Akamai Technologies Inc (AKAM) — Q1 2020 Earnings Call Transcript

Thank you, operator. Good afternoon, everyone. And thank you for joining Akamai’s First 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. 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 April 28, 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 at akamai.com. And with that, let me turn the call over to Tom.

Thanks, Tom. And thank you all for joining us today. Before I get into the numbers, I want to acknowledge how much the world has been disrupted by the COVID-19 pandemic. All of our lives have been impacted in ways that would have been hard to imagine only a short while ago. At Akamai, our primary concern is for the health and safety of our employees, their loved ones, our customers and partners, and the communities where we work and live. Fortunately, we're in a position where almost all of our employees can work remotely, and we've been doing that successfully for the last two months. We've also implemented special measures to protect employees who need to travel, for example, to a data or operation center. And we're doing what we can to help employees to face especially challenging situations as a result of the pandemic. As businesses and consumers around the globe adjust their routines in the interest of public health, the internet is being used at a scale that the world has never experienced. In addition to the hundreds of millions of people who have been working from home, governments are leveraging the internet to keep citizens informed and to provide economic assistance. Houses of worship are streaming services and communities are engaging online to relieve the social isolation felt by many. And of course, education, commerce and entertainment are now almost entirely online. As much of the world hunkers down in place, Akamai is continuing to work behind the scenes to keep the internet functioning as a lifeline for organizations and people everywhere. I'll talk more in a minute about Akamai’s unique role during the pandemic and the impact of the pandemic on our business. But first, I'll review our Q1 financial performance. I'm pleased to report that Akamai had a very strong first quarter on both the top and bottom lines. Revenue was $764 million, up 8% year-over-year and up 9% in constant currency. Non-GAAP operating margin in Q1 was 30%, up 1 point over Q4 and consistent with Q1 of last year. Non-GAAP EPS in Q1 was $1.20 per diluted share, up 9% year-over-year and up 11% in constant currency. These excellent results were driven by the continued strong performance of our security solutions, greater than expected traffic levels, and by our continued focus on operational efficiency. As more business is conducted over the internet, the ability to scale becomes critical. And when it comes to scale, Akamai is the clear leader. Traffic on our platform increased dramatically in March as enterprises turned to Akamai to move more of their operations online. Despite the cancellation or postponement of major sporting events, like March Madness, and Champions League Soccer, our traffic increased by about 30% over a four-week period at the end of Q1. Traffic reached a peak of 167 terabits per second, which was more than double the peak of the first quarter of 2019. We're very pleased that the capacity we added to the platform last year has enabled us to help our customers, when they need us most. We're also making a big difference when it comes to helping the major carriers handle the explosion in demand. That's because we've deployed our infrastructure deep into carrier networks and close to end users, thereby offloading an enormous amount of traffic that would otherwise congest core backbones and routers. Of course, performance is also critical as businesses move the majority of their operations online. Although some other companies have experienced cases of performance degradation and even extended outages in recent months, I'm very happy to report that Akamai's performance has remained consistent and strong over the past quarter. In fact, our measurements indicate that the page download times provided by our industry leading Ion service have significantly improved over the past year. This is in spite of the large increase in traffic, and is a direct result of our relentless efforts to improve the performance of our services. Akamai is also helping to protect many of the world's major enterprises as more employees work from home and as IT departments increase their focus on business continuity. We believe that Akamai’s market leading security services are needed now more than ever, as attackers take advantage of the pandemic to ramp up their exploits on enterprises across all verticals. In Q1, our cloud-based security portfolio generated $240 million in revenue, up 28% year-over-year in constant currency. Sales continue to be led by our flagship services for DDoS prevention, application-layer firewall and bot management. We also saw a strong surge in bookings for our next-gen Zero Trust enterprise security solutions. The strong demand we saw in Q1 for our security and media services more than offset the reduced revenue we received from companies that have been hit hardest by the pandemic, especially in the travel and hospitality vertical. Where appropriate, we are modifying the terms of these customers’ contracts to provide them some relief and flexibility, often in return for extended contract line. We value our customers and want them to think of Akamai as a supportive and reliable partner for the long run. We are fortunate that our financial strength enables us to provide assistance to customers in need, which we believe will benefit our shareholders and the global economy over the long term. We've also played an important role in helping to support websites and applications associated with response to the pandemic. And the Akamai Foundation is providing sustainable financial assistance for numerous relief efforts around the world. Most of all today, I want to recognize and thank our nearly 7,800 employees for working so hard to serve the thousands of organizations and billions of internet users who rely on us during these very challenging times. I couldn't be prouder of the way that our people have stepped up and of what they're managing to accomplish, despite their own personal challenges and dealing with a pandemic. Their spirit and leadership during a time of crisis is a key part of what makes Akamai such a unique and strong company. Lastly, I want to offer a warm welcome to our Board's newest member, Marianne Brown. Marianne joined Akamai's Board last month and brings with her extensive financial and operational expertise, as well as valuable leadership experience with global technology-driven companies. I'll now turn the call over to Ed for more details on our Q1 performance and our outlook for Q2. Ed?

