阿卡邁科技 (AKAM) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Third Quarter 2020 Akamai Technologies, Inc.

Earnings Conference Call.

(Operator Instructions) Please be advised today's conference call is being recorded.

(Operator Instructions)

I would now like to hand the conference over to your speaker today, Tom Barth.

Please go ahead.

Thank you, operator.

Good afternoon, everyone, and thank you for joining Akamai's Third Quarter 2020 Earnings Conference Call.

Speaking today will be Tom Leighton, Akamai's Chief Executive Officer; and Ed McGowan, Akamai's Chief Financial Officer.

Before we get started, 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 uncertainty stemming from COVID-19 pandemic and any impact from unexpected geopolitical developments.

Additional information concerning these factors is contained in Akamai's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q.

The forward-looking statements included in this call represent the company's view on October 27, 2020.

Akamai disclaims any obligation to update these statements to reflect future events or circumstances.

As a reminder, we will be referring to some non-GAAP financial metrics during today's call.

A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the Investor Relations section of akamai.com.

And with that, let me turn the call over to Tom.

Thanks, Tom, and thank you all for joining us today.

I'm pleased to report that Akamai achieved excellent results in the third quarter.

Revenue was $793 million, up 12% year-over-year and up 11% in constant currency.

Non-GAAP operating margin was 32%, up 3 points from Q3 of last year.

Non-GAAP EPS was $1.31 per diluted share, up 19% year-over-year and up 18% in constant currency.

These very strong results were driven primarily by the continued strong performance of our security products and high traffic levels on our edge platform.

We're very proud of how Akamai has continued to deliver fast, intelligent and secure online experiences for billions of users around the world as we support our customers during these challenging times.

We're also very pleased that our hard work to improve operating efficiency and profitability has put us in an excellent position to exceed our goal of 30% operating margins for the year.

Our Media and Carrier business continued to perform very well in Q3, benefiting from high traffic levels for video streaming and gaming software downloads.

In fact, one giant video-on-demand service increased their traffic on our platform by a factor of 4 last quarter.

As more entertainment moves online, Akamai has continued to prove that our unique edge platform scales to meet the unprecedented demand for streaming video, popular gaming releases and complex API transactions.

We can do this in part because we've positioned more than 325,000 servers in more than 4,000 locations in over 1,000 cities.

At Akamai, we position content very close to end users, and we make sure it's available when and where it's needed.

In addition, our highly advanced Internet mapping algorithms route traffic around congestion to maintain excellent application performance for our customers.

Our unique edge platform also allows our customers to perform a wide variety of computational tasks close to end users, resulting in faster performance, instant scalability and lower cost.

For example, a leading social networking company uses Akamai's edge platform to manage API requests for their recommendation engine.

A leading apparel company uses our platform to supply health information to users based on their fitness tracker.

Several major companies use Akamai to provide critical weather updates based on local conditions as well as geographic information such as nearby points of interest or locations of desired services.

Many of the world's largest OTT companies use Akamai to help manage the critical components of their architecture on the edge, including functionality for user authentication, content recommendations and payment processing.

Some of the world's largest credit card companies use our platform to assist with authentication and authorization of payments via digital gateways.

Several of the world's largest gaming companies use Akamai's edge to assist in managing user profiles and registration as well as event leaderboards.

And the ad tech ecosystem uses applications running on the Akamai edge to assist with ad calls, bidding and placing consent cookies to remain compliant with data privacy regulations.

It's important to note that while some CDMs are talking about edge computing or serverless computing as if they're somehow new technologies, Akamai has been providing these services to thousands of customers for well over a decade.

And already this year, we've handled well over 100 trillion API requests on our edge platform.

The vast capacity of our platform, combined with our unparalleled security intelligence and machine learning algorithms, has also enabled Akamai to defend many of the world's most important enterprises against the largest and most sophisticated cyberattacks.

This capability is proved to be especially important during the recent wave of ransom DDoS attacks.

Since August, we've been approached by dozens of major businesses around the world that had received extortion letters, threatening them with massive DDoS attacks if they didn't pay a ransom.

In response, our security experts performed emergency integrations of our Prolexic service, which enabled these enterprises to continue or resume business operations without experiencing any service disruptions from the attacks.

As a result, we've added many new enterprises to our Prolexic customer base, including several global banks and insurance companies, a leading travel website and 2 national stock exchanges.

In addition to Prolexic, we also continued to see strong growth from our market-leading Kona Site Defender and Bot Manager services.

Bot Manager has been especially valuable in stopping account takeover attacks, which have greatly increased in scale and sophistication.

In fact, the number of malicious log-in attempts by bots that we blocked in Q3 was more than double the number we handled in Q2.

I'm also pleased to report that our recently launched Page Integrity Manager Solution, which is designed to identify and thwart Magecart attacks and malware and third-party scripts is off to an excellent start with strong customer interest and bookings.

In another sign of our leadership in cybersecurity, Forrester recently named Akamai as a leader in Zero Trust, with the highest possible scores for network security, workload security, APIs, Zero Trust advocacy and market approach.

And just last week, Gartner recognized Akamai as a leader in its 2020 Magic Quadrant for web application firewalls for the fourth year in a row.

Overall, Q3 revenue from our Cloud Security Solutions was $266 million, up 23% year-over-year in constant currency and accounting for 34% of Akamai's total revenue.

To further build on our growth in security, we were pleased to announce today that Akamai has acquired Asavie, a leader in securing mobile access for enterprises.

Asavie partners with some of the world's largest mobile network operators to enable enterprises to connect, manage and secure communication among cellphones and other IoT devices, without the need for client software on the device.

These capabilities are critical for organizations with mobile workforces or large numbers of connected devices.

By integrating Asavie solution with Akamai's unique edge platform and arming it with Akamai's vast array of real-time security data, we plan to enable enterprises to greatly improve the security of their operations while also improving the performance of their internal applications.

