Akamai Technologies Inc (AKAM) — Q2 2017 Earnings Call Transcript

Thank you, Brian. Good afternoon, and thank everyone for joining Akamai’s second quarter 2017 earnings conference call. Speaking today will be Tom Leighton, Akamai’s Chief Executive Officer; and Jim Benson, 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 risk and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. 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 July 25, 2017. 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 our website. Also, please note that all growth rates referenced will be in constant currency unless otherwise noted. With that, let me turn the call over to Tom.

Thanks, Tom, and thank you all for joining us today. Akamai delivered solid overall results in the second quarter. Revenue in Q2 was $609 million, up 7% compared to Q2 of last year in constant currency, and was at the high end of our guidance range. Non-GAAP EPS for the second quarter was $0.62 per diluted share, $0.01 above the high end of our guidance range and up 4% compared to Q2 of last year when adjusted for foreign exchange and the dilution from the recent SOASTA acquisition. The second quarter showed strong growth from our Web Division customers, contributing $315 million in revenue, which is up 16% from Q2 of last year in constant currency. Notably, Q2 was the first quarter where our Web Division customers made up the majority of our revenue. This milestone highlights our success in diversifying and growing Akamai, both through new product lines and a wider range of customers. Over the years, we have expanded beyond our origins as a content delivery network into the largest and most trusted cloud delivery platform. We widened our product range to include application acceleration and cloud security services, attracting many large financial institutions, retailers, airlines, and auto manufacturers, rather than just media companies. Innovation has been crucial for developing new product lines, especially in cybersecurity. Our cloud security business generated $115 million in revenue during Q2, an increase of 34% compared to Q2 of last year in constant currency. Looking ahead, we expect to continue growing this leading business rapidly, with annual revenue projected to exceed $1 billion within the next four to five years. This potential is supported by opportunities to further enhance our Kona Site Defender, Prolexic, Bot Manager, and Web Application Protector product lines. The latest version of Kona Site Defender protects API endpoints for customers like DSW, ensuring their websites and mobile infrastructure are secure. Our newest Bot Manager product, Bot Manager Premier, was launched this month following a successful beta with clients like Hyatt Hotels. It includes machine learning technology acquired from Cyberfend to handle sophisticated account takeover attacks. Scale is crucial for cyber defense as typical attacks can generate vast amounts of malicious traffic, overwhelming even the best-equipped data centers. Akamai's solutions stand out in this regard due to the massive capacity of our platform, which supports all our security offerings. We’ve also gained traction with our latest web performance products, Ion 3.0 and Image Manager, both of which significantly improve user experience, especially on mobile devices. Our customers, including the Telegraph Media Group in the U.K., Billabong, and Six Flags, are focusing on mobile applications due to the increase in mobile device usage and related performance challenges. Additionally, Ion is now complemented by two new products from the SOASTA acquisition: mPulse and CloudTest, designed to help customers like Dick’s Sporting Goods and Churchill Downs measure and enhance the business impact of their websites and applications. Overall, we are pleased with the performance of our Web Division and believe we can maintain a mid-teens annual revenue growth rate from this customer base, with potential for acceleration in the long run as our new enterprise offerings gain traction. As many enterprises move their applications to the cloud, IT managers are reconfiguring their networks and security management. Traditional devices in data centers are being replaced by cloud services, creating opportunities for Akamai to enhance application access speed, reliability, and security. Our new enterprise products address critical needs arising from this IT transformation. Enterprise Application Access meets the need for secure management of application access for a diverse mix of users without compromising enterprise firewall integrity. Adoption of this solution has followed the same growth trajectory we saw with Kona Site Defender in its first year, indicating that our emerging enterprise business could match the success of our web security business. After a successful beta, we launched Enterprise Threat Protector in late Q2. It defends against phishing, malware, and data theft by providing a cloud-based DNS service to block access to harmful sites and botnets. This service utilizes extensive security data collected by Akamai to offer companies like Norwegian Cruise Lines a layer of intelligent security across their offices and cruise ships worldwide, safeguarding both employees and passengers from targeted attacks. Now, let’s shift to our media business. Our Media Division customers accounted for $276 million in revenue for Q2, a decrease of 1% year-over-year in constant currency. As noted in previous quarters, our Media Division's performance was impacted by six major internet platform customers, whose contributions decreased by 17% compared to Q2 of last year. They represented 19% of our Media Division revenue and 8% of Akamai's total revenue in Q2. Importantly, while overall traffic from our media customers is growing, the current growth rate is slower than expected. Excluding the six large internet platform companies, our media customers’ traffic growth has significantly outpaced the overall internet growth rates reported by Cisco. This slower traffic growth impacts our media product revenue and web performance solutions. We are taking steps to improve our media business quickly and plan for long-term performance. In terms of long-term prospects, we see significant potential for growth from increased online video consumption. Video currently accounts for the majority of traffic on our platform and is growing faster than industry benchmarks for internet video. TGG Research forecasts that over-the-top viewing will outpace traditional broadcast viewing in the next four years, indicating a substantial shift online that Akamai is well-positioned to leverage. Our reputation as a top provider for delivering high-quality video online, regardless of device or location, sets us apart. Our video support services further differentiate us, especially in live and linear delivery. Therefore, media remains a vital business for Akamai, expected to contribute significantly to revenue and profit growth in the future, even as its share of our overall business may shrink as we diversify into web and enterprise sectors. We acknowledge how media customers impact our financial results and are actively working to improve the media business. The media division is now led by Adam Karon, who has a strong history of success and operational excellence in growing our services. Since March, he has been implementing strategies to increase our traffic share by focusing on providing top-notch service to our top 250 media clients, who generate most traffic on our platform. While we currently have a strong position, there is room for improvement through tailored support for each customer's needs, including customized integration of Akamai capabilities, differentiated pricing, and leveraging our carrier relationships for regional pricing. We continuously strive to reduce costs in media, and under Adam’s guidance, there is a renewed effort to cut operational and CapEx expenses tied to high traffic volumes. Reducing costs will enhance our profitability and allow us to pass on savings to customers, making our services more appealing. Currently, the media business generates cash for Akamai, supporting the infrastructure we need for cybersecurity across enterprises. Through our initiatives, we aim to boost cash flow from this segment while maximizing future growth opportunities in over-the-top video. Our strategy for improving the media business will keep overall company EBITDA margins in the mid to high 30s, allowing us to invest in our new enterprise initiatives and our profitable web business. In summary, Akamai is well positioned for future growth, backed by our innovative technology, expanding service portfolio, diversifying customer base, and talented employees. These factors contribute to my confidence in Akamai's future, and I will continue my share repurchase program throughout the year. Now, I’ll turn it over to Jim for a detailed financial review, and then we’ll take your questions.