Thank you, Tom. Before I begin, I would also like to thank our fellow employees for their amazing work and dedication. And I would like to acknowledge our customers and partners, especially those who have been hardest hit by the global pandemic. Today, I plan to review our Q1 results, discuss the impact the pandemic is having on our business and provide Q2 guidance and an update on the full year. As Tom mentioned, we delivered a very strong quarter on both the top and bottom line. Q1 revenue was $764 million, up 8% year-over-year or 9% in constant currency, driven by a significant increase of global traffic, as well as continued strong growth across our security portfolio. Revenue from our Media and Carrier division was $358 million, up 8% year-over-year and 9% in constant currency. The outperformance in media was primarily due to the surge in traffic from OTT video, gaming, social media and news and information sites as more and more people around the world began to shelter in place. Revenue from our internet platform customers was $45 million, in line with our expectations. Revenue from our Web division was $406 million, up 8% year-over-year and 10% in constant currency. Revenue growth for this group of customers was again driven by our security business. Moving on to revenue by geography. International revenue was $335 million, up 16% year-over-year or 19% in constant currency. We continue to see very strong international growth, especially in APJ. Foreign exchange fluctuations had a negative $3 million impact to revenue on a sequential basis and had a negative $7 million impact on a year-over-year basis. Sales in our international markets represented 44% of total revenue in Q1, up 3 points from Q1 2019 and up 2 points from Q4 level. Revenue from our U.S. markets was $429 million, up 3% year-over-year. Moving on to costs. Cash gross margin was 77%, consistent with our expectations. GAAP gross margins, which includes both depreciation and stock-based compensation, was 65%, down a point from Q1 of last year. Non-GAAP cash operating expenses were $260 million, in line with expectations. Adjusted EBITDA was $327 million, up $8 million from Q4 and up 9% in the same period in 2019. Our adjusted EBITDA margin was 43%, up 2 points from Q4 and up 1 point from Q1 of 2019. Non-GAAP operating income was $230 million, up $8 million from Q4 levels and up $20 million or 9% from the same period last year. Non-GAAP operating margin was 30%, up 1 point from Q4 levels and consistent with Q1 of last year. Capital expenditures in Q1, excluding equity compensation and capitalized interest expense were $136 million. This was lower than our guidance range, given some pandemic-related supply chain disruptions and travel restrictions that delayed some planned network buildup. However, thanks in part to the capacity work we undertook in 2019, we are very pleased that we've been able to maintain network resiliency during this virus outbreak. Moving on to earnings. GAAP net income for the first quarter was $123 million or $0.75 cents of earnings per diluted share. This included a restructuring charge of about $11 million associated with the prior actions I mentioned on our last quarterly call. We did not take any new restructuring actions during Q1. Non-GAAP net income was $196 million or $1.20 of earnings per diluted share, up 9% year-over-year, up 11% in constant currency, and $0.02 above the high end of our guidance range, due to higher than expected revenue in the quarter. Taxes included in our non-GAAP earnings were $35 million based on a Q1 effective tax rate of 15%. This was slightly better than we expected, due to stronger than expected growth outside the U.S. Now, I will turn to some balance sheet items. We believe that our balance sheet is strong. We anticipate that we can maintain this position in the face of the current economic uncertainty. As of March 31st, our cash, cash equivalents and marketable securities totaled $2.2 billion. Our total debt at the end of Q1 remained unchanged at $2.3 billion. As a reminder, our debt is comprised of two convertible notes with par values of $1.15 billion each and maturity in 2025 and 2027, respectively. Now, I will review our use of capital. During the first quarter, we spent $81 million to repurchase shares, buying back approximately 900,000 shares. We have approximately $750 million remaining on our previously announced share repurchase authorization. We plan to continue to leverage our share buyback program to offset dilution, resulting from equity compensation over time and subject to global financial conditions. In summary, we are very pleased with our Q1 results. Given these uncertain times and with the increased volatility we are seeing in global markets, I thought it would be helpful to provide some additional context on the impact that the recent elevated traffic levels may have on our media division and the negative impact