Asavie will complement our security product lines with a cellular-specific security offering, which is an important step in our strategy to capture the emerging opportunity in 5G.

It is also synergistic with our Enterprise Application Access product and complements our IoT edge cloud solution, allowing enterprises to improve the reliability and consistency of real-time communications with IoT devices and to easily secure those endpoints to avoid compromise.

As we look to the future, we believe that the deployment of 5G and IoT applications can provide significant opportunities for Akamai.

5G technology improves the performance of the last mile, providing higher throughput and lower latency and the potential to connect a lot more people and things.

And that could spawn the creation of new applications, such as ultra-low latency video, augmented reality, IoT applications and analytics at a massive scale, deep threat intelligence for attack mitigation and much more that we can't even imagine yet.

The impact of 5G on innovation could be similar to the way broadband enabled new social networking apps that few could have imagined before.

As 5G networks come online, we believe that end users and connected devices will demand faster performance and greater scale than cloud data centers can provide, and thus that our edge architecture will become more important than ever.

In fact, Gartner estimates that by 2022, more than half of enterprise-generated data will be created and processed outside of traditional cloud data centers.

The breadth of our edge platform means that we're incredibly close to billions of end users, and being so close means that Akamai is in a unique position to provide the near-instant response times, very high-quality video experiences, serverless computing capabilities and the market-leading security services that our customers are demanding.

In summary, we're very pleased with our performance so far this year.

We believe that our strong growth, profitability and cash generation provides us with the financial firepower to continue investing in the innovation, network capacity, novel products and world-class talent needed to fuel our future growth.

Now I'll turn the call over to Ed for more on Q3 and our outlook for the fourth quarter.

Ed?

Thank you, Tom.

As Tom outlined, Akamai delivered another excellent quarter in Q3.

We were very pleased to exceed the high end of our guidance range on revenue, operating margin and earnings.

Q3 revenue was $793 million, up 12% year-over-year or 11% in constant currency, driven by another quarter of robust security growth, continued strong performance from our Media and Carrier Division and a weaker U.S. dollar.

Revenue from our Web Division was $418 million, up 8% year-over-year or 7% in constant currency.

Revenue growth for this group of customers was again led by our security business, and to a lesser extent, we also benefited from lower-than-expected COVID-related credits to customers.

Revenue from our Media and Carrier Division was $375 million, up 16% year-over-year.

The overachievement in Q3 came from higher-than-expected OTT video and gaming traffic, along with continued momentum in security.

We were pleased to see traffic remain at elevated levels, which helped offset the approximately $15 million negative impact from India's ban of 59 Chinese apps that we discussed on our last quarter's call.

Revenue from the Internet platform customers was $51 million, up 15% from the prior year and above our expectations due to higher traffic.

Security revenue for the third quarter was $266 million, up 23% year-over-year, driven by continued global demand for our web and enterprise security solutions.

And as Tom mentioned earlier, we also saw strong demand for DDoS protection from our Prolexic product in Q3.

Foreign exchange fluctuations had a positive impact on revenue of $10 million on a sequential basis and positive $4 million on a year-over-year basis.

International revenue was $355 million, up 20% year-over-year or 18% in constant currency.

We had strong performance internationally despite the sequential headwinds in India that I previously mentioned.

Sales in our international markets represent 45% of total revenue in Q3, up 3 points from Q3 2019 and up 1 point from Q2 levels.

Finally, revenue from our U.S. market was $437 million, up 6% year-over-year.

Now moving to costs.

Cash gross margin was 76%, in line with our expectations.

GAAP gross margin, which includes both depreciation and stock-based compensation, was 64%.

Non-GAAP cash operating expenses were $252 million, roughly flat with Q2 levels and in line with our guidance.

Now moving on to profitability.

Adjusted EBITDA was $351 million, up $51 million or 17% from the same period in 2019.

Our adjusted EBITDA margin was 44%, up 2 points from Q3 2019.

Non-GAAP operating income was $251 million, up $43 million or 20% from the same period last year.

Non-GAAP operating margin came in at 32%, up 3 points from Q3 last year.

Capital expenditures in Q3, excluding equity compensation and capitalized interest expense, were $200 million, in line with our guidance range.

GAAP net income for the third quarter was $159 million or $0.95 of earnings per diluted share.

Non-GAAP net income was $216 million or $1.31 of earnings per diluted share, up 19% year-over-year, up 18% in constant currency and $0.07 above the high end of our guidance range due to higher-than-expected revenue.

Taxes included in our non-GAAP earnings were $37 million based on a Q3 effective tax rate of approximately 15%.

Now I will discuss some balance sheet items.

We continue to have a very strong balance sheet.

As of September 30, our cash, cash equivalents and marketable securities totaled approximately $2.6 billion, up approximately $163 million from the end of Q2.

After accounting for the $2.3 billion of combined principal amounts of our 2 convertible notes, net cash was approximately $254 million as of September 30.

This increase was driven by a number of factors that include an exceptionally strong cash collections quarter.

Now I will review use of -- our use of capital.

During the third quarter, we spent $13 million to repurchase shares, buying back approximately 120,000 shares.

We ended Q3 with approximately $644 million remaining on our previously announced share repurchase authorization.

Our long-term plan remains to leverage our share buyback program to offset dilution resulting from equity compensation over time.

In summary, we are very pleased with our Q3 results.

Before I provide guidance, I wanted to take a moment to remind everyone of several factors that will impact Q4.

First, 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 for our e-commerce customers, which are both difficult to predict, especially in the current economic environment.

Also, as Tom mentioned earlier, today we announced the acquisition of Asavie.

In the fourth quarter, we expect the acquisition to add approximately $4 million of revenue and to be dilutive by approximately $0.01 of non-GAAP EPS.

