Akamai Technologies, Inc. (AKAM) Earnings Call Transcript & Summary

Thanks, everyone, for joining us. My name is Sterling Auty, Software Technology Analyst here at JPMorgan. Very happy to have with us, for the final session of our 48th Annual Technology Media and Communications Conference, the management team from Akamai. We have both Tom Leighton, who is Co-Founder and CEO; Ed McGowan, who is CFO; and Tom Barth, Head of Investor Relations. Mr. Barth, do you need to do any safe harbor or are we good to jump right into it?

We'll run right into it today, Sterling. Thank you, though.

All right. Sounds good. Before I fire off my first question, just as a reminder to participants, if you'd like to ask a question, please hit the Q&A button on the bottom of your screen or the top right of your screen, depending on your device. Enter in your question, and I'll be happy to include it as part of our session. So just to get kicked off, first of all, thank you guys. It's good to see everyone that you're healthy and safe. Tom, with everything that's going on with quarantine, maybe share with us what you're experiencing in terms of some of the Internet traffic volumes.

Traffic volumes are very high. They're double what they were a year ago, which is very substantial growth. Really saw about a 30% jump overnight and not just the traffic volume, which is driven by streaming and software downloads and updates for games and so forth, but transactions are up quite a bit. And also the attack traffic is up quite a bit. The attacker is taking advantage of the distractions caused by the pandemic and taking advantage of remote work, which, in many cases for companies, is less secure. So just about every way you can measure big increases in Internet usage and activity.

So with this explosion in traffic and attack vectors, et cetera, how's your network holding up? And how are the carriers holding up under the load?

We're doing very well. We are adding a lot of capacity, as we speak. But we're in a great position with our edge architecture to deliver enormous volumes and unexpected volumes of traffic without putting a lot of stress on the core Internet. And as I'm sure you've read, certainly in Europe, you've read about carriers that are feeling the stress. And it's also true here in the U.S., although there's not as many stories there. And when Akamai delivers the traffic, we deliver it from points that are very close to the end user. We're in 4,000 places in 1,000 cities. And not just in the big carriers, but in 1,500 networks. So the launching off point for traffic that we carry is very near the end user. And so it doesn't contribute nearly as much to the congestion, more in the core and the cloud data centers that you're reading about. Internet as a whole, I'd say, is doing reasonably well. There are congestion spots. People's homes sometimes are having congestion with the kids there, with distance learning and people trying to work from home. But by and large, I'd say things are good.

All right. Fantastic. And how have you been able to increase your capacity? There have been comments because of shelter in place that companies have had difficulties even getting into colocation facilities to rack and stack servers?

Yes, pretty much everywhere, Akamai is considered a national critical resource. And so even in places where you got total lockdowns, our employees are able to get into data centers and do what they need to do. Early on, we did have some supply chain holdups coming out of parts in China. That's now back to over 100% of where they were. We've also developed alternative supply chains that don't require on parts -- require parts from China. And so we're taking delivery of tens of thousands of servers and adding significant port capacity in all the major networks out there. So not a problem for us to be adding very sizable amounts of capacity to the platform.

All right. That's great to hear. Listen, you guys were very open and transparent in terms of one of the key concerns on investors' minds in this COVID environment situation is, how much exposure is actually out there to some of the hardest-hit industries? For those that didn't get a chance to hear, can you give a sense of what are those exposures?

Yes. Sure. I'll take that one, Sterling. So what we called out on the earnings call was really 2 areas. The first being travel and hospitality, which is roughly about 4% of our revenue. And the other one is in the retail and commerce space, which is about 16% of our revenue.

And the other part that people worry about is kind of the SMB exposure. I always think about Akamai as more of an enterprise provider. Is there any exposures on that front?

Very little, Sterling. We've got some partners, like, for example, Microsoft Azure, does sell some of our services through their store. So there's a little bit of exposure there. And some of our carriers will take some specialized security offerings to market and sell to SMBs. But in general, we don't have very much exposure at all to SMBs.

What do you think, Tom, is the potential for permanent change in either Internet traffic or security or the way that companies use your security solutions as a result of what we're experiencing with COVID?

I think there's tremendous increase in demand for pretty much every use of the Internet. And I think a lot of that will persist past the end of the shelter-in-place orders. I think a lot more employees will be working remotely and from home in the future. We've been really favorably surprised at how efficient our workforce is working remotely. And I think we'll be taking advantage of that ourselves going forward. I think there'll be a lot more usage of social media, gaming, streaming online coming out of this, a lot more distance learning, transactions. Today, pretty much all of the commercial transactions are now online. And before, it was really a small percentage. I think a lot of that will persist after we're done with the pandemic. And these are all tailwinds for Akamai, which is great. And the only worry you have is how bad does the global recession get? How long does it last? And barring that, once you're past that, I think this is something that really does help Akamai in the future.