the pandemic may have on some key verticals in our Web division. First, as Tom mentioned, with many countries around the world issuing shelter-in-place orders, we have seen a dramatic increase in media traffic across our platform. We expect this elevated traffic to continue to have a positive impact on our Q2 results. However, we anticipate that traffic levels may start to moderate if life begins to return to normal, and as the warmer summer months get underway in our larger markets. As an aside, some of you may be wondering about live sports. As a reminder, no individual live event has a significant impact on our results. And to date, the stronger traffic from shelter-in-place orders has more than offset the impact of live sports cancellations and postponements. Moving now to our Web division. There are two verticals notably impacted by the global pandemic, travel and hospitality, and commerce and retail. The travel and hospitality vertical accounted for roughly 4% of total Akamai revenue in Q1. This vertical is comprised of over 200 customers globally, including some of the largest airlines, hotels, cruise lines and travel-related sites. Most of these customers have seen sharp declines in demand. The trend is expected to continue throughout 2020. Our commerce and retail vertical is an area we have highlighted for some time as being under financial pressure. This vertical includes more than 900 customers globally and represents approximately 16% of Akamai's total revenue. So, while we have seen a recent traffic uptick with some customers, other customers are struggling, especially those that rely heavily on brick and mortar operations. We believe they could become increasingly challenged the longer the shelter-in-place orders continue. As Tom mentioned, we have already begun to work with many of our customers whose businesses have been impacted by the pandemic. Q1 was negatively impacted by approximately $5 million due to a combination of contract restructurings and elevated bad debt reserves. Although it is difficult for us to project the total impact, we do expect to incur additional charges in the coming quarters if the economy continues to suffer. I'd now like to provide our outlook for the second quarter. We are projecting Q2 revenue in the range of $752 million to $778 million, or up 6% to 12% in constant currency over Q2 2019. Given the COVID-related impacts on the business I just discussed, we expect to see continued sequential growth in our media division and a slight decline sequentially on our Web division in Q2. At current spot rates, foreign exchange is expected to have a negative $7 million impact on Q2 revenue compared to Q1 levels and have a negative $11 million impact on a year-over-year basis. At these revenue levels, we expect cash gross margins of approximately 76%. Q2 non-GAAP operating expenses are projected to be $252 million to $260 million. Factoring in the cash gross margin and operating expense expectations I just provided, we anticipate Q2 EBITDA margins of approximately 43%. Moving now to depreciation. We expect non-GAAP depreciation expense to be between $98 million to $101 million. We expect non-GAAP operating margins of approximately 30% for Q2. Moving on to CapEx. We expect to spend approximately $186 million to $206 million, excluding equity compensation in the second quarter. This assumes there's not a significant change in the overall economic environment and that we will catch up on our CapEx spend for the first half of 2020 in Q2. With the overall revenue and spend configuration I just outlined, we expect Q2 non-GAAP EPS in the range of $1.18 to $1.24, or up 14% to 20% in constant currency. This EPS guidance assumes taxes of approximately $34 million to $36 million, based on an estimated quarterly non-GAAP tax rate of approximately 15%. It also reflects a fully diluted share count of approximately 164 million shares. As our Q1 results and Q2 guidance demonstrate, we are optimistic about the continued strength of our business, even in light of the pandemic. As you're seeing from other companies reporting, however, it has become much more challenging to predict economic conditions, resulting customer impacts in the second half of the year. As a result of this uncertainty, especially as it relates to the holiday shopping season in Q4, we are withdrawing full year 2020 guidance at this time. We plan to reassess providing annual guidance next quarter as we gain additional insights into the direction of the global economy. We're very thankful for the resiliency of our employees, the diversification of our revenue, the strength of our customer relationships and our strong balance sheet. We believe we are well-positioned to continue to help our customers during this very difficult time by providing them with the best and most secure digital experiences around the world. Thank you. Tom and I would be happy to take your questions.

