Q3 2022 Akamai Technologies Inc Earnings Call
Good day and welcome to the Akamai technologies third quarter 2022 earnings Conference call.
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I'd now like to turn the conference over to Tom Barth head of Investor Relations. Please go ahead, Sir. Thank you operator, good afternoon, everyone and thank you for joining Akamai third quarter 2022 earnings call.
Speaking today will be Tom Leighton, Akamai, Chief Executive Officer, and Ed Mcgowan, Akamai as Chief Financial Officer.
Please note that today's comments include forward looking statements, including statements regarding revenue and earnings guidance. These forward looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements.
The factors include any impact from macro economic trends the integration of any acquisitions and any impact from geopolitical developments additional information concerning these factors is contained in <unk> filings with the SEC, including our annual report on Form 10-K, and quarterly reports on Form 10-Q.
Forward looking statements included in this call represent the company's view on November eight 2022.
Akamai disclaims any obligation to update these statements to reflect new information future events or circumstances, except as required by law.
As a reminder, we'll be referring to some non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the Investor Relations section of Akamai Dot com and with that let me turn the call over to Tom.
Thanks, Tom and thank you all for joining us today.
I'm pleased to report that Akamai delivered strong results in the 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 too.
Business lines accounted for 55% of our overall revenue in the quarter.
Q3, non-GAAP operating margin was 28% and non-GAAP EPS was a dollar and 26 cents per diluted share down 13% year over year or down 7% in constant currency.
P. S 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 will now say a few words about each of our three 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 guard of course segmentation solution continued to lead the way with several major customer wins for example, one of the largest energy companies in the world adopted Garda core to help protect against solar winds types of ransomware attacks.
Leading global developer of dietary supplements adopted our segmentation solution to help meet European regulations and limit cyber security risk.
And a major south American broadcast or deployed Garda court to protect their reporting of election results.
Our market, leading app in API protection products also performed well in Q3 with many wins against the competition. For example, the largest bank in South East Asia came to Akamai last quarter. After suffering repeated outages by a competitor that had lord them in with low pricing when the bank face large.
Finds from regulators for the extended outages, they saw more value and being back on Akamai 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 lowered 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 our competitor.
And in Germany, and 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 is web app and a P. I protection was named a leader in both Gardner's Magic quadrant and in Forrester 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 lienau 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 blood nodes 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 five of which are expected to go live in Q1 with eight 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 hyperscale or in terms of points of presence in proximity to both enterprise data centers and users of.
Of course, we plan to have all of our compute sites integrated into Akamai is unique edge platform, which has over 4000 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 manage my sequel in May and manage post grass in June .
We released the next generation of our Kubernetes platform in Q3, two enhanced performance and reliability.
We expect to launch early versions of an enhanced object storage product as well as Nextgen server less capabilities next quarter.
And we expect to become Sox to an ISO 27 O O. One compliant this quarter with PCI compliance expected to follow in the first half of 2020 three.
Although we still have much work to do we're encouraged by the customer use cases that are compute platform began serving in Q3.
One of the world's top development studios for gaming move 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 hyperscale or 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 expressed 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 is unique edge platform with over 4000 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 a slower traffic growth rates. We've experienced this year. In addition.
To scaling back discounts upon renewal, we're continuing to decline business from the 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.
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.
And our first decade, we pioneered the CDN industry, a multibillion dollar market, where we remain the leader by far.
And 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.
Having already scaled content delivery and cloud security into billion dollar businesses. We now have an opportunity to do it again with cloud computing.
Faq I believe our opportunity in cloud computing is even larger than it's been for delivery and security.
Cloud computing is 100 billion dollar market rolling 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 they don't want to be locked in to more expensive options with our cloud giant that competes against them.
<unk> 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 and Akamai is 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. It can be five one trading plan not to sell but to buy $3 million in akamai stock over the next six am.
Months.
We expect to announce the adoption of my plan and a formal filing later this week.
Now I'll turn the call over to Ed for more on Q3 and our outlook.
Ed.
Thank you Tom as Tom mentioned Akamai delivered a solid quarter in Q3, despite a very challenging macroeconomic environment.
Q3 revenue was $882 million up 3% year over year or 7% in constant currency.
The stronger U S dollar negatively impacted our year over year growth rate by approximately four points or about $39 million of revenue year over year and $14 million on a sequential basis.
On a combined basis, our security and compute businesses represented 55% of total revenue up 23% year over year and 28% in constant currency.
Security revenue was $380 million and grew 13% year over year and 19% in constant currency.
Led by another strong contribution from Garda core Carter core delivered approximately $14 million of revenue in Q3.
Security represented 43% of total revenue in Q3, which was up four points from Q3 a year ago.
Compute revenue was $109 million in Q3 up 72% year over year and 77% in constant currency.
As Tom mentioned, while we are in the early innings of our cloud computing journey. We are very excited about initial feedback from customers and the significant growth opportunity ahead.
Delivery revenue was $393 million down 15% year over year and down 11% in constant currency.
Sales in our international markets were $421 million and represented 48% of total revenue in Q3 up one point from Q2.
International revenue was up 2% year over year or 12% in constant currency.
