question comes from Alex Henderson with Needham. Please go ahead.

Tom Leighton:

Yes. I'll take our first half and turn it over to Ed. And the answer will be pretty similar to the last question. I would say our biggest users and the biggest segment for compute today is our large media customers. And that's by design. And our -- a lot of our QCP, our Quality Compute Partners are media workflow companies. So that's sort of the biggest segment. I would say observability as a capability, a very large one as well, and that spans across all verticals and would include new customers. So we do have a bunch of customers in nontraditional Akamai verticals that are using compute. And I think over the longer run, that opens up a whole new market verticals for us. But the biggest chunk today would be existing Akamai media companies is the biggest. And Ed, do you want to add some color on that?

Operator:

The next question comes from Fatima Boolani with Citi. Please go ahead

Ed McGowan:

Yes, sure. So I talked a little bit about the expectations for Q4. Just based on what we're seeing now in terms of traffic growth and what we saw last year, we're not expecting the normal hockey stick to any significant degree like we've seen in prior years. And also keep in mind, we closed the transaction with StackPath and Lumen last year, and that's all delivery revenue. So that makes sure Q4 tougher comparison if you're looking at sort of year-over-year growth rates, that's going to skew your perspective a bit. And as we talked about on the last call, there were some dynamics going on with one of our larger social media customers. The good news there is we've got a good handle on that. That's sort of playing out as we expected. But as we talked about, those are the factors that as you put that into your model, why it may look like it's deteriorating a little bit. But I'd say the biggest issue is the fact that you're anniversary-ing the StackPath and move contribution from Q4 last year.

Tom Leighton:

Yes. Compute is different than delivery. So it's not a situation where delivery revenue was going into compute. That's not the case here. And that compute opportunity is orders of magnitude bigger than the delivery opportunity. And so I think, over time, it becomes a much bigger business than delivery. And I think delivery does its thing and it's a very good business for us in terms of cash generation, in terms of cross-selling. And in terms of actually of the economics of the platform, so we can go out there and offer compute at and especially for chatty applications and applications where data is moving around at a much lower price point than the hyperscalers because we have the delivery platform, but it doesn't -- it's not a situation where it's plugging a hole in delivery. I think compute is a huge revenue growth driver for us in the future, independent of anything in delivery.

Unidentified Analyst:

This is Quinton on for Jim Fish. Maybe touching on that first question there. A competitor in the space recently talked about pricing pressures from some of the largest medium customers getting worse over the past couple of months. Are you seeing those pricing trends in the market that's maybe driving some of that second half weakness alongside, obviously, the StackPath and Lumen impact? Or are you not really seeing these pressures given your decision to move away from these kind of lower margin delivery opportunities?

Unidentified Analyst:

Yes. That's really helpful. And then obviously, it's still really early here with the Noname acquisition. But any update you can provide on the integration between Noname and your kind of existing Neosec API opportunity? And maybe how you balance that go-to-market of those two platforms and how you can kind of leverage a full suite to kind of grow the wallet here within a customer.

Ed McGowan:

Yes. Just to add the -- just add the Noname acquisition came with a pretty sophisticated channel as well as a number of specialists. So we have both of those, so that's going to help drive some sales. And actually, from the minute we announced the close to when we closed or announced the deal ultimately closed, we saw a nice pickup in deals closed. So not no impact on the funnel and the teams already out there selling. So very excited about that. I think we've just enhanced our go-to-market capability as part of the acquisition.

Jonathan Ho:

Hi. Good afternoon. As you listen to customers and what they need or want from the compute side of things. Are there any core services or capabilities that you feel like you're missing or you're going to add pretty soon that are maybe potentially catalyst for even faster adoption?

Jonathan Ho:

That makes a ton of sense. Just in terms of the delivery business, as we continue to see this decline as a percentage of revenue, it seems to be carrying the business in terms of margins. How concerned are you over deleveraging effects and CapEx efficiency as we see sort of the two sides of the business move in opposite directions?

Operator:

The next question comes from Tim Horan with Oppenheimer. Please go ahead

Tom Leighton:

Yes. On the first question, we have built capabilities for ourselves as part of our migration. So we're off of Snowflake and Data bricks which we had big spends there. Looking at over time, making our capabilities available to customers, again, a service that is more efficient, which I think is really important for customers. In terms of the growth rate, I would say that you want to compare the enterprise compute number, which we've talked about was a $50 million ARR at the end of Q1. We think that will more than double by the end of the year. That's sort of the number you want to look at that's comparable. We've got more in the overall compute number, but those are -- have products like image and video manager, legacy Akamai net storage, other kinds of things. which aren't as comparable for what you're looking at in terms of the hyperscaler growth. So if you focus on the enterprise compute, which is really going to be the growth driver for us, that's going in a very fast percentage now and, of course, on a much, much smaller number than the hyperscalers. Ed, do you have -- want to add to that?

Timothy Horan:

And do you think you're capital constrained at all or product constrained at all in the enterprise there?

Operator:

The next question comes from Rudy Kessinger with D.A. Davidson. Please go ahead.

Ed McGowan:

Yes, sure. So just in terms of some of the puts and takes, just remember, last year, in Q3, we had little over $6 million of license revenue, that's a couple of percentage points. So that's going to make your Q3 compare a little bit more challenging. The other thing to keep in mind, too, last year, we introduced some new security bundles for web app firewall that did phenomenally well. So we've anniversaried that, so that makes sure our compare is a little bit more challenging. And then between Guardicore and API security as they start to ramp, we think APIs going to ramp very, very quickly. It's just a smaller number. So as you've talked about, the growth has bounced around a little bit over time. That happens as you bring new products into the market and they start to ramp up, think about when we brought [ Batman ] manager to the market. It was a small product and then go to hundreds of millions of dollars. I think the same thing you'll see with Guardicore and API security.

Ed McGowan:

Yes. No, we're not seeing a phenomenon of someone moving to low-cost providers. As a matter of fact, there's two less of them in the market today. So we're not seeing that. As I talked about earlier, we have a tough compare with a [indiscernible] Q4. And then we've just seen just a lower traffic year. Gaming has been unusually weak, video traffic isn't as robust as it normally is. That stuff happens from time to time, but we're not seeing a shift to low-cost providers or any new low-cost providers in the market.

Unidentified Analyst:

This is Yan Samilton for Will. Ed, just going back to that more muted Q4 seasonality you're expecting for delivery again this year. If I remember correctly, last year, you were pointing to weaker trends in retail, including an uptick in bankruptcies there and then also weaker in terms of gaming. And now I know it's probably still a little early to forecast though, but is it those same verticals where you're expecting weaker traffic again this year that you're informing your expectation? Or is it some others or maybe it's more broad-based?

Operator:

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Stoutenberg for closing remarks.

Operator:

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Operator:

Good day and welcome to the First Quarter 2024 Akamai Technologies Incorporated Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Stoutenberg, Head of Investor Relations. Please go ahead.

Tom Leighton :

Thanks, Mark. Akamai got off to a strong start for the year with our Security and Compute portfolios. And we continued to experience industry headwinds with our delivery product-line. First quarter revenue grew to $987 million, up 8% year-over-year as reported and in constant currency. Non-GAAP operating margin was 30% and non-GAAP earnings per share was $1.64, up 17% year-over-year and up 18% in constant currency. The fast growing parts of our business, security and cloud computing, grew to represent almost two-thirds of total revenue in Q1, and combined they grew 22% over Q1 of 2023. The continued shift in Akamai's revenue mix towards security and compute, is a clear indicator that our growth strategy is achieving the intended results. We continue to successfully leverage the market leadership and cashflow of our delivery product line to invest in our faster growing and more profitable security and cloud computing portfolios. And we are excited about the opportunities we have ahead of us, especially with our planned acquisition of Noname Security, which we announced this week. I'll say more about Noname in a minute. But first, looking at our security portfolio more broadly, security revenue grew 21% year-over-year in Q1 to $491 million, driven in part by continued strong demand for our market-leading Guardicore Segmentation Solution. Customers who purchased Segmentation from Akamai in Q1 included one of the top telcos in the US, a supermarket chain with more than 1,500 stores across Canada, and a major business management software company in Latin America. Our Zero Trust Network Access Solution, is also seeing good traction. For example, the United States Army announced last month that it selected Akamai for Zero Trust Security in Battlefield Networks. After a competitive evaluation of more than 40 vendors, the Army will use Akamai for its tactical identity, credential, and access management to enhance defenses in high-risk operational environments and limit network access to authorized users, devices, applications, and services. In response to customer requests to bring our Enterprise Zero Trust solutions together into a single platform, we've integrated Guardicore with our other enterprise security solutions to form our recently announced Akamai Guardicore platform. This new platform is the first of its kind to enable Zero Trust Security through a fully integrated combination of micro segmentation, Zero Trust Network Access, multi-factor authentication, DNS firewall, and threat hunting. All designed to strengthen and simplify enterprise security with broad visibility and granular controls through a single console. We think it will appeal to customers looking to consolidate security vendors and integrate their security tools. We also continue to see strong customer interests in our app and API security solutions. Customers who purchased Akamai API Security in Q1, included a major consumer financial services company, a US supermarket chain with more than 1,200 stores, and a leading US manufacturer of electric vehicles. Last month, one of our largest customers, a well-known hyperscaler, was hit with a massive denial-of-service attack, 24 million requests per minute. Using our rate controls and custom web app firewall rules, the customer successfully forwarded 99.999% of the attack traffic. That's five nines of protection. The customer was delighted, telling us, “that's an A-plus by just about every calculation”. Unlike some of our competitors who struggled to defend against far smaller DDoS attacks in recent months, Akamai is capable of protecting even the hyperscalers. The scale of Akamai defenses and the depth of our expertise really matter for customers, who named Akamai a Customer's Choice for the fifth-year in a row in the new Gartner Peer Insights Voice of the Customers report for cloud web app and API protection. And soon, our suite of app and API security solutions will become even stronger with the planned acquisition of Noname Security. The use of APIs has exploded in nearly every industry, driven by digital transformation, the widespread adoption of mobile phones and IoT devices, and the increased sharing of data between third-party providers. The increasing use of APIs also opens up new threat vectors for attackers and the need for API security. For example, we saw API attacks on our platform more than double from January 2023 to January 2024. And IDC Research now predicts that the API security market will grow at a CAGR of 34% to nearly a $1 billion by 2027. That's one reason why we are so excited about our plan to acquire Noname, as we accelerate our momentum in this fast growing segment. As one of the market leading API security offerings, Noname delivers visibility into API business logic abuse and contextual awareness between API requests and responses to ensure that anomalous traffic is detected, inspected, and blocked when warranted. We believe that the addition of Noname to our API security solution will offer Akamai customers enhanced attack analysis, more flexible deployment options, and extensive vendor integrations. Ed will share some financial details about the acquisition shortly. Turning now to cloud computing, I'm pleased to say that 2024 is off to a great start, with strong early momentum across multiple verticals. Customers are excited about our differentiated cloud platform, which offers superior performance through a more distributed footprint, cloud diversification, and lower costs. Examples of major enterprises using our cloud computing platform now include one of the world's largest e-commerce platforms, several global auto manufacturers, several large direct-to-consumer and OTT providers, several global SaaS providers, numerous travel and hospitality companies, including one of the world's largest cruise lines and a large airline in Asia, one of the largest credit unions in the US. A multinational financial services company. An iconic global corporation that manufactures and sells consumer electronics, computer software, and online services. A European cyber security company, and a leading ad tech company. Just this week, we signed up one of the world's best known media companies to a two-year deal worth several million dollars per year for compute. Yet another great example of major enterprises using our new cloud computing platform is Sony Group. Sony is excited about Akamai's investment into Edge Compute and has multiple latency-sensitive compute workloads that are running on Akamai. Current use cases include PlayStation.com, leveraging Edge Compute to improve search engine optimization, and PlayStation Direct, leveraging Edge Compute to ensure a fair experience for customers purchasing PlayStation Hardware. We're also seeing strong early traction with our Independent Software Vendor, or ISV, partners. They offer solutions that run on our compute platform in which our go-to-market teams co-sell to help customers solve big challenges with a better together solution. For example, a media workflow provider, which powers OTT video, now offers its live encoder solution on Akamai Connected Cloud. The solution is designed to increase efficiency for large scale streaming while also lowering egress fees, by as much as 90% according to their calculations. Joint customers of the offering include OneFootball, one of the world's biggest digital soccer platforms, backed by clubs such as Real Madrid, Manchester City, and Bayern Munich. In partnership with an observability solution provider, we won cloud computing deals in Q1 with one of the world's leading gaming companies, a leading luxury goods brand in Europe and one of India's largest conglomerates. Their solution powers observability using Akamai Cloud computing and enables real-time data ingestion at scale, lightning fast query performance, and extensive data retention at a fraction of the cost of other platforms. Another ISV partner that is providing distributed database services, enabled a well-known online travel marketplace to go live in Q1, with a geolocation implementation that uses Akamai’s Edge Computing to execute code at the edge for optimal performance. The travel site invoked more than 68 billion Edge Compute instances in March alone. By the end of Q1, we had over 200 customers spending $36,000 or more in Annual Recurring Revenue for our new compute services, with about half spending $100,000 or more, and six spending over $1 million per year, all just for compute. All of these customer counts are triple what we had in Q1 of last year. Collectively, these customers are spending over $50 million annually coming out of Q1 for our new cloud computing solutions, which is up more than 4 times year-over-year. Beginning this quarter, our global enterprise cloud sales team is now led by Dan Lawrence, who joined us from AWS, where he ran data and analytics for its private equity segment. Before that, Dan ran the Americas analytics business for five customer segments, including gaming and high-tech SaaS. Dan joined Akamai for the potential he sees to combine Akamai's trusted brand and Edge Computing platform with the large market opportunity and distributed cloud. I'll now say a few words about content delivery, which represents a little over one-third of our overall revenue. Akamai remains the market leader in delivery by a wide margin, providing the scale and performance required by the world's top brands as we help them deliver reliable, secure, and near-flawless digital experiences. That said, our delivery revenue was less than expected in Q1, due to slowing traffic growth across the industry, and a large social media customer that is now optimizing their business to reduce costs. As a result, and as Ed will discuss shortly, we now expect our delivery revenue to decline at a higher rate this year. As we've noted before, delivery continues to generate profits that we use to fuel our future growth. It also helps our security and cloud computing portfolios, as we harvest the competitive and cost advantages of offering delivery, security, and compute on the same platform. Of course, we are not happy to see the declining revenue in our delivery portfolio. And while it remains difficult to predict exactly when that business will begin to stabilize, we believe that Akamai’s CDN remains a critical enabler of doing business on the internet. This has been the case for the past 25 years, and we remain convinced that businesses will continue to need Akamai's superior scale, reliability, and security in the future as they migrate more workloads to the cloud, seek to secure their internal and external applications, and look to unlock the promise of AI, often while also leveraging Akamai security and compute capabilities. Moreover, given the exciting growth we're seeing in our security and compute portfolios, we believe it is only a matter of time before these businesses drive accelerating revenue growth for Akamai as a whole. In summary, we are pleased by the strong performance of our security and compute portfolios to start the year. And we are very excited about our potential for future growth and profitability, as we add Noname to our security portfolio and as our fast-growing compute portfolio contributes a larger share of revenue. Now I'll turn the call over to Ed for more on our Q1 results and our outlook for Q2 in the full year. Ed?

Operator:

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Madeline Brooks from Bank of America. Please go ahead.

Ed McGowan:

Hey, Madeline, this is Ed. Yeah, so the renewals are going as planned in terms of the pricing expectations. We've got a few of them done now. We'll have about five of the seven completed by the end of this quarter, and the other two will be done in early Q3. As far as expectations go, like I said, pricing is coming in-line. Volume a little bit lower than we expected normally when we do these large renewals. We tend to see an uptick in traffic. We just haven't seen that. So that's all been reflected in our guidance.

Ed McGowan:

I'm sorry, could you just repeat that again?

Tom Leighton:

Yeah, they're not directly tied, but as we talked about, several of the world's largest media companies are starting to use our compute capabilities for a variety of tasks. So that's a good new story. It's not tied to the traffic levels in any way. Of course, these big media companies still use Akamai for a large fraction of their delivery needs, but traffic in the industry as a whole, especially media and gaming, is lower than we had initially expected.

Operator:

The next question comes from Keith Weiss from Morgan Stanley. Please go ahead.

Ed McGowan:

Yeah, I think just the rest of that would just be due to the lower delivery revenue as a whole.

Ed McGowan:

Yeah, sure. So there's really no structural change. Obviously, we're making some pretty big investments in R&D, and you can see that in the R&D line. And also just the acquisitions, we made an acquisition last year, made an acquisition now. So we're investing in growth. But there's also a fair bit of investment that goes into the cost of goods sold-line as we build out our compute platform. So you can see that in the higher co-location costs. And there is some accounting that you have to do when you enter into some of the long-term agreements for co-location. So we should start to see that, get some benefit of that as compute grows even faster.

Operator:

The next question comes from James Fish from Piper Sandler. Please go ahead.

Tom Leighton:

Yeah, for the large social media customer we talked about, there's a few components generally tied to their efforts to reduce costs. You know, they are using less bits per transaction and end-user experience. They're optimizing their doing less prefetching. They do have a very large DIY component as well and we haven't seen the impact of that yet but we do think that they may use that more throughout the rest of the year and that's factored into our lower guidance for this particular customer. So we haven't seen that yet, but we anticipated at this point as part of their overall cost reduction efforts.

Tom Leighton:

I'll take the first part and then let Ed to answer the second part. Yeah, Noname is a market leader. And they have a lot of capabilities that we don't have yet. And it's actually very synergistic with what we have. They have an on-prem and hybrid-solution. Our solution has been SaaS-only. They have a great channel partner ecosystem, market-leading presence, very easy to use and to integrate. And by the time we get the acquisition closed later this quarter, we anticipate we'll have full integration with Akamai Security Services, which is the piece they were really missing. And great user experience and console. So really strong capabilities and of course much bigger business. And with our solution, we can add to that I think stronger forensics and threat hunting with our data lake capabilities and by putting the pieces together, really a very compelling solution. I was just out at RSA earlier this week and I got to say the news was incredibly well received. A lot of customers, both ours and Noname customers, very happy about the acquisition and what we're going to be able to do for them. Also, the partner ecosystem, Noname is very partner friendly. That will really help our go-to-market motion and they were very excited about the news as well. And Ed, I'll turn it over to you for the second part there.