It is also worth noting, as I mentioned earlier, that our Q3 revenue was negatively impacted by approximately $15 million due to the actions taken by the Indian government to ban 59 Chinese-based web applications in India.

Our Q4 guidance assumes the ban in India remains in place for the balance of 2020.

In addition, the U.S. government has taken a similar stance with respect to some of these applications.

And absent court action or a change in policy, those bands are scheduled to take effect in mid-November.

As a result, our Q4 guidance assumes an additional $4 million to $5 million negative impact to revenue sequentially based on the U.S. ban going into effect in mid-November.

In the unanticipated events, these 59 applications were subject to a total global ban, the total additional negative impact to our revenue would only be approximately 3%.

To be clear, this represents an extreme assumption that we do not currently expect to occur, and we are not modeling in our current outlook.

However, I wanted to provide you with additional color for added transparency and to make the point that our customer base remains well diversified across many customers, industries, products and geographies.

Finally, at current spot rates, foreign exchange fluctuations are expected to have a positive $2 million impact on Q4 revenue compared to Q3 revenue -- Q3 levels and a positive $6 million impact year-over-year.

Taking all of these factors into consideration, we are projecting Q4 revenue in the range of $812 million to $837 million or up 4% to 8% in constant currency over Q4 2019.

To frame our guidance further, we'd expect to be towards the lower end of the range if we see a more modest quarter for OTT and gaming traffic; if e-commerce activity is weaker than expected; the impact of the COVID pandemic leads to an inability of our customers to pay for our services; and the U.S. dollar strengthens and creates foreign exchange headwinds.

Conversely, we would expect to be at the higher end of the range if we see -- if we experience a more robust than normal online holiday shopping season, and we see stronger-than-expected demand for OTT video and gaming traffic, including potential upside from 2 highly publicized new game console releases expected later this quarter.

At these revenue levels, we expect cash gross margin of approximately 76%.

Q4 non-GAAP operating expenses are projected to be $268 million to $279 million, with the sequential increase primarily due to higher commissions-related expenses from sales compensation accelerators kicking in during the fourth quarter, given our very strong performance this year relative to our plan.

Factoring in the gross margin and operating expense expectations I just provided, we anticipate Q4 EBITDA margins of approximately 43%.

Moving now to depreciation.

We expect non-GAAP depreciation expense to be between $106 million to $108 million, reflecting our accelerated server deployment in Q3.

Factoring in this guidance, we expect non-GAAP operating margin of approximately 30% for Q4.

Moving on to CapEx.

We expect to spend approximately $193 million to $199 million, excluding equity compensation in the fourth quarter.

And with the overall revenue and spend configuration I just outlined, we expect Q4 non-GAAP EPS in the range of $1.28 to $1.32 or up 2% to 5% in constant currency.

This EPS guidance assumes taxes of $36 million to $37 million based on an estimated quarterly non-GAAP tax rate of approximately 15%, and it also reflects a fully diluted share count of approximately 165 million shares.

In light of the Q4 guidance I've provided and our strong performance through the third quarter, for the full year 2020 we now expect revenue of $3.164 billion to $3.189 billion, which is up 10% year-over-year in constant currency.

We expect non-GAAP operating margins of approximately 31%, and we expect non-GAAP earnings per diluted share of $5.16 to $5.20, which is up 15% to 16% year-over-year.

In summary, we are very pleased with how our business has continued to perform during a very challenging time.

Thank you.

Tom and I would be happy to take your questions.

Operator?

(Operator Instructions) Our first question comes from the line of Tim Horan with Oppenheimer.

Good quarter.

Can you talk about edge a little bit more?

Maybe how do your service offerings compare to your peers?

And what do you think your win rate is on pitches for edge?

Well, edge refers to our platform, which really is unique in the sense that we're in 4,000 locations.

We're in 1,000 cities.

We are uniquely close to the end users out there, the billions of end users around the world.

Other companies talk about edge and they might be in a couple of dozen locations, a factor of 100 less.

And because we're close, that's really important because we're going to give better performance.

If you're closer, the latency is less and it's going to be faster.

Also, if you're close, you've got access to the bandwidth and the scale.

And that's why we have so much more scale than the other CDNs.

And that's really important to customers that have a lot of traffic, the big OTT providers and the big software downloaders, and that's why so much of their business comes to Akamai.

Also being in those locations gives us a huge advantage on cost because in the large fraction of those 4,000 locations, we don't pay for bandwidth in colo and power.

And so it's free for us with the infrastructure.

We pay for our CapEx.

But our competitors aren't there.

Our competitors are in big data centers, and that is the most expensive real estate in the world.

And so we're in a position that we can provide compelling pricing to the major enterprises out there.

And our competitors, if they're going to do that, they have to do it losing money, and that's not sustainable.

Now any one of the many competitors we have out there, all, generally speaking, much, much smaller, at any given time, they could take on some traffic and show some high percentage growth on very small numbers.

But it's hard to sustain that when you don't really have a sustainable advantage.

And then you see that happen as the traffic -- some of the traffic share moves around among the smaller players.

Now in addition, it's not just about CDN and delivering traffic, it's accelerating the traffic.

It's providing functionality on the edge close to the end user.

And I talked about a lot of examples that where we're doing that today.

And of course, processing a lot of the API transactions, which are tied to functionality, over 100 trillion so far this year.

And then you have the security aspect, which our CDN competitors, by and large, don't have.

They may partner with other companies or start-ups to have some security story, but that's now $1 billion business for Akamai and growing at over 20%.

And security is just really vital for our customers and it works in tandem with the application acceleration, with the edge computing, all is one service, all on one platform.

And if you're not on the edge, there's no hope to withstand the large attacks that we're seeing today.

And our next question comes from the line of Colby Synesael with Cowen.