Finally revenue from our U S market was $461 million up 3% year over year.
Moving now to costs and profitability.
Cash gross margin was 75%.
GAAP gross margin, which includes both depreciation and stock based compensation was 61%.
non-GAAP cash operating expenses were $291 million adjusted EBITDA was $368 million and our adjusted EBITA margin was 42%.
non-GAAP operating income was $243 million and our non-GAAP operating margin was 28%.
It is worth noting that on a year over year basis, our non-GAAP operating margin was negatively impacted by approximately one point due to unfavorable foreign exchange rates.
Capital expenditures in Q3, excluding equity compensation and capitalized interest expense were $111 million.
As we mentioned on our Q2 earnings call our strategy in our delivery business is to be more selective on the peak traffic levels, we will take on our network.
As a result delivery network capex, excluding the node was just under 4% of revenue in Q3.
GAAP net income for the third quarter was $108 million or 68 cents of earnings per diluted share.
non-GAAP net income was $200 million or $1.26 of earnings per diluted share down 13% year over year and down 7% in constant currency.
It's worth noting that on a year over year basis foreign exchange rates negatively impacted our non-GAAP EPS by approximately 10 cents in Q3.
Taxes included in our non-GAAP earnings were $41 million based on our Q3 effective tax rate of approximately 17%. This was about one point higher than our guidance due to a more unfavorable mix between U S and foreign earnings.
Now moving to cash and our use of capital.
As of September 30th our cash cash equivalents in marketable securities totaled approximately $1.4 billion. During the third quarter, we spent approximately $163 million to repurchase shares buying back approximately 1.8 million shares.
Our ongoing share repurchase activity has resulted in a net reduction in our non-GAAP fully diluted shares outstanding of approximately 5 million shares or roughly 3% on a year over year basis.
We ended Q3 with approximately $1.4 billion remaining on our current repurchase authorization.
Our intention is to continue to buy back shares to offset dilution from employee equity programs over time.
And to be opportunistic in both M&A and share repurchases.
Before I provide our Q4 outlook and an update to our 2022 guidance I want to highlight several factors first with nearly half of our revenue coming from outside the U S. The strong U S. Dollar continues to be a significant headwind to our reported results at current spot rates our guidance now assumes four.
Aaron Exchange will have a negative $130 million impact to revenue and.
In 2022 on a year over year basis.
As I mentioned previously the strong dollar also impacts our margins and earnings we estimate FX will negatively impact our non-GAAP operating margin by approximately one point year over year.
And non-GAAP earnings by approximately 34 cents for the full year 2022.
Second we have seen a lengthening in some of our sales cycles. We believe that this is this primarily reflects the uncertain macroeconomic conditions that our customers are experiencing and it is visible in many parts of our business.
Finally, we continue to closely monitor our costs in light of ongoing inflationary and macroeconomic pressures across the globe.
We've made good initial progress on our cost cutting measures that we mentioned on our last call which include real estate costs, where we sublease some of our underutilized office space in Q3, and we'll continue to look for additional savings going forward.
Reducing our third party cloud expense in 2020, three where we look forward to making significant progress on shifting workloads to Lenovo.
And lowering network capex associated with our delivery business, where I noted our continued progress on reducing spend significantly related to traffic delivery.
In addition to these items as Tom mentioned, we plan to be very disciplined with head count and focus our investments on higher growth areas like cloud computing and security and.
In particular, we are closing over 500 open positions and re tasking. Many other employees to work on compute these closures went into effect today.
And just a quick reminder, about our typical fourth quarter dynamics before I turn to our Q4 guidance Hasnt.
As in prior years seasonality plays a large role in determining our fourth quarter financial performance, we typically see higher than normal traffic for our large media customers and from seasonal online retail activity from our e-commerce customers, which are both difficult to predict especially during this more challenging macroeconomic environment.
With that in mind, we are projecting Q4 revenue in the range of $890 million to $915 million were down 2% to up 1% as reported or up 3% to 6% in constant currency over Q4, 2021.
Foreign exchange fluctuations are expected to have a negative 11 million dollar impact on Q4 revenue compared to Q3 levels and a negative $44 million impact year over year.
At these revenue levels, we expect cash gross margins of approximately 74%.
This roughly one point sequential decline is primarily driven by increased third party cloud costs and some compute related data center build out costs.
Q4, non-GAAP operating expenses are projected to be $298 million to $306 million, we anticipate Q4, EBITDA margins of approximately 40% to 41%.
We expect non-GAAP depreciation expense to be between $125 million to $126 million and we expect non-GAAP operating margin to be approximately 27% for Q4.
Moving on to Capex, we expect to spend approximately $122 million to $127 million, excluding equity compensation and capitalized interest in the fourth quarter.
This represents approximately 14% of projected total revenue.
And with the overall revenue and spend configuration I just outlined we expect Q4 non-GAAP EPS in a range of one dollar and 23 cents to one dollar and 30 cents.
This EPS guidance assumes taxes of $38 million to $40 million based on an estimated quarterly non-GAAP tax rate of approximately 16%. It also reflects a fully diluted share count of approximately 158 million shares.