James Fish:

Thanks Ed.

Fatima Boolani:

Good afternoon. Thank you for taking my question. Just one on delivery. You know, I can appreciate how difficult it is to sort of parameterize some of the trends that are playing out in the industry. I think both of you sort of laid that out in the prepared remarks. But how should we think about the floor in terms of declines in this business and what type of GuardRails you're anticipating and putting around this business? And essentially what I'm trying to get around is how confident are you that this recalibration lower does take into consideration everything that's happening in them? And then I have a follow-up.

Ed McGowan:

Yeah, as Tom talked about, we use the best information we possibly can. We obviously work with a lot of the big telcos. We try to get feedback from them to see what they're seeing. We talk to our large customers to get an understanding of what they have planned in terms of the big events or if they're doing downloads, how big the downloads are going to be, what sort of share we should expect as we go through things like our large renewals and that sort of stuff. When we see a trend like we saw in March where traffic was lower than we expected and then continued into April, it did cause us to go back and relook at our forecasts and be a little bit more cautious. But those forecasts, it's unusual to see traffic decline month over month. It doesn't generally happen. But there is a big pressure in the industry to save costs, especially in the streaming business. Gaming tends to be very seasonal and a little fickle in terms of different titles being popular and not. We're just sort of in the downtrend in gaming. But as Tom mentioned, we've seen these trends before. We're usually pretty good at predicting when things will turn around. But when we do see something that is concerning, we're going to call it out and reset our forecast.

Tom Leighton:

Yeah, it's more of the latter and getting really solid experience and expertise as we increase our investment in the go-to-market effort around compute. And we think Dan is an excellent addition to our leadership.

Mark Murphy:

Thank you very much. I wanted to congratulate you on the strength in the Compute and Security and the US Army win the Sony -- win, obviously good things happening there. Going back to the social media company that you referenced, is that a typical kind of [garden variety] (ph) case of cost optimization or is there perhaps anything unusual like a corner case where The clock might be ticking on legislative proposals and they are moving in advance of that. Could it be a social media company that is struggling and shrinking? Anything along those lines?

Mark Murphy:

I understand. Okay. And then Ed, the security company you're acquiring, I forget the name of it, can you provide any metrics on the headcount or their growth rate in the last 12 months or the gross margins? And I'm just wondering, does it focus on API security that aligns any more or less across any of the particular hyperscalers?

Tom Leighton:

Yeah, in terms of the question on the hyperscalers and API security, they don't offer API security. They have API gateways, which is something totally different. In our competition, in API security is more startups or younger companies smaller. It's an emerging field and really we feel Noname as a leader there.

Operator:

The next question comes from Frank Louthan from Raymond James. Please go ahead.

Tom Leighton:

Well, PAR, we don't want to see revenue decline in our portfolio. We'd like to see it to grow. And we're declining, obviously, now in delivery. And in the particular case of the large social media company, I don't think, this is a price-related issue, really. And as Ed mentioned, I think pricing, obviously very competitive out there. And we don't go and chase the bottom stuff that's not really profitable for us. But you know, pricing is sort of as we expect and more of it's a traffic, overall traffic in the industry right now.

Ed McGowan:

Yeah, you know as Tom talked about, it's hard to predict. I mean, I think what you need to see for that to happen is traffic growth to improve, to see pricing rationalize a bit more than where it is now, and less concentration of big renewals. But that's really the formula that you would need to see a sort of a stabilized delivery business.

Operator:

The next question comes from Amit Daryanani from Evercore. Please go ahead.

Tom Leighton:

Yes, we talked about the Olympics as a decent event for us. Our estimate is $3 million to $4 million this year. As far as the election goes, really hard to tell. You know, we saw back in [2016] (ph) a bit more traffic, [2020] (ph) didn't really drive a ton of traffic. I'd say this is probably closer to what we saw in 2020, so we're not really anticipating a significant amount of traffic as a result of this year's election, but we'll see.

Tom Leighton:

Yeah, so I would think that next year should play out, or excuse me, 2024 should play out like it's done in the past. Q1 was a little bit stronger than normal. As we talked about on several calls back last year, we did move some folks to a stock-based bonus program. So we used to have a cash-based bonus program that would play out in Q1 that would drive cash flow down a little bit in Q1, but in terms of the progress throughout the year, it should look like the other years.

Operator:

The next question comes from Jonathan Ho from William Blair & Company. Please go ahead.

Tom Leighton:

Yeah, this is a really good platform for Zero Trust for enterprise applications. So you get your micro segmentation and your employees Zero Trust Network access which is your employee access. That's your North, South and East, West now combined. Same agents, you don't have to have two different agents, same console and [plane of class] (ph). And on top of it, you get your MFA, your DNS security, and your threat hunting service, all packaged in a platform. And that's something customers have been asking for. It makes their lives a lot easier than having what seem to be different products with different agents and different interfaces. On top of it, at RSA we demonstrated a very cool new capability that actually uses a GenAI, LLMs, to give a very nice human interface into your enterprise infrastructure. It identifies what your various applications and devices are, and you'd sort of think, oh, well people would know, but they don't. Enterprise, major enterprises just have zillions of applications and devices on the internal network and they don't even know what they all are. And this tells you, in actually a human language form, can actually tell you what is not sufficiently protected or if the firewall rules, the agent rules are out-of-date. We've got a lot of positive feedback about that at RSA. And it's something that over time we want to take to our entire suite of security services, which I think will be pretty exciting. So yeah, so this helps because customers want to see, really have a few basic platforms of which Akamai is one and simplification of interface and control, both for the control plane and for the agent that's on their applications and service.

Tom Leighton:

Yeah, great question. It very much is a land small. Somebody will try out a single app with a little of the traffic forward and then grow it, and then add more apps. And you see that with our profile of customers, starting with the ones that $3,000 a month, then half of them now up to [$100,000] (ph) a year, [$60 million] (ph), [$100 million] (ph) a year. And Akamai is actually our first $100 million a year customer on the platform. And that's the same progression we went through over the last year-and-a-half. And we expect, and that's what we're trying to do with all of our accounts. These customers I talked about I couldn't give you most of their names, but you would recognize them. And they are -- what they're spending now with us is a tiny fraction, even the big ones, of their overall cloud spend. And they are finding the platform is easy to use, performs very well, and is saving them a boatload of money. And I think that's why we're seeing such good early traction. And now the goal is to grow those accounts, both in terms of the number of use cases and the scale of a use case, and then to add more customers. And again, they will come in at the lower revenue volumes to start.

Alex Henderson:

Great, thanks. First off, congratulations. Picking off Noname was a real coup for you. I think that's an outstanding acquisition. So congratulations on that. I wanted to ask some content around the compute piece. First, you moved a bunch of your internal apps from other compute platforms to internal. Where are you on that? What does that look like in terms of the cost savings? And what has been the variance relative to what you'd expected when you started it, I assume you probably got better results, not worse results. And I was hoping you could, within the context of the compute platform, talk about gross retention as opposed to net retention. Obviously your net retention looks very good with these upticks, but I was wondering if there was any churn of people who were on the platform before that may have fallen out of the equation?

Ed McGowan:

Yeah, so if you think about where you see that, Alex, is there some absolute savings if you look at our – in our cost of goods sold line, you can see that on that network build and support sub-line, sub-category. It's offset a little bit by what you see in [colocation] (ph) fees. So you're not seeing a ton of margin expansion. But what doesn't show up there is that that line was growing at 30%, 40%, or 50% a year. Now, probably we'd be growing 30%, 40% if we hadn't done it. So the cost avoidance is pretty significant. As Tom said, we're finding this to be much better than we had expected. We should get the rest of the expected applications moved over here between now and the early part of next year, end of this year into the early part of next year. So I'm very, very pleased with that. And again, a lot of cost avoidance and some absolute cost savings, like I said, being a little bit [massive] (ph), investments we're making in the platform. And then you also asked a question on gross retention, I think was the term you used in terms of are we seeing any churn. On the enterprise side, we're not seeing any churn so far. We haven't seen any customers that have left the platform. We do see a little bit of churn in the legacy retail node business which was pretty common when you talked about the SMTs. But where we're really aiming to grow the business, we're not seeing any of that yet.

Tom Leighton:

Oh yeah, we already have several customers doing all sorts of AI, but inference AI on our platform, and we have partners, our ISV partners. Some of them, that's their product capability. So yeah, we foresee substantial use of the platform for inference.

Operator:

The next question comes from Rudy Kessinger from DA Davidson. Please go ahead.

Ed McGowan:

Yes, so if you look back a few years ago, they've been compressing a bit. We had some pricing pressure as we always do in the delivery business. But I talked a little bit about this a few questions ago, and even a little bit with Alex in the last question. As we invest in the platform to build out compute locations, we're doing the GECO build out. We built out 25 core locations last year. We entered into these long-term leases for colocation. And where there's underlying [commits] (ph), you have to straight line that. So there's some non-cash colocation expenses. So if you look at our [co-loc] (ph) cost line, that's been growing pretty substantially. So that's masking a lot of the savings that you're seeing from our third-party compute costs. There's also additional build out and support costs that go along with it as well. So that's why you're seeing that margin sort of holding flat to where they've been over let's say the last year or so, but I don't expect them to decline. Hopefully over time they should start to expand a bit, but as we're building out aggressively in the compute platform that does put a little bit of pressure on margins, but as we start to fill up those locations, we should start to see expansion in margin.

Ed McGowan:

Yeah, so we don't share those numbers for obvious reasons with the price compression because obviously there's customers that get certain discounts, others don't get as high discount because they don't have as much traffic. And also it's a competitive number. I'd want to know what my competitors are doing with that number as well. But if I think about sort of the mix of what's driving it. Pricing is always a factor. And if you don't get the commensurate traffic growth offset that, then you're going to decline. And that's what we're seeing. It's really the back-half story is a lower than expected traffic. Now, couple that with your, some of your largest customers renewing at the same time. You don't have that, that volume offset. It just exaggerates the impact at the back half of the year. So like I said, it's really more of a volume issue than it is an overall pricing issue.

Operator:

The next question comes from Tom Blakey from KeyBanc Capital Markets. Please go ahead.

Ed McGowan:

Yeah, so good questions. What -- I'll start with what the components of CapEx are today. So we said 16%. About 8% of that is Software CAP, so that's probably going to be 7%, 8% sort of going forward. Don't expect much of a change there. That's kind of been historically in that range. Compute this year is about 4%. CDN and securities around 3%, and then there's always 1% call it first. You know, you're [back-off](ph) if there's your IT systems and your facility related stuff. So in terms of how that's going to go throughout the years, we've obviously driven down our CapEx on the CDN business pretty dramatically. That used to be sort of 8% to 10% is what we used to talk about. So we've more than cut that in half. And I expect that -- that kind of low single-digit range will probably be where we stay unless we see just a dramatic increase like we saw during the pandemic. But there's no reason to believe that is to happen with what we know about the industry right now. In terms of the compute business, it's really a question of growth. Now we're expanding in terms of the number of locations right now. Obviously, revenue is growing very fastly, we made a big investment last year, and we talked about having room for revenue growth. And obviously, that enterprise revenue growth is quite substantial in terms of year-over-year and getting to more material numbers. Tom and I talked about being on a $50 million run rate just for that and growing it over 300%. Now, we've used kind of a metric of about a $1 of CapEx for a dollar of revenue. Not a perfect metric, but it's not a bad one to use. I've actually looked at some of the hyperscalers and some of the other public information that's available. It's a fairly decent proxy, obviously, as you're making major investments like testing an AI now. But I think that's a fairly decent place to put it for now and then obviously as we get more experience we'll update you from there.

Tom Leighton:

Yeah, I'll just do a quick answer on the second part there. Yeah, Noname is strategic, API security is strategic, and we're looking forward to integrating that more deeply in the Akamai platform and then building on top of it with new capabilities. And Ed, I'll let you talk about the financial.

Tom Blakey:

Thanks. Thank you.

Operator:

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

Operator:

Good afternoon, and welcome to the Akamai Technologies. Inc. Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Tom Barth, Head of Investor Relations. Please go ahead.

Tom Leighton:

Thanks, Tom. And thank you very much for the terrific job that you've done over the last 10 years at Akamai. It's truly been a pleasure working with you. And I'd like to join you in welcoming Mark as your successor. Turning now to our Q4 results, I'm pleased to report that ACMI delivered a strong finish to a very successful 2023. Fourth quarter revenue grew to $995 million, and non-GAAP operating margin was 30%. Non-GAAP earnings per share in Q4 was $1.69, up 23% year-over-year, and up 22% in constant currency. For the full year, revenue was $3.81 billion, and non-GAAP operating margin was 30%. Full year non-GAAP earnings per share was $6.20, up 15% year-over-year, and up 16% in constant currency. Security revenue in Q4 grew 17% year-over-year, and was up 18% in constant currency, contributing nearly half of our total revenue in the quarter. Security growth was driven in part by continued strong demand for our market-leading Guardicore Segmentation Solution, as more enterprises relied on Akamai to defend against malware and ransomware. Customers who purchased Segmentation in Q4 included one of the largest global tech firms in India, and a leading payment systems company based in Hong Kong that handles 15 million transactions a day. We've also seen strong interest in our new API Security Solution that we announced in August. Early adopters of this new solution include three major financial institutions, several major retail brands in Europe and North America, and a leading industrial automation company in Europe. Our customers are seeing the value of this new capability with several already paying over half $0.5 million per year for the service. Akamai’s API Security Solution also earned recognition from industry analysts in Q4. KuppingerCole named Akamai an overall industry leader in their API security and management leadership compass report. And Gartner validated our strong and expanded API capabilities in its market guide for cloud, web application and API protection. Turning now to cloud computing, I'm pleased to say that we accomplished what we set out to achieve last year in terms of infrastructure deployment, product development, jumpstarting our partner ecosystem, onboarding the first mission critical apps from some major enterprise customers, and achieving substantial cost savings as we moved our own applications from hyperscalers to the Akamai Connected Cloud. After launching Akamai Connected Cloud. After launching Akamai Connected Cloud last year, we rolled out 14 new core computing regions around the world, giving us a total of 25 overall. We also enhanced our cloud compute offering by doubling the capacity of our object storage solution and adding premium instances for large commercial workloads that are designed to deliver consistent performance with predictable resource and cost allocation. Also, our Akamai Global Load Balancer is now live. This integrated service is designed to route traffic requests to the optimal data center to minimize latency and ensure no single point of failure. Last year, we also amplified our go-to-market approach with our cloud computing partner program. The collaborative nature of the program provides a unique model for Akamai to engage with customers at a consultative level to deeply understand their requirements and pain points and to provide a complete solution leveraging the combined strength of the partner’s technology and Akamai's distributed compute platform. We've already partnered with several leading SaaS and PaaS providers and cloud data and processing platforms. We're very pleased with the progress that we've made thus far and are looking forward to adding more new partnerships in 2024. We've also begun to gain traction with some of our largest customers as they migrate mission-critical apps onto our cloud platform. For example, one of the world's best-known social media platforms spent approximately $5 million on computing services with us last year and they're already on a run rate to do more than double that this year. Two of the world's best-known software companies recently signed on and are already spending about a quarter of a million dollars per month on cloud computing with Akamai. In Q4, we also signed up a major global media measurement and analytics company and we displaced a hyperscaler when we signed Blu TV, the largest VOD streaming company in Turkey. The streaming customer told us that they found our platform to be simple to use, automated and intuitive, cloud agnostic for a smooth multi-cloud migration and affordable with very low egress cost, all backed by a trusted and reliable partner. In addition to exceeding our full-year cloud computing revenue goal of $500 million last year, we also derived significant cost savings by migrating several of our own applications from hyperscalers to Akamai Connected Cloud. Our bot manager and enterprise application access solutions were among the first to migrate. Together, these products are used by over 1,000 customers and they generate over $300 million in annual revenue for Akamai. But all that is just the beginning. Today, we're excited to announce the next phase of our multi-year strategy to transform the cloud marketplace, taking cloud computing to the edge by embedding cloud computing capabilities into Akamai's massively distributed edge network. Akamai's new initiative, codenamed Gecko which stands for “Generalized Edge Compute”, combines the computing power of our cloud platform with the proximity and efficiency of the edge to put workloads closer to users than any other cloud provider. Traditional cloud providers support virtual machines and containers in a relatively small number of core data centers. Gecko is designed to extend this capability to our edge pops, bringing full stack computing power to hundreds of previously hard-to-reach locations. Deploying our cloud computing capabilities into Akamai's worldwide edge platform will also enable us to take advantage of existing operational tools, processes, and observability, enabling developers to innovate across the entire continuum of compute and providing a consistent experience from centralized cloud to distributed edge. Nobody else in the marketplace does this today. In the latest implementation phase that we're announcing today, Akamai aims to embed compute with support for virtual machines into about 100 cities by the end of the year. We've deployed new Gecko-architected regions in four countries already, as well as in cities that lack a concentrated hyperscaler presence. These initial locations are listed in today's press release. Following that, we plan to add support for containers. And then, we plan to develop automated workload orchestration to make it easier for developers to build applications across hundreds of distributed locations. We've been conducting early trials of Gecko with several of our enterprise customers that are eager to deliver better experiences for their customers by running workloads closer to users, devices, and sources of data. Their early feedback has been very encouraging, as they evaluate Gecko for tasks such as AI inferencing, deep learning for recommendation engines, data analytics, multiplayer gaming, accelerating banking transactions, personalization for e-commerce, and a variety of media workflow applications, such as transcoding. In short, I'm incredibly excited for the prospects of Gecko as we move full stack compute to the edge. Turning now to content delivery, I'm pleased to report that Akamai remains the market leader by a wide margin, providing the scale and performance required by the world's top brands as we help them deliver reliable, secure, and near flawless online experiences. Our delivery business continues to be an important generator of profit that we use to develop new products to fuel Akamai's future growth. And it's an important driver of our security and cloud computing businesses, as we harvest the competitive and cost advantages of offering delivery, security, and compute on the same platform as a bundle. As we've noted in past calls, we're selective when it comes to less profitable delivery opportunities. And this is a discipline that we intend to maintain, and in some cases, increase in 2024. To be clear, we still aim to be the best in delivery for our customers. And we believe that our disciplined approach will benefit our business by allowing us to focus more of our investment in security and cloud computing, which are now approaching two thirds of Akamai's revenue and growing at a rapid rate. In summary, we're pleased to have accomplished what we said we would do in 2023. Our cloud computing plans are taking shape as we envisioned. Our expanded security portfolio is enabling us to deepen our relationships with customers. And we continue to invest in Akamai's future growth while also enhancing our profitability. Now I'll turn the call over to Ed for more on our results and our outlook for Q1 and 2024. Ed?