Great. Okay. Thank you for taking the question. Well, I guess first, I hope everyone in the Akamai team is staying as healthy and safe as possible. Maybe two quick questions, if I can. First, would love to get more granularity if possible on the sources of strength in media? Maybe just trying to understand, the strength in OTT video versus gaming, if there's any way to kind of rank order what you're seeing there? Then, the second question is on security, given the uncertain climate and questions on IT budgets. Maybe just talk about how you're thinking about security growth going forward and what you're seeing in terms of potential lengthened sales cycles versus the need for work-at-home capabilities.

Yes, sure. I'll take the first one, Tom, and maybe you take the second one. So, the strength in media really came, like I mentioned in the earlier remarks, we really saw strength across several different sub-verticals in media, probably the largest would be in OTT video. It also was a very, very strong gaming quarter, especially in March. And really, we saw a significant uptick in traffic over the last couple of weeks of March. And as the shelter-in-place orders came around the world as we got to places like Europe, India, and the U.S., we really saw a dramatic increase. So, there’s pretty much strength across the board and really across the globe as well.

Yes, thank you for your concern about Akamai employees. I'm pleased to say that overall, we're all doing well. Regarding security growth, it is looking very strong, partly because attackers are not limited by the pandemic or remote work. In fact, we've observed a notable rise in attack activity, possibly because they know IT managers have many other responsibilities related to supporting their remote workforce, which increases vulnerabilities. This creates an ideal situation for attackers to carry out their exploits. Our products are well-designed to help major enterprises manage these challenges, both in securing their websites and applications and in providing secure access for their suddenly remote employees. Consequently, we have seen a significant increase in bookings for enterprise security products. Additionally, our customer base consists of some of the world's largest enterprises, which are likely to fare better than most during the pandemic. We have strong relationships with them, putting us in a better position to offer the new security capabilities or increased capacity they need. Overall, I believe the security business is looking very strong. Of course, we all hope that the global recession does not deepen or persist for an extended period.

Great, thank you.

Thank you for taking the question, and congratulations on a great quarter. I have two questions. First, as we look at Q2, can you provide any details regarding the factors influencing the results, particularly concerning the challenges of adjusting some of those contracts? What kind of impact does that have on Q2? Secondly, can you share your expectations for how the increased traffic will hold up into Q2 and how much of that was incorporated into your guidance moving forward?

Sure. Hey, Keith. It’s Ed. Let’s start with the Web division. I aimed to highlight a few verticals where our customers are facing significant challenges. We are addressing these issues on an individual basis. In my prepared remarks, I mentioned that we anticipate a slight sequential decline in the web business. This is due to a few factors that we need to consider. In some cases, customers approach us directly for assistance during this uncertain time. Sometimes, we'll adjust contracts and receive something in return. Other times, we must evaluate the customer's ability to pay. We are particularly concerned about some customers in certain geographic areas. If we have doubts regarding their ability to pay, we need to reserve that revenue. This combination of factors is under consideration. I am pleased to see that capital markets are accessible, and several customers have managed to secure funding. There are also opportunities through various government bailout programs. Nevertheless, we are monitoring this situation closely. Bankruptcies are another consideration. We ran multiple scenarios, anticipating continued pressure on the web business leading to a slight decline. This situation is largely beyond our control, as well as beyond the control of our customers, due to the pandemic. On the media side, we expect the strong traffic growth we experienced in March to carry through most of the quarter. However, we assume there might be a slight decline in traffic by June as conditions hopefully normalize and summer begins. Traffic growth has been robust in April.

Got it. And just in terms of the nature of the contract negotiations, is it more on billing terms, or does actual pricing change? Give us some color on to what you're willing to give to your customers and is there anything kind of out of bounds in what you're not willing to do in terms of contract amendments?

Yes, we evaluate each situation individually while maintaining a long-term perspective. Many of our customers have been with us for 15 to 20 years, particularly in the travel and hospitality sector, which has always included excellent companies that reliably pay on time and often embrace our new solutions. However, they experienced a significant drop in demand in the first quarter. We work closely with them, and in some cases, we may set up zero overage contracts or accommodate requests for extended payment terms. We consider each situation carefully, and thus far, our customers have made reasonable requests without anything extreme.

I just want to double click on Will’s question. What are you guys seeing thus far with the security solutions with work-from-home, specifically more about that new cloud, web gateway or security solution and the EAA product?

Yes. So, strong bookings there. Now, the secure web gateway is just now available in beta and as part of our Enterprise Threat Protector solution, version 3.0. And I think that really increases the strength of the offer. Where we're seeing a lot of the bookings now is an Enterprise Application Access. And you think of that as the VPN replacement, think of that as a thing that lets all your employees who used to just log in, in a physical building now have to do it from home and you need to secure them and you need to scale that overnight. And so, I think that's why we're seeing a real uptake there. And in general, I think these are the solutions of the future for enterprise security. They enable the zero-trust model, they are much more secure within the traditional solutions that enterprises have been using now for decades and can put a big dent in enterprise data breaches in the future.

And then, on the media side, I mean, one of your peers and in that space get the share loss of some of the streaming services. Were you guys able to capture some of that share, given the Akamai network size or did you see any specific media share gains with some of newer OTT services?

Yes, that's a great question. One of the challenges in the industry has been the surge in demand, which makes capacity a larger factor. Along with that comes the issue of performance. In some instances, we've seen significant share gains overall, and we're very pleased with that in the first quarter.

You mentioned in your prepared remarks that no single live sporting event is a meaningful part of revenue. But, I think you've talked in the past that things like the Olympics and World Cup that span a couple of weeks are more meaningful. So, I'm wondering how you quantified or how you gauged the potential for a fade off in traffic in June, versus the loss of the Olympics this year, within the guide and what we should be thinking as we go into the back half of the year?