And finally for the full year 2022, we now expect revenue of $3.58 billion to $3.6 billion, which is up 3% to 4% year over year as reported were up 7% to 8% in constant currency.
We continue to expect security growth of approximately 20% in constant currency for the full year 2022.
We now estimate non-GAAP operating margin to be approximately 28% and non-GAAP earnings per diluted share of $5.23 to $5.30 and non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 16, 5% fully diluted share count of approximately 160 million shares.
Finally full year Capex is anticipated to be approximately 13% of revenue.
In closing we are very pleased with how the business is continuing to perform despite a very challenging macro macroeconomic backdrop. We are very excited about our future growth opportunities ahead.
Tom and I would be happy to take your questions operator.
Angela Speaker firm, we actually you. Please pickup your handset before pressing the keys to charter. Your question. Please press Star then two.
Today's first question comes from Keith Weiss of Morgan Stanley . Please go ahead.
Excellent. Thank you guys for taking the question and nice quarter in a difficult environment.
I bet.
Difficult environment.
I was hoping you could help us out a little bit.
More specificity in terms of where you guys are seeing the macro impact.
Sounds like Securities is still holding up relatively well and on the delivery side of the equation there's.
Akamai specific impacts there. So can you give us some kind of detail in terms of where where the risk factors are sort of where the macro lies on a product and geographic perspective, I think that would be helpful. And then I guess on the Capex side of the equation you talked a little bit about.
Types of business that you guys are.
Not looking to take on board I on a go forward basis is it very peaky workloads that perhaps were overly taxed the system. If you will can that lead to a fundamental different kind of capex intensity for the business on a go forward basis or is it just too small to make a difference. Thank you.
Thank you. 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.
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 digit were just under 4%. So.
Certainly in the near term it'll have an impact in the delivery business is the compute business gets larger obviously, that's going to be the main driver for Capex, but certainly you saw that in Q3 are the.
The impact of overall capex down at around 13% for the year is around 13%. So it is less capital intensive, but as we look at our cloud.
Cloud compute business, obviously theres going to be some you know Tom talked about building out more locations. So there'd be some more capex associated with that but.
We are seeing a pretty 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.
<unk> seen customers pushing off the upgrades for certain products and things like that which is pretty typical you know most companies are doing that and know where we're doing something similar as we go through our budget cycle, we think it's temporary in nature.
Also seeing a little bit of pressure on 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 mess 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 it's.
Then a little bit cautious on our guidance I would say in Q4, just relative to seasonality just trying to take that into consideration.
Got it and on the energy cost is that a topline concern in terms of you're worried about your what are your customers are experiencing or is that more of a gross margin concern or that you guys are worried that there's energy cost can impact your gross margins on a go forward basis.
Yeah, I'd say, it's more on our customers and their customers. So how does the consumer behavior. You. Obviously retail is a driver of seasonality as in spending for media. So those two things could be impacted and then obviously if there are customers who can see it was shut down 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.
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 cost you know our server costs were pretty pretty isolated insulated excuse me from from cost there on the bandwidth side that tends to be deflationary Colo. There is some energy exposure, but the teams are really good job of trying to lock in longer term deals. So we're not seeing that its possible that may start to affect us. We let you know later.
Into next year, but right now, we've got a pretty well under control.
Awesome.
Thank you so much guys.
And our next question today comes from James Breen of William Blair. Please go ahead.
Thanks for taking the question can you just talk a little about the compute business.
Recognize it was up a lot year over year. After you close the node.
A few million quarter to quarter, what do you have to do to accelerate that business is it is it building out more resources. It just youre getting some larger customers and sort of what are the thoughts there and what that could ultimately grow.
It seems like with the opportunity it could grow faster than the security business. Thanks.
Yeah, Great question are the compute business, even before the node was on a pretty strong trajectory of growth.
And with her know that accelerates it a lot as you look to the future the big growth Thomas we're tapping into the core cloud compute market.
A market that's over 100 billion today and growing rapidly and that's something that you know, we're working really hard on now.
Two we can exploit that you know next year and that involves increasing scale.
Having a lot more core.
<unk> regions, and then introducing the lighter weight distributed computing regions. So that will be in a position to offer at least as good or better performance integration into the Akamai platform, which has great delivery, great security and of course edge computing at a lower total cost of ownership.
And for a lot of our customers, especially you think of the media vertical in the commerce vertical they spent a lot more on compute than they do with delivery and security. Moreover.
They compete pretty heavily with the hyperscale or so the big growth for US we're really going after over the next several years is in that core cloud compute market.
Mission critical applications for major enterprises.
Because that's a that's a very big potential market for us and that's what will drive are there major growth in compute and ultimately I think the company going.
Going forward.
Great. Thanks.
And our next question comes from James Fish with Piper Sandler. Please go ahead.
Hey, guys I appreciate the questions, obviously I agree with you deceleration in traffic overall, especially on the media side, but what makes you guys confident that you arent, losing profit share some of the media customers, especially as you know are you purposely not doing.
Some of the.
Large events for example, or kind of a gaming peak traffic and any sense for how much that's kind of impacting the media business. This quarter and this year overall that we should kind of normalize as we start to think about for next year.