Operator:

[Operator Instructions] And our first question will come from Fatima Boolani of Citi. Please go ahead.

Ed McGowan:

All right, sure. Let me see if I can tackle all those for you. I'll start with the performance in Q4. So I'll break it down into a couple of buckets. So in Q4, we tend to see a stronger seasonal quarter for us. And we did see some of that. So from the retail customer perspective, we saw bursting roughly to the tune of about half of what we saw last year. And I think that has to do mostly with the zero overage. As that's become more popular, we are seeing less bursting. If I look back a few years, that's down above 50%, 22 compared to 21, and again, 23 compared to 22. Some of it could be macro factors, hard to tell. We're not really the best gauge for folks' consumption, but more they're surfing. If I look at gaming, gaming was a better year. If I look last year, gaming was pretty weak. This year, it was pretty good. Gaming tends to be fairly lower priced delivery, so you don't get as much upside in revenue. Video was up quarter-over-quarter, but not as much as we saw the prior year. So I would say kind of an okay fourth quarter from delivery. The one area that was probably the weakest was more in sort of high tech. So think about that as new connected devices, maybe it's connected TV or a new, say an iPad or something like that, printer drivers, that sort of stuff. That was much weaker than what we saw last year. Last year was a pretty good bump up in that category. So that really sort of sums up what the dynamics are in terms of the delivery business in Q4. And I looked at that, not including the acquisition traffic. The second question you asked, if I wrote it down correctly, was the absorption of the traffic from the acquisitions. We've largely done that. The services team did a phenomenal job migrating over the customers. We did it in probably about a third of the time that we had expected to be able to do that. There's still a few stragglers, but the transition services costs are immaterial. So that's why we didn't call that out. But that's largely been done. In terms of this year, why are we seeing a down 6% if that's the math you're using for delivery? A lot of it has to do with the renewals. Unfortunately, these larger customers, as we've talked in the past, we only have about eight customers that are greater than 1% of revenue. And unfortunately, seven of them are renewing in the first half of the year. That does have a bit of an impact on the delivery business. The majority of the revenue from those customers comes from delivery. We've seen this in the past. It seems like every two years, we kind of bump into this. Even though we try to sign staggered contracts, what happens often is someone might sign a two or three year deal with a revenue commit. They'll spend that in a shorter period of time. And we just get a combination of renewals here. And then the other thing was on the shedding of traffic. So let me just get a little bit more specific with what we're doing. So last year, if you remember, we talked about being a bit more stringent with the peak to average ratios. And we're going to continue to do that. We did a pretty good job. There's still a few customers we need to adjust. And that generally happens where customers will split and they have lots of day-to-day traffic and they might split that among three or four CDNs. And then they'll have peak events, whether that's a big video event or a big download event. And we get the disproportionate size of that peak. So you want to make sure you're compensated for that. So the way to do that is you get a higher percentage of the day-to-day or you just limit the peak. So we'll continue doing that. And sometimes that may mean we lose a little bit of traffic, but that's okay because you can see the results in CapEx. The new thing that we're doing now is we've worked with product and IT to enable us to be able to build for very granular level on destinations. In the past, we generally would build based on large geos, say for example, a large geos, say for example, the U.S. or Europe or Asia. Now we're able to get one level deeper. And so we can go after some of the areas where our costs are a bit higher to deliver. It's unclear. We're assuming that customers have choice. They may decide to take that traffic somewhere else. Some of our competitors don't really focus as much on profit as we do. If that's the case, then that's okay with us. So I think as we tried to factor all that in, those are the two driving factors as to why we're not seeing a better delivery performance in 2024. I think I hit all your questions.

Ed McGowan:

Sure. No problem. In terms of the cost of goods sold, I'll start with the good stuff that's going on in cost of goods sold. Obviously, you touched on the mix. So as we get a higher degree of security business, that obviously helps our gross margin line. And the second thing is the movement of our third-party cloud costs onto our own platform. We did a great job so far this year. Tom talked a bit about that in his prepared remarks. And we have more to go, and we have a roadmap to get that. So that'll drive some significant savings. The downside or what's sort of contracting them or not expanding the margins as much, I should say, we could be going a bit higher, is that with the build of the Gecko sites, we'll incur some additional co-location costs. So as we start to build out those facilities, you don't have revenue to go against it. But also, as I talked about last year, when we built out some of the bigger sites, with the accounting rules, when you do long-term Colo commitments or any kind of a commitment for long-term leases, you have to straight line any commitment. So we end up with a bit of a disconnect between what we're paying in cash and what we're actually expensing. So we're able to offset that with the savings we get from the third-party cloud in the mix, but those are the underlying dynamics.

Operator:

The next question comes from Frank Louthan of Raymond James. Please go ahead.

Tom Leighton:

Yes, I'll take the first question. Yeah, Gecko is not packaging. Gecko is a new capability where we're going to be offering full-stack compute in 100 cities by the end of the year, and ultimately in hundreds of cities. We're actually taking full-stack compute, the kinds of services you get in Linode or a hyperscaler, and making that available in our edge pops. Now today, the edge pops, we have 4,000, and they run function as a service. We'll spin up JavaScript apps in 4,000 locations in over 700 cities in milliseconds based on user demand, but that's not full-stack compute. Now we're going to be taking virtual machines and containers and supporting those in our Edge platform, and that enables our customers to get much better performance and scalability, also lower cost because of the financial benefits we get from our edge platform. So it really becomes, I think, a very compelling cloud computing offering that just doesn't exist in the marketplace today. It's not a packaging thing at all. This is a new capability, and of course, ultimately, after we get the support for VMs and containers, we want to make it work just as we do function as a service, so that we'll be spinning up containers and VMs on demand where and when they're needed, and that capability doesn't exist today in the market. Ed, you want to take the CDN question, the acquisition?

Frank Louthan:

Okay, great. Thank you very much.

James Fish:

Hey, guys. First, just Tom Barth. Look, you've been a class actor and appreciate all the help over the years, and just wanted to echo Tom Leighton and Ed's sentiment there. I really appreciate the help over the years. I want to circle over to security, actually. Look, security was a little bit lower than I think we were all anticipating for Q4. I get that we have some drivers underneath that are helping the business, but did you see any push out of deals and maybe that's contributing to your confidence around mid-teens growth for 2024? Help us on the confidence for sustained mid-teens growth, and really how is that selling outside the install base and penetration of those new security packages going?

Tom Leighton:

Maybe just to click down one level into Fatima's earlier question on the CDN side, and something that Tom said as well in his prepared remarks, is there any way to understand how much on the CDN side of the base you plan to essentially -- I don't want to say give away for free, but give away for free to get that compute revenue or help us understand kind of the dynamic between what we should expect between CDN and compute kind of dollar shifting. Thanks, guys.

Operator:

The next question comes from Keith Weiss of Morgan Stanley. Please go ahead.

Tom Leighton:

Yes, I'll take this one, Tom. You broke up a little bit there, Keith, but I think I got the genesis of the question. So yes, we've done, I thought, a great job of making some acquisitions over the last few years, investing in a compute business, spending an awful lot to build out our compute facilities, adding a lot of functionality, growing our security business, doing acquisitions there as well. And got back to 30% margin last year and continuing this year. We've always said that's been a pretty healthy spot to run the business. We're investing because we see opportunity for growth and there's always a balance. You can't cut your way to greatness. Perhaps we could cut a few more points, but then what are we leaving on the table? I think we've been pretty disciplined and balanced with our approach in terms of investing for growth and returning to margin. We've got some pretty exciting areas. We're seeing great growth in API security. It's still early days there. The product will continue to get better. We've seen good ARPUs there, so I'm very excited about what we're doing there. We've made investments in go-to-market and Guardicore, and that certainly has paid off. And the investments in Computer Stein has shown some early returns. So again, it's a balanced approach. We're in this for the long-term, and I think we don't want to shoot ourselves in the foot and not go after some of these big opportunities that we have in front of us.

Tom Leighton:

Thank you.

Mark Murphy:

Thank you very much. So, Tom, you've done a very solid job with the compute business. And in the prepared comments, you mentioned onboarding of submission-critical apps. I'm wondering if you could shed a little light on the pipeline of that kind of critical app that you see coming to you in 2024 and thus far. How well is your infrastructure handling the intensity of those larger workloads in terms of stability, reliability, uptime, etc? And then I have a quick follow-up.

Mark Murphy:

Yes. It's great to hear the tie-in with the inferencing and Apple Pay as well. So I appreciate the color of that. Ed, I wanted to ask you, you're providing the fiscal year guidance in constant currency and, of course, we all understand it's going to be very difficult to predict the actual fluctuations in the spot market, but if we looked at it at current FX levels, do you think it would skew that 6% to 8% revenue growth level higher or lower? If we were to try to translate it into reported U.S. dollars in our models right now today?

Mark Murphy:

And just to clarify, so it's still in that 68% range if we put it into USD or are you saying it's still kind of mid-single-digit, but maybe some like a point lower?

Mark Murphy:

Understood. Thank you very much. And I want to also thank Tom Barth for a lot of great interactions over the years.

Madeline Brooks:

Hi, team. Thanks so much for taking my question tonight. Just one on security. Outside of Guardicore, I just want to touch on this year, the rest of the Zero Trust portfolio trends that you've seen and maybe if you're feeling any additional competitive pressure now that the market has really expanded there? And then I have one follow-up.

Madeline Brooks:

Thanks so much, Tom. And then just one quick one on compute, too. I think if we think about earnings that have happened so far, especially with hyperscalers like AWS, Microsoft, Meta, we've kind of heard of this theme of the optimization inflection in terms of cloud computing, meaning maybe this year we're going to see a little bit more investment in new workloads. I'm just wondering if you've heard of any of those trends among your customers who are thinking about compute for the first time, or maybe if you're seeing increased appetite for compute for this coming year versus 2023. Thanks so much.

Operator:

The next question comes from Rishi Jaluria of RBC. Please go ahead.

Tom Leighton:

Great. So let me start with edge inferencing. And so some of the examples I gave, that's exactly what's happening for commerce sites in figuring out in real time what content you're actually going to give to the user that's coming to the site. Ad targeting, what ad do they get? Anything that involves personalization. On the security side, a ton of inferencing is used to analyze real-time data. For example, even our own bot management solution. Is that entity that's coming to the site, is it a bot or is it a human? And even if it's a human and they have the right credentials, is it the right human? And you use AI and inferencing for that, and you've got to do it really fast. You can't afford to send it back to the centralized data center because you've got a massive number of people that you've got to process in real time, especially if you're doing some kind of live event. And so being at the edge matters, because you can be scalable, you can handle it locally, you get great performance, you can make it be real time. And Akamai's unique value proposition with Gecko is that we're going to be able to now support this, not in a few cities, but in a hundred cities by the end of this year. So anything you can put in a VM, virtual machine, which is most things, you're going to be able to do that in a hundred cities. And then ultimately in hundreds of cities, because we can put this in general Akamai Edge pods. And then next will be containers, which is pretty much the rest of what you do in cloud computing. And then to be able to spin it all up automatically. It's a whole new concept for compute that I think is very powerful, and there's a high overlap of wanting to do that with inferencing engines, where you're trying to do something intelligent based on that end user or that end entity that's interacting with the application. Now, in terms of Gecko, we're just now in the early stages of getting it deployed. We're in nine cities, we'll get the 10th new city up in another month or so. By the end of the year, we'll be in a total of a hundred cities supporting compute. So not a lot of revenue is factored into the guidance based on Gecko for this year. That would come more next year. So this year's revenue guidance is based on the original 25 core compute regions that we've set up by the end of last year. Now we will deploy this, of course, just as fast as we can and as customers want to adopt it. And hopefully we have the situation where we want to build out more, get more compute capacity because there's so much demand for compute on Akamai. Ed, do you have any color you want to add around the guidance there?

Rishi Jaluria:

All right, wonderful. Thank you so much, guys.

Michael Elias:

Great. Thanks for taking the questions. Two, if I may. Just first on Gecko, presumably the pops that you have, they're already supporting security and delivery workloads. So from an architecture perspective, can you help us think about what expanding the compute platform into these pops means? Is it just additional co-location deployments and on the CapEx side, networking gear and servers? Any color that you could give there in terms of the mechanics of what the expansion would look like? And then second, Ed, last year you were talking about elongation of enterprise sales cycles. Just curious what you're seeing in terms of the buying behavior of your customer base. Any notable call-outs there? Thank you.

Ed McGowan:

Sure. Yes. So I think the trend, obviously, acquiring new customers is always challenging in an environment like this. The one probably exception to that is in the security space. That tends to be something that obviously, now with the requirements with the SEC reporting and I added a disclosure with CISOs being now potentially criminally charged for breaches and things like that. Audit Committee is spending more and more time on cybersecurity as a topic. That tends to be a budget that, one, you don't typically cut and, two, you're generally adding to. But yes, new customers are challenging. I do think this kind of environment helps us what we were just talking about in the last few questions, around optimizing cloud spend. Certainly, if you've seen what we've done, we've spent [ph] a tremendous amount of money. So I think that can also help us in this particular environment. But definitely, new customer acquisition is a bit more challenging, but we're still doing pretty well. Obviously, the environment can change. But it hasn't been a major factor for us yet.

Operator:

The next question comes from Ray McDonough of Guggenheim Securities. Please go ahead.

Tom Leighton:

Yes. Great question. So what we're doing now is, as I mentioned in the last question, deploying more hardware in existing edge region and generally the larger edge regions. We already have network there. We already have delivery security located there. So there's some additional color and servers. And yes, the goal is to put it all on one common software stack. Now initially, we have the Linode stack is moving into these edge pops for Gecko. But as we once we get the support for virtual machines and containers, then next, we want to add the software stack that we have for delivery and for security and for function as a service that automatically, for example, spins up JavaScript apps and milliseconds based on end-user demand, we want all of that to be operating on containers and VMs. So that you don't have to think ahead of time about how many VMs do you want in each of these hundreds of cities? It just happens based on end user demand. You automatically get new ones spun up, load balancing, fail over, really a very compelling concept. And that doesn't exist in the cloud marketplace today. That is the vision -- I think you really nailed it when you talked about the common software stack because only Akamai has that full edge platform today, that software stack around delivery and security that will be now including compute.

Ed McGowan:

Yes, sure. So the majority of the growth in the compute guidance is going to come from enterprise compute. So the stuff that we built out for the last year. So if you kind of go back and look at the math in terms of -- we've kind of said roughly speaking, $1 of CapEx is $1 of revenue. You can kind of look at what we're doing for compute build-out now what we did last year. We said we got about $100 million roughly for our -- all in for our internal use. So that leaves a pretty significant amount left for customer demand. Now obviously, the way people buy today, they pick a location, etcetera. So it's not going to be exactly a dollar for dollar right now, but it's a general rule of thumb. So I would say the majority of what we built out is for customer usage.

Operator:

The next question comes from Tim Horan of Oppenheimer. Please go ahead.

Tom Leighton:

Yes. So I think one platform really in terms of being able to do everything together and all the same software so that we have our Edge software running with the Linode software to spin up VMs and containers that's not until 2025. We are, first, combining the infrastructure and of course, customers can buy the services as a package. We have common reporting now in many cases. But in terms of doing all the automatic spinning up and truly serverless used for VMs and containers, think 2025 for that. And let's see. So -- and what was the other question you had?

Tom Leighton:

Yes. And it's -- it depends how you define serverless, initially with Gecko, you would operate it the same way you would Linode. You decide how many VMs and containers you want in the various cities. And it is very developer-friendly, works just like Linode. So if you're familiar there, that would now work in -- well, at the end of the year, 100 cities for your virtual machines. Now if you define serverless to be -- which doesn't exist today out in the marketplace for VMs and containers, they just spin up automatically like we do today for Function as a Service and for JavaScript, that's what comes 2025.

Tom Leighton:

Yes, that's a great question. They don't support VMs or containers at all, never mind serverless or anything else, just -- they don't have support for that. They don't do this full stack cloud computing.

Operator:

The next question comes from Alex Henderson of Needham. Please go ahead.

Tom Leighton:

Ed, do you want to go with the first one, and I'll take the second one?

Alex Henderson:

Just to be clear, is this the full year growth rate? Or is this the fourth quarter growth rate?

Alex Henderson:

That's sufficient. I just needed to know what it was.

Alex Henderson:

Great. Thanks for the complete answer.

Jonathan Ho:

Hi, good afternoon. Just one question from me. How important is the global load balancing capability? And what does that maybe mean for your ability to either attract more customers or to drive revenue from that product? Thank you.

Jonathan Ho:

Thank you.

Operator:

Our last question will come from Rudy Kessinger of D.A. Davidson. Please go ahead.

Tom Leighton:

Yes. So I'll just -- let me address that part first. So I would say if you look at the underlying components of what's growing, it's actually that enterprise compute opportunity that's growing very, very, very fast, like those numbers, the percentages would be kind of foolish to break out because they're going off of small numbers and adding to them very big numbers. Now also part of our strategy is to be competitive and have big core centers in many cities, and that does require a larger build out. So there's a lot of capacity that we have to sell. And then also, we're seeing demand in certain cities, you have to build out more capacity where you're getting demand. And then the Gecko sites that we're building out, it's not a significant -- I mean it's a decent amount of capital. But I think that is another big key differentiator for us. And as Tom mentioned, we think there's a big opportunity there. So I know a lot of people have been questioning us being able to take on large workloads, etcetera. We clearly have a lot of capacity out there. As I talked about earlier, we've made the change with our compensation plans where our reps now have to sell compute. So we're going to see a lot more of that. We've done a tremendous amount with the platform in terms of adding functionality. We built out the platform, connected it to our backbone, and we have a lot of new compute partners. The platform is ready to be sold so we're pretty optimistic about it. And I think we're building in a pretty responsible manner. As I talked about, our CapEx is relatively modest for this business right now. So I think we're in pretty good shape.

Operator:

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect.

Operator:

Good afternoon, and welcome to the Akamai Technology Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Tom Barth, Head of Investor Relations. Please go ahead.