So, I'll get into a little bit of detail on this one, just to try to help you guys out. So, we did talk about there's no individual events is material. Take the Olympics for example. When you think about the Olympics, there's obviously the direct right holders, there's the web traffic that can sometimes go along with an event of that size, the travel and news, and things like that. And then there's also live television. We've got several folks that show live television. And then obviously, the duration of the streaming is what really matters. We do web delivery, we do services, we do security, etc. But it's really the length of the streaming. An event like that could be, let’s call it, the $3 million to $5 million range, maybe a few million on a really good year. If I think about live sports in general, it’s probably a little over 1% of our total revenue throughout the year. So, right now, you see in Q1, we certainly more than offset the lack of live sports, and we expect that to happen in Q2. So, in terms of what we've built into our guides, we're assuming that live sports is not fully back up and running and that what we're seeing from the OTT and other gaming and other sub-verticals will more than offset that in Q2.

That's great transparency. Thank you for that. And then, on the security side, can you give us a sense of where the strength is coming from, from this aspect? How much of that strength in spending is new customers coming onto the platform versus existing customers, either taking more product, or existing customers just paying more because of either some sort of volume commitment on any of this or just help peel back the onion a bit on the contributions from the growth in security?

Yes, sure. Good question, Sterling. So, first of all, I'll take it from a couple of lenses. I'll start off with the product side. So, we saw great strength with strength with Bot Management, KSD services, and EAA and ETP, albeit a bit smaller, good uptake of multiple solutions. And I've provided this metric before in terms of the number of customers that have purchased a security product for up to 57% now, up from 55% last quarter. So, we're seeing good uptake in the installed base and growing there. And also, customers taking on more than one product, customer buying two or more, up to about 29%, that's up 1 point from last quarter as well. So, doing well with the installed base. In terms of bookings, we're seeing new customer bookings, again being led by security. And, again, so you see this stuff in your installed base. And we're also very excited about page integrity. We came up with our limited availability page integrity. We signed a number of customers this quarter and expect to continue to do that throughout the year. Tom mentioned secure web gateway, which is up in beta now and then obviously enterprise has got a long way to go there.

Hi. This is Caroline on for Heather. First off, I do want to echo the comments that my colleagues on the line have already made. I do hope that you and your families are staying safe and healthy. First off, I wanted to dive a little bit more into the comments that you made about OTT. I'm curious, how has the OTT demand environment trended relative to your expectations, or I guess, put another way, how much of the OTT strength would you characterize as due to the new launches, the share gains versus the general increase in user traffic that was driven by the shelter-in-place orders?

Yes, that’s a good question. I've asked my team to quantify this, and it's somewhat challenging. During times like these, market trends can accelerate, and we’ve observed growth in OTT and an increase in cord-cutting. In March, we noted a significant rise in traffic, undoubtedly influenced by shelter-in-place orders. Additionally, a major customer launched a new service in EMEA around that time. We had our expectations, and I believe we performed a bit better than anticipated, likely due to the impact of shelter-in-place. It's really a mix of factors: while the stay-at-home orders helped speed up the trends we’re seeing, we also gained market share in several areas, outperforming competitors where we have capacity. So, overall, shelter-in-place has certainly accelerated the market trends we’re experiencing.

Got it. And can you talk through what the demand was like, sort of in the last two weeks of March? And what are you seeing now, especially in areas like APJ where some of the countries have sort of relaxed the shelter-in-place orders and people are starting to return back to their workplaces?

Yes. The demand increased steadily through March, with total traffic rising from March to April. As countries implemented shelter-in-place orders, traffic saw an uptick. Currently, most areas are still experiencing high traffic levels. Looking ahead, we might observe a return to more normal growth, influenced by factors like live events and OTT launches. In the APJ region, the performance has also been very strong, contributing to substantial growth.

Got it. Thank you so much.

Thanks for taking the questions. Just on the CapEx side, you talked about a little bit delay and sort of the expansion that you had, you were prepared for just because some of the build out you did at the end of last year. Is there any concern about those delays continuing and the ability to sort of meet demand from a customer side, as we go forward here?

Yes. We think we're past the delays. We did have about 90 days of delay on delivery of a bunch of servers, but we've had plenty of capacity. And as you can tell by hitting a peak, which is really what the CapEx governs of doubling year-over-year. And at this point, we think we're in very good shape, with the supply lines and getting the full capacity we want for the rest of the year. We have the tax in all the cities where we need to do that. We do the installation. And we have the approvals from pretty much all the major governments that our folks can move around, even where it’s a very strict lockdown, just because we're such a critical resource in countries around the world. So, we're optimistic, as Ed said, on being able to continue to deploy capacity and to stay ahead of the demand.

Great. Thank you.