Yeah, Hey, Jim This is Ed. Good question. So you know actually with traffic we are starting to see a little bit of a recovery in September .
We continue to bid in October as well, but in general It is a you know 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 in these particular customers all have multi CDN. So.
In this particular case, we did lose a couple of million dollars its not significant in terms of the impact on the year.
But as you can see it saved us about call. It four points on Capex, So it's pretty meaningful from an overall economic standpoint, now that said.
We still are you still a 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 quick as the economics, just don't work for US anymore. So we just you know we'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.
That's helpful. I appreciate that maybe following up a little bit on Keith's. Prior question around more specifically on the security growth, which slowed to about 15% wanted to normalize everything what makes you guys confident that we're going to see an acceleration in this business back to that.
20% all in.
Constant currency growth rate over the next couple of years is the impact today being more felt on the new business side, given kind of your comment along elongated sales cycles or is it you're seeing a slowdown in existing customers expansion as well thanks guys.
Yeah. Good question, the 20% of all of course includes M&A and we're about to do the year over year lapping an article which is a very successful acquisition.
And we haven't announced any other acquisitions in security to you know sort of fill that gap.
Terms of increasing the security growth rate over time, obviously, the global economic conditions, you know are important there.
So was that several of the newer products that are growing very rapidly.
Aside from Garda core.
<unk> management doing extremely well the new account protector solution doing very well page integrity management, which would 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 are still small enough and revenue that they can swing the whole number as much you know 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 the mark.
Leader by far and continuing to grow that faster than the market and our competitors there, but that market is as a whole. This is slower growing so what we'll need to see is you know a better economic environment continued growth in the rapidly growing.
<unk> that are as they get bigger they rapid growth can drive a security as a whole and ultimately M&A, which is a key part of that 20% goal.
Thank you ladies and gentlemen, our next question today comes from Franklin fan of Raymond James. Please go ahead great.
Great. Thank you with the sales cycle more elongated could you give us a little more detail there or is that across the board or is it concentrated in any verticals and and 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 lenovo to compute that sort of making the the suite of services.
Take a little longer for folks to make a decision. Thanks.
Hey, Frank Good question, so actually I'll start with Lenovo actually one node in an environment like this given what Tom talked about we will be able to provide a.
Comparable services at a much better set of economics actually thinks and opportunity for us. So I would expect that as we go into next year that should be a tailwind for us on the headwind side, we are seeing.
Cross the board certainly from a geographic perspective that sales cycles are elongated and we've seen some deals push probably the easiest place to identify it as an Garda core CLARCOR.
CLARCOR as Tom mentioned is still doing really well, but we have a dedicated sales team. So it's a little bit easier to track those deals as they are going through the pipeline. Those deals also sometimes tend to be a little bit larger so it's a bit easier to follow that.
You know with our business given it's a SaaS business and we've got recurring revenue contracts are constantly going through and renewing contracts. What youre seeing is some customers that are talking about adding page integrity manager our bot manager account protector, just pushing that off into the future.
As they go through their budget cycles. So we're not seeing as much on the renewal side from an upgrade perspective, a little bit of slowness, there and then from the new customer acquisition perspective, I think pretty much every tech company you talk to these days.
Seeing it a little bit harder to attract new customers. So it's a little bit of a combination of everything.
That's been impacted by this.
Economic impact here.
Alright, great. Thank you very much.
And our next question today comes from Cynthia Mayer with Citigroup. Please go ahead.
Hey, guys. This is more concourse.
The final question.
So just maybe a follow up in regards to the September and October recovery on the delivery side. We're starting to see can you maybe give a sense of which end market cohorts really driving that momentum and then when you're going to negotiate negotiating tables are there parts of the pricing and other contract terms can you also give a sense of how that has been developing.
Thanks.
Sure Yeah, 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 albeit thin 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 a of a.
The uptick here in the gaming vertical the last couple of months.
<unk>.
And then your other question can you remind me I forgot.
Oh, sorry, just in terms of pricing and other contract terms have you guys coach at the negotiation table.
Yeah. So one of the things we've talked about is obviously like in the media Division in particular and 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 our traffic growth rates, 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 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.
Yeah.
Okay got it thanks, and then maybe just a follow on on the lighter weight.
Development.
Any sense of how your customers are there any number one customers in the beta testing phase.
And also I got Scott, where whether it's for the milestones we should look out there look how far there.
I didn't catch the question can you repeat the question. Please.
Yes.
Oh, sorry, just in terms of the lighter weight the partner.
On the cloud side Yep Yep.
And what's the question about the lighter weight deployment.
Yeah, just in terms of are there any customers currently in the beta phase or testing out the product and how has that feedback.
Are there any milestones we should watch out for.
Right. Okay. So there are customers on the platform today.
And a key reason that they are using one node and plan to grow their use of unnoticed because of these deployments and the advantage of a lighter weight deployments as we can get into markets and to regions, where it's hard to build out a massive core compute data center.
So that you know we're gonna have before next year more than double over a couple of dozen of the core compute data centers, but several dozen more.