Tom Leighton:

Thanks, Tom, and thank you all for joining us today. I'm pleased to report that Akamai delivered excellent results in the third quarter with revenue, operating margin and earnings all exceeding the high end of our guidance range. Revenue grew to $965 million in Q3, up 9% year-over-year. Non-GAAP operating margin was 31%, and non-GAAP earnings per share was $1.63, up 29% year-over-year. Ed will cover the key factors that drove our bottom line performance in his portion of the call. I'll now say a few words about each of our 3 main product areas, starting with security, our largest source of revenue. Security revenue grew 20% year-over-year in Q3. The acceleration in security growth was driven in part by especially strong demand for our market-leading Guardicor segmentation solution as enterprises confront the ever-present threats from malware and especially ransomware. CISOs and corporate Boards everywhere have seen the recent headlines about devastating ransomware attacks, including at 2 casino hotels in Las Vegas, a major manufacturer of cleaning products in the U.S. and at a multinational provider of systems for smart buildings. One of them reportedly paid $15 million to get ransomware out of their systems. Another is reportedly spending $25 million to deal with the after effects and a third has reported more than $100 million in losses from the attack. Customers who purchased our segmentation solution last quarter include a major global services provider, one of the world's most recognized entertainment brands and a leading bank in Switzerland that renewed their segmentation protection with a significant upgrade. We also saw strong demand for our market-leading web app firewall solutions in Q3, where we continue to win against competitors who are challenged to provide the levels of reliability and performance required by major enterprises. Customers who switched to Akamai, including a nationwide retail chain in the U.S. and a leading global manufacturer based in India, also told us that our competitors simply can't provide the level of support and professional services that they need and have come to depend on from Akamai. Customers also value being able to purchase an entire suite of integrated security products from Akamai, a provider who they trust to keep them safe against a wide variety of attacks. For example, we're seeing very strong interest in our new API security solution that we announced last quarter. This new product is in its very early days, but we've already integrated it with our market-leading web app firewall solution to make it even easier for customers to implement. At the Black Hat security conference last quarter, Akamai API Security was named one of the 20 hottest new cybersecurity tools by CRN, a major trade publication for channel resellers. And as with Guardicore, you don't need to be a CDN customer to benefit from this new solution. Turning now to cloud computing. I'm pleased to say that we're on track with our product development, infrastructure deployment and conversations with customers about use cases well suited for the Akamai connected cloud. Since our last call, we've gone live with 7 more core compute regions in Amsterdam, Jakarta, Los Angeles, Miami, Milan, Osaka and Sao Paulo. In addition to the 6 that we opened earlier this year and the 11 that we acquired from Linode, this brings our total to 24 core compute regions to serve Akamai connected cloud customers. Of course, there are other cloud companies with a few dozen data centers. But Akamai is unique in having these data centers interconnected to the world's most distributed edge platform with more than 4100 points of presence across 750 cities and 130 countries. As one trade pub block and files recently wrote, Akamai is focusing on a future where scale becomes more about the size of the network versus the size of its data centers, more effectively powering modern applications. We agree. Akamai's massively distributed edge network, 25 years in the making and managed by Akamai's team of experts around the world is a key differentiator in our strategy. We believe that next-generation applications will need next-generation cloud infrastructure, and we intend to chart the course for the next decade of cloud computing when more of the compute will be done closer to the end user and where we believe our platform will have an important edge over more centralized models. As IDC put it in July, Akamai brings the simplicity, affordability and accessibility of its cloud computing services to larger commercial customers on an architecture built for the next decade, not the last. The Akamai Connected Cloud will put containers and VMs closer to end users and bring enterprise workloads to locations around the world that are otherwise difficult for organizations to reach. Customers are responding to Akamai's unique offering, and we've already gained cloud computing business across multiple verticals in every major geography, including a European streaming media company, a digital advertising company in Japan, a large financial institution in Indonesia, and e-commerce platform in Korea, major carriers in EMEA and Central America and a television network in South America. In addition to direct sales, we're seeing good traction in our cloud computing partner ecosystem, where we're acquiring new customers by selling with cloud service providers and managed service providers. We've also partnered successfully with independent software vendors and SaaS and PaaS providers. In fact, we recently signed one of the world's best-known SaaS providers and our second largest cloud computing deal since we acquired Lanone [ph] Turning now to content delivery. I'm pleased to report that we saw an acceleration of traffic growth in Q3. In addition, we acquired enterprise customer contracts from StackPath and Lumen Technologies following their decisions to exit the CDN market. As Ed will talk about shortly, the financial terms of the acquisitions were very attractive for Akamai shareholders. In addition to the delivery business that we acquired, we're planning to introduce these customers to our full portfolio of security and cloud computing solutions to help them power and protect their businesses online. In summary, we are very pleased by our performance in Q3. Our expanded security portfolio is deepening our relationships with customers. Our cloud computing plans are executing on schedule, and we continue to invest in Akamai's future growth while also enhancing our profitability. Now I'll turn the call over to Ed for more on our Q3 results and our outlook for Q4 and the full year. Ed?

Operator:

[Operator Instructions] The first question is from James Fish of Piper Sandler. Please go ahead.

Ed McGowan:

Jim, this is Ed. I'll start. Tom, you can jump in if there's anything you want to add. So actually, it's interesting, you started off by saying Guardicore is mostly to the installed base. Actually, we've done a really nice job of selling to new customers. One of the things that came over as part of the Guardicore acquisition is a pretty robust channel and pretty much every deal is done through the channel. As a matter of fact, I think we can do a better job of selling in the installed base and probably come up with some new incentives to incentivize the sales force to do that. So there's a ton of room in the installed base because most of the growth in Guardicore has come from outside the installed base.

James Fish:

Helpful, guys. And just a follow-up, Tom, you had actually started to allude to it a little bit. But as we think about those lumen and Exacto [ph] contracts, I guess how much wallet share do you have in aggregate of these new customers? Or what's the overall opportunity for those specific customers beyond just that CDN revenue that you bought?

Operator:

The next question is from Fatima Boolani of Citi.

Tom Leighton:

Yes, I wouldn't call it a pattern. It's been a long time, really since we've acquired a competitor or a competitor contracts. This is a situation where 2 of the many CDNs out there decided to discontinue their operations. And they wanted -- now they're still remaining as companies, obviously, and they wanted to have their customers have the best possible experience as they exited the CDN space. And so they approached Akamai as the leader by far in CDN and made very compelling financial terms for the transaction. So it makes a lot of sense for our shareholders that we take on these customers. And also, it's a good opportunity as we mentioned, to sell them security and compute. So really good for shareholders. It's not something that we're actively doing trying to go buy other CDMs. But every once in a while, there is an opportunity that is compelling for shareholders. I don't see any fundamental change in the marketplace the hyperscalers and a dozen - 2 dozen other companies are selling delivery services. So I don't think there'll be any fundamental change there or change with pricing. Separately from this, of course, you know that we talked about Akamai as being more conservative with pricing, as we talked about, we're not taking some of the spiky traffic, if the pricing doesn't make sense because we've been focusing more on the capital deployment into our compute offering, which we see enormous potential future growth for...

Ed McGowan:

Yes, sure. That's a great recollection, thought me you're correct. That's about $100 million or actually north of $100 million. So we are still in the earlier innings of the journey. However, we've made a lot of progress, and the team is doing a great job. So we expect to see that the savings continue to ramp. I'm very happy to say that we're slightly ahead of where we expected to be, and we have a lot of confidence that we'll be able to drive the type of savings that we expect to throughout next year.

Operator:

The next question is from Magellan Brooks [ph] of Bank of America. Please go ahead.

Tom Leighton:

I don't think there's a fundamental difference. The attacks are global in nature and the same attacks we see here domestically. We see in pretty much all of the major geos. And yes, you do see a little bit more attacks where there's hotspots wars taking place or political tensions, there'll be more attacks, but the nature of the attacks is similar. You got a denial of service attacks, you got ransomware. You've got application layer attacks, more recently, AI attacks. So -- and that happens everywhere because there's no reason it should be in one geography versus another.

Tom Leighton:

Again, I think that is universal as well. We'll have special advantages in locations where the hyperscalers aren't. But that kind of compute capability can be accessed by customers anywhere. Big U.S. companies care a lot about being able to give really good performance for their users all around the world. So again, I think that's -- there's not a fundamental difference between the U.S. or other regions. We have gotten off to a really good start, and I would say APJ, but it's across the board. We're deep in conversations with major enterprises across all the major geos.

Operator:

The next question is from Ray McDonough of Guggenheim Securities. Please go ahead.

Ed McGowan:

Yes. So I'll start and then Tom, if there's anything you want to add. So this is a pretty targeted program that we identified customers in selected verticals primarily in commerce, manufacturing, health care, pharma, financial services, what we traditionally call sort of our legacy web customers. And as we have talked about, included a lot more services and functionality into the bundles. And upon renewal, we're able to upsell. And we're about -- this is probably 2,000 to 3,000 customers that fit into this sort of targeted group. We're probably about halfway through in terms of the customers that come up for renewal. If you remember, our customer -- average customer contract length is about 18 months. So this probably runs about 18 months to 2 years kind of a program, but we're very happy with what we're seeing with the average uplift on the average sale price.

Ed McGowan:

Yes. In terms of the capital, we pretty much now done the major buildout. And of course, we're big consumers of that ourselves as we move our own applications in-house to Akamai Connected Cloud. And we've also got plenty of room to take on major enterprise business. So I don't think you'll see a lot of CapEx associated with the big core data centers until we start generating a lot more revenue from that. And then we would build out further. There'll probably be another couple that we do. What you will see is a relatively smaller amount of CapEx as we do build out into our existing Edge pops. And our goal is to start equipping them with compute so that you can run containers, VMs, Kubernetes and many more cities around the world. And so that -- and more cities than you can do that with, for example, the hyperscalers. And so that will be taking place over the course of the next year, but it's not a large amount of CapEx, so much smaller than what you saw this year. And then going from there, it will depend on how fast the revenue grows. So it will be a good news story if we're back next year saying that, okay, great, we fill that up, and now we're going to be building out some more. So it's a much better situation than we were in this year where there was a lot of build out getting ready and no revenue yet.

Frank Louthan:

Great. Thank you. Can you give us some color on sort of the nature of the compute deals that you're getting now versus maybe 6 to 12 months ago? And then what have you learned by putting some of your own enterprise-level workloads on the compute platform that you've maybe been able to utilize as you sell to customers? And how has that process benefited the product?

Operator:

Next question is from Tim Horan of Oppenheimer.

Tom Leighton:

Okay. A lot of components there. I'll start with some of them and then probably Ed will fill in with some. Yes, we're in a lot of really good conversations, as you can imagine, because the world's major media companies, gaming companies, commerce companies all use Akamai. They had for many, many years. They trust us for scale, reliability, performance, they trust us with security. They trust us not to compete with them. And as they see what we're building in terms of compute, they like the idea of getting better performance, more distributed compute capabilities. And some of those folks really like the idea of a much lower price point. And as an extra benefit, especially if you're in media or commerce, it's getting to be a bigger problem that they're cutting such giant checks to their leading competitor and sharing all the crown jewels of their data with their leading competitor. So they're taking the Akamai solution with great interest, I would say. Now in terms of being cheaper, Akamai has been for a long time, the world's most distributed platform. We run one of the world's largest backbones. We have worked for many, many years to be incredibly efficient in terms of moving data around and doing the delivery. And that gives us a real advantage of being able to do this now for compute in a very cost-effective way. Now that said, I am sure that the hyperscalers pay a little bit less for their hardware than we do, probably not a lot less, maybe a little less. But when it comes to everything else, I think Akamai is in an excellent position. And what we're seeing in the marketplace is that they'll get their best offer from the hyperscalers, and we can be a lot lower than that and be very profitable at doing it. And the good news, I think, for Akamai is that here you've got a $10-plus billion market growing at 20% a year. And we're a tiny guy there compared to the hyperscalers. So we can operate at a level that is not threatening to them in any way. They got to worry about each other. And there's plenty of room for us to take on a lot of revenue at lower price points and very good margins for Akamai. Now in terms of the marketplace, that's an area, obviously, with the hyperscalers are way ahead some of those folks, every application ever made is available in the marketplace. -- as a managed service, we are growing our marketplace. We are growing the tools that are available on Akamai Connected Cloud. And the first applications that we're targeting are applications that are more easily able to be cloud agnostic, that are not locked in, that aren't using 20 other applications in the marketplace. And so that we are much easier to port onto Akamai Connected Cloud. And so there are some applications that won't be able to report in the near term. But we don't need all those applications. All we need is to get going as a tiny share of that market. And we've identified just, for example, in the media vertical alone, there's a lot of applications that are amenable to moving to our platform. And of course, a lot of our partners in our marketplace to begin with our media-related companies, for that reason because they're also threatened by the hyperscalers, and they're very excited about having media applications beyond Akamai. Ed, do you want to add anything there?

Operator:

The next question is from Alex Henderson of Needham & Company.

Tom Leighton:

Okay. Great question. In fact, there's a lot of components to this one, too. At a high level, there's a lot of potential opportunity, I would say. But let me step back just a minute. Akamai has been using AI and machine learning in our products for a long, long time. Obviously, useful for anomaly detection, bot detection, when an entity is accessing their bank account with the right credentials. Is it the right person or not detecting that malware has infected an application inside an enterprise. Lots of ways that we've been using AI and machine learning. Now with Gen AI, I think it helps some, but it really helps the attack. It's much easier now to morph malware into a lot of different forms, makes it harder to detect. Our teams have created some very nasty bots very quickly using Gen AI. And I think we're already seeing more penetration as a result of Gen AI. That's one area where really it is being actively used today. Now on that side of the house, the implications are -- there's more risk in terms of cybersecurity for enterprises. They're going to get penetrated more. And so you really have to double down on your defense and depth. I think it makes products like [indiscernible] segmentation even more critical because you're going to get penetrated, the key is to identify it quickly and proactively block the spread. And that -- I think when you look at our growth rate there, very, very hot with a market-leading solution. Now you also asked about what about compute and the impact of Gen AI there? I do think over time, it will suck up a lot more compute. And that's good for vendors selling compute, like Akamai sales compute. And you're right, there's a difference between the generation of the model, which is -- if they're large models, very heavy, and that will be done in core compute and storage data centers. inference engines can run at the edge and will make sense to run at the edge for many applications. And we already have several partners that are porting their AI models on to Akamai for inference engines -- and so -- and I expect that they will be selling that in our marketplace to other companies. And so in fact, we're already in a sense, using AI as we put our internal applications on to Akamai Connected Cloud. So I think you will see, over time, a lot of revenue generated there because of all the uses that I think will come about through AI. Now you ask about risk. I think you will need -- you do the model generation in the big data centers. That's not a risk for Akamai because we've got 2 dozen of those today. So that's -- it's just to be done in a different place. It won't be done at the edge. But inference engines, yes, a lot of that work will be done at the edge, and we're in a great place there because other companies don't have an edge, anything like Akamai..

Q – Unidentified Analyst:

This is Dua speaking for Abdul. And I just wanted to ask for you broadly on the enterprise spend environment. And I know we've previously we've noted elongating sales cycles. And I was just generally curious whether there's any change there. And if you had to characterize it, is enterprise IT spend incrementally worse or better or about the same versus, let's say, 90 days ago?

Operator:

Next question is from Mark Murphy of JPMorgan.

Tom Leighton:

Yes, let me just start on the product side, and then Ed will pick up your questions. So ransomware isn't related to scrubbing centers. scrubbing centers are just restricting the flow of packets and screening out or scrubbing out the packets that are trying to flood any particular resource. And that's nothing really per se to do with malware and ransomware to filter that out, you need application layer defenses where the scrubbing centers are routing layer defenses. And putting the scrubbing centers in Canada, and we're actually putting scrubbing centers in many more cities around the world and greatly increasing our capacity so that with local customers there, we can do the scrubbing for them locally. And that gives them better performance while we're giving them the defense against the volumetric attacks. For ransomware, you need Gardicor for malware, you need app and API security. And those are different products where they're done at our edge network in the 4,000 POPs, EdgePops we have around the world. And then, Ed, do you want to pick up the other part of that?

Mark Murphy:

Okay. Understood. And then, Ed, just as a follow-up, did you mention what was the total consideration paid for the acquired contracts from StackPath in Lumin? I'm wondering, I believe those are expected to contribute something like $60 million to $70 million next year in aggregate. Is that -- are you taking -- like are you assuming a similar ongoing run rate that those contracts had with the prior providers and extrapolating that into next year? Or are you contemplating into that any kind of expansion, contraction, right, or pricing that up or pricing that lower?

Operator:

The next question is from Rishi Jaluria of RBC.

Tom Leighton:

Great. Yes, the data residency, data sovereignty issues are increasingly important, as I imagine you know, -- and that's where Akamai has a great opportunity because we're in 130 different countries with our infrastructure. And as we move compute into our edge pops, that enables us to do the work locally, keep the data local, which is an exciting opportunity for us. And I think in the not-too-distant future, we'll be in locations and countries that even the hyperscalers aren't there. Now in terms of the work on the software stack to be able to do that, that is ongoing work now. We are actually already in beta with a few customers -- so we're pretty far along. And then next year, as I mentioned, there'll be relatively small amount of CapEx as we do build out in a nontrivial number of our edge pops to be able to support compute. Now today, at the edge, I don't -- we support GPUs today, but that would be more in the core data centers. I think for the inference engines, we're running that just fine on CPUs. And so as we look at the edge, where you'd be running the inference engines, I don't, I think, run on CPUs and be much more cost-effective than trying to buy GPUs or custom hardware there. I think where you might see that as more if you're working with large-scale model development. And then that would be in the core data centers. That wouldn't be at the edge. The edge is where you want to do the inferencing. And that's -- it seems like that's going to be working very well on our edge platform with CPUs.

Tom Leighton:

Yes. Good question. I think first is the approach that we took, right? We got an inbound request from these 2 companies, and some of them are customers we know and have had a long relationship with. And providing an orderly transition is step 1 in the relationship, right? So now you get a warm relationship and introduction to it's a new customer, and certainly, for the customers that we have. They obviously know us -- and you get -- instead of having a jump ball in the open market, you have a chance to sit down with the customer and understand what their needs are, understand what's going on with their contracts, length of contracts, pricing, et cetera. And you could just set up a relationship and just go through a normal sales cycle effectively. I think we've got a pretty good track record, and I'm certainly understanding the customers. And if I think about sort of the weighted average of where the revenue is, we've obviously gone and talked to a lot of those customers. We obviously have had a long-term relationship with a lot of these folks. So I think we have a fairly high degree of confidence in the numbers that we've put out. Obviously, things can change. But based on our experience with a lot of these folks and with some of these new folks that we have not worked with us in the past, we have an awful lot of other services to offer that they didn't have before. And especially with security being such a big topic these days. We're hearing from some of these customers that they're glad that they have a relationship with us now.