With you guys withdrawing guidance, as I think through your different segments, I’d like to just try to focus on which are the ones that provide that uncertainty. Because it sounds like CDN is strong now. And really, it worst, at least on the media side at worst, come back to the level it was at. Security, it doesn't sound like you think there's some uncertainty that's macro related, but perhaps there isn’t. And you can tell me if you think there is. So, we're left with ecommerce and around travel and retail. So, am I right, Ed that that’s really the reason why we have an uncertainty that caused you to pull guidance in that segment?

Yes. I mean, obviously, we hated to do that, as we ran our scenarios, there is so much that's out of our control and really impacts our customers. For example, if you run into a second flare-up against in the fall and get into another round of shelter-in-place, how does that impact our customers business, especially in the Web division? Obviously we would be bullish for the media division because we’d see those elevated traffic levels. But on the website, it could be considerable. And what's the consumer going to do, how is the consumer going to behave? And with Q4 being a very strong seasonal quarter for us, you can imagine, as you run through a number of scenarios, your range just gets really wide. And we just didn't think it would be helpful. And that's why we provided some additional color, so, you guys can run your models by giving you some size, relative size and number of customers, etc. That's really what's driving, Michael, is just the uncertainty around those Web division customers and more, in particular to what's happening with the virus. There's just so much that's out of all of our controls, and including capital markets. Who knows in the second round right now, it's good to see some of our customers getting funding, but that may close down at the second round happens, and elevated bankruptcies, consumers may not be spending, may not be travelling. So, it's not something that we're experts in and we wanted to give it more time to get some more color rather than providing something we thought was unhelpful.

And then, if I think about CDN as a division, obviously the only thing you’ve guided to is 2Q. But, CDN is made up of both the media side as well as the website. So, do you think that it is enough in traffic to give you an offset to both, live sports and to web that you can see growth in the CDN business year-over-year next quarter?

So, in Q2, yes, I would say right now there's a good chance that we could see the strength medium, no more than offset live sports and potentially the impact on Web. Right now, we have 60 days to go. And you never know what's going to happen here in the last 60 days, whether it gives you a larger than normal range, but it is possible and I wouldn't be surprised if we saw CDN growth here in Q2.

Tom, could you take a moment to discuss what you anticipate regarding the long-term changes in internet usage and trends, and how COVID might influence your strategy or any new areas you may consider investing in? Also, could you provide some comparisons regarding bookings from the past quarter? Have you noticed trends that align with the last few years, potentially in the 10 points and above range? Any insights would be appreciated. Thank you.

Yes. I believe that there is a strong likelihood of increased internet usage coming out of this situation compared to before. For instance, ecommerce has seen its penetration grow significantly, with most commerce now occurring online. As people adapt to this, it's possible that these changes will become permanent, which is favorable for Akamai. Additionally, the trend of online media consumption and movie releases is rising, likely to remain a lasting shift. Remote work, which was minimal before, has now become widespread, and many may continue to do so permanently. Overall, this isn't just about new internet users but a massive increase in scale for existing users. While there are concerns about a potential global recession, which we cannot predict, we are hopeful that we will exit this pandemic phase by the year's end. Once we do, it seems there are strong tailwinds for Akamai, especially since the areas I mentioned are where we excel. My long-term outlook for Akamai is very positive. Although our go-to-market strategy is shifting to virtual due to travel limitations, we've had a successful start, evidenced by high attendance and positive feedback at our virtual edge live event. Regarding security bookings, there has been a significant year-over-year increase in enterprise security products during Q1, which appears to be continuing into Q2, indicating good prospects. Although it takes time for these bookings to convert into revenue, this is encouraging news. With more employees working from home and the increasing need to prevent data breaches, I believe there is a promising future for our Zero Trust enterprise security products.

Thank you.

Thank you. I have two questions. First, I would like to get more details on bad debt. Could you share what it looks like as a percentage of revenue or the actual increase during the quarter? What indicators should we be aware of that might suggest a potential rise in the second quarter? Secondly, regarding pricing, I'm interested in whether the additional volume tied to the CDN business is driven by the overall OTT trend or related to COVID-19, and if there are any noticeable changes in pricing trends. Thank you.

Certainly. Bad debt increased by a couple of million this quarter. We adopted a new accounting standard at the start of January, ASC 326, which changes how we assess credit losses. Previously, we focused on historical data and quarterly events; now, we need to consider potential future credit losses. It's similar to how banks evaluate their trade receivables and set aside reserves for future losses. As I mentioned earlier, we will be extending payment terms in some cases, either due to customer requests for more time or specific situations, like in India, where customers can't access offices or make electronic payments. We will assess this, as all companies adopting this standard will. I do anticipate that debt expenses will increase, and we have accounted for that in our guidance. You will see this reflected in the general and administrative expenses, which will rise slightly. On the pricing front, there were no unusual developments in the CDN market this quarter. However, we are noticing an increased demand for capacity reservation fees, which is slightly raising costs above usual delivery expenses. Capacity is currently limited, so we are seeing a small benefit there. Overall, the pricing environment remains volume-based, and I don’t see significant changes in the market at this time.