Just going back to security.

I'm just curious, would the security results thus far this year have been much different had COVID-19 not had happened?

I'm just curious how you would quantify the impact that COVID-19 has had on the security business, whether good or bad?

And then secondly, the long-term operating margin of 30%, I think you've messaged that, that should remain flat as we go into the outer years after now hitting your target.

But can you just remind us why that is and why we won't continue to see increased operating margin leverage?

Sure.

I think we'd see strong security growth with or without COVID.

There are some of our products that are really helpful for enterprises as they have more of a remote workforce, and so we did see uptick in bookings there.

So I think there's some help.

The attack rates have gone way up, and I do think some of that is -- has tied to COVID.

Now whether we see the ransom DDoS attacks that are widespread just in the last couple of months, we might have seen that anyway.

Maybe there's an increase because the prize is bigger now.

If you're attacking a commerce company that had 90% of their business in brick-and-mortar, well, they care about the 10% for sure, but when all of their business is online, now they really, really care.

So there is a bigger prize, and maybe that's incented the attackers to up the attack level or maybe that's just the world we're living in, where we're going to be seeing more and more attacks, even if we get COVID under control.

And I can tell you, we see a lot of attacks in Asia-Pacific just like we do here and in Europe, even though in APJ, COVID is largely under control there and operations are largely returned to normal.

And yet the attacks, the ransom DDoS attacks are just as -- increasing just as fast over there.

In fact, one of the national stock exchanges that was taken offline that is now an Akamai customer was in Asia Pacific.

In terms of the 30%, we do think that's a good place to operate the company over the longer term.

And we're -- that said, we're going to do everything we can to operate as efficiently as possible and you see that this year.

We -- this year, we've been doing over 30%.

And so if we can do that and continue to make the investments we want to make to achieve long-term growth in the business, then we will.

But I think the right way to think about it is 30% is a good baseline and when we can overachieve that, we're going to do that.

And I guess just one quick follow-up to the security question.

I mean given what sounds like some upside, arguably, do you think that you're in a position to sustain that 20% plus growth rate over the next few years?

Certainly, we'd like to do that.

We're seeing very strong growth in Kona Site Defender and Prolexic.

Kona Site Defender is our web app firewall product.

Bot Manager doing very well, and the next generation of that will be even stronger at preventing account takeover.

Security services business, we've talked about, is doing very well.

And I think with the increase in attacks and the sophistication of attacks, we're seeing even more demand for our security services.

It's just too hard for even major enterprises to keep up.

And then you have the newer solutions, our enterprise services, Enterprise Application Access, Enterprise Threat Protector now equipped with the first version of our Secure Web Gateway.

We're going into beta with our multifactor authentication service next month.

As we talked about, our Page Integrity Manager, which sits on top of Kona, off to a great start.

We'd like to see that track the way that Bot Manager did getting out of the gate.

And of course, we announced today, and I'm really excited about the Asavie acquisition.

I think that opens up a whole new category for us that we'll see accelerated growth as we get more 5G deployments as you see more IoT applications out there.

And what that does is it sends all the cellular traffic safely and directly to Akamai before it gets on to the Internet.

And in that way, we can really protect enterprises in their cellular devices.

And I think that's a market that is very exciting for the future.

And our next question comes from the line of Sterling Auty with JPMorgan.

So wondering, you made the comment that one of the big video providers, you saw 4x increase in traffic.

That would seem to be more than just COVID-related.

I'm just wondering what else you saw in that particular account?

And is that something is happening in other accounts as well?

Yes.

As we talked about and we're continuing to gain share, if you exclude the 59 Chinese apps where obviously government regulation has lessened the traffic we're delivering there.

And that's based on our scale and performance and ability to offer market competitive prices for our customers.

And so I think you've seen that trend.

Over the last couple of years, we've talked about it.

We put a lot of effort into continuing to improve performance, continuing to improve our scale and on a global basis.

And that puts us in a great position against the competition in the market.

And you're right, the 4x is obviously not due to COVID.

COVID did improve traffic, there's no question about that, but nothing like 4x.

That's great.

And then one follow-up.

You touched upon it in your prepared remarks and your guidance, which is e-commerce heading into the holiday season.

It's been a little while since you've updated us.

Can you give us a sense of where do you sit in terms of your customer base within like that e-tailing 100 or that 100 largest e-commerce sites and vendors that are out there?

Very, very strong.

Well north of 90% of the top commerce companies rely on Akamai for application acceleration and also importantly -- and increasingly, importantly, security.

And as I mentioned before now that these companies, a lot of them, most all of their business is online.

And so security really, really matters now, and we're obviously the go-to supplier there.

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

Tom, you sound really excited here on these new security solutions again.

I guess, how are you thinking about the web security gateway market?

And do you need more investment in an enterprise security sales team to get this product more penetrated and beyond just the CDN installed base?

Yes.

In fact, a lot of our customers for the enterprise products are new to Akamai and hadn't bought our pre-existing product line.

And that's because our web products, delivery and web app firewall were primarily to a subset of the Fortune 500, maybe 1/3 of the verticals to half of the verticals.

But enterprise security is something that pretty much all the Fortune 500 would need.

And so that has increased our market, and we have put effort into our specialist teams that help the sales force.

I would say that all of our sales force now is very adept at selling the traditional Akamai security products.

And most of them are actually pretty good now at the newer products with enterprise security, Page Integrity Manager.

Swig is just new out there, so very early on.

But I think we're in good shape there.

And as of the, of course, that's sold by carriers as is our SPS solution.

And so we would sell to the world's or Asavie -- now Akamai sell to the world's major carriers and provide a solution that they then take to enterprises.

And I think that's a model that we're very excited about.

And increasingly, you'll see with our enterprise security products will be led by channel partners and carriers being the majority of that.