Thank you, Tom, and good afternoon, everyone. As Tom highlighted, Akamai delivered a solid Q2, with revenue coming in at the high end of our guidance range and earnings slightly above the high end of our expectations. Revenue in the second quarter was $609 million, up 6% year-over-year, or up 7% in constant currency, and up 10% in constant currency if you exclude our six large Internet platform customers. Before I dive into the revenue details, please note that all revenue growth rate references will be in constant currency. Looking first to the Q2 revenue results by our customer division lens. Revenue from our Web Division customers was $315 million, up 16% year-over-year. We continue to see solid growth and diversification into this customer base, particularly with our cloud security offerings, with over half of Akamai’s second quarter revenue now coming from our Web Division customers. Revenue from our Media Division customers was $276 million in the quarter, down 1% year-over-year and up 3% excluding the impact of the large platform customers. As we had projected in our last call, media growth rates are lower than the past several quarters driven primarily by a continued moderation in traffic growth across our media delivery and lower-end web performance solutions. As Tom outlined, we are working diligently to improve the media business. We are confident that our action plan to aggressively increase traffic share could improve our traffic and revenue growth trajectory. We are beginning to see early signs of traction, but it will take a few quarters to realize the full benefits of our actions. Finally, revenue from our Enterprise and Carrier Division customers was $18 million in the quarter, up 10% year-over-year. Turning now to our Q2 results for our solution categories, revenue from our Performance and Security Solutions remains strong, coming in at $376 million, growing 16% year-over-year and contributing 62% of total revenues in Q2. We continue to see very strong growth for these products from our Web Division customer base, although we saw a downtick in revenue from our traffic-related web performance solutions sold to our Media Division customers. Within our Performance and Security solution category, we saw particularly strong growth continuing in our Cloud Security Solutions. Second-quarter revenue for our Cloud Security Solutions was $115 million, up 34% year-over-year led by our flagship Kona Site Defender and Prolexic offerings and our continued portfolio expansion into new areas like Bot Management. Our Cloud Security business is now nearing an annualized revenue run rate of $0.5 billion. Our Media Delivery Solutions revenue was $179 million in the quarter, down 9% year-over-year and down 4% excluding our large Internet Platform Customers. As I just mentioned, this revenue moderation was due to further traffic growth deceleration in our Media Division customer base, most notably in our Americas theatre. Finally, revenue from our services and support solutions was $54 million in the quarter, up 13% year-over-year. Moving on to our geographies. Sales in our international markets represented 34% of total revenue in Q2, up one point from Q1 levels. International market revenue was $206 million in the second quarter, up 19% in constant currency driven by strong growth in our Asia Pacific theatre. Foreign exchange fluctuations had a negative impact on revenue of $5 million on a year-over-year basis and a positive impact on revenue of $4 million on a sequential basis. Revenue from our U.S. market was $403 million, up 2% year-over-year and up 5% excluding our large Internet Platform Customers. Moving on to costs. Cash gross margin was 76%, down one point from Q1 levels and the same period last year and in line with our guidance. GAAP gross margin, which includes depreciation and stock-based compensation, was 65%, down one point from Q1 levels and up one point from the same period last year. GAAP operating expenses were $307 million in the second quarter. These GAAP results include depreciation, amortization of intangible assets, stock-based compensation, acquisition-related charges, and other non-recurring items. Excluding these charges, non-GAAP cash operating expenses were $239 million, up $11 million from Q1 levels and in line with our guidance. The sequential expense increase was heavily impacted by the absorption of the SOASTA acquisition. Adjusted EBITDA for the second quarter was $224 million, down $17 million from Q1 levels. Our adjusted EBITDA margin was 37%, down two points from Q1 levels, down three points from Q2 last year and in line with our guidance. Approximately 1.5 points of the EBITDA margin reduction is driven by the impact of the SOASTA acquisition. GAAP depreciation and amortization expenses were $89 million in the second quarter. These GAAP results include depreciation associated with stock-based compensation, amortization of intangible assets and amortization of capitalized interest expense. Excluding these charges, non-GAAP depreciation was $77 million, up $2 million from Q1 levels and in line with our guidance. Non-GAAP operating income for the second quarter was $147 million, down $19 million from Q1 levels and down $10 million from the same period last year driven by the areas I outlined earlier. Non-GAAP operating margin came in at 24%, down three points from Q1 levels and from the same period last year and in line with our guidance. Moving on to other income and expense items. Interest income for the second quarter was $4 