Thank you very much.

Hi. Thank you. This is Jane for Mark Mahaney. I appreciate the opportunity to ask a question. I wanted to touch on the guidance. You mentioned some weaknesses in your hospitality, travel, and commerce sectors. Could you provide an estimate of the impact? Additionally, are you factoring in a similar impact for Q2, or do you anticipate it worsening, especially considering the events of the last month of the quarter? I have a follow-up question as well. Thank you.

Yes, certainly. In our guidance, we anticipated additional pressure in those sectors, and I mentioned that we expected a slight decline in the Web division. This division typically does not grow steadily, except for a stronger Q4 leading into Q1. We are forecasting this decline and have factored it into our range of scenarios to cover different outcomes. So far, in the first 28 days of the quarter, we are trending as I expected, but we will see how the next 60 days unfold as we complete the quarter. I hope that as some regions start to lift shelter-in-place orders, we will not see a return to negative trends and that consumer confidence improves, reducing pressure. This is our perspective moving forward.

Got it. And another question just on security, maybe pre and post COVID. Maybe parsing out the COVID impact before that really hit and you see a surge in booking. How the growth has been trending versus your expectations and what's kind of the cadence of transition to Zero Trust? And maybe after the COVID impact, you mentioned a few new launches and it has obviously page integrity being one, SWG as well that will be a more material revenue driver in the out years. Now, do you see any of these new product launches actually becoming more meaningful revenue drivers in perhaps this year or next year, sooner than projected?

Yes, the growth in security remains very strong, consistently in the high 20s for a while, as we noted in Q1, even during COVID. The pandemic has led to an increase in attacks, which is unfortunate as attackers try to exploit the situation. New services such as page integrity, secure web gateway, and enterprise security, along with the rise in bookings for enterprise security, are expected to drive future revenue. There's typically a gap between bookings and revenue growth. The pandemic has heightened the need for Zero Trust in our enterprise security offerings, making it more urgent than before. Although we're not seeing an immediate impact on revenue like we do with traffic, where monetization happens quickly, the security products are yielding bookings and recurring revenue as customers find and expand their services. We anticipate future benefits, though we haven't seen them yet in the same way as with traffic.

I wanted to revisit retail and commerce as a sector. I understand it has faced challenges, even before COVID-19. However, it seems that some areas within this sector are performing better than others, particularly those like Walmart that offer essential goods and services, along with emerging segments of e-commerce. I'd like to know what you are observing within this sector. Regarding your decision to withdraw guidance, is that influenced by uncertainty surrounding the holiday shopping season? Could it be related to the ongoing recession and the potential delay in recovery, which might lead to a decline in discretionary spending? Additionally, I wanted to ask about the payment terms and the restructuring of your agreements. A competitor mentioned that some customers are deferring minimum traffic commitments in the current environment. Are you experiencing that as well? Thank you.

I will begin with the second question. Regarding the deferral of minimum traffic commitments, we haven't engaged in that. In fact, traffic has increased significantly, so it hasn't been a problem for us. Some customers in the Web division have chosen the zero overage option, which is typical for our sales process. I wouldn't really categorize it as an issue. As for your question about retail, you’re right that there are both winners and losers. Some businesses are performing well and experiencing increased traffic, while many others are under significant stress. The retail vertical represents 16% of our revenue with over 900 customers globally. Our main concern is the severity of this recession and consumer behavior; will people resume spending and return to stores? We're also worried about our customers' ability to secure enough capital to navigate through this situation. Unfortunately, some customers may declare bankruptcy, which is unfortunate but does happen. Some may liquidate while others may emerge stronger. However, this process disrupts our operations, leading to revenue loss, write-offs in the quarter, and a hit to bad debt for older receivables. This situation creates substantial disruption, making it difficult for us to predict what lies ahead. The outcome will largely hinge on the evolution of the virus and how comfortable people feel about going out, a situation we've never faced before. Therefore, it's challenging to make reliable predictions, and given the size of that retail vertical, our outlook can fluctuate significantly. That’s why we decided to withdraw our guidance.

That's helpful. Thank you.

Great. Thanks for taking my questions. I wanted to focus first on the security business. I think, last call, you guys kind of highlighted 20% growth as the baseline for the year. Obviously Q1 is tracking kind of ahead of that, and you're speaking to some momentum with bookings. Is it reasonable to say that that 20% or possibly higher is still reasonable? And then, second question, I just wanted to focus on international. Maybe could you parse out contribution of security versus media delivery, especially with the context of new launches on the OTT side? Thanks for taking my questions.