These lighter weight distributed locations, where you can do the compute you wouldn't have a huge monolithic storage there, but you don't need that yeah that could be in the core regions and that is a key consideration to some of our larger customers that are working with lienau today doing proofs of concepts or in some cases.
Are you 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'll put akamai in a great position to have equal or better performance than the hyperscale or.
Of course, we have already our edge deployment with 4000 locations, which also supports edge computing on top of that delivery and brought total lower total cost of ownership. So yeah. The lightweight distributor regions are important for a lot of our customers and prospects with among the major enterprises on my note.
Great. Thank you guys very much.
Thank you and our next question today comes from Michael Elias.
Great. Thanks for taking the questions. The first one you mentioned it a bit a bit ago relating to your long term guidance and M&A on the security front, yes, 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.
Yeah that we have a large pipeline and we generally do we're constantly you know looking for appropriate acquisitions.
As Ed said, we're very disciplined buyers, though.
And you know the market as a whole is still highly priced you know I think the realities of what's going on in the global economy haven't saw these sat in yet that may take another year.
And so you.
No.
We're very careful buyers.
You know were being very selective there I think there's a variety of capabilities that would be interesting as tech tuck ins and occasionally we'll make an acquisition with a product adjacency I think Garda core has been a fabulous acquisition. You know there are the market leaders now in segmentation are making akamai as a market leader there and I.
That's the most important defense and enterprise can have you know you can buy every engineer every company zero Trust offer and malware is still getting in to enterprises and the real key is to identify it quickly and proactively block it from sporadic and that's how you limit the damage caused by ransomware.
And data acts filtration attacks and that's what <unk> does and so.
I think you know very important strategic product with enterprise security and zero Trust, but overtime I think there'll be other capabilities that will be interested in in terms of broadening the portfolio.
Got it thanks for that 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 like just given some of your prior comments. My question for you is as you think about executing the long term vision for Akamai.
You believe being a public company has the right setting for you to achieve that long term vision.
Yeah sure I think it's great being a public company.
And yeah and I do think you know the stock is undervalued, where we are today in this market and that's why I get it.
By more shares.
You know, it's and over time the stock has has grown.
You know and I think there's excellent prospects for future growth as we continue to grow akamai.
And I'm really excited about what we can do in the compute landscape you know that's an enormous market.
Just look at Akamai, you know next year, probably security would be our biggest product line. That's a big step forward given that we started as a CDN company and I think if you look you know three to five years down the road well maybe that timeframe compute could be our largest product line. So I think there's lots of opportunity for continued growth.
We're very disciplined when it comes to costs that means theres a lot of opportunity for bottomline growth or an earnings per share.
You know we've continued to buy back our equity to reduce the number of shares outstanding. So I think theres a great value proposition for you know public akamai shareholders.
Perfect. Thank you. Thank you Tom.
Okay.
Thank you and our next question today comes from Tim Horan with Oppenheimer. Please go ahead.
Thanks, guys I hate to harp on it but the sales slow down can you just give us a little more color maybe you want it when you started to see it as a continuing.
Maybe what the lag is in terms of sales and revenue showing up.
I guess I'm trying to get a sense of what next year's revenue growth could be I guess at a high level. You know are we looking at.
Two or three more quarters of flat you know from what we know now or are you at a high level can growth be better next year than this year at this point. Thanks.
Hey, Jim.
I'll take a stab at that so I would say we started to see it.
Really in this quarter and you know continuous sorry, this quarter, meaning Q3 saw a report in Q3.
Here in Q4 or to say how long this economic slowdown last now keep in mind most of our business is under contract we've got.
The impact of the new signings doesn't have an overly material impact.
On the business, especially in any one given quarter, obviously of 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 got stronger throughout the year. So when you think about it from an as reported perspective, that's going to be a pretty big headwind to annualized appointing went back all at the beginning of the year Youre talking a couple of hundred million dollars of revenue or 40 cents 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 as something that I'd be more concerned about.
From a growth perspective, but what will give you an update on guidance next year.
We got we have our Q1 call or excuse me, our Q4 earnings call in Q1 so.
So I'm not going to provide any guidance right now, but hopefully that gives you enough color to think about it you know on FX. Some of your largest competitors, particularly in cloud, but even on the C D and security space people out of bundling kind of charge in dollars.
No pretty regularly and you know some of your other smaller competitors and lienau does raise prices quite a bit here lately.
You've thought about maybe switching over the pricing in dollars or do you do much of that and have you taken a.
Pricing steps to increase prices.
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.
In terms of price increases to that's not something that we.
We're considering at this point.
Obviously, it's kind of a risky thing to do.
When you see companies raised prices a part of.
The reason, we're actively looking to move our cloud spend is the reason that we're seeing the.
Suppliers in that area.
Neither 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 gonna be making any changes in terms of.
Changing customers out from paying in local currency to dollars.
In the U K, you're 20% below your peers in the last nine months of price reduction effectively but on my last question is a little note is your opex and Capex run rate.
Enough to transition load and rolling out.
Yes. So if you think about where the investments are going to be and that's where we're primarily investing our head count is in litho and also in security.