Ruby Kessinger:

Ed, I just want to quantify the TSA impact. It seems to be about 1.5 points impact cash gross margins in Q4. Is that accurate? And just to be clear, it sounds like that, that TSA ends at year-end? Or when exactly does that TSA add?

Ruby Kessinger:

Okay. Got it. And then if I just look at your delivery guidance, which, I guess, is implied by your compute security revenue guidance, and then I back out the expected $17 million to $20 million of revenue from Lumin and StackPath in Q4, it implies delivery revenue flat to down in Q4 versus Q3. So is any extra conservatism in the Q4 delivery guide just based on what you're seeing from traffic trends or any pricing pressure to call out? Or why not -- why aren't we seeing a typical seasonal Q4 uplift in delivery revenue ex those acquisitions.

Ruby Kessinger:

Okay. That's helpful.

Q – Unidentified Analyst:

This is Yan Simoes on for Will. So first of all, just looking at delivery, how are you thinking about Q4 delivery trends this year versus normal seasonality given all the questions around the consumer and media activity in general? Any color there would be great.

Operator:

The next question is from Michael Elias of TD Cowen.

Tom Leighton:

Yes. Great question. I think partners are really helpful there because they do a lot of the work in the first place to get into the third-party cloud provider. And today, some of them move between third-party cloud providers. And so there is a natural partner ecosystem that can be helpful porting that to Akamai. And I think they're finding that the terms are even more favorable for them as well as for the partners. Also, as we grow the ecosystem of third-party capabilities, which with our qualified compute partner program we're doing early focus on media there, which is our initial focus in terms of applications to move to Akamai. And yes, what it depends on the data center and the third-party cloud provider, but we do have direct connections in many cases. And of course, we operate, as I mentioned, one of the world's largest backbones and in a position to also make direct connections to major enterprises, which can help quite a bit. And then just as a quick follow-up. Just curious if you could talk a little bit about the M&A environment that you're seeing. I know you have that your security growth guidance that you gave at your Analyst Day, which includes some M&A. Just curious, any thoughts around the M&A environment, particularly for security? And maybe as part of that, just comments on valuation. Yes, valuations in the companies that we're most interested in are still extremely high. And you see some of the recent acquisitions that have been done at very high revenue multiples. So not a lot of change yet. Probably at the fringes, it's getting harder. But for companies that we have an interest in, I'd not say it's made a lot of improvement yet. That may change with time. We just have to see. It's something we keep a close eye on. Of course, we're always looking, but we're very disciplined buyers. So it really has to make very good sense for our customers and for our shareholders. Operator, we have time for one more, please.

Jeff Van Rhee:

Just one quick one on compute, Kind of getting to the inflection or the acceleration in growth. I have a couple of questions. Just on sales cycles there, refractory, what is the typical sales cycle for a compute deal? And then secondly, with the bulk of the build-out done, and it sounds like functionality isn't the limiter, then it's really just getting to maturity of these sales cycles. The sales force has trained the functionalities there, the infrastructure is there. So it looks like Q4 builds in organic growth roughly similar to Q3. So just trying to get a sense of timing of acceleration there.

Jeff Van Rhee:

Okay. Well, thank you, everyone. In closing, we will be presenting at a number of investor conferences and events throughout the rest of the year. Details of these can be found in the Investor Relations section of Rockmy.con. Again, thank you for joining us, and all of us here at Akamai wish you and yours a wonderful rest of the year. Have a nice evening.

Operator:

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.

Tom Leighton:

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

Tom Barth:

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.

Tom Barth:

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?

Ed McGowan:

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 and expense policy management. With respect to third-party cloud spend, I’m pleased to report that for as long as we attract this expense, Q2 was the first quarter where total third-party cloud spend declined year-over-year. While the decline was relatively modest, it reflects disciplined vendor management as well as the beginning of savings related to the migration of our workloads onto our own cloud platform. This migration effort to move away from third-party clouds is in the early stages, and we are seeing promising signs. For example, our bot management solution is now running production workloads for hundreds of customers on our own cloud computing platform. As a reminder, we anticipate that the amount of savings we will be able to achieve will start to ramp through the end of 2023 and into 2024 as we bring online the needed capacity and features. Moving to margins. Our cash gross margin was 73%. Adjusted EBITDA margin was 41%, and our non-GAAP operating margin was 29%, slightly ahead of our guidance. Moving now to cash and our use of capital, as of June 30, our cash, cash equivalents and marketable securities totaled approximately $1 billion. During the second quarter, we spent roughly $137 million to repurchase approximately 1.6 million shares. We now have about $700 million remaining in our previously announced share buyback authorization. Our approach to capital allocation remains the same to opportunistically buyback shares to offset dilution from employee equity programs over time while maintaining sufficient capital to deploy when strategic M&A presents itself. Finally, I am pleased to announce that Akamai has obtained investment-grade credit ratings from Moody’s and S&P. These ratings are part of a broader financial policy to further reinforce our business and financial strength, not only with investors but also with customers, vendors and other parties that we engage with from a commercial perspective. The credit rating also broadens our financial toolkit, allowing us to evaluate all available financing instruments to determine what’s best suited for our financial goals. Finally, as a reminder, Akamai currently has two convertible debt instruments outstanding, $1.15 billion due in May 2025 and $1.15 billion due in September 2027. Before I provide our Q3 and full year 2023 guidance, I want to touch on some housekeeping items. First, our annual merit-based wage increases became effective July 1. This will result in an additional net operating cost of approximately $12 million per quarter. Second, in late July, the IRS released a notice that granted temporary relief for determining eligibility of foreign tax credits. This will result in a lower-than-expected non-GAAP effective tax rate in Q3 and for the full year. And finally, the guidance I will provide assumes no change, good or bad to the current macroeconomic environment. So with those factors in mind, I’ll turn to our Q3 guidance. We are now projecting revenue in the range of $937 million to $952 million or up 6% to 8% as reported and 5% to 7% in constant currency over Q3 2022. The current spot rates foreign exchange fluctuations are expected to have a positive $1 million impact on Q3 revenue compared to Q2 levels and a positive $10 million impact year-over-year. At these revenue levels, we expect cash gross margins of approximately 74%. Q3 non-GAAP operating expenses are projected to be $297 million to $302 million. We expect Q3 EBITDA margin of approximately 42%. We expect non-GAAP depreciation expense to be between $121 million to $123 million, and we expect non-GAAP operating margin of approximately 29% for Q3. Moving on to CapEx. We expect to spend approximately $162 million to $170 million, excluding equity compensation and capitalized interest in the third quarter. This represents approximately 17% to 18% of our projected total revenue for the third quarter. Based on our expectations for revenue and costs, we expect Q3 non-GAAP EPS to be $1.48 to $1.52. The CPS guidance assumes taxes of $42 million to $45 million based on an estimated quarterly non-GAAP tax rate of approximately 16%. It also reflects a fully diluted share count of approximately 155 million shares. Looking ahead to the full year, we have increased revenue to a range of $3.765 million to $3.795 billion, which is up 4% to 5% year-over-year as reported and in constant currency. At current spot rates, our guidance assumes foreign exchange will have a negative $4 million impact to revenue in 2023 on a year-over-year basis. We are also raising our security revenue growth expectations to 12% to 14% for the full year 2023 and we continue to expect to achieve approximately $0.5 billion in revenue from compute in 2023. And despite a significant year of investments, we are estimating non-GAAP operating margin of approximately 29%. With all that in mind, we have raised our estimated non-GAAP earnings per diluted share to a range of $5.87 to $5.95. Our non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 17% and a fully diluted share count of approximately 155 million shares. Finally, our full year CapEx is expected to be approximately 19% of total revenue. In closing, we are very pleased with our financial achievements for the first half of the year, in our ability to increase our overall revenue, security revenue and non-GAAP EPS guidance for the full year. We believe that Akamai is a special class of businesses that have the ability and discipline to invest in future revenue growth while continuing to be extremely profitable and generate significant cash flows. With that, we now look forward to your questions. Operator?

James Fish:

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.

James Fish:

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.

Operator:

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

Tom Leighton:

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.

Tom Leighton:

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.

Operator:

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

Tom Leighton:

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?

Ray McDonough:

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?

Ray McDonough:

Great. Thanks for the color.

Frank Louthan:

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.

Frank Louthan:

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

Frank Louthan:

Okay. Great. Thank you.

Unidentified Analyst:

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?

Tom Leighton:

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.

Tom Leighton:

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.

Operator:

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

Tom Leighton:

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 in media, gaming and commerce. So, that’s really what we are targeting, which is a pretty reasonable subset of the $200 billion. Now, within that subset, if you are an enterprise that uses a lot of the third-party apps that are available as managed services on the existing platforms, probably it’s harder to migrate, and that’s not where we would go first. Fortunately, if you look at media workflow and the areas where we are targeting, often that’s not the case. And it’s easier for us to manage the porting. Now, you don’t just flip a switch, so it’s not that easy, unfortunately. And we have learned that. But at Akamai, pretty much all of our applications are in the process of migrating from third-party cloud onto our compute platform. And so it does take some effort, but it is eminently doable, and we are going to save a lot by doing that. And we are not the biggest company out there. Our big media customers spend, well, hundreds and hundreds of millions of dollars a year in the cloud with often case, their primary competitor. And so I think we are in a position that we can now help them based on our experience, migrate a bunch of those applications to Akamai. Good for us, good for them.

Operator:

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

Ed McGowan:

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.

Tom Leighton:

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.

Tom Barth:

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

Amit Daryanani:

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?

Amit Daryanani:

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?

Amit Daryanani:

Perfect. That’s helpful. Thank you.

Operator:

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

Operator:

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.

Tom Leighton :

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 visibility and threat hunting capabilities to discover APIs, analyze their behavior, identify vulnerabilities and help customers defend against attacks. We plan to take Neosec to market immediately while our combined teams work together on product innovation with the majority of its engineers located in Tel Aviv, where we already have a significant security engineering presence, we expect Neosec will be an excellent fit with our culture. And like our Guardicore acquisition, we can sell Neosec to customers that don't use our CDM. Speaking of Guardicore our segmentation solution to protect against ransomware continued to achieve strong traction with new customers in Q1, including with one of the largest banking groups in Europe and one of the largest airlines in the UK. We're also continuing our organic investment in innovative new products to help protect major enterprises. For example, at the RSA conference two weeks ago, our new Brand Protector Solution was named 1 of the 20 hottest security products by CRM. Another trade publication, CSO, listed both Brand Protector and our new Prolexic Network Cloud Firewall among the most interesting products to see at RSA this year. At RSA, we also featured a new managed security service called Akamai Hunt, Akamai agentless segmentation and multiple enhancements to our market-leading bot management solution. In addition to our investments in new products, we're focused on accelerating security growth by winning new customers and expanding our relationships with existing customers. For example, one of the biggest security threats in the news last quarter was Kill net's coordinated series of DDoS attacks against some of the top medical centers in the U.S. In response, some very prominent health care institutions adopted Akamai's industry-leading solution for DDoS protection. In recognition of the value Akamai provides, the CIO of a world famous clinic e-mailed us afterward, thanking Akamai for enabling him to sleep well at night. We're also making good progress on the cloud computing front. Last quarter, we acquired the cloud storage company -- Ondat. Storage is a key component of cloud computing -- and we expect that Ondat's technology and considerable expertise will further enhance our enterprise-grade storage solution for Akamai Connected Cloud. Akamai intends to offer the world's most distributed platform placing compute, storage, databases and other cloud services closer to end users and enterprise datacenters. As a result, we believe that Akamai will be able to offer customers better performance, more points of presence and lower cost for many mission-critical enterprise workloads. That's the fundamental difference in our approach compared to other providers. We already have partners working with Akamai to run globally distributed databases with very low latency for synchronization. We have partners utilizing our cloud platform to provide customers with real-time visibility into telemetry from their end users around the world. We're working with customers in e-commerce, travel, hospitality, software as a service, media and entertainment to improve their ability to personalize experiences monetize content, accelerate data processing, facilitate collaboration, simplify management, improve performance and reduce costs, in some cases, by large amounts. And we're having early discussions about potentially leveraging Akamai Connected Cloud for AI inference engines. Each of these use cases plays to Akamai's advantage in terms of numbers of POPs, global reach performance and cost. Another advantage that we hear repeatedly from customers, including those I met with last month at the NAB conference is that they trust us. They value the years of highly reliable service that we provided in delivery and security, and they trust us not to use their data to compete with them. I'll now say a few words about our delivery business, which experienced an encouraging uptick in traffic growth late in Q1. Akamai continues to be the market leader in delivery, providing industry-leading performance and scale as we continue to support the world's top brands by delivering reliable, secure and near flawless online experiences. And we continue to see a strong synergy between our delivery business and our security and compute offerings, especially for customers in the gaming, media and commerce verticals. The synergy is both on the top-line, as long-time delivery customers buy our security and compute products and also on the bottom line as we realize the cost benefits of using a single infrastructure to provide security and compute services as well as delivery. We plan to pass some of the cost savings on to our customers, which is especially valuable for customers who are paying exorbitant egress fees to the hyperscalers to access or move their data. The synergy of having a single cloud platform will also help us in our ongoing effort to improve profitability. Not only can we leverage existing infrastructure, but we can also leverage existing talent as we shift resources and focus from delivery to compute. As Ed will explain shortly, we are very focused on managing costs and deploying resources where they generate the best long-term returns. As one part of this effort, we plan to reduce our worldwide workforce by a little less than 3% this quarter. This was a difficult decision, but it was necessary for us to prioritize investments in the areas with the greatest potential for future growth as we strive to deliver greater value for shareholders. I'd like to take this opportunity to thank all of our employees for their hard work on behalf of our customers and shareholders. From our developers and engineers who build and operate the services that power and protect life online, to our sales, services and marketing teams who do such a great job helping our customers in this challenging environment, and our back office and administrative support teams who help make Akamai be such a great place to work. It really is a privilege for me to be able to work with such an outstanding group of people as we make life better for billions of people, billions of times a day. While this is a time of substantial macroeconomic uncertainty, I believe that it is also a time of great future opportunity for Akamai as we bring new security and compute capabilities to market and as we deploy Akamai Connected Cloud. As you may know, I continue to be a personal buyer of Akamai stock under the 10b5-1 plan that I filed last year. And I'm pleased to let you know that Akamai repurchased 4.6 million shares of Akamai stock in Q1 for a total of $349 million. Now I'll turn the call over to Ed for more on our Q1 results and our outlook for Q2 and the full year. Ed?

Operator:

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

Tom Leighton:

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?

Tom Leighton:

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.

Ed McGowan :

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.

Operator:

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

Tom Leighton:

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?

James Fish :

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.

Operator:

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

Tom Leighton:

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?

Tom Leighton:

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.

Tom Leighton:

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?

Jonathan Ho :

Thank you.

Unidentified Analyst:

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?

Unidentified Analyst:

Great. Thank you.

Rudy Kessinger :

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?

Rudy Kessinger :

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?

Rudy Kessinger :

Got it. Fair enough. Thank you.

Ray McDonough :

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?

Ray McDonough :

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?

Ray McDonough :

Great. Appreciate the color.

Unidentified Analyst:

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.

Unidentified Analyst:

Got it. Thank you.

Unidentified Analyst:

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?

Unidentified Analyst:

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

Unidentified Analyst:

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

Tom Barth:

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.

Operator:

Good afternoon, and welcome to the Akamai Technologies, Inc. Earnings Q4 Fiscal Year 2022 Earnings Conference Call. [Operator Instructions] Please note that this conference is being recorded. I'd now like to turn the conference over to Tom Barth, Head of Investor Relations. Please go ahead.