million, down slightly from Q1 levels. Non-cash interest expense related to our convertible debt was roughly $5 million. As a reminder, this non-cash expense is excluded from our non-GAAP results. Moving on to earnings. GAAP net income for the second quarter was $58 million or $0.33 of earnings per diluted share. Non-GAAP net income was $108 million or $0.62 of earnings per diluted share and slightly above the high-end of our guidance driven by strong revenue achievement. For the quarter, total taxes included in our GAAP earnings were $30 million based on an effective tax rate of 34%, up from 29% in Q1 due primarily to the accounting for the SOASTA acquisition. Taxes included in our non-GAAP earnings were $44 million based on an effective tax rate of 29%, consistent with Q1 levels and in line with guidance. Finally, our weighted average diluted share count for the second quarter was 173 million shares, down 2 million shares from Q1 levels and down 3 million shares from Q2 of last year driven by increased share buyback activity. Now I’ll review some balance sheet items. Day sales outstanding for the second quarter was 60 days, up two days from Q1 levels and from the same period last year. Capital expenditures in Q2, excluding equity compensation and capitalized interest expense, were $105 million and slightly below the low end of our guidance for the quarter, primarily due to the timing of some planned network investments and IT projects that shifted into Q3. Cash flow generation continued to be solid, with cash from operations of $225 million in the second quarter. Our balance sheet also remains very strong with roughly $1.4 billion in cash, cash equivalents, and marketable securities on hand at the end of the quarter. If you factor in our convertible debt, our net cash is approximately $725 million. During the quarter, we spent $105 million on share repurchases buying back roughly 2 million shares. As we’ve discussed in the past, we believe the strength of our balance sheet and cash position is an important competitive differentiator that provides us with the financial flexibility to make key investments at opportune times, including the share repurchase program. In summary, our Q2 top and bottom line results met or exceeded the high end of our guidance. We continue to see a robust pipeline of innovation and strong revenue growth in our web and enterprise divisions and have put in place plans we believe will improve the performance of our media business. Looking ahead to the third quarter and as signaled in our last call, we expect Media Division revenue to continue to moderate from Q2 levels. In addition, this is a particularly difficult compare period, given last year’s Olympics and various selection coverage events. We are confident that our action plan to aggressively increase traffic share can improve our traffic and revenue growth trajectory. We’re beginning to see early signs of traction, but it will likely take a few quarters to realize the full benefits of our actions. Overall, we are expecting Q3 revenue in the range of $604 million to $616 million. At the high end of this range, year-over-year growth would be 6% in constant currency. At current spot rates, foreign exchange fluctuations are expected to have a positive impact on Q3 revenue of $3 million compared to Q2 and a negative impact of $1 million compared to Q3 of last year. At these revenue ranges, we expect GAAP gross margins of 64% and cash gross margins of 76%. Q3 non-GAAP operating expenses are projected to be $241 million to $246 million, up roughly $5 million sequentially at the midpoint, driven by targeted investments in our web and enterprise divisions. Factoring in the cash gross margin and operating expense expectations I just provided, we anticipate EBITDA margins of roughly 36%. While we are not providing specific guidance beyond Q3 during this call, we believe continued targeted investment in select areas is the right decision for the medium and long-term growth prospects for the company while we work through our media action plan. In the near term, we intend to operate the company in the mid-30s EBITDA. As we work to improve our media performance and deliver continued strong growth from our Web Division customers, we would expect to see EBITDA margins return to the high 30s. And we remain committed to balancing both top line and bottom line growth over the longer term. Moving now to depreciation. We expect non-GAAP depreciation expense to be $80 million to $82 million. Factoring in this depreciation guidance, we expect non-GAAP operating margin of 22% to 23% for Q3. And with the overall revenue and spend configuration I just outlined, we expect Q3 non-GAAP EPS in the range of $0.57 to $0.60. This EPS guidance assumes taxes of $40 million to $41 million based on an estimated quarterly non-GAAP tax rate of 29%. This guidance also reflects a fully diluted share count of 172 million shares. On CapEx, we expect to spend $110 million to $120 million, excluding equity compensation. This amount is an uptick from second quarter levels, primarily due to the timing of planned network and IT investments that shifted from Q2 into Q3, as well as some additional infrastructure investments for our Security Solutions. In closing, we remain confident in our ability to accelerate growth rates for the business, execute on our continued product and customer diversification strategy, and deliver a compelling financial model for our shareholders. Thank you, and Tom and I would now like to take your questions.