And Tom also mentioned that we'll be moving some of the people that have skills that are transferable do you think about building out scaling up the CDN and there's a lot of transferable skills.
So we'll be able to move some some folks that have talent into the 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 the Capex perspective.
We will be building out the two taken the consideration moving our own workloads as well as the future demand will give you an update on that.
The next call.
Thanks.
And our next question today comes from Amit <unk> with Evercore. Please go ahead.
Yep. Thanks, taking my question I have two as well.
Maybe on the first one if you could just talk about the edge business, Illinois asset and I guess, maybe the question of I struggled with a fair bit as you can you grow this business in the cloud infrastructure side without sacrificing operating margins over the next several years or is that growth in lienau, what on that on that side going to come at lower margins inherent.
Lee.
Yeah. So good question I think we bring some pretty interesting synergy just mentioned on the last question. How we've got a lot of skill sets in house.
That can do say network build outs. For example, we don't have to build out a separate team to do network build outs.
We've got engineering talent in House, we also have a big enterprise Salesforce in place debt.
Tom talked earlier in one of the earlier questions about the spending of some of our larger verticals and the relationships we have with those customers are spending.
Only 10 to 15 times more on cloud computing and they are on <unk>.
And so there's a significant synergy that you got there and then also with our network infrastructure that we have built out.
I'm talking about connecting our backbone to the existing one node centers that that drives a significant.
Cost benefit so I think that actually we could have very attractive operating margins similar to what I showed on the IR day, we can.
Get pretty good operating leverage just like we did with the.
The security business. So you know our long term our goal is to get back to 30% or higher in operating margin and I think as we scale that business, we should be able to do it.
Got it and I guess, maybe just stick to that team around Linda what other sort of use cases that make lenore more attractive a worst of the top three cloud providers that are out there I guess I would just love to understand you know when you folks walking to a customer a pitch what are the reasons. Once you use lienau at worst says sub it appears that might provide a cloud solution.
At least cheaper me that was really helpful. Like what are the two that you think that stands out.
Yeah, Let me answer that question in the context of where we'll be next year because as you know we're doing a lot of the build out now we're doing a lot of the functionality now, but if you look at where we'll be this time next year I think first our our footprint.
We will be better than that of the hyperscale or if it will be closer to a lot more enterprise data centers and users so that means better performance.
I think you know will be hooked in now than to the Akamai platform with 4000 Pos to do delivery do you know the outer layer of security to do edge computing. So that's a big advantage as Ed noted that also lowers our cost substantially for egress.
And so lower total cost of ownership is another I think very attractive you know feature that Akamai would have you know akamai is known for scalability for reliability. In addition, and you know theres been some pretty well publicized issues with some of the Hyperscale is in terms of reliability extended issues.
And I think that's an area, where we can be very competitive you know really the the only area where we.
No we wouldn't be as competitive is in the large number of third party apps and the ecosystem that are available as managed services on the Hyperscale and that's a key way that you get vendor lock in.
And so customers that want to enterprises that want to have that fine. Okay. You know, but if you don't want lock in.
And you do want better performance at a lower cost I think you know akamai will be very competitive and you know also keep in mind just relative scale, you know those hyperscale or sorry, a giant companies. If you know if we can go get you know a one 2% market share in a multi 100 million.
Business that'll be very meaningful for us and you know I think I think we're in a position that we can go do that.
The other issue is that you know in the sectors, where we're very strong like media and Commerce you know those companies they compete heavily with at least some of the hyperscale.
And you know with the cost of the hyper scalar is rising that's becoming more of an issue for those companies.
You're paying a large bill to a company that's buying out the media rights from underneath you and that sort of tough for some of them to take so.
So I think that also gives us a competitive advantage, where we don't compete.
With our customers you know, where we will help them grow with their business and be good partners to them and they can trust us.
Perfect. Thanks, a lot for the clarity.
Thank you and our next question today comes from Mark Murphy with JP Morgan. Please go ahead.
Yeah.
Great. Thanks for taking the question center cooler here on for Mark Murphy.
Digging a bit deeper on the new pricing strategy, particularly around delivery.
Have you noted any incremental changes in customer retention or churn levels. As a result of some of these pricing adjustments.
Typically around some of the inflationary environment pressures driving price sensitivity in the market.
Yeah, Hey, this is Mike no we havent seen anything notable.
If anything we're actually starting like I said to see some but some bit of a moderation in the pricing declines, but we haven't seen anything on the churn side.
Got it. Thank you that's very helpful. And then a quick follow up would you would you say some of the macro pressures that you've called out have intensified in Q3 relative to Q2 or or has it remained fairly in line with some of the pressures that you called out during our last earnings call.
Yeah, I'd say, it's intensified a bit in Q3.
Thank you.
Thank you and our next question today comes from Rooney Messenger with D. A Davidson. Please go ahead.
Great. Thanks for taking my questions guys I don't want to labor the point on security growth, but again, when we exclude guard a core and look at it it at constant currency. It looks like organic has come down about five points from Q1 to Q3 and so if you were to look at it.
Could you maybe breakout with what's been the impact in your assessment from the macro and versus just maybe some of the larger projects maturing and growing slower.