Tom Leighton :

Thanks, Tom, and thank you all for joining us today. I'm pleased to report that Akamai delivered strong results in the fourth quarter, exceeding the high end of our guidance range on both the top and bottom lines, despite ongoing challenges with the global economic environment. Q4 revenue was $928 million, up 6% year-over-year in constant currency. Our revenue growth was driven by continued strong demand for our security products, our fast-growing compute business and by higher-than-expected delivery traffic. Security and compute accounted for 55% of our overall revenue in the fourth quarter and grew a combined 22% year-over-year in constant currency. Non-GAAP operating margin in Q4 was 28%. Q4 non-GAAP EPS was $1.37 per diluted share, down 2% year-over-year in constant currency. For the full year, revenue was $3.62 billion up 8% over 2021 in constant currency. Non-GAAP operating margin was 29%, down from 32% in 2021 and slightly below our goal of 30%. The decline last year was due to the impact of foreign exchange, the challenging macroeconomic environment, the investments we made to grow Guardicore's segmentation product and the rising cost of third-party cloud services. As Ed will describe in a few minutes, we're taking several actions to reduce costs and to shift resources to areas with the strongest potential for growth, such as cybersecurity and especially cloud computing. Going forward, we anticipate that our margins will likely remain slightly under 30% in the near term, and our goal is to grow margins back over 30% during the medium to long term. Non-GAAP EPS last year was $5.37, down 1% over 2021 in constant currency. 2022 was another strong year for cash generation at Akamai, with $816 million in free cash flow, representing 23% of revenue. Akamai's strong cash generation enables us to make strategic acquisitions while also returning value to shareholders. In 2022, we spent $608 million to buy back 6.4 million shares. Over the last 10 years, we've reduced the number of Akamai shares outstanding by approximately $21 million or 12%. I'll now say a few words about each of our three main lines of business, starting with security. Our security products generated revenue of $400 million in Q4, up 14% year-over-year in constant currency. For the full year, security revenue reached $1.54 billion and grew 20% over 2021 in constant currency. We saw especially strong growth through our market-leading Guardicore Segmentation product with revenue reaching $68 million for the full year. New segmentation customers in Q4 included one of the largest insurance companies in the U.S., a leading Internet services conglomerate in Japan and one of the largest banks in Scandinavia. Enterprises are choosing our segmentation solution because of its ability to protect against ransomware and data exfiltration attacks and also for the visibility it provides into their internal infrastructure. These are also among the reasons that Akamai was named as the Leader in The Forrester New Wave for Microsegmentation last year. We also saw large wins for our market-leading application security solutions in Q4, including at one of the UK's largest multinational energy companies, one of the big three multinational banks in Singapore and two of the largest tech hardware companies in the U.S. Overall, security accounted for 43% of our revenue last year, up from 39% in 2021. In 2023, we expect security to become our largest line of business. This represents a significant milestone in our evolution since we pioneered the CDN marketplace 25 years ago. That said, and as the security business becomes larger and with customers becoming more cost conscious due to the challenging macroeconomic environment, the growth rate of our security business has slowed, a trend that we anticipate will continue over the coming year. As you might expect, we're working hard to realize the full potential of our security business, both in terms of growth and efficiency. For example, we're in the process of moving the compute components of our security products from third-party cloud providers to our new Akamai connected cloud platform a transformation that will save us a substantial amount of OpEx over the next several years. We're redeploying resources within security from lower growth areas to high-growth areas such as segmentation. And we're redeploying go-to-market resources to achieve stronger cross-sell and penetration within our existing base. We're also working more closely with partners to drive better adoption among new customers. And we're continuing to innovate new capabilities, such as our recently released Account Protector and our new Brand Protector solutions to keep our customers safe amidst a rapidly evolving attack landscape. While we believe that our security business will continue to generate strong returns for our shareholders, we foresee an even bigger opportunity in cloud computing and its potential to return Akamai to double-digit top line growth over the longer term. Our compute business performed well in Q4 with revenue of $112 million up 65% year-over-year in constant currency. For the full year, compute revenue was $405 million and grew 64% over 2021 in constant currency. Earlier today, we unveiled Akamai Connected Cloud, our massively distributed platform for cloud computing, security and content delivery. Akamai Connected Cloud links Linode's 11 core data centers with Akamai's 4,100 edge computing locations. In addition, we're in the process of building out 14 more core enterprise scale data centers with at least 3 expected to come online in the next few months. We believe integrating these core cloud computing data centers with our unique edge platform will allow us to offer customers better performance, greater scale and lower cost for enterprise workloads. We also plan to have our new virtual private cloud capability and the first of more than 50 distributed cloud computing sites available in the second half of the year. The distributed sites will enable us to bring cloud computing much closer to end users around the world, which will further enhance the performance benefits of Akamai Connected Cloud. Of course, and as Ed will describe shortly, we'll be incurring substantial CapEx and colocation costs associated with the build-out of our compute infrastructure over the near term. We're also in the process of recasting approximately 1,000 positions or about 10% of our workforce to spend the majority of their time working on the development, deployment, support and go-to-market efforts associated with Akamai Connected Cloud. Because of the natural synergy and close integration between cloud computing and our existing edge platform, we believe we can accomplish this transformation without adding significant headcount to the business. This shift will also further enhance the efficiency of our delivery business. We're undertaking this ambitious investment in Akamai Connected Cloud because we believe it will create substantial value for shareholders in the medium and long term. We expect to achieve nearly $0.5 billion in revenue from compute in 2023, and the investment we're making this year should help drive that number substantially higher in 2024 and beyond as we use the new capabilities and capacity to support mission-critical enterprise workloads. I think it's worth noting that Akamai is taking a fundamentally different approach to the cloud computing market than providers who base their platforms solely on core data centers. Our strategy is to offer the world's most distributed platform placing compute, storage, data base and other cloud services closer to end users and enterprise data centers. As IDC’s VP of Research Dave McCarthy says “The cloud’s next phase requires a shift in how developers and enterprises think about getting applications and data closer to their customers. It redefines how the industry looks at things like performance, scale, cost and security as workloads are no longer built for one place but are delivered across a wide spectrum of compute and geography.” IDC adds that “Akamai's innovative rethinking of how this gets done and how it is architecting the Akamai Connected Cloud, puts it in a unique position to usher in an exciting new era for technology and to help enterprises build, deploy, and secure distributed applications.” We couldn’t agree more, distributed applications require a distributed architecture. Akamai’s leadership positioned at the edge of the Internet enables us to scale just about everything we touch. We scale content putting digital experiences closer to users than anyone. We scale cybersecurity, keeping threats father away from business and people. And now, we are building on Akamai’s 25 years of experience with scaling and securing the Internet for the world’s largest enterprises, so we can scale cloud computing and provide better performance at lower cost. Although we still have much work to do, we are encouraged by the reaction from customers who want to realize the value of our approach. Last quarter, a well-known digital fitness platform brought business to us that they previously did with a major cloud provider. They chose Akamai Connected Cloud because we can optimize their performance and provide better economics. When a gaming company suffered a DDoS attack that took out their Internet relay chat servers, they turned to Akamai Connected Cloud to get back on line. After utilizing connected cloud for a few weeks, they also migrated their peer-to-peer match making servers to Akamai. This is what they say to other gaming businesses with similar use cases

Operator:

[Operator Instructions] Our first question will come from James Fish with Piper Sandler.

Tom Leighton:

Yes. No, good question. And we are increasing the allocation of our go-to-market investments around the enterprise side and Zero Trust. We have specialist teams there really focused on Guardicore and now the other enterprise products as we integrate them in with the Guardicore solution. And we've had a lot of success with that team, as you can see from the really good growth in the Guardicore product. And so we're doubling down there. And over the course of this year, you'll see, I think, more cross-sell with our Enterprise Application Access product in Guardicore and ETP. And then I'll turn the other question over to Ed.

James Fish:

Helpful. And just a follow-up on the compute side. A big question we've been getting is whether the compute business could get traction really outside the media vertical? Or is that really going to be the focus in terms of gaming and streaming kind of storage and compute on the back end? And kind of what's the confidence level that you're not going to see an erosion in that more traditional windows that's SMB based?

Operator:

Our next question will come from James Breen with William Blair.

Tom Leighton:

Well, yes, I think it makes good sense to be shifting resources towards the higher growth areas both security but especially in cloud computing. I think we'll see a lot stronger return on the investment. We still have the market-leading delivery business. We haven't lost share, to the best of my knowledge. We have turned away some -- a small amount of the business that's very spiky. And that doesn't make as much sense for us to take that business at the price point isn't right today. And that's because traffic growth rates are lower than they used to be. So you have to spend money to build out for the spike. And if your traffic growth rates are lower, it takes longer to fill that capacity on a daily basis. With delivery, your cost is associated with your peak and your revenue more associated with the daily usage or total aggregate usage. And so we have, as we've talked about, turned down some deals there just because the ROI doesn't make us much sense in this environment, and we get a lot better ROI from investing in compute and I think, obviously, security. And then within security, we're reallocating investment decisions there to focus more resources on the fastest-growing security products. So I think it just makes good sense. And for now with compute, it's something our customers are really asking us to do. And even in this challenging macroeconomic environment, it's something that I think the timing may be even a little bit better there because of that.

Keith Weiss:

Excellent. A couple of questions, I have a ton of questions, but I'll try to limit it to two or three. On the cloud computing side of the equation, the word of the year amongst investors has been optimization, and we've heard it from AWS, we've heard it from Azure. I'm really interested to hear how that impacted Linode. Given kind of being a lower cost provider in the marketplace, did you guys -- did you see optimization of people trying to sort of reduce the amount of consumption on your platform? Are you guys like more of a net beneficiary because of, people are ultimately seeking just kind of lower cost overall? And then also on cloud, I don't know, did you guys mention what the contribution was from Linode this quarter? I believe you guys have been given the kind of inorganic contribution over the past couple of quarters. And then I have one for Ed on the margin side of the equation.

Ed McGowan:

Yes, sure. So Linode, it will get more difficult to break up sort of merging in with everything, but it was about $34 million, a little over $34 million. We did see a slight increase in the growth rate as the year went on, and we haven't seen any change in the consumption around optimization, meaning folks are using less of the cloud at this point.

Ed McGowan:

Yes, Keith. So the way to think it will probably go up a little bit. It won't be up as much as it's been up certainly last year. But I mean, you're thinking about it in the right way. And one of the things that we're fortunate enough to do is if you think about what we would -- the typical company would do if you didn't have the skill sets and how it should have to do a layoff, that's expensive and then you have to go hire new talent. We're fortunate enough in the areas that Tom talked about, whether it's development or build out of the network, the sales functions that we can shift those resources over. So if you think about the cost to build out what we're doing, would cause somebody else a significant amount of money, but we're able to shift those resources. And as far as the new headcount going forward, we're going to be pretty judicious with where we're hiring, but it's going to be primarily in the areas of cloud and security and maybe a few on the go-to-market side.

Tom Leighton:

There's a lot of resources being shifted within our platform and delivery organizations. Think of the hundreds of people that are managing our network deployment that build out our 4,100 regions today and the tremendous scale we have, and they are now heavily focused on building out compute resources. Think of the people that manage the operations, the automatic deployment of software, the payload or the load balancing, the resiliency, they are heavily focused on incorporating those capabilities for compute, building on top of the Linode framework. So I would say the large majority of the resources are of that nature that we're retasking.

Tim Horan:

Also on the cloud, can you talk a little bit about your improvement in price and performance versus the comments? Can you give us some metrics there? And then can you talk a little bit about what type of cloud you're building out for? I know, Tom, in the past, you were a little skeptical that we could do kind of gaming as a service over cloud infrastructure. Is that changing? And you could optimize your cloud for AI or blockchain or more networking or very, very low latency? Just any color there? And then lastly, have you contemplated maybe partnering with some of the larger cloud providers with AI really starting to take off? Can you be a partner to a few of them or one of them that would really accelerate things?

Operator:

Our next question will come from Mark Murphy with JPMorgan.

Ed McGowan:

Yes. Mark, it's Ed. There's about $5 million, roughly.

Tom Leighton:

Not in compute in Q4. Obviously, we compete very successfully in delivery and security with the hyperscalers. We're the market leader there. Now in compute, they are the market leaders by far. And so nothing that we would do in compute is going to make any difference to them. I mean we're looking to get to a 1% market share in a market that's $100 billion to $200 billion a year. So it will take us a while in compute before I think a hyperscaler would even really, really notice. And of course, a 1% or 2% market share means a lot to us in compute, that's several billion dollars means less, obviously, to folks at the scale of those guys.

Rishi Jaluria:

Wonderful. I've got two. First, I wanted to start on the compute side of the equation. I appreciate all the color around CapEx. And please forgive me if my math is shouty over here. But if I just do a rough back of the envelope numbers, right, with 9% of total revenue being CapEx, specifically for the compute business and then I strip out $100 million of nonrecurring, that's still telling me that CapEx -- compute CapEx this year in 2023 is going to be 45% of compute revenue, which, again, it's a growing business and everything. Number one, am I directionally thinking about this? And maybe number -- piece number 2 to that is, how should we be thinking about steady state CapEx for the compute business once we get through maybe the next year or 1.5 years? And then I've got a follow-up.

Rishi Jaluria:

Okay. Got it. That's helpful. And then just maybe going back to the security business. Going past this year, longer term, what needs to happen to see security overall reaccelerate growth rate that you'd be happy with? Is that primarily going to be driven by a continued Guardicore mix shift? Is that going to be more on the Zero Trust portfolio ex Guardicore? Maybe walk us through kind of what needs to happen to get security up to kind of an organic growth rate that you'd be happy with?

Operator:

Next question will come from Amit Daryanani with Evercore.

Ed McGowan:

Yes, sure. So well, we didn't give specific guidance for either delivery or compute. Tom did talk about us achieving $0.5 billion or so in compute revenue. So depending on where you put your models, you decide the $0.5 billion for compute and just solve for the delivery. I think if you were to be on the higher end of the business, delivery might do a little bit better as we saw in Q4, potentially get security going. If the macroeconomic conditions improve and then obviously there really is just a timing issue in terms of when we can start moving major workloads on compute.

Ed McGowan:

Yes. So it's a little bit of everything, right? But I think as we laid out about five or six different things that we're doing, probably the biggest near-term item would be the third-party cloud costs. So as we migrate that our own cloud, we're going to save about $100 million or so. Think about that as some of that will happen this year, a lot more of it in '24 and then by '25, we should have almost the majority of our internal cloud or third-party cloud on our eternal system. So that's 2 points to 3 points right there. Colocation, I talked a bit about the audit of the ASC 842 in lease accounting. We have a little bit more of a burden that we have to take at the beginning of some of these longer-term agreements. But also, we're spending on colocation that we haven't quite scaled into yet. So there's your question about revenue. As revenue scales, you'll get scale with your margins. And then just through some of the depreciation savings that we're getting on delivery and the real estate savings. We're spending, call it, before this year around $100 million in real estate, we're going to save about $20 million this year. Probably room to get maybe another $20 million or $30 million out of that as well. So it's really a combination of getting the compute revenue to scale into our investments in mostly our colocation facilities and third-party cloud savings, those are probably the two biggest areas for margin expansion.

Ed McGowan:

Yes. I mean I think that's -- when you look at the size of those numbers, certainly, I mean, obviously, revenue cures all your rails, right? We've got a pretty scalable model. So if we see acceleration in revenue, especially on the compute side, you're going to see a pretty good flow-through. But yes, there's a lot in our control here. And I think we're doing the responsible things as far as hiring goes, shifting resources, focusing on reducing our real estate costs and really focusing on driving down that third-party cloud cost, which is really taken a pretty big chunk out of our gross margin.

Fatima Boolani:

Two for me. On the delivery segment, the last couple of years for you have been maybe a little bit more erratic just by way of lapping some of the benefits from the pandemic, some of the dynamics you saw in the gaming area where trends are moderating. So at a high level for you, when we think about the underlying cadence from a volume perspective, what are you assuming that's maybe different the same, better or worse versus the trends you saw this year? And I'm considering the renewal cohort what you've mentioned around holding on pricing. So any sort of color commentary you can give us for the delivery segment in terms of traffic trends and then pricing trends under the hood? And then I have a follow-up, please.

Fatima Boolani:

I appreciate that. And just the delineation between your U.S. business and the international business, anything you can point to by way of geographical differences in procurement? Is there more sensitivity on budgets in the U.S. versus international? Any characterization there because international continues to be a stronghold for you versus some of the -- maybe some of the malaise on the U.S. side, but would love to get a little bit more granular on what's continuing to drive that strength and if some of that budgetary pressure that you alluded to on the security side is maybe showing up more pronouncedly in U.S. versus international? That's it for me.

Operator:

Our next question will come from Frank Louthan with Raymond James.

Tom Leighton:

Yes. So on the Akamai Connected Cloud architecture, we already have 4,100 edge regions. And these regions do delivery and security. They're the first line of defense. They also do what we call edge computing, which is function as a service, JavaScript at the edge. Now in the core, where Linode had 11 data centers, and we're going to more than double that, you have very large-scale storage object and block storage. You've got VM as a service, Container as a Service, Kubernetes, core cloud compute. Now we're adding also an intermediate layer, we call those sort of the distributed compute layer. And this would have not the monolithic storage, but you'd have containers as a service. Kubernetes, VMs as a service, so you could do compute there. And so what you do and where you want to do it depends on the application, things that are a lot of back and forth with the end user that are lighter weight, that could be handled in JavaScript. You want to be doing that in the 4,100 edge regions, something like transcoding, you're doing some data processing, you got an app in a container, but performance matters, you want to be close to the end user or say a gaming application that you'll want to do in our distributed edge platform. And the reason we have that is there's a lot of cities and places in the world that don't have a giant cloud data center there. And they can't really take advantage of the cloud for applications that have -- where the proximity to the user is important, and so that's something that we want to be able to provide. So there's three sort of levels here of compute and you want to be actually using generally all three for a major company, but the specific application dictates where you want to be doing it and what combination that you want to use.

Tom Leighton:

Yes, good. So I think tuck-ins are a team that has the beginnings of a product or technology that we can scale on behalf of our customers. We've done a lot of acquisitions like that. More substantial would be something like Guardicore that had, at that time, the #2 product in the marketplace, and we've invested around that. They're now #1, which is great to see and a more significant cost associated with that. And they had a developed product already. Go back farther Prolexic is another example of that where they had a developed product, they already had $40 million, $50 million in ARR. And those are -- we do occasionally, and we're always looking. But we do those occasionally. But more you'll see the tech tuck-ins and then we develop from there.

Rudy Kessinger:

I guess I'm curious, how did the macro trend in the quarter just with deals lengthening? And how many deals did you see push, I guess, relative to Q3? And the guide assumes no positive or negative change in the macro. Just why make that assumption, why not be a bit more conservative, maybe assuming it gets a little worse?

Rudy Kessinger:

Yes. Okay. That's fair. And then at a higher level, I mean, obviously, it sounds like compute has kind of slotted into growth priority one, if you will, kind of ahead of security. And just at the high level, I'm curious what really is giving you conviction to invest so much in compute. Is it the early customers that you've signed? Is it just conversations? Is it the pipeline growth you've seen over the last few quarters since you made the acquisition? What's giving you so much conviction to make such a large investment go-on on compute?

Operator:

Our next question will come from Ray McDonough with Guggenheim.

Tom Leighton:

Yes, good question. First, the work on Linode which is extensive is use different teams by and large than our security technology group. And so yes, we are in a position that we can continue that work and also do security acquisition. I don’t think there’s any challenge there. Now we have, as we talked about, retask a lot of the positions, either people or positions from our platform and delivery organizations to the compute effort. So there is a lot of effort there, and that will be increasing throughout the year. Now in terms of the 20%, what we're talking about is we're guiding this year into the low double digits and then we'll see where we are. Obviously, we'd like to be growing faster than that, but there are very challenging conditions out there, as we've talked about, and we'll have to see. So we'll update that guidance as we -- maybe we get to an Investor Day or get into next year. But right now, we're just guiding for this year in security in the low double digits.

Tom Leighton:

Yes. So good question. There's the contracting, there's the build-out, there's getting it all turned on. And the way you want to think of it is we would be doing the core data center build-out. The focus of that is in the first half, and we'll have a lot of that done then, and we should finish that early in the second half or get substantially more than we have today. And then late in the second half, taking on the distributed architecture, we should have a bunch of those regions turned on live later in the year. And at that point and also, at the same time, getting the certifications in place, virtual private cloud, other capabilities that the big enterprises need so that when we get to the later part of the year, we're in a position that we can take on this business, and it will just happen all at once. A major enterprise will try it, use some applications and then some of the big ones, you port some of the traffic over. And so I think the major feeling of it and use of it really comes more in '24, not so much this year. We expect, as we talked about this year to do about $0.5 billion in compute. But the real growth, I think and the monetization of what we are building out now comes in '24 and '25. And also for our own use. This year, we are in the process of porting our own applications. And as Ed talked about we are going to save some this year but really the big savings for us comes in '24. So that's the way I think to think about it.