Thanks. Just a little more color, please, on the traffic slowdown. I know you called out the Americas as a region where you had that traffic slowdown. I think last quarter, I think you also called out verticals and you talked about the gaming vertical. Could you spend a little bit more time on which industry verticals were behind that, that you’re seeing are behind that traffic slowdown? Thank you.

Yeah, sure. As we talked about the deceleration in traffic and remember traffic is still growing, the deceleration is primarily due to the six large internet platform companies that we’ve talked about and as we talked about on the last call, there was some share loss and some large gaming customers in the Americas and that is exactly what happened, I would say, in Q2. Beyond that, we don’t see any evidence of major share loss. In fact, there are a lot of accounts where we’ve increased share and our traffic is growing. If you take out the six large platform companies, it’s actually growing faster than the published results for the internet as a whole. So, it’s just the issue is it’s not growing as fast as we’d expected and it’s not growing as fast as the historical trends and so that’s why we’re putting in place some pretty significant steps to increase traffic share and get revenue growing and at a stronger pace including the six largest internet companies.

Thank you, Tom.

Hey, good afternoon. You mentioned that as you drive costs lower in media delivery, you can potentially offer lower pricing to those customers. Is that a big part of the strategy going forward to reduce the gap in pricing between you and your competitors for media delivery? Thanks.

It’s not a big part I would say, but it is a part. We want to be sure we’re offering competitive pricing. When I talked about several of the steps that we’re taking, a lot of it is around providing the very best service and really customized service to the world’s largest media companies, and we’re focused on the top 250. We’ve got a lot of unique capabilities that I mentioned earlier that we are going to be helping those customers integrate into their platforms. And I think we have a much greater focus with those accounts providing exactly the services they need, and in some cases, it will involve differentiated pricing if they’re doing a background download or they’re working in a particular geography or if they’re using our client-assisted delivery software that the pricing can be more tailored for them. But pricing is I think a component, and as you know pricing always decreases on an annual basis and we are seeing and as far as we know we’ll continue to see price decreases within historical norms. So, I would say it’s mostly a focus on providing better and differentiated services with a lot more focus and energy there on the top 250 global media companies.

All right. Thank you.

Hi, thanks good afternoon. If I could just go kind of in more detail on your commentary around traffic, it seems as if your traffic is still growing faster than market, but I think the comment was not as fast as we’d like. I’m just trying to square up. Have you lost share, where would you say your share stacks up versus maybe a year or two ago and is the issue more broadly defined in terms of the traffic slowdown, and if so, I guess how do you think, why do you think your initiatives will be successful in kind of clawing that back?

Sure. As we’ve talked about, we’ve lost significant share in the big six internet platform companies due to their do-it-yourself efforts and we’ve talked about that a lot that they drive a lot of traffic on the internet. And just to be clear, even counting that, we’re still growing traffic on the Akamai platform at a good clip. And in fact, if you take out those big six, it’s growing faster than the internet as a whole. In terms of share and as we talked about, we did lose some share in a few large primarily American gaming companies. We’re actually working hard at getting that share back and I’m optimistic about that. Otherwise, I don’t see any share loss compared to say last year and in fact, our goal and we’re working hard to do this is to increase share, and as I talked about, I think we see strong potential to do that. As Jim mentioned, already the steps we’re taking, and we’re beginning to see some acceleration in traffic and an increase in share. It’s very early, and as Jim mentioned, I think you really want to be thinking about a few quarters to see the full benefit from the action we’re taking, and it really is centered around greater focus and energy and customization of what we do for the world’s largest media companies. And as you might imagine, aside from having a lot of traffic and a lot of end-users, they have special needs and we’re in a great position I think to satisfy those needs with the right packaging of capabilities for them. And we believe that by doing that we can increase our share, which is already large in the world’s largest media companies. We can increase it and drive revenue growth going forward.