One of the questions we're getting from the attendees or from the audience is, when you look at the percent of revenue coming from commerce customers, I think you split between essential retailers and discretionary. What is that split? So in other words, what are the impacts that you might see there? And then one follow-up.

Yes. So I'll take a stab at that one. So if you think about our retail exposure, first, I'll attack it from a geography perspective. Most of the retail business is in the U.S., largest component of that, 16%. But it really spans across a broad swath of different customers, anything from luxury brands to large department stores, traditional clothing retailers, shoe manufacturers, grocery store chains, sporting goods, home goods, electronics, restaurant chains, et cetera. So when you think about the primary exposure would be around the brick-and-mortar locations, a store, to say, your big-box retailers are the ones that have hundreds of stores, the customers that are very highly levered. I get asked a lot from investors saying, well, wait a minute, wouldn't you see an increase in retail or commerce traffic? And in some cases, we do. But oftentimes, it's not enough to offset the potential impact. So if you think about some of the bankruptcies that have been announced recently at J. Crew or Neiman Marcus , that's really where the exposure is. And the way to think about how a retail customer -- the size of a retail customer, against the global brands with the most brands around the world, those that are driving the most traffic and those that are buying the most security products, we gave you an approximate number of customers that we have. So if you kind of use that as an average across all of our customer base, certainly, the larger retailers could be 4 or 5x the average of what a typical customer does. But if you think about that 16%, obviously, the entire group is not exposed, but there is some decent-size exposure with some of those larger brick-and-mortar locations.

But as some of those look to move to online ordering and curbside pickup, is there some incremental benefit that you could see?

Yes. We could see some additional traffic. And in some cases, we have seen some additional traffic. I think the biggest disruption for us is when a company files bankruptcy. You not only have to write-off the receivables that you have, it's a hit to the EPS line, but there's also a disruption in the revenue flow. But yes, certainly, as more folks do more online, that's overall a good trend for us. We're just concerned that there could be some sort of short-term disruption as companies get into financial difficulty and possibly file bankruptcy.

The other thing that was great transparency on the March quarter call, it's been a big point of debate for years and years, which is sports and live events, and how much you depend on it. And maybe for those -- because I do have a question you hear from the audience in terms of, what kind of drag can it be on your 2020 revenue not having live sports coming back any time soon? And what have you kind of factored into your guidance?

Yes. So I talked on the call that live sports tends to be probably a little over 1% of our revenue. It does tend to be concentrated. So you do see certain quarters where it can be meaningful. Obviously, a lot of the live sports is, the rights are held by very big customers of ours or do a lot of different things. So the reason we disclosed that was that we were getting a lot of questions and want to make it clear that it's not overly material, but it is a nice piece of business. I think one thing to think about, there's a potential for a really nice tailwind and potential upside as live sports comes back. If you think about the size of the audience that went to watch the NFL Draft, it was massive. And I think there's a huge pent-up demand for people wanting to watch live sports. And if you envision a world of live sports coming back where there's no one in the stands, well, there's another 50,000 to 100,000 potential viewers that are going to want to watch their -- consume the game, watch the game and a good percentage of those will be online. So I think it could be a nice tailwind for us. We're not anticipating, certainly here in Q2, any major impact from live sports. Obviously, nothing has been announced as coming back yet, and we're already halfway through the quarter. But in the back half of the year, if you got a few different leagues stacked up on top of one another, you might have all 4 seasons going at once. Here in the U.S., that could be a nice benefit for us.

You also talked to -- I mean you always have customers that are coming up for renewal that, I mean, every single quarter. But I do think you did highlight that -- whether it's some of the big Internet platforms or some others that are coming up for renewal. Is that dramatically impacted because of the current environment in terms of either the contract length or pricing or otherwise?

No. I would say right now, we didn't call anything out in Q1. And last year, if you recall, we did talk about some consolidations where it was very unusual. I would say the environment is pretty normal at this point. If there are other big customers coming up -- stacked up against each other, we'll certainly call it out in future calls. But in terms of pricing and contracts at the moment, there's really nothing that I would say is unusual or unexpected at this time.

So we're all sitting at home, binge watching every series that we can on Netflix, obviously, which is driving up the OTT traffic. How much of the business in the CDN segment is really coming from these OTT providers?

Yes. So we don't break it out specifically. But let me see if I can try to give you some data that might be helpful. So if you think about our media division, that's where all those customers sit, obviously, that's a little less than half of our business. We talk about the fact that video is a little over half of our traffic. Now it doesn't translate into half of that revenue being from OTT. But you can think about security, other services, et cetera, as being a certain percentage of the revenue, and some of our largest customers are OTT. So it is a meaningful part of the business and obviously, becoming a bigger part of the business as new services come online like Disney, and then we've got a couple more coming here with HBO and NBC in the May and July time frame. So it's a big component of the business and becoming larger as time goes on.