Operator:

Okay. Our last question will come from Michael Elias with Cowen & Company.

Ed McGowan:

All right. I'll try, the second one is going to be a little bit more challenging and maybe I'll come back with a metric on that one. I don't have exact metric down to the megawatt, but I'm sure somewhere in the business, I can find somebody who does. But I've sort of used sort of a rule of thumb of $1 of CapEx is $1 of revenue roughly speaking, that may change a bit, but sort of a good rule of thumb. In terms of sales cycles, the good news with the deals slipping is they're not going away. This is typically a big purchase that you make, especially with Guardicore that it could be something where the decision-maker is just pushing it off a quarter or two. And it's not that the deals are losing. It just becomes a longer sales cycle and a fight for budget. In terms of just overall sales cycles, like I said, the biggest impact is new customers, right? It's a lot easier with your existing customers, you're going through renewal cycles, you're having upgrade conversations and things like that, getting new customers to open up a new buying pattern is challenging. I do think one thing that will work in our advantage in all of this, though, is as we talk about compute and the need to find a cheaper alternative go multi-cloud. I think that's going to work in our favor. So I think one thing this -- all the negatives that come with the macroeconomic backdrop that we have. I think that's one positive that will work in our favor, and we are starting to see our pipeline grow pretty dramatically in that area. And as Tom talked about, we should start to see deals close towards the back half of the year and then really set ourselves up for '24.

Operator:

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Operator:

Good day, and welcome to the Akamai Technologies Third Quarter 2022 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Tom Barth, Head of Investor Relations. Please go ahead, sir.

Thomson Leighton:

Thanks, Tom, and thank you all for joining us today. I'm pleased to report that Akamai delivered strong results in the third quarter despite the ongoing challenges with the global economic environment and the effects of a strong U.S. dollar. Q3 revenue was $882 million, up 3% year-over-year and up 7% in constant currency. This result was driven by the continued strong growth of our security and compute businesses, which collectively grew 23% year-over-year and 28% in constant currency. These 2 business lines accounted for 55% of our overall revenue in the quarter. Q3 non-GAAP operating margin was 28%. And non-GAAP EPS was $1.26 per diluted share, down 13% year-over-year or down 7% in constant currency. EPS was negatively impacted once again by foreign exchange rates and a higher effective tax rate compared to last year. Free cash flow was very strong at $271 million in Q3, and it amounted to 31% of our revenue. I'll now say a few words about each of our 3 main lines of business, starting with security. Our Security solutions generated revenue of $380 million in Q3, up 13% year-over-year and up 19% in constant currency. The growth was particularly strong for our enterprise Zero Trust products, which were up 51% year-over-year in constant currency. Our Guardicore Segmentation solution continued to lead the way with several major customer wins. For example, one of the largest energy companies in the world adopted Guardicore to help protect against SolarWinds types of ransomware attacks. A leading global developer of dietary supplements adopted our Segmentation solution to help meet European regulations and limit cybersecurity risk. And a major South American broadcaster deployed Guardicore to protect their reporting of election results. Our market-leading app and API protection products also performed well in Q3, with many wins against the competition. For example, the largest bank in Southeast Asia came to Akamai last quarter after suffering repeated outages by a competitor that had lured them in with low pricing. When the bank faced large fines from regulators for the extended outages, they saw more value in being back on Akamai's platform. One of the top banks in North America is in the process of bringing all of their traffic back to Akamai after struggling with outages at another competitor who would also lure them in with lower pricing, but couldn't deliver the performance and reliability needed by a major enterprise. After testing our capabilities against competitors, one of the world's largest financial services companies expanded their relationship with us, contracting for 10 of our products and services, including Bot Manager and Page Integrity Manager. A Fortune 100 food processor and commodities trader became a new Akamai customer last quarter after an anonymous threat drove them to seek better DDoS and web app protection than they were getting from a competitor. And in Germany, an online advertising business with one of the country's busiest websites suffered severe account takeover attacks, load problems and reputation damage before coming to Akamai for bot management and app and API protection. Given such examples, it's not surprising that Akamai's web app and API protection was named a leader in both Gartner's Magic Quadrant and in Forrester's Wave report last quarter. Our compute product group also performed well in Q3 with revenue of $109 million, up 72% year-over-year and up 77% in constant currency. We're continuing to make good progress on integrating Linode into our edge platform and on adding the capabilities and scale needed to support mission-critical applications for major enterprises. In particular, we've connected all of Linode's 11 existing locations into our private backbone, enabling us to provide lower latency, higher throughput and improved egress economics. We've also expanded the capacity of these facilities and are in the process of adding 13 additional sites, 5 of which are expected to go live in Q1 with 8 more planned for Q2. As we discussed at our Analyst Day in May, we're also developing a lighter-weight deployment model that is suitable for distribution at a broad scale. This will enable us to get compute much closer to end users around the world. We plan to deploy several dozen of these lighter-weight sites next year, at which point we expect to compare well with the hyperscalers in terms of points of presence and proximity to both enterprise data centers and end users. Of course, we plan to have all of our compute sites integrated into Akamai's unique edge platform, which has over 4,000 locations for edge computing. As a result, we expect to be able to offer superior performance as well as lower total cost of ownership for enterprise computing needs. We've also made significant progress on adding new and improved enterprise capabilities to our compute platform. We launched Database-as-a-Service with managed MySQL in May and managed Postgres in June. We released the next generation of our Kubernetes platform in Q3 to enhance performance and reliability. We expect to launch early versions of an enhanced object storage product as well as next-gen serverless capabilities next quarter. And we expect to become SOC 2 and ISO 27001 compliant this quarter with PCI compliance expected to follow in the first half of 2023. Although we still have much work to do, we're encouraged by the customer use cases that our compute platform began serving in Q3. One of the world's top development studios for gaming moved their matchmaking service to Akamai to help them with data processing and analysis. A large online legal services platform in India chose Akamai as part of their multi-cloud strategy after they concluded that we could help them optimize their cloud computing budget. And a large media workflow company in Germany is planning to migrate their apps from a hyperscaler to Akamai, calling our new capabilities a great addition, especially with the plans for a high number of distributed sites and the tight integration with Akamai content delivery. Over the past few months, I've spoken with many of the world's leading enterprises about our plans for cloud computing. Most tell me that they want more choice in cloud computing, and they often express concern about being locked into contracts with cloud giants that are consuming larger portions of their IT budgets, especially in cases when their cloud vendor is also a direct competitor. Customers also understand the value of leveraging a more widely distributed cloud platform and one that directly connects to Akamai's unique edge platform with over 4,000 points of presence. Turning now to our CDN business. Our delivery products generated revenue of $393 million in Q3, down 15% year-over-year and down 11% in constant currency. These results reflect continued deceleration in traffic growth among our largest customers and the impact of some large renewals that we completed in the first half of the year. As we said at our Analyst Day in May, we've aligned our pricing strategy with the slower traffic growth rates we've experienced this year. In addition to scaling back discounts upon renewal, we're continuing to decline business from a very small number of customers who have extreme traffic peaks compared to their daily usage patterns. While this resulted in less revenue in Q3, it's enabled us to meaningfully lower our delivery network CapEx as we direct cash flow from our delivery business to our compute and security businesses where we have a higher ROI. As Ed will detail shortly, we're also taking several steps to reduce OpEx, including reducing our real estate footprint and limiting hiring to our most critical areas. Although we're facing the same challenging macroeconomic environment as other companies, I believe that Akamai is on the right path to long-term growth and success with our disciplined management of expenses and strong focus on opportunities for future growth such as cloud computing. Becoming a force in the enormous cloud computing market won't be easy, but I believe that it's something that Akamai can accomplish. Akamai has a strong track record of continuous innovation and business expansion. Along the way, we've achieved significant milestones that many thought were impossible. In our first decade, we pioneered the CDN industry. a multibillion dollar market, where we remain the leader by far. In our second decade, we created the industry for app and API protection as a cloud service, our second multibillion dollar market, where we are the leader by a wide margin. Looking ahead, Akamai is on the cusp of another major phase of expansion with our foray into cloud computing. Having already scaled content delivery and cloud security into billion dollar businesses, we now have an opportunity to do it again with cloud computing. In fact, I believe our opportunity in cloud computing is even larger than it's been for delivery and security. Cloud computing is a $100 billion market growing at a very rapid rate. We believe we're in an excellent position to capture a share of this business, particularly from companies that value our market-leading delivery and security solutions and that don't want to be locked in to more expensive options with a cloud giant that competes against them. Akamai is a company that enterprises can trust to be their partner, to scale with their business and to provide the best when it comes to security, reliability and performance. By adding compute to our unique edge platform, we can provide a full suite of cloud services that will help lower our customers' cost to build, run, deliver and secure their applications. In summary, my confidence in Akamai's future prospects for growth and success has never been higher. In fact, my confidence in what I see ahead for Akamai has led me to take steps to put in place a 10b5-1 trading plan, not to sell, but to buy $3 million in Akamai stock over the next 6 months. We expect to announce the adoption of my plan in a formal filing later this week. Now I'll turn the call over to Ed for more on Q3 and our outlook. Ed?

Operator:

[Operator Instructions]. Today's first question comes from Keith Weiss at Morgan Stanley.

Edward McGowan:

Keith, this is Ed. I'll take those. I'll start with the second question first. So from a CapEx perspective, the way to think about it is in the delivery business, we had -- if you go back to our May Analyst Day, we talked about CapEx and delivery being in sort of the high single digits. We've been running in the lower single digits. We're just under 4%. So certainly, in the near term, it will have an impact in the delivery business. As the compute business gets larger, obviously, that's going to be the main driver for CapEx. But certainly, you saw that in Q3, the impact of overall CapEx down at around 13%, and for the year, it's around 13%. So it is less capital-intensive. But as we look at our cloud compute business, obviously, there's going to be some -- Tom talked about building out in more locations. So there'll be some more CapEx associated with that. But we are seeing a pretty healthy decline in our delivery business, which is as anticipated. On your first question, you asked about the macroeconomic environment where we're seeing some challenges. I mentioned in my prepared remarks that we are seeing some of our sales cycles lengthening, seeing customers pushing off upgrades for certain products and things like that, which is pretty typical. Most companies are doing that. I know we're -- we're doing something similar as we go through our budget cycles. We think it's temporary in nature. Also seeing a little bit of pressure in some of the advertising-related businesses, a little bit of pressure there. And then Europe is something that we're keeping a pretty close eye on, that's about geographically where we're worried. Obviously, with what's going on with energy costs and things like that in Europe, that's something that we're keeping a very close eye on and have been a little bit cautious on our guidance, I would say, in Q4, just relative to seasonality. Just trying to take that into consideration.

Edward McGowan:

Yes, I'd say it's more on our customers and their customers, so how does the consumer behave. Obviously, retail is a driver of seasonality as is spending for media. So those 2 things could be impacted. And then obviously, with our customers, if you see shutdown in manufacturing and things like that, that's obviously going to have a ripple effect on GDP across Europe. So that's from that perspective. As far as our risk with energy, we do a pretty good job. The team has done a nice job with our colo negotiations. If you think about our costs, our server costs were pretty insulated from costs there on the bandwidth side that tends to be deflationary. Colo, there is some energy exposure, but the team has done a really good job of trying to lock in longer-term deals. We're not seeing that. It's possible that may start to affect us later into next year. But right now, we've got it pretty well under control.

James Breen:

Can you just talk a little bit about the compute business? I recognize it was up a lot year-over-year after you closed Linode. It was up a few million quarter-to-quarter. What do you have to do to accelerate that business? Is it building out more resources? Is it just you're getting some larger customers? And sort of what are the thoughts there on what that could ultimately grow? It seems like with the opportunity, it could grow faster than the security business.

Operator:

And our next question today comes from James Fish at Piper Sandler.

Edward McGowan:

Jim, this is Ed. Good question. So actually with traffic, we are starting to see a little bit of a recovery in September. It continued a bit in October as well. But in general, it is, as we talked about, a much lower year relative to what we typically see. As far as the specific customers, you're talking about only a handful of big customers that can drive this kind of peak. And these particular customers all have multi-CDN. So in this particular case, we did lose a couple of million dollars. It's not significant in terms of the impact on the year. But as you can see, it saved us about, call it, 4 points on CapEx. So it's pretty meaningful from an overall economic standpoint. Now that said, we still -- these still are big -- very big customers of ours. They've just sort of flattened out the peak a bit. So as their daily average traffic is not growing as quickly, the economics just don't work for us anymore. So we just -- they're still good customers of ours, but just decided we weren't going to allow them to peak as much as they did in the past. It just makes sense for us. But it's not an overly material number. A few million dollars is the way to think about it.

Thomson Leighton:

Yes. Good question. The 20% goal, of course, includes M&A, and we're about to do the year-over-year lapping on Guardicore, which is a very successful acquisition. And we haven't announced any other acquisitions in security to sort of fill that gap. In terms of increasing the security growth rate over time, obviously, the global economic conditions are important there. Also, we've got several of the newer products that are growing very rapidly. Aside from Guardicore, bot management doing extremely well. The new Account Protector solution doing very well. Page integrity management, which will be, I think, really important for companies that want to be PCI compliant beginning in 2025, and they're already working towards that. Those areas are doing very well in terms of growth, but they're still small enough in revenue that they can't swing the whole number as much. The vast majority of our security revenue today is in the app and the API protection area. And the large majority of that is in our web app firewall, where we're the market leader by far and continuing to grow that faster than the market and our competitors there. But that market is -- as a whole, is slower growing. So what we'll need to see is better economic environment, continued growth in the rapidly growing products that are -- as they get bigger, their rapid growth can drive security as a whole, and ultimately, M&A, which is a key part of the 20% goal.

Frank Louthan:

Great. With the sales cycle more elongated, can you give us a little more detail there? Is that across the board? Is it concentrated in any verticals? And give us a little bit more color on what's driving that. Is it more economic? Or is there anything to do with the mix with Linode and compute that's sort of making the suite of services take a little longer for folks to make a decision?

Operator:

And our next question today comes from Fatima Boolani with Citigroup.

Edward McGowan:

Sure. Yes. So in terms of the traffic sort of getting a little bit healthier, I would say, coming out of the summer months, media is probably the vertical that it's most obvious in. So we're starting to see that across video, a little bit in gaming. Gaming is still overall very, very weak compared to what it's been in the future, but a little bit of an uptick here in the gaming vertical over the last couple of months. And then your other question, can you just remind me again? I forget.

Edward McGowan:

Yes. So one of the things we talked about is, obviously, like in the media division in particular, media verticals in particular, as we see traffic levels decline or not grow as quickly, I should say, we typically would give a discount commensurate with what you see in the traffic growth rate. So obviously, as traffic growth rates are not growing as quickly, we are lowering our discounts that we're providing to our customers, and we're starting to see that make its way through the system. It will take a while for it to really impact the growth as we go through our renewal cycles, but I am seeing that the pricing declines are certainly moderating a bit.

Thomson Leighton:

I didn't catch the question. Can you repeat the question, please?

Thomson Leighton:

Yes. And what's the question about the lighter-weight deployment?

Thomson Leighton:

Good. Okay. So there are customers on the platform today and a key reason that they are using Linode and plan to grow their use of Linode is because of these deployments. And the advantage of the lighter-weight deployments is we can get into markets, into regions where it's hard to build out a massive core compute data center so that we're going to have before -- next year more than double by having over a couple of dozen of the core compute data centers, but several dozen more of these lighter-weight distributed locations, where you can do the compute. You wouldn't have huge monolithic storage there, but you don't need that. That can be in the core regions. And that is a key consideration to some of our larger customers that are working with Linode today, doing proofs-of-concept, so in some cases, already running mission-critical applications. Because those lighter weight regions being closer to enterprise data centers in many parts of the world and to end users gives you better performance. And I think that will put Akamai in a great position to have equal or better performance than the hyperscalers. Of course, we have already our edge deployment with 4,000 locations, which also supports edge computing on top of delivery. And for a total -- lower total cost of ownership. So yes, the lightweight distributed regions are important for a lot of our customers and prospects with among the major enterprises on Linode.

Michael Elias:

The first one, you mentioned it a bit ago relating to your long-term guidance and M&A on the security front. Just a question around how would you describe the pipeline of opportunities for M&A in the security market? And as part of that, maybe any capabilities which are top of mind as you think about adding to the platform?

Michael Elias:

Got it. Now just a philosophical question for you, Tom. Over the years, you've taken steps to continue to grow the business and expand Akamai into new verticals. But the stock really hasn't responded in the way that I think you would have liked, just given some of your prior comments. My question for you is, as you think about executing the long-term vision for Akamai, do you believe being a public company is the right setting for you to achieve that long-term vision?

Operator:

And our next question today comes from Tim Horan with Oppenheimer.

Edward McGowan:

Jim, let me take a stab at that. So I would say we started to see it really in this quarter and continue -- sorry, this quarter, meaning Q3, sorry, we're reporting Q3, continuing here in Q4. Hard to say how long this economic slowdown lasts. Now keep in mind, most of our business is under contract. The impact of the new signings doesn't have an overly material impact on the business, especially in any one given quarter. Obviously, over a prolonged period of time, it can slow growth down a bit. I think the bigger thing to think about as you build your models is the impact that foreign exchange has had. I've been trying to call it out as we go. Obviously, the dollar has gotten stronger throughout the year. So when you think about from an as-reported perspective, that's going to be a pretty big headwind. If you annualized at a point we went back all the way to the beginning of the year, you're talking a couple of hundred million dollars of revenue or $0.40 of EPS, a couple of points of operating margin. But that's a much bigger issue in terms of growth. And given our strong growth internationally, FX, assuming the dollar continues to get stronger, is something that I'd be more concerned about from a growth perspective. But we'll give you an update on guidance next year when we have our Q1 call -- or excuse me, our Q4 earnings call in Q1. So I'm not going to provide any guidance right now, but hopefully that gives you enough color to think about it.

Edward McGowan:

Yes. So we tend to price most of our -- not all of our international business is in the local currency, most of it is, though. So you can see that's why we have such a big impact. Generally speaking, it's hard to switch with a customer who has been paying in one currency and then switching to another one. Then you also -- the -- in terms of price increases, too, that's not something that we're considering at this point. Obviously, it's kind of a risky thing to do, when you see companies raise prices. Part of the reason we're actively looking to move our cloud spend is for the reason that we're seeing the suppliers in that area either increase price or not give any commensurate declines with volume increases. So I think the long-term strategy of introducing price increases can come back and backfire on you. So we're not planning on -- we're not going to be making any changes in terms of changing customers out from paying in local currency to dollars.