Okay, thanks. And then as a follow-up just on the enterprise initiatives, enterprise networking initiatives specifically, I think you made mention that you expect that business to track similarly to how the Cloud Security business kind of ramps in the early days. Can you just provide a little bit more insight around kind of where you are in those conversations, how your Cloud Security products are enhancing your conversations with customers, and if there’s sort of synergy there, and how quickly we can expect a meaningful revenue contribution from that business?

Sure. The buyer for our Enterprise security products differs from the buyer for our web security products; however, both report to the same CSO and CIO. Our status as the world's largest pure-play web security provider greatly benefits our customer base and is likely to accelerate our Enterprise security business, which currently includes Enterprise Application Access and Enterprise Threat Protector. Looking long-term, we anticipate that the Enterprise product market will surpass the web security market, and our aim is to grow this segment at a pace similar to our web security growth, which has already been evident in the first year. The Enterprise Application Access product we introduced through an acquisition late last year is performing better than our initial year with Kona Site Defender, our flagship product that launched our web security business. Regarding the timeline for significant results, we are hopeful that we will see impactful results by the end of next year, potentially reflecting in our dollar volumes for enterprise security. If we continue on our current path, we expect to see a significant difference in our outcomes by the end of 2018.

Okay. Thank you very much.

Hi. Thanks for taking the questions. The first question I had, I’m trying to piece together the commentary around the pricing actions you’re taking in the Media Division and the efforts around increasing customization, as well as your comments about the long-term margin. And I just was wondering if you can offer some color on what you think the long-term impact to margins will be from increasing customization for these customers in the context of also taking actions to maybe provide differentiated pricing to these customers?

Yeah. I think, in the long run, not only does it grow revenue, it also improves margins. Growing traffic is generally a good thing. And it’s not just about pricing. We’re driving a lot of our costs out of the delivery, and that improves our margins. It does enable us to pass through some of the savings to customers, which we always do, and that keeps our products competitive in the marketplace. It’s not just an issue of competition, but as you look at OTT, which we look at as driving a lot of the future growth for the media business, the cost is an important component for our media customers. The broadcasters come from a world of satellite delivery, and in the satellite world, every additional subscriber is free. Now in the Internet, that’s not true. And so, we have to do work to decrease costs to help enable the increasing growth in OTT. Now, in terms of what we’re doing with the largest customers, as I mentioned, we’re working hard to take unique Akamai capabilities and integrate them better into our largest customers' platforms, things like accelerated NGS, broadcast operations support, low-latency streaming technology, Akamai client software. And these are all things that improve the end-user experience, several that do lower costs for everybody for the ecosystem, so that’s a good thing. And there is – for some of our customers, they need differentiated pricing models to make it work for their businesses. For example, subscriber-based pricing, peer-assisted delivery, folks with background software downloads. In that case, our cost is lower, and it makes sense to be able to pass that on to the customer. And in some cases, customers need us to be leveraging our deep carrier relationships in countries around the world. And they need regional pricing, and they need things like dedicated managed CDN services. These are all capabilities Akamai has and, generally, are uniquely capable of providing. And they’re going to see and you’re going to see a lot more focused support for the largest customers, and we’re really putting our effort there. And we think that by doing that, we can increase – we have a large share today. We can increase it substantially. That’ll improve revenue. It will improve our margins and be good for the business.

Okay. Thanks. And then one quick follow-up, the SOASTA acquisition, Jim, I appreciated the commentary about some of the impacts to the financials, but one thing which I think I missed was did you offer some color on what the topline contributions for SOASTA was in Q2 and also what you’re expecting for Q3 and maybe when you think SOASTA could be accretive to the EPS line?

Sure. I spoke about that beginning of the investor summit and a little bit on the last call that because of the deferred revenue impact in purchase accounting, there was a few million dollars for SOASTA revenue in our Q2 results, and we’re managing that business as part of our web performance business unit and that’s where it resides. We aren’t going to guide to it specifically each quarter, but what I said during the investor summit is that that business, kind of on an annual basis, once we work through the purchase accounting impact of deferred revenue, could be roughly a $30 million business, so that’s the rough profile of what you should be looking for going into 2018.

Okay. Great. Thank you very much.