Got it.

Just as my follow-up, we're starting to see a new wave of applications, get the size again, like we did last decade with Netflix and YouTube being 2 examples.

I guess, what are you guys hearing from customers regarding their own potential CDN build-outs for some of the applications that they have?

One of your customers, for example, hit their 5-year goal within 1 year.

Wait, so are you asking about what are we seeing in terms of DIY or what are we seeing in terms of big OTT players in their market penetration and success?

Both.

I'll take both.

Okay.

Well, yes, OTT is certainly increasing, and a lot of the offers are seeing substantial success.

Obviously, some are doing better than others.

But I do think OTT is here to stay.

Obviously, got tailwinds from the pandemic.

But I think people are -- as they view more online, that becomes more the pattern and that will outlive the pandemic.

Of course, I think we'd all like to get back to a world when you can go out and see a movie, probably not it's going to be anytime soon here in the Americas or in EMEA.

And I think more and more of the movie watching and TV shows will be watched online.

DIY is something that you know that we exist in a few of the largest content providers.

And I don't think we've seen a huge shift there.

You can sort of track that with our -- the cloud giant customers, which has been fairly steady over the last year or so.

It's really hard to build-out something like that for yourself.

It costs hundreds and hundreds of millions of dollars, if not more.

You end up spending more than you would with Akamai, and you don't get the quality you get with Akamai.

And not only that.

If you're a global company, you got to do it all around the world.

That's just -- it doesn't make sense.

Now some of the biggest companies do it, and I think you'll continue to see that.

But there's not been a real fundamental shift there.

And our next question comes from the line of Brad Zelnick with Credit Suisse.

This is Ray McDonough on for Brad.

First, Tom, if I could, I wanted to ask about gaming.

And as you mentioned, we're approaching a new console cycle with both Sony and Microsoft coming out with new consoles.

And from what I understand, they've made some changes to how games will be downloaded.

With the caveats that downloads and gaming files are becoming larger and more ubiquitous, how should investors think about the contribution of gaming?

How much does it represent today?

And how big of a growth driver do you think it can be into next year?

I'm going to hand that one over to Ed.

Yes.

So obviously, gaming has been a business that's changed for us quite a bit over the last couple of years.

You see the multiplayer gaming has changed the dynamics.

And if you think about the consoles that are coming online, obviously, 2 major players, it's been, say, 4, 5 years since we've had a major upgrade cycle.

So I would say you can kind of throw history out.

This is sort of a new chapter.

I think it could be a good source of upside for us.

In terms of its contribution, we don't break it out specifically, but I would say it's probably the second largest contributor in our media business next to video.

So as I talked about in the guidance section that this could be a source of upside.

And it's hard to tell.

We'll know when we get there, but this could last into the early part of next year as some of the publishers come up with new games and the consumers are buying the new consoles, they have to update the system with firmware and then catchup with all the old games that they had.

So I think this is a pretty good trend for us.

It's hard to predict whenever you have something that's large.

And as you rightly pointed out, the game downloads, the frequency and the size are only increasing.

Yes.

That makes a ton of sense.

I appreciate that color.

And if I could, just a quick follow-up.

Coming out of the first half of the year, there seems to be some supply constraints industry-wide.

Understanding that every region is a bit different, how is capacity industry-wide trending?

And how should investors think about your capital expenditure plans into next year?

Yes.

Great question.

So obviously, this year was a pretty big year for CapEx.

And we've really been on the journey here for the last, call it, 18 months, where we've increased the capacity of the network.

And I'm glad we did.

I think Tom and the team made a great decision to do this.

Obviously, we couldn't have predicted the pandemic, but we had a lot of new OTT launches coming.

And as we talked about just a few minutes ago on gaming, that's becoming more and more challenging because customers want to get their games at the same time.

And that requires a lot more capacity.

And so we spent quite a bit on CapEx.

We actually took advantage of some bulk purchases here at the end of the year.

We've added a tremendous amount to our capacity.

So I would expect next year to be back in sort of the normal level of CapEx and down several points from what we're seeing today.

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

Okay.

Great.

I'll ask, I guess, a couple here.

Maybe first, I'd love to get some perspective on what you're seeing in international arena.

And I guess, really despite the challenges you were facing in India, continue to see strong growth.

So maybe just if you can just touch on what the sources of the strength were kind of outside of India?

Yes.

Sure.

So yes, you're right to point out.

It's actually not India that was impacted.

It was actually China because the customers that were impacted were 59 Chinese apps.

We serve about 30 of them.

Those were actually customers in China.

So China revenue, obviously, was a bit more challenged this quarter.

Actually -- India was actually one of the areas of strength.

What I was encouraged by is I saw many different countries in all different geographies.

So Latin America, Brazil and Mexico, over in Europe, we saw strength in the U.K., Germany, in the Netherlands.

And then over in Asia, we saw strength in Australia, Indonesia and continued strength in Japan.

So it's really across the board.

We're very pleased with international growth.

And if you think about coming into a quarter where you're losing $15 million of revenue from your international customer base and to be able to still grow sequentially and grow 20% year-over-year, it's very impressive.

And as I've talked about in other calls, I think we have a unique advantage in the industry.

From an international perspective, we made the investments early on in sales and building out our network and our capabilities that I think it's a huge advantage for us, and we've done remarkably well not only in just delivering media but also in security.

Is that international strength concentrated in any particular products or solutions or is it more broad-based?

I'd say it's more broad-based.

Certainly, the early days, it was all about media delivery and application acceleration.

The U.S. market was the first to adopt the security solutions, but now security is becoming a really nice growth engine for us internationally.

Okay.

And then kind of my second core question, just around M&A, notwithstanding the acquisition announced this morning.

Maybe you can just update us on appetite for M&A as we exit this year and into 2021.