Sure. So, I'll start with the security question. Obviously, we’re off to a great start here. 28%, constant currency growth. Feeling pretty good about Q2. Obviously, Q1’s bookings were strong. We signed one of our largest security deals in our in our history with one of our large media companies. So, good to see that and we see the benefit of that in Q2. So, I think Q2, we’ll see really strong growth. And we did call out 20%. It's possible we could do better than that. Obviously, the verticals we call out that are challenged, do have big security customers. So, to the extent that there's bankruptcies and things like that can bump you around a little bit. But, feeling pretty good here in the first half., certainly that will be growing greater than 20%. And it's possible for the year, really just depends on how things go, some of the comments I made earlier. And your second question on international in terms of the strength, I’d say, there it’s similar to what we see in the U.S. probably a bit more security adoption, quite more greenfield internationally, especially in places like Latin America, pretty low penetration there, which is good. That’s part of the reason we did the exceeded transaction that gives us a good basis to grow the security business there. We are seeing similar trends that we saw in the U.S. there where you see security and verticals like financial services and commerce and travel first and then you’re seeing media start to catch up. We've done some pretty good deals on the media side as well. So, I'd say there's probably more greenfield in outside the U.S., but we are seeing very similar trends.

Great, thanks. I think most might have been answered. Just one remaining. I think as you look at the enterprise sales effort, and this is a little outside of sort of the COVID environment currently, but I know long term, tremendous growth opportunity. When you look at the sales process and where you are at this point, can you just talk to your satisfaction with win rates, with process, with just the overall execution effort in sales within enterprise and things that are yet to be done to really get that running where you wanted, it if it isn’t.

Yes, we're quite satisfied with our current position regarding the people, process, and execution. As you can imagine, it's a challenging time to secure bookings since we can't physically meet with clients, and buyers in IT are overwhelmed with adapting to the new situation. Nonetheless, we achieved a strong bookings quarter, exceeding expectations for our enterprise security products, showing significant improvement compared to last year, and we're starting the second quarter on a positive note. While this may not be reflected in current revenue, it will certainly benefit us moving forward.

Thank you for answering my question. I have a couple for Ed, perhaps both of you. Can you provide some insight into your customer base regarding the potential worst-case scenario if we enter a global recession throughout 2020? What percentage of revenue might be at risk? Additionally, with some customers experiencing increased traffic this quarter, how does pricing adjust? Is it a dynamic situation where they reach a new traffic threshold and adjust to a lower price? I'm interested in understanding how that process works. Thank you.

Yes. I'll take the first part and Ed will likely address the second. As Ed mentioned, unless we experience a severe and prolonged recession that significantly impacts major customers or consumer spending, we believe we are in a strong position. Our customer base is quite diverse, with our largest vertical being media, which is actually thriving and adapting positively to the changes brought about by the pandemic. We primarily serve some of the biggest names in the industry, who are generally more resilient, even if there is a deepening global recession. However, the future remains uncertain amid the global recession, and if it proves to be severe by the end of the year and extends into 2021, our commerce clients and many businesses may face challenges. The potential repercussions are difficult to predict and could affect any guidance we provide. On the positive side, there are significant opportunities in the media and security sectors that exceed our initial expectations. We need to be cautious, as there is no guarantee that this growth will continue throughout the year, and Ed noted we moderated our outlook in June. Our current assessment reflects the possibility of substantial upside as well as hard-to-quantify downsides, which are beyond our control. Overall, the business remains strong, evidenced by a robust Q1 performance and a solid outlook for Q2, despite a broader range in projections. Ed, would you like to discuss pricing in relation to the increased traffic?

Yes, sure. So, obviously, customers know one size fits all for customer pricing. But, what I would say is that typically we do have tiered pricing in most of our contracts, especially the ones with very large volume, so that as you do clip into new tiers, you do get typically a lower rate for that tier. But again, it does vary from customer-to-customer, but we do in most cases have some kind of a tiered pricing structure.

And I guess, just as a follow-up, you guys gave the travel hospitality exposure and sort of talked about live events, but could you give us what percentage of revenue is coming from what you would call SMB? Thanks.

Oh, it's very small. Yes, we do very little with SMB. We have a couple of partners that work with SMB. Like, for example our carriers will sell some security offerings to small, medium business. It’s such a small part of our business. We have a few OVP partners and other partners. But, it’s not a significant part of our business at all.

Okay. Well, thank you, everyone. In closing, we will be presenting at several virtual investor conferences and events throughout the rest of the second quarter. Details of these can be found in the Investor Relations section of akamai.com. I want to thank you for joining us. And all of us at Akamai wish you continued health, and I wish you a very nice evening. So, thank you.