Thank you very much. I wanted to delve deeper into the performance unit. Can you discuss the market trends there? Additionally, following your acquisition of SOASTA, can you explain where the demand is coming from? Is it from mobile or other use cases, and what does the competitive landscape look like? I have a follow-up question as well.

Yeah, no I think you nailed it. The biggest trend in performance is around mobile performance where the conditions can be particularly challenging for a good end-user experience. That’s what our Ion 3 is all about. Image Manager makes a huge difference for mobile performance. We’re seeing great traction with that new product. And of course, the SOASTA acquisition with mPulse and CloudTest are all about measuring performance, helping our customers optimize it in a way that maximizes their business, and I would say mobile is front and center there. Of course, security, also very important for those customers and that’s partly why you see our security business growing so rapidly as really the industry leader and the only company capable of providing the kind of security that major enterprises need online today.

The follow-up question, I wanted to speak about the margin guidance. I mean you had opportunities to bring that down in the last couple of quarters, and now it’s taken another step down. Can you talk about the rationale that you did mention continued investments? So if you can delve into specifically where you’re investing in? What product lines that will kind of give us a sense of where we can expect leverage? Thank you.

So obviously, we talked about the media business and when the traffic has been less than we’d expected and therefore the revenue less than we’d expected. That put pressure on our margins in the near-term, and as you know, we’ve just talked about we have an active plan to improve the performance there. When you look at our Web Division there and you see very high margins, you see excellent growth rates; I think it’s really important that we continue the investments there to fuel the growth of that business. If you look at our Enterprise business which is very early days, we now have two products in the market off to an excellent start, and we think that has an even better longer-term potential for growth. And so, the last thing we want to do is do anything to interrupt the great performance and growth that we’re seeing there. So, we are incurring lower EBITDA margins in the near term as we work through and improve the media business. And as we talk about, as we do that, and as we continue to drive very strong growth for our highly profitable web business, and as the enterprise business starts to make a difference in our numbers next year, we do expect to see margin improvement.

Yeah. Thanks. Yeah, hi, Jim, Tom.

Hi.

So, my question is really on the new enterprise opportunities you guys are pursuing. Help us understand the magnitude of the opportunity next year. And when should we start kind of baking it into the model? Would it be as early as the fourth quarter of this year? Would it be front half of next year? And roughly, what are the components of the enterprise opportunity? Would it primarily be this behind the firewall security opportunities? Also, some, like, corporate video offload? So, anything and everything you could help us with this new enterprise opportunity would be very helpful. Thanks.

Yes, I believe it encompasses everything you've mentioned and more. For instance, Enterprise Application Access focuses on securely and cost-effectively authenticating employees for access to enterprise applications. In the past, these applications were restricted to behind firewalls. However, as enterprise applications shift to the cloud, it becomes necessary to provide access to contractors, third parties, and mobile employees. The traditional methods are no longer effective. In fact, unintentional access is currently the leading cause of data breaches. This highlights the need for innovative solutions, which is exactly what Enterprise Application Access provides. This product is currently experiencing faster adoption and revenue growth than our Kona Site Defender product. Looking at Enterprise Threat Protector, which recently concluded a successful beta trial, this product is designed to prevent malware, block phishing attempts, and stop data exfiltration, which poses significant threats and costs to enterprises. When companies suffer data breaches, the consequences can be catastrophic. During the beta trial, we identified instances with major enterprises where our product intercepted data exfiltration, including an incident involving an air-conditioning unit that was unexpectedly compromised. It had a CPU and complete communication capabilities, and it collected and transmitted corporate data without anyone realizing it. The potential market for these products is considerable. Traditionally, enterprise security was managed on private networks through device purchases, representing a much larger market compared to web security. As the enterprise network evolves, this market is also transforming, requiring cloud-based services. We are well-positioned to provide these services, which involve new technology. This isn't simply about taking existing products and deploying them online; they will be platform cloud services, and Akamai has extensive experience in delivering such solutions.

Thanks. Very helpful. A quick follow-on for Jim. Price competition is a strategy, would that be kind of a near-term one-time? Or would it be structural in terms of looking to get back some large business in gaming or in software or even in over-the-top video? Thanks.

Well, I think Tom covered that pretty well, as outlined. The plans that we’re going through to increase traffic share in the accounts, I’m not sure there’s much more to comment on.

Yeah, it’s not a pricing strategy. Obviously, pricing drops every year, it has for 20 years. And it’s dropping within historical norms. I don’t see anything that’s going to change that. Now getting the right pricing model and how the services are packaged, which can vary for each major customer, that certainly we’re working on with the major broadcasters and video customers.

Thanks.

Yeah. Thanks. Sorry for the background noise. But you mentioned this customized solutions for the large media customers. Will that actually take extra investment to customize for each customer? Or is there a way to make that efficient?