Maybe any color around areas of focus and potential size, kind of what you're seeing out there in the market?

Yes.

We continue to be very active in looking at potential deals.

Obviously, it's a little trickier with the pandemic because travel is restricted, but that's not preventing us from doing transactions, as you saw from today's announcement.

I would say, so far, the pandemic really hasn't impacted market caps very much.

That may happen at some point depending on what happens with the global economy.

So I would say it's business as usual right now.

And our next question comes from the line of Keith Weiss with Morgan Stanley.

Excellent, and nice quarter.

A lot of the questions I had were covered.

So a couple of, kind of, more detailed questions, if you will.

One, on that gaming theme, a lot of what people are talking about for gaming on a go-forward basis is shifting to more streaming, to game subscriptions.

And it's not just Microsoft, but like other vendors have their platform for game streaming.

Can you talk to us about how Akamai is positioned for that potential shift towards more of game streaming?

It sounds like something that would be kind of right up your alley.

Yes.

So it depends exactly what you're referring to.

But if it's a gaming tournament where a lot of people are watching, yes, we do that already, and that creates a fair amount of traffic.

If it's a situation where an individual's gain and their screen is being streamed, we don't do that very much.

We will handle the metadata and the security around that.

The economics around streaming individuals, what they would see on their screen, that's pretty challenging.

People have been working at that, the big gaming companies, for well over a decade and haven't really gotten the economics to work.

But we would handle the metadata, the security, the log-ins, the leaderboard, all of that kind of stuff we handle.

It's just the individual stream is not so economical.

Got it.

Got it.

That makes sense.

And then one detailed question on the security solutions.

In particular, access is a solution that you guys have rolled out.

And it's something that we hear a lot from a lot of different vendors across the spectrum, whether it's guys coming from like a security perspective, like Zscaler or Citrix as their access solutions.

Can you talk to us about sort of how the competitive environment in there is shaking out for you guys?

Where do you guys see yourselves doing well?

And who do you run-up against most often?

Yes.

We compete well with Zscaler there.

I would say that the vast majority of the competition is the traditional CPE vendors and their traditional ways of doing things.

And our value proposition is that we can do it in the cloud.

That's a lot easier and more secure.

And we can -- once we have it and we're providing the access, we can layer in Kona Site Defender and our other technologies, which the other companies don't have.

And that makes it a superior service.

So I'm optimistic about the future growth there.

And even though we compete with Zscaler and compete well, really, the 2 of us are out there competing against the traditional way of doing things.

And our next question comes from the line of Amit Daryanani with Evercore.

This is Lexi on for Amit.

So I guess, the December quarter guide implies that sales were up around 7% year-over-year, and that's kind of a strong deceleration versus the 12% to 13% range we have seen over the last few quarters.

I guess the India and U.S. ban account for $20 million or 200 basis points of drag.

But beyond that, what do you see as kind of the headwinds there?

Yes.

So I think if you look the last couple of quarters, certainly, Q2 was -- we saw a big jump due to the pandemic and the additional traffic that we've got.

Now the good news is we've been able to maintain the traffic and even fill in the divot that was caused by the $15 million in Q4.

And you're right to point out the fact that, that revenue has gone and I talked about an additional $4 million if this U.S. ban goes into effect here coming up in mid-November.

Last Q4 was an exceptionally strong quarter-over-quarter.

There's a few things if you want to look at kind of comparing the jump that we normally see from Q3 to Q4.

We just talked about those applications, the Chinese applications is one piece.

As you recall, in Q2, I talked about some license revenue.

It was about $7 million that we saw from our carrier business that traditionally we see in Q4 and we saw in Q4 last year.

We're not expecting that again.

So that's a piece of it.

And then the other thing that is a little bit different this year, if you recall back in Q2 of 2019, we had our customer conference, and we introduced our 0 overage offering to our Web Division customers.

And that was really a response to customers who are looking for more predictable spend with Akamai.

You can imagine retailers, the ones who mostly go for this offering.

And again, it's just people webcast.

It's not for media customers.

And that's to smooth out some of the different holidays and various peaks that they have in their business.

Now that's been in the market now for about 18 months.

So we're starting to see some pretty good uptake on that.

And what that means is you just see a little bit of a flattening out in your seasonality.

And our next question comes from the line of James Breen with William Blair.

Just one on security.

Can you just give us a little color around the 23% growth?

And how much of that came from existing customers taking new products?

And maybe on that point, if you have a security customers taking 3 of your products and they take a fourth, I believe most of that business is contractual.

How does that manifest itself into the relationship or the contract with the company at the time?

And then just secondly on CDN and media, traditionally, we see a little bit of a step-down in volumes in the third quarter as more people are outside in July and August.

We didn't see as much last year in this time frame.

It doesn't seem like you saw it this year.

Just your overall thoughts on that and OTT sort of overtaking some of the linear television, et cetera.

Yes, great question.

So I'll start with the second one.

We didn't -- you're right, we didn't see as much of a seasonal dip.

I did see a little bit in Europe towards the end of the quarter.

You got to remember that we also have been in kind of a partial lockdown for most of the summer.

So I would say that, that probably adds to it.

We do typically see a seasonal dip here in Q3.

But again, outside of a little bit in Europe, I didn't really see much across the world.

So that was a good trend for us.

And your first question was around security growth of 23%.

What's making it up?

I think it was the -- the question was around new versus existing.

Primarily, the biggest growth is from existing customers.

Today, we have about 61% roughly of our customers buy security from us.

And our new customer acquisition is led by security, but in the recurring revenue business in any given quarter, new customers aren't going to add a ton to the revenue pile.

So it's typically your existing customers.

And then the other question on as customers contract with us for multiple services, it tends to be -- sometimes it can be demand-driven.

So if you have something like a ransomware attack, you have an emergency integration, you just add that to your contract.