Edward McGowan:

Yes. So if you think about where the investments are going to be, and that's where we're primarily investing our headcount is in Linode and also in security. And Tom also mentioned that we'll be moving some of the people that have skills that are transferable. If you think about building out, scaling up a CDN, there's a lot of transferable skills. So we'll be able to move some folks that have talent into that group as well. So that won't put any pressure on the bottom line, but we will be spending some money and continuing to grow because we think the opportunity is significant. And then on a CapEx perspective, we will be building out to take in the consideration, moving our own workloads as well as the future demand, and we'll give you an update on that at the next call.

Amit Daryanani:

I have two as well. I guess maybe on the first one, if you could just talk about the edge business, the Linode asset. And I guess, maybe the question I struggled with a fair bit is, can you grow this business on the cloud infrastructure side without sacrificing operating margins over the next several years? Or is that growth in Linode on the edge side going to come at lower margins inherently?

Amit Daryanani:

Got it. And then, I guess, maybe I'd just stick to that theme around Linode. Are there certain use cases that make Linode more attractive more so the top 3 cloud providers that are out there? I guess I'd just love to understand, when you folks walk into a customer pitch, what are the reasons want to use Linode versus some of the peers that might provide a cloud solution at least cheaper? Maybe that would be really helpful. Like what are the 2, 3 reasons that you think stands out?

Operator:

And our next question today comes from Mark Murphy at JPMorgan.

Edward McGowan:

Yes. This is Ed. No, we haven't seen anything notable. Like if anything, we're actually starting, like I said, to see some bit of a moderation in the pricing declines. So we haven't seen anything on the churn side.

Edward McGowan:

Yes, I'd say it's intensified a bit in Q3.

Rudy Kessinger:

I don't want to belabor the point on security growth. But again, when we exclude Guardicore and look at it at constant currency, it looks like organic has come down about 5 points from Q1 to Q3. And so if you were to look at it, could you maybe break out like what's been the impact in your assessment from the macro and -- versus just maybe some of the larger products maturing and growing slower that's led to that roughly 5-point deceleration in the last couple of quarters?

Rudy Kessinger:

Okay. And then on Linode, I don't know if you gave it. Could you share how much revenue Linode did in the quarter? And then last quarter, given the commentary today about the increase in cost of the hyperscalers, last quarter, you talked about moving your hyperscaler spend over to Linode internally. Have you started that process yet? And if not, when do you plan to do so?

Thomson Leighton:

Go ahead, Ed. You take the first part and I'll...

Thomson Leighton:

Yes. So that's well -- the migration of our cloud spend to Linode is well underway. We've already done some. The lion's share of that work or the migration will take place, I would say, over Q1 to Q3 next year. And by the end of next year, we ought to have the vast, vast majority migrated.

Tom Blakey:

I think it's been touched on a couple of times by my peers here. Just wanted to get -- go back to that. Some sort of normalized CapEx level, from my estimation, we're clearly overspending on Linode as a percentage of Linode revenue, anyway, right, if you do the percentage of total revenue. And you've made great strides in terms of lowering the CapEx from a delivery perspective down to this kind of 3% to 4% range. But as things kind of normalize, Tom, when you look out, and we're at , maybe 2/3 of revenue coming from compute security, CapEx is nil. You're just riding the rails of what already exists. What does the CapEx kind of bridge or normalized structure of this company look like a few years from now?

Tom Blakey:

I'm sorry, I didn't understand the last comment of 20% growth in Linode, the CapEx was...

Tom Blakey:

That's exactly what I was asking. I understand, obviously, you're overspending today. And that comment was just a structural comment for the question on what CapEx would be as a total percentage of revenue, total revenue in the -- again, when you're at scale for Linode? Will it be structurally lower or higher than delivery?

Tom Blakey:

It's a more capital-intensive business with compute, okay.

Charles Erlikh:

This is Charlie Erlikh on for Will. I just wanted to ask a 2-parter on the comment that you guys are going to basically take some resources from delivery and put them into security and compute headcount-wise and hiring-wise. So the first part is, how do you feel about competition for talent in the security business and the compute business maybe relative to a few months ago? Kind of what does that hiring environment look like in those 2 businesses? And then part 2 on the delivery side, how should we interpret that comment as far as trying to turn around that delivery business and just sort of what should we expect from that business as far as trends going forward?

Edward McGowan:

Yes, sure. So the way to think about the delivery business, I'll call on 4 factors in terms of thinking about, as you called it, a turnaround. Obviously, one is renewal. So we went through a very heavy phase of renewals. So we're not going to have that next year. We'll always have some renewals, but it's very unusual to see 8 of your top 10 customers renewing at the same time. Number two is pricing. So we're -- as we talked about several times on the call, we are moderating the discounts that we provide on pricing. And then the third thing is traffic. Traffic, we're starting to see some encouraging signs, albeit early, that the Internet has been growing at 30% a year for many, many years. This year is a sub-30% year, but it's reasonable to think that we should start to get back to more traditional growth rates. And then the fourth thing I would say is I think we get a tailwind in our delivery business from being in the compute space. We actually do see some customers that are on hyperscalers get to a certain size that they -- even though they offer their own CDNs, come to us for better performance. So as we add customers, get into new verticals, et cetera, we do have the opportunity to just grow the delivery business by being a proxy of being in the compute business.

Alexander Henderson:

Sliding in before the final. Nice. So I wanted to go back to the commentary that you've made about the outlook for the upcoming quarter, particularly in the security space. If I adjust the numbers for the contribution from the acquisition of Guardicore, I'm getting an as-reported growth rate of around 9%. And I'm wondering, given your commentary about more difficult conditions and a little larger currency translation year-over-year in the fourth quarter, whether in fact you're expecting the security business to slow to that level in your guidance?

Alexander Henderson:

So a similar kind of question. If I take the Linode comments, it looks like that actually accelerated from about a 15% baseline growth rate to around 20%, making the adjustment for the Linode acquisition. On an as-reported basis, that's actually pretty good, considering the currency. Can you talk a little bit about the geographic play between -- in the Linode business and how much currency would have impacted that side of it? And then again, as we look into the baseline growth rate, it does seem like it's accelerating. Can you talk a little bit about whether that's a function of the investments you're making in marketing and like? Or whether that's something that's sustainable in the guide?

Alexander Henderson:

If I could slide in one last one, since I'm the last guy here. As the mix shifts here, how do you expect the mix shift between the segments to start impacting the overall margins?

Thomson Leighton:

And thank you, everyone. In closing, we will be presenting at a number of investor conferences and presenting at events, road shows and other things throughout the rest of the fourth quarter. Details of these can be found in the Investor Relations section of akamai.com. So thank you for joining us. And all of us here at Akamai wish continued good health to you and yours, and have a nice evening.

Operator:

Good day, and welcome to the Akamai Technologies Second Quarter 2022 Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Tom Barth, Head of Investor Relations. Please go ahead.

Thomson Leighton:

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 2 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've been leveraging our financial strength to make substantial investments in enterprise security and cloud computing. We've also used some of this cash to buy back 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 3 main lines of business

Operator:

[Operator Instructions]. The first question is from James Breen of William Blair.

Edward McGowan:

Jim, this is Ed. So in terms of the guide, there's really 2 pieces to it. The first one is obviously FX has gotten incrementally worse. That's probably about half of the delta. The rest of it is the slower traffic that we talked about. I think your question was specific to the trade-off that we're making. The first immediate impact that you get on that trade-off from taking less of that peak traffic as you save on CapEx. So that will make its way through the P&L through lower depreciation and obviously immediately through cash flow. And so the decision that we've made is obviously, as we talked about in May, as traffic levels have come down, the discounts that we offer upon renewal are lower. And in some cases, we've seen a small handful of customers that have the traffic. Their peaks are still growing at pretty significant rates, but their day-to-day traffic is not. So there's a formula that we go through in a trade-off that we made that I think makes a lot of sense for us, especially as I look at the types of returns we can get from the faster-growing areas like security and compute.

Edward McGowan:

Yes. I mean, I would say, obviously, compute can be, I wouldn't call it an asset-heavy business, but it does have a fair bit of CapEx. We talked about our CapEx for Linode being about 2% of revenue in total. And obviously, it's going to be a little bit front-end loaded. We actually took the advantage to try to spend a little bit more for Linode. Based on some of the conversations we're having, we're starting to see some good demand. And obviously, Tom talked about signing a pretty significant customer in the quarter. So what we're doing though, on the Akamai, of course, I call it the legacy Akamai delivery business is we are being a bit more selective in reducing CapEx. I made a comment that our network CapEx excluding Linode was 3%. That's typically around, call it, 8% to 10%, at least where it's been running over the last couple of years. So I think it's just a question of being more selective with certain types of traffic. It's really a handful of customers that have that type of traffic pattern. It's generally event-driven. And what we're seeing is it's just a better return to shift some of that investment in other places.

Thomson Leighton:

Yes. Obviously, very early days. We've got a lot of work ahead of us with Linode, as we've talked about. But it's great to land our first very large customer, putting a critical app. Actually, it's for transcoding, user content onto the Linode platform. As I mentioned, that's just that app alone as it scales is worth several million dollars a year of revenue for us. And tip of the iceberg, this is a customer that spends many hundreds of millions of dollars a year on cloud computing. And that's just 1 customer. So a lot of good opportunity ahead, and we're making good progress on our road map for Linode.

James Fish:

We've seen some security vendors report here and Security is going through kind of actually still a strong environment despite the macro. And when I look at your normalized rate of about 17%, it's a bit lighter than what we saw in Q1 in the last couple of years really. What's going on, especially on the core WAF and DDoS and in Bot management in terms of the sizing and growth against some of the newer solutions like EAA and PIM here? And is there a way to think about if you guys are seeing any higher net churn overall or how to balance net new business versus the expansion that you're seeing with your existing customers and security?

James Fish:

Got it. And maybe for Ed, on the delivery side, Ed, you alluded to a handful of customers that you guys essentially don't really want to deal with going forward just in terms of the type of traffic that you're delivering for them versus obviously the peaks versus the average. Taking a step back, what are you seeing in terms of this new pricing strategy versus kind of the churn as well as how to think about this removal of customers on the second half guide and if it really impacts the Security business going forward?

Operator:

The next question is from Rishi Jaluria of RBC.

Edward McGowan:

Yes, Rishi, sure. So I'll take that. Keep in mind, if you remember last quarter, we talked about Guardicore revenue having about $7 million of onetime license revenue, which was a pull forward of about 1% or so of growth into that quarter. So that impacted it as well. We are -- one other thing to keep in mind, too, if you recall, with our [indiscernible] business during 2020 and 2021, we had a pretty strong uptick from the educational vertical. And there, that was when kids were working from -- sorry, working from home, doing school from home. And there was some government funding that was enabling folks to be able to work or go to school remotely and that funding has gone away. So we've seen a little bit of a decline there. I think it's a combination of those 2 factors that led to a little bit lighter of a sort of a sequential growth quarter-over-quarter. But some of the other things that we're seeing underlying our business, we're seeing very strong demand in Bot Manager. Account Protector is a newer version of that product or an add-on. That's going pretty well, but it's still pretty early days. It takes a while for that to -- good to add to growth. But those are some factors that you need to consider as you think about the slowdown in the growth there.

Edward McGowan:

Sure. Yes. So let's see, I'll start with pricing. So one of the things -- the biggest area where you see pricing impact the business is on delivery. We don't see the typical price declines that you would expect to see in the Security business. The business just doesn't work that way. And I don't anticipate that being a significant problem for us. Obviously, we're anticipating that traffic is not going to recover to growth rates like we've seen in the past. We said that in our prepared remarks. So kind of a muted -- more muted Q4 than we typically see. Q4 tends to be a strong quarter for us. We anticipate that the macroeconomic environment is not going to get any better. One of the areas that I'm keeping a close eye on is Europe. We're seeing a lot of challenges in Europe, seeing energy prices, for example, are really, really high over in Europe. We're coming into the winter session. So you could see potentially less graphic related to people cutting subscriptions or doing things like that, less shopping online. So that's one of the things that I'm concerned about. And then also the recession and the impact that it could have on our customers potentially delaying buying decisions and things like that. But obviously, we're producing a tremendous amount of cash. The business is in great shape. It's much more well diversified than in the past. So I think we'll weather the storm pretty well. But I do think, as Tom and I both mentioned in our prepared remarks that it is going to dampen our revenue growth a bit here and also our margins for a short period of time.

Joshua Baer:

This is Josh Baer on for Keith. I wanted to ask about Linode. Are these enterprises that are testing out the platform? Are they considering Linode as primary cloud vendor? And I guess assuming it's a multi-cloud strategy approach, what are some use cases that enterprises are testing with Linode? What types of workloads or products do you expect to be popular with enterprises?

Joshua Baer:

Great. And it sounds like a lot of the focus is on the hyperscalers and the enterprise opportunity. Just also wanted to ask if you're seeing any changes in the competitive landscape around some of the other alternative cloud providers serving SMB just in regard to any pricing changes or any other moving pieces in the market.

Operator:

The next question is from Frank Louthan of Raymond James.

Thomson Leighton:

Yes. As we mentioned, there's a variety of factors that are impacting the media companies and hence traffic. You've sort of got a year -- I mean we still got COVID, but this is more like a non-COVID year lapping a COVID year. And so people are out and about more, and so there's less traffic growth due to that. You've got impacts of what, in some places is a recession. And you've seen some of the media companies report that they've got their own challenges with usage. And so that tends to reduce traffic. Obviously, we've got foreign exchange headwinds, which impacts the revenue we get from media companies overseas. And so all of that is impacting traffic in the media business for Akamai. I don't see those as being permanent. And we do expect over the long term that the traffic returns to more normal growth rates and that the revenue for the Delivery business stabilizes. May take a little while, several quarters at this point, but I don't think it's a long-term phenomenon.

Edward McGowan:

Yes. So probably the best way to think about that, if you remember, coming into the year, we were sort of guiding that 15% to 16% range. We said, Linode will be a couple of points. We're now down to 12% to 13%. So that's somewhere in the 3% to 4% range is probably a good number to be working with. I also gave the data point out that our network-only sort of legacy Akamai Delivery business or Akamai network CapEx is around 3% where typically it had run around 8%. Now we'll, obviously, you still have to invest in the network, and we expect traffic to grow, et cetera. But I think we can remain in a lower than sort of long-term trend model here for a while. Obviously, if we see significant increase in traffic, we'll obviously have better delivery results and deal with it at the time. But kind of looking out over the next several quarters and into next year, I'd expect to see the CapEx levels at sort of levels you're seeing here.

Fatima Boolani:

Ed, this was for you, just with respect to a lot of the detailed commentary on your expectation of the delivery franchise for the second half. So a number of moving pieces here. But what I want to focus on is maybe doubling back to some of your comments from the last earnings call with respect to the observations around gaming, traffic slowing down. So I am inferring up the bulk of the pain that you're talking about from a delivery standpoint is purely coming from the OTT side, but I'd love to kind of get a confirmation and maybe get more of an in-depth under the hooded view of where you're seeing the most, I guess, elasticity or volatility from a traffic type standpoint? And how you're thinking about those trends in maybe a more granular fashion in the back half, especially on the back of the renewals that are now behind you?

Fatima Boolani:

I appreciate that. And just really quickly, on the macro commentary that you shared especially with some of the key observations in Europe. I'm curious about any concerns or observations with respect to sales cycle elongation, deal decision -- delays in deal decision and deal making from a procurement standpoint, anything tangible that you can share with us just with respect to those dynamics, just as the broader economy sort of softened.

Operator:

The next question is from Tim Horan of Oppenheimer.

Thomson Leighton:

Yes, the savings can be substantial. The list pricing that we offer for Linode is substantially less than when you see the hyperscalers offering, that's public information. And for major enterprises, obviously, you can have some discount to that. And the really good news is that we believe we can do this at substantial margins. So as we grow the business, actually, they'll improve our margins overall. And Ed, do you want to take the second part of that?

Operator:

The next question is from Rudy Kessinger of D.A. Davidson.

Edward McGowan:

Yes. I'd say the majority of it comes from the slower traffic. That's going to be the biggest component of it. The impact for some of the traffic we're turning away isn't all that significant, but does contribute to it. I don't have an exact percentage for you, but that's not a significant part of it. And then the macroeconomic would be the remainder. So if you were to stack rank it would be slower traffic macroeconomic and then the impact from turning away some of the traffic that we talked about in terms of the peaky traffic.

Thomson Leighton:

Yes, we're spending about $100 million a year annually now with the cloud companies. And over the next year or 2, ultimately, we would migrate pretty much -- most all of that on to Linode. And substantial savings. So that's why it's one of our several initiatives we're taking to improve margins. Also, it's great to be using our own services, and it will help us as we do the work with Linode to make it enterprise-ready, to be using it across the spectrum of applications at Akamai. We're very much like our customers and looking for ways to save on cost and get great performance out of our cloud compute platform.

Jeff Van Rhee:

Just a couple for me. I think on the Security side, I just want to clarify, I know you said you're comfortable at 24% revenue growth. To be clear, as reported or constant currency and then just kind of the puts and takes of being able to sustain that 20% in the outyear, given kind of the deceleration we're seeing right now?

Thomson Leighton:

Yes. And in terms of the longer range, obviously, we're seeing very good growth in our flagship products, Web App Firewall and Bot Manager. They're the largest contribution of revenue. Really good growth, but on smaller numbers, obviously, for Zero Trust enterprise computing. In the longer time frame, I think that's what drives a lot of the growth in security. The infrastructure category growing more slowly today, also on a moderate size number. But I think in the long term, you see the enterprise Zero Trust security group grow, led by Guardicore as the market leader in stopping ransomware. .

Thomson Leighton:

Well, there's the three categories we have today. The biggest is app in API security, very strong growth. I think we get continued strong growth there. A lot of innovation going on with Account Protector, Page Integrity Manager we talked about being really important for PCI compliance. We have a new audience hijacking prevention capability that looks really cool. Infrastructure is moderate size today, and that's not growing as fast. That's your DDoS protection and your D&S defenses. And then the really high-growth area, Zero Trust enterprise security led by Guardicore, but it's the smallest of the 3. And so you sort of have 3 different comps with a little bit different dynamic in each.