Yeah. What we’re doing is reallocating investment within the Media Division to weight much more heavily in the top 250 customers and for smaller companies to handle those in more efficient ways. So, this is not a net increase in investment. In fact, Adam is working very hard to lower the costs in our Media Division.

And that’s the perfect segue. I guess I don’t understand what types of products you would be able to take out to lower the overall cost of products?

We have been actively working to reduce our costs for the past 20 years. Each year, both our pricing and internal costs decline. We achieve this through improved CPUs and software enhancements, which allow us to deliver significantly more traffic per dollar spent on CPU and Co-Lo. Our infrastructure is utilized more efficiently to optimize server performance and timing. For example, during periods of low demand, we can schedule background downloads to make the most of our Co-Lo capabilities. If we have excess bandwidth, we can apply it to background downloads, significantly reducing our marginal costs, which we can then pass on to our customers. We also utilize peer-assisted delivery in certain cases, which helps to lower ecosystem costs drastically. The cost structure for bandwidth varies across the numerous cities we operate in globally, and optimizing our use of this bandwidth can further decrease expenses. We have a strong commitment to this approach and are currently allocating more resources toward it. On the sales side, we are optimizing how our team interacts with customers, with a primary focus on the largest media companies, which represent a small group of around 250 customers that generate most of our traffic and revenue in the media sector.

Thank you, guys.

Hi guys, Michael Turits, thanks. I wanted to just make sure the two clarifications on EBITDA margin guidance. I think when Tom finished his section he said mid to high 30s, and then Jim, I think you said mid-30s. So, I just want to make sure that’s right so it’s mid-30s I assume in the near-term which I would think as kind of a one-year timeframe. Is that how to think of it?

Yes, Tom highlighted that we plan to achieve the Company’s EBITDA margin in the mid to high 30s. We expect to elevate the model back to the high 30s as we implement our media improvement plan outlined by Tom. It will take a few quarters for us to realize the full benefits of these actions. In the near term, we will operate with the Company in the mid-30s to support the necessary investments in the Web Division and the Enterprise division, as Tom mentioned. Our strategy is to focus on both maintaining mid-30s in the near term and, as we see the media improvement plans materialize on both the revenue and cost sides, we anticipate margin expansion.

Okay. And then there’s been a lot of discussion on the call that you guys mentioned about the traffic slowdown, and caution around that, and yet, you beat revenue this quarter. You actually guided nicely above the street, and it looks like revenue growth is stabilizing a bit instead of decelerating. And I don’t know if part of that is but I noticed the Internet Platform Customers are actually flat quarter-over-quarter. So, what’s despite these headwinds from traffic slowing, what’s sustaining the level of growth right now? Is it that the IP guys are just not moving off quite as fast right now or what’s holding you in there?

Well, we do have a little bit of stabilization in the big six customers. We have a great security business which is really meaningful in terms of revenue and growing at a really good clip. We have new product introductions, and we’re particularly excited about our Enterprise products, and that, as I mentioned, should start to be noticeable towards the end of next year, and those are all very helpful to growing our revenue. The Web Division customer base is growing at a very solid clip, which we think we can maintain mid-teens there, and so really, the area where we’ve got, and we’re planning to do better is around media, and that’s growing share and providing a better service to the top media customers, and that will help us grow revenue. I think with some of the technologies we talked about, we can grow margins.

Thanks, Jim and Tom, and Tom I’d love to drill down a little bit more in areas of security at some point, but obviously not on this call. Thanks very much.

Great. Most of my questions have been answered but just to follow up on Michael’s question. Last quarter, I think the commentary was that margins could dip below 37% and now we’re saying mid-30s. And I’m just curious is that a difference, or are you just using different nomenclature to describe margins? And if it is different and you are signaling this quarter versus last quarter some increased pressure, where exactly is that coming from? I know we’ve been talking about media, but is for example, gaming getting worse? Is there now a new sub-segment that’s pushing on that? Is the security business even though it’s growing very strongly, just not growing strong enough to make up for everything? Just a little bit more specificity to understand what’s changed and how that’s impacting margins versus the comments you guys made last quarter would be helpful.

Yeah, I don’t think anything is substantively changed, Colby. I think what we said last quarter was that we were seeing traffic moderation in the media business, and we had even said that we thought it could persist into the back half, and we also said that at that time that we thought that the EBITDA margins would dip below 37. So, kind of mid-30s is we’re not that precise, and we certainly guided to 36. And I think what we’re signaling now is consistent with what we said then. It’s just a matter of I think we’re trying to be very candid about working through some very specific actions in the media business. We’re starting to see some of those actions take hold, still early. We think it’s going to take a few quarters to see the full benefits of them, and that really is the sole reason why you’re seeing pressure on EBITDA margins, which is challenges in the Media Division customer base that we have our arms around and that we’re working. And I think we’ll be able to work through that in the next few quarters. EBITDA margins in the mid-30s will allow us to make the investments we think we need to in critical areas of the business that will fuel growth for the Company longer term which are huge catalysts for growth of the company that we don’t want to constrain right now. And so, think of it as mid-30s for kind of the next several quarters. And once we start to see the media actions take hold, we expect that we should be able to see expansion from there.