In other times, it can be upon renewal where you're adding functionality, so somebody might be a Kona Site Defender customer, they want to add Bot Manager.

What we're seeing some really good early uptake with customers that are Kona Site Defender customers that are adding Page Integrity.

And that can be done mid-contract, if you go in and just add it to your contract.

Typically, you have some form of an MSA with your customer and you can just add that product fairly easily.

And just a follow-up to that.

As you look across your entire revenue base right now, in terms of total revenue, how much of that is contractual versus more volume-driven like your traditional CDM business?

In that business, I'd say the majority of this is contractual.

There is some volumetric components to security.

But really, when you think about the business in total, the big variable in terms of volumes is in the media business.

And in terms of total revenue, if you look at media and security combined, how much of your total revenue you think is more volume-driven?

That's a good question.

Probably 1/4, maybe 1/3 at the most.

It depends on the quarter.

Like in a quarter like this, Q4, where you have stronger seasonality, you'll see a little bit more than normal.

But the majority of the business is contractual.

And our next question comes from the line of Jeff Van Rhee with Craig-Hallum Capital Group.

Most of what I had has been answered.

Just a few on the managed security services.

I remember a while back you had referenced that I believe is 1,000 customers and $100 million in revenue.

I don't know that we've gotten an update.

Just curious if you could update that.

And then any commentary around verticals that stood out, pro or con, in the quarter?

Sure.

So in terms of managed security services, don't have a customer number here for you.

We'll probably give you a more fulsome security update later when we get to next year.

But it's still growing at double digits, which is great.

So managed security services has been actually really a key differentiator for us.

What we're finding is while we've built tools for customers to be able to manage their security products on their own, a lot of times they want us to do it for them.

For example, Bot Manager, we're finding that there's a lot of demand for managed Bot Manager.

It doesn't sound like the greatest product name, but it's sort of descriptive of what's happening.

And then on the Kona Site Defender side, managing firewall rules can be complicated, and oftentimes, customers would like us to do that as well.

Yes.

In terms of the verticals, obviously, the financial vertical is huge.

As you can imagine, forward security.

Commerce, increasingly important as more of their business moves online.

And interestingly enough, big media, gaming sites are now seeing a lot of attacks.

New sites, obviously, especially during an election cycle are big targets.

And OTT sites and protecting accounts there is really important.

So pretty much any big brand name is a big buyer of our security services.

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

This is Hannah Rudoff on for Rishi.

So on the Asavie acquisition, could you just talk about what overlap there is between you and them, both in terms of the actual technology today and then the customer bases?

I didn't catch that question.

Can you repeat it, please?

Yes.

On the Asavie acquisition, could you just talk about what overlap there is between you and Asavie in terms of actual technology and the customer bases?

Great.

No, really good question.

There is not a lot of overlap there.

Their primary capability is to take the traffic from a cellular device and vector it through the carrier into what today is their platform.

Now we are going to take that and vector it into the Akamai platform, and then we can layer in our enterprise security capabilities, our application firewall capabilities, Secure Web Gateway, make sure that traffic stays secure, so that the device doesn't end up going to a site with malware or -- and if it does, to make sure that malware doesn't get back on the device.

And so there's a very little overlap in capabilities, but very strong synergy.

And the really nice thing is that their technology doesn't need to make use of a client.

And a lot of the devices out there, especially in IoT, may not be equipped with that kind of capability.

They'll just go straight with a cellular connection.

And also, there's no way around it because it's handled with the SIM card layer.

So it's not a situation like with a normal device where the user can sort of get around any corporate security and go where they want and then get malware on the device and bring it back into the enterprise.

Great.

That's really helpful.

And then is there anything to call out on this quarter with regard to the internet platform customers aside from the higher traffic?

I know you guys expected a greater sequential decline due to repricing.

And then how should we think about growth of this cohort for the remainder of the year?

Yes, great question.

So yes, definitely a nice upside surprise for us.

As I mentioned on the last call, we did do repricing with 2 large customers in that cohort.

And typically, it takes, call it, 6 to 9 months to get back to traffic levels where your revenue sort of gets back to where it started from.

We were able to do that and more here in Q3.

So that was great, and it was a big jump in traffic from a couple of customers.

So there's really good news there.

And I would say, in terms of this year -- remainder of this year, Q4 tends to be a pretty strong quarter.

So I'd expect something in this range, maybe a touch higher.

And our next question comes from the line of Brandon Nispel with KeyBanc Capital Markets.

Two, if I could.

What are you guys seeing from a traffic perspective thus far in the fourth quarter versus really the third quarter.

And taking a step back, how should we think about the higher traffic growth in 2020 translating into some contract repricing situation into 2021.

Then on the acquisition, you called out $4 million in revenue.

Is it safe to assume that, that acquisition you've closed today, and it's a 2-month benefit for this year, roughly.

And can we annualize that in terms of modeling purposes for next year with some growth expectation?

Yes.

So why don't I start with the last one and find my way back.

So as far as the acquisition goes -- yes, I mean, that's the way the math would work out for this quarter.

Just keep in mind that when you go through purchase accounting and you do your integration costs and things like that, there's some movement there.

We'll give you an update on how much revenue contribution this will be for next year when we do our next call.

But yes, you're thinking about it in a good way.

But in terms of like how much growth add-on and things like that, we'll update you as we get few months into the integration and have a plan fully built out.

For 2020, '21, you talked about pricing and volumes.

It's just a standard part of the business.

We'll always have some number of customers that are up for renewal at any given time.

Average contract length is typically 18 months.

And from a year to 2, sometimes you get a little longer.

So at any given time, you're going to have renewals.

I think we've done a good job of calling out when there's anything that's unusual, meaning you have a big group of customers that are all coming up at once or we had talked about last year when we had some big acquisitions and some of our customers acquiring each other.