That roughly five point deceleration last couple of quarters.
Yeah, I'd say, it's a tough one to two to really.
Figure out what the impact is on the macro.
I'd say, that's probably you know maybe thats a point or two.
But I think it's really the issue of what Tom talked about where if you look at it.
The biggest product we're the market leader in web App firewall growing faster than the market, but that market isn't growing as fast as some of the other markets that we're in it's just not at scale, yet so I'd say that that's the bigger and bigger issue is that those newer products are growing faster.
At the scale that we're at just isn't.
Is it isn't offsetting the slower growth and that's been the biggest problems.
Okay and then on the note I don't know if he gave it could could you share how much revenue did in the quarter and then last quarter you know given the commentary today about the increase in costs at the Hyperscale or last quarter, you talked about moving.
Your hyperscale or spend over to Linda internally have you started that process, yet and if not when do you plan to do so.
Yeah, I'll take the first one.
Go ahead.
Okay.
Simple so well noted added about 33 million this quarter from what you are talking about the the movement. Yeah. So that's a well at the migration of our cloud spend to Lenovo as well on your way.
We've already done some the lion's share of that work.
Gration will take place you know I would say over a Q1 to Q3 next year.
And by the end of next year, we ought to have the vast vast majority migrated.
Yeah.
Yeah.
Thank you.
Ladies and gentlemen, our next question today comes from Tom Blakey, What's your Securities. Please go ahead.
Hey, guys. Thanks for the question I think it's been touched on a couple of times by my peers here.
Just wanted to go back to that.
You've made great strides in terms of lowering the capex from a delivery perspective down to there's kind of 3% to 4% range.
But if things kind of normalize Tommy when you look out.
60, plus maybe two thirds of revenue coming from compute security Capex.
As nil you just riding the rails of what already exists what what does the capex.
You know kind of bridge or horse.
Normalized structure of this company look like.
A few years from now.
Yeah, So I'll take a stab at that time, if you want to add anything feel.
Feel free to jump in.
Obviously with the what we're talking about here, where Lenovo was primarily focused on small medium business and we're moving towards the enterprise workloads, you're talking about much larger workloads, even with our own spend and what we're moving Tom talked about on the last call. We had that were spending roughly $100 million that's growing.
Pretty pretty fast.
That's a much bigger scale than what we know who's doing so looking at capex as a percentage of existing load business isn't the right metric to look at at this point to think of it as we're in the build phase. So you can see capex is starting to creep up a bit as we.
We're building out as we see better visibility into demand and also as we start to build out our plans to migrate the workloads that we do have on the hyperscale is onto us so you're going to see it a bit of a disjoint. So if you're looking at that as a metric.
It doesn't send the right signal I'd say look at that as more of a bullish signal in terms of how we feel about our customer pending customer demand and also how we think will be very successful in being able to migrate those workloads. So for the next several quarters youre going to see more capex going until the note and then the revenue and the <unk>.
Cost savings will follow.
Alright.
Because it really depends on the growth right. So as you're as you're growing revenue at.
At significant rates and so youre doubling revenue you're going to obviously have a higher percentage of capex, but that at some point it will normalize out to approximate what the future revenue growth would be and so let's say for example, we get to 20% growth as a run rate in the long term capex will probably be somewhere in that range.
I'm, sorry, I didn't understand that last comment its 20% growth.
It would be the Capex right.
No no no no no no I was using that as an example, and I'm, saying as well.
We will give you detailed guidance on what we're going to do next year, but we're in a building phase now where Tom talked about getting into many new centers. We're building out for our own demand and also what we're hearing from our customers. So what I was saying is if youre looking at Capex as a percentage of what node. It is not the right way to be thinking about it because we're going after a much different.
That's right, we're going after big enterprise workloads. So there's a build phase we have to build out ahead of the demand.
And then you'll start to see the revenue come our way and as you get to scale like many years out when you get to scale you can start thinking about as a proxy that roughly speaking to your capex will approximate what your future demand. So if you say you have a long term run rate of 20, or 30% and capex will be somewhere in that range.
But in the near term will be higher than that.
Well, that's exactly what I was asking I clear.
Clear 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.
Okay.
When you're at scale for Lenovo will it be structurally lower or higher than delivery.
You know it.
We'll know when we get there probably will.
It would be certainly higher than what we're seeing in delivery now.
But it is a more capital intensive business by nature.
It's more capital intensive business with compute okay.
Thank you very much.
And our next question today comes from World Power of Baird. Please go ahead.
Hey, guys. This is Charlie Ehrlich on for will thanks for getting me in here.
I just wanted to ask a two parter on the comment that you guys are going to basically take some resources from delivery and put them into security and compute head count wise and hiring wise.
So the first part is how are you.
You feel about competition for talent in the security business and the compute business, maybe relative to a few months ago kind of what is that hiring environment look like in those two businesses and then part two on the delivery side.
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.
I'll take the first question you know, it's still a competitive market for hiring.
You know we've been very pleased to see our attrition rates take a major drop over the last quarter. You know we had stayed at a low attrition rates through COVID-19, well better than market ticked up a little bit on the first half of the year, but now again down to over the last three months very low attrition.