And then just on the other question, Michael asked around the top six being flat quarter-over-quarter. Was that an anomaly, just something, I guess more coincidental or would you expect that the worst of that reduction is behind you and that sub-segment of customers will may now grow effectively in line with the rest of the business?

Well, clearly the worst of it is behind us by the fact that it’s only 8% of our revenue. And as you know, they were more than double that. Not so long ago. So, the worst is behind us. I think it would be prudent to plan that there could be some further erosion there. That said, we’re working very hard to grow with those customers. I do believe that it makes sense for them to grow their business with Akamai. I think we can do a better job at a lower price point. And you know, in the past we have seen some of those folks that had DIY and they were taking share reverse course and then put more traffic on Akamai. It does take a little while for a particular DIY project to run its course, but at the end of the day I think we do offer a better service at a lower price point. And so, we are working hard to grow that business. That said, I think given what we’ve experienced in the last year, it is prudent to be planning for further declines, but certainly nothing like it just can’t be, because it’s only 8% now like what we’ve seen over the past year or so.

Great. Thank you very much.

Thank you for the opportunity to speak. Regarding the media business, you mentioned it’s experiencing more traffic and a slowdown in revenue than anticipated, and we are entering a phase of deleverage as those factors align. I would like to revisit Jim's comments from Analyst Day about the media segment operating at approximately 25% adjusted EBITDA in 2016, with a long-term target in the low 30s. Could you provide insight on where you anticipate the media business will perform in terms of margins over the next few quarters relative to that baseline? Additionally, should we expect any adjustments to the long-term target? Thank you.

Yeah. Let me preface it with that we’re a one-segment company. So, we go through an exercise once a year to attempt to take the Akamai cost structure and cut it into our kind of three solution categories. But we actually don’t manage the company internally that way. And so that – those profiles are kind of our best effort as trying to allocate costs that way and to basically look at general profit models for those businesses to give investors a flavor of what’s the general profile of our media business, our performance and security business and our services businesses, and where we think we’re trying to drive them to. And nothing is going to change. I don’t think the models that we’ve outlined, as far as target models for those businesses has changed in a material way. I do think it’s fair to say that the EBITDA margin pressure that you’ve seen for the company over the last few quarters is specifically driven by the media business. So, the profile that we provided for 2016, if we were to go through that allocation exercise right now, you would see the EBITDA margins for that business have come down. But as Tom said, it’s still a free cash flow generating business. Margins are down from where they were in 2016. I think the actions that we’re taking to reaccelerate growth to drive down costs should yield both revenue acceleration and margin expansion, but it’s going to take time for these initiatives to take hold.

This is Tom, Brian. I think we’re running a bit over. So why don’t we take one more question.

Oh, great. Okay. Yeah. Thanks for sticking me in. Tom, just kind of stepping back, I was interested in some of the long-term media commentary and optimism. I think video is one of the key. I think you also said that video was already a majority of revenue. So how do investors get confidence that this video growth is really going to help you accelerate revenue relative to what you’ve seen over the last couple of years? Any further color there with respect to just traffic trend, pricing, et cetera would be helpful?

Sure. Video today is now the majority of our traffic. And that said, we still have a substantial portion of traffic. We have other media customers, software downloads, gaming, some social networking, and so video is not yet all of it. Video is growing at a good clip. And I think as you look at the estimates and the modeling that people are doing about the rate at which TV and typical delivery of video moves online, that leads to a very good place for Akamai. And I think it depends now, who will be delivering that. But I think by the models that you look at, a lot of that is ideally suited for Akamai. We do a lot of the delivery for the world’s major broadcasters and also a lot of the world’s major aggregators of video. So, I think it’s not – you can’t say the next year everybody is going to be watching their video online, but it’s certainly growing. The industry is certainly planning in the long term to have the majority of the video be watched over IP. And that is an excellent outcome for Akamai. And it will probably take us some time to get there, but already it’s a majority of traffic. It is growing at a good clip, and it’s growing faster for Akamai than it is for the industry as a whole or the internet as a whole on video.

Thank you, Will. Again, I want to thank everyone for joining us on this call this evening. In closing, we’ll be presenting at a number of investor events throughout August and September, and details of these can be found in the Investor Relations section of akamai.com and I want to thank you and again for joining us and have a nice evening. Brian, back to you, please.