We'll continue to do that, but there's really nothing to call out at this point, and we'll be giving you a full update on '21 in the February call.

And then I think your third question was on traffic for the fourth quarter.

Are we seeing anything relative to Q3?

Obviously, back-to-school, fall season, we do see a slight pickup in traffic.

We included that in our guidance.

I think the only thing to call out is weekends, we do see elevated traffic.

Sports has been a nice source of traffic for us and that certainly continues this year.

And our next question comes from the line of Lee Krowl with B. Riley Securities.

Two quick questions.

I think you mentioned the Web Division saw some upside from customer credits.

Curious if you could quantify that upside?

And then if there is a similar contribution in Q4?

Yes, sure.

So I wouldn't necessarily call it a contribution.

I think the way I would describe it is if you recall on the Q1 call, we talked about how the negative impact was around $5 million.

And in the Q2, we talked about it being $14 million.

So going into the quarter, we had modeled that we would have a further negative impact.

It's really hard to predict what's -- we've never been in one of these before.

So it's really hard to predict what customers are going to request and ask for.

So the good news there is we had very little -- less than $1 million impact.

As a matter of fact, we had a little bit of a positive impact in our bad debt assumptions as we had assumed, with some customers that had filed for bankruptcy that have come back post bankruptcy, were a little bit higher up on the chain there.

So we were able to recover some of that money that we had to write-off.

So in general, that was a positive surprise.

So I wouldn't say that it was a pickup of any kind that we would expect in this quarter.

I think what I outlined in the guidance section was there's a potential that if we get into a second wave and we see customers get under a lot of stress that you could see something similar to what we've seen in prior quarters.

We're not anticipating that right now, but that's obviously something as you kind of build your models and handicap that you'd want to think about.

The worst the pandemic gets, the more stress the retailers are under, the more stress the travel and hospitality customers are under.

There's a potential that you could see a little bit of headwind there if we have to do some things on restructuring or credit side.

Got it.

And then just another question.

You guys added a lot of capacity in '19 and certainly significant capacity in 2020 in response to both streaming media as well as kind of the pandemic-related uptick in traffic.

As we lap those comparisons for both capacity as well as traffic growth and we kind of hit some of the slower quarters with that added capacity, maybe just talk about the puts and takes between margins and keeping the servers running hard to offset cost.

One of your competitors kind of indicated a little bit of a margin headwind as server capacity overstretched a pullback in demand.

As we lap some difficult comps over the coming quarters, how do you kind of think about capacity versus the margin standpoint?

Yes.

Good question.

So mix is obviously something that you have to take into consideration.

The good news for us -- if you think about the 20-plus years we've been in this business, we've always seen unit economics where volumes go up, prices go down.

We've been able to do a phenomenal job of driving down costs in our network.

And the fact that we're at such a scale, there's a mix between fixed support contracts versus variable contracts.

We get -- as Tom mentioned, a lot of our traffic is free, and that sometimes can include both space power and bandwidth.

So we have a whole team that is maniacally focused on that, and we continue to make improvements in our server capacity to be able to get more throughput per machine.

So obviously, as mix changes, you can have a point here or there move.

But in general, I think we've done a phenomenal job maintaining margins despite the realities of the high-volume media business.

So I don't know the specifics of what you're talking about with our competitor, but we don't see any significant declines in margins as a result of adding all this capacity.

If anything, I think it gives us a tremendous advantage.

One of the interesting things that we saw this quarter, well, I saw -- we lost a lot of traffic in India.

We actually picked up a lot of traffic in India from other customers as a result of having additional capacity.

You get better performance, the more capacity you have.

And we were able to benefit and fill in some of that gap that -- of the $15 million we lost and some of it was in the India region.

And our next question comes from the line of Mark Mahaney with RBC.

Okay.

All my business questions were asked.

So I'll just ask, in the event of a change in administration next week and you think about the implications for your business in terms of everything from R&D tax credit policies, I don't know, immigration issues, corporate tax rates, what do you think will be the biggest impacts on your business were there to be a change in administration?

Well, maybe the -- just settling down the overall environment out there would be good.

Stress levels are obviously pretty high in the country -- in this country right now, and it'd be good to get past that.

Obviously, taxes might rise.

I don't think that changes the operation of the business in any way.

Obviously, there'll be a onetime reset on EPS if the tax rate were to go up.

And Ed can talk more to that.

But I don't see the fundamentals of our business changing one way or another depending on who wins.

Ed, what thoughts do you have about that?

Yes.

Good question, Mark.

So I would say, in terms of taxes, obviously, a lot of our earnings come from outside the U.S. So it's rumored that there's a 7% increase or whatever may come at some point.

And it's -- who knows if it comes in '21 or they wait a year and put it in '22.

That would have some impact on us.

But like I said, a lot of our earnings are outside the U.S.

A couple of other things to keep an eye on, though.

Interest rates.

So with the Fed being very accommodative and interest rates near 0, think about our reinvestment of our marketable securities.

So you're going to get a lower interest rate in terms of returns.

So that's going to impact your EPS.

And then the last thing would be around foreign exchange.

So depending on what type of stimulus you have, if the dollar gets weaker because as a result of us printing more money, then obviously, that could be a benefit for us because the way to think about our international business is we've got -- we're profitable outside the U.S. and nearly half of our business is outside the U.S. So that can be a benefit potentially if the dollar were to get weaker.

So those would be sort of the 3 areas financially that sort of jump off the page at me.

Well, thank you, everyone.

In closing, we will be presenting at a number of virtual investor conferences and events throughout the rest of the fourth quarter.

Details of these can be found in the Investor Relations section of akamai.com.

Thank you for joining us.

All of us here at Akamai wish you continued health to you and yours, and have a very nice evening.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program, and you may all disconnect.

Everyone, have a great day.