We have very successful recruiting akamai is considered to be a great place to work as measured by the various studies that are done and also employee satisfaction.
Our surveys that we do.
So people really like working at Akamai, we have really great employees very smart, we set a high bar for who we recruit.
And of course, everybody wants to hire those people in.
Pretty much everybody wants to hire akamai employees.
But our retention rates are good I would say our success in hiring is good but it's a competitive market out there and Ed you want to talk about the delivery business.
Yeah sure. So what do you think about the delivery business I'll call off four factors in terms of thinking about it as you as you called it a turnaround.
Obviously, one is renewals so we went through a very heavy.
As of renewals and so we're not going to have that.
Next year, we'll always have some renewals, but it's very unusual to see.
Eight of your top 10 customers renewing at the same time, our number two is pricing. So we as we talked about several times on the call.
Moderating the discounts that we provide on pricing.
And then the third thing is traffic cause traffics were starting to see some encouraging signs, albeit early that the internet has been growing at 30% a year for many many years this year as 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 Hyperscale is get to a certain size that they even though they offer their own CDN 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 <unk>.
Roxy of being on the compute business.
Great. That's very helpful. Thanks, guys.
Operator, we have time for one more please.
Thank you and our final question today comes from Alex Henderson with Needham and company. Please go ahead.
Oh geez sliding in before the final a 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 the numbers for the contribution from the acquisition of guard, a core I'm kidding and as reported growth rate of around 9% and I'm wondering.
Given your commentary about a more difficult conditions and a little larger currency translation year over year in the fourth quarter, whether in fact, you are expecting the security business to slow to that level in your guidance.
Yeah, Hey, Alex is that here I'll give that one a try.
Honestly, we don't break out specific guidance for individual products like that in the quarter, but.
Right now the FX impact because you quoted the as reported numbers about 6%.
Or as reported was a 13 constant currency was 19. So if you assume that youre getting to about if you're using nine you get to about 15% since we're lapping in constant currency that is since you're lapping.
The guard a core acquisition at this point and we just came off of 15%.
Organic growth rate.
If you back out the contribution from <unk> in Q3, that's probably a reasonable number if you're solving for what we gave you in terms of 20% constant currency somewhat somewhere in that 14% to 16% constant currency, obviously, I can't predict where FX is going to be but if you just to kind of keep it.
It was this quarter that's up.
Youre doing a roughly the right math.
So so a similar kind of question if I take the node comments are it looks like that actually accelerated from about a 15% baseline growth rate to.
So around 20, making the adjustment to the windowed acquisition on an as reported basis, that's actually pretty good considering the currency can you talk a little bit about the the geographic split between them you know in the load business, how much currency would have impacted that side of it and then again.
You know as we look into.
The baseline growth rate. So it does seem like it's accelerating can you talk a little bit about you know whether that's a function of.
You know the the investments, you're making in marketing and like or whether that's something that's sustainable.
In the guide.
Sure So I'll start with the currency with Lenovo.
Uh huh.
Not really.
We acquired Lienau.
Most if not all of their revenue was in U S. Dollar. So they were not billing in local currency, so theres not as much.
Currency headwinds associated with the one node portion of the business, obviously with the normal node.
Compute business, we have the normal dynamics in our business.
On the.
Investments in terms of marketing et cetera.
<unk>.
I think we can.
Maintain the current levels and not I'm not expecting a significant increase in marketing spend next year, we are increasing it a bit but nothing.
Significant from a sales perspective, we are adding some.
Sales folks some specialists.
Especially on the technical side to help our sales force, but it's not going to be a significant investment there.
Believe our sales force can be trained and we're also changing our comp plans to have added incentive for compute so all.
All of that I think can fit into sort of a normal run rate.
The expense level that we've been sort of operate again I don't see any major investments in that part of the business.
If I could slide in one last one centralized guy here.
As the mix shifts here sure.
How do you expect the mix shift between the segments to start impacting the overall margins.
Yeah. So obviously if you go back to the IR day slides.
Western earlier about the leverage that we get on the compute business.
That is the faster growing parts of the business security and compute become a bigger part of the business.
Get some operating leverage it won't happen right away, but over time, then obviously there is a dynamic that we talked about with some.
Accelerated capex ahead of revenue.
So that's another thing to keep in mind the other.
The thing you notice I talked a bit about having a bit of a pressure on the gross margin line. That's also I would say is more of a temporary thing will be.
Reducing the.
Gross margin line as we move our third party costs over but also with some of the buildout cost, including some of our co location agreements network build costs.
Little bit that's frontloaded, so as revenue scales, we should start to see some scale on the gross margin line as well so as Tom talked about security should be our biggest product lines to higher gross margins higher operating margin. So we should start to see that flow through as the mix changes to those two product lines over time.
Well. Thank you there was a benefit to being last getting three in there. Thanks.
Yes, no problem, Alex Thank you and thank you everyone in closing, we'll be presenting at a number of investor conferences, and presenting that events roadshows and other things throughout the rest of the fourth quarter details of these can be found in the Investor Relations section of Akamai Dot 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.
Thank you Sir.
Today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.