How do those big go-lives actually impact the business, not only from a revenue perspective, but I also imagine just -- the hypersensitivity to make sure that, that launch goes well, they need to have that capacity. And there probably needs to be some cost component to it. So maybe what are both sides of the coin to prepare for one of these big launches?

Yes. So I'll take that one. I used to run the sales organization and be very heavily involved in there in those launches. And I can tell you that the work starts many, many, many months in advance. The nice thing about our relationship with these customers is we're brought in early to help them think about everything, from the workflow components to the security, to the live streaming. We are able to do load testing. We're able to do a lot of different things to help them get ready for these events. From a capacity standpoint, typically, what will happen is the customers will have their own view of how large the event can possibly be. We'll build out capacity in advance. Sometimes it might be one of these large players launching in Europe or Latin America or a country in Asia. And we'll make sure that we have the capacity built up well in advance. Now last year, we had talked about spending a bit more in CapEx than we normally do. And a lot of that was anticipation of building out for these large events. And we're really glad we did that. We were able to take that surge in traffic pretty flawlessly.

Tom, I muted your lines. So go ahead and make sure you are unmute. Question for you in terms of the technology. When we look at these OTT streaming services, what quality of video stream are we getting, are we actually getting 4K at this point? And if not, what should we look for in terms of the impacts, or kind of the impending impact, if you will, as we start to see a lot of our 4K traffic coming across the Internet.

Today, it's very rare for 4K. We broadcast in 4K. There's -- but not many people are viewing it that way. And in fact, as a result of the pandemic and some of the carriers, worrying about their capacity, a lot of the big streaming companies are now -- they ratcheted down the bit rate on the streams to be more at SD levels, maybe 3 megabits a second or 4. To have a good quality screen on any decent size screen, you want to be up at 10 megabits a second. And 4K, probably you start there 15, 16 terabits per second, more for sports where you need more frames per second. So I would say right now, pretty small bit rates compared to where they will be in a more normal future, I think.

So you made some big capacity increase investments, even starting a couple of years ago in anticipation of this trend. Where is the capacity utilization in the Akamai network? And is there another wave of investment that's going to be necessary to support the growing use of 4K?

Sure. We're at pretty high utilization now. We built out a lot of capacity for the big sporting events this year, which aren't taking place, but we're now using that capacity on a daily basis, just because traffic has increased so much. And we're adding a lot more, as we speak. We think there is the potential for substantial future growth in traffic. And you saw that a little bit of a delay in the CapEx, Q1 to Q2. We had the server pipelines, a little bit of delays there, but that's now back fully operational.

All right. Great. Let's switch gears and talk a bit about the security business. Can you remind investors, at this point, what are the biggest contributors to that security revenue line?

Sure. There's DDoS prevention, which is partly our Prolexic service, which works at the routing layer and partly our Kona Site Defender, which works with the app player. Second, you have web app firewall, which is the primary component of Kona Site Defender. Third, you have Bot management, which is all about detecting what is the entity that's coming to use an application? What are they trying to do? And what response should we give it? The worst of those being the account takeover bots that are guessing or have passwords that are stolen elsewhere and trying them out here, very, very sophisticated. All those areas are well north of $100 million a year for us. We also have security, professional services, another category, more than $100 million a year. They're all growing at a very good clip. We have new capabilities. We've talked about our enterprise security offers, and they're getting a big boost with people working remotely, had a great bookings quarter in Q1 for enterprise security, way, way up over last year. It's tough doing bookings right now, but that's one area where you can certainly have a good conversation with the customer. We just released our secure web gateway. That's a big step forward for our enterprise security offers. We just released page integrity that rides on top of Kona Site Defender and stops the mage card attacks and the third-party malware that are very prevalent now to steal user information as they're using your site. So a bunch of new products coming to market, which aren't large revenue today but have a lot of future potential.

If you were to kind of rank order them, what are the ones that you think have the biggest potential revenue impacts here in the near term?

Well, the near term would be the ones that are big today and growing rapidly, led by Kona Site Defender, Bot Manager and DDoS prevention because they're large and rapidly growing. So they'll give the biggest all time revenue. If you're looking towards the future and you look at enterprise security, which isn't large today, but has a ton of runway, and we just launched Page Integrity, 0, almost 0 right now. But that could be a big product, ultimately like Bot Manager. And where that goes with the whole new attack vector that the bad guys are using. So I think it's a blend. The biggest revenue contributors are always the big products you got that are growing rapidly. But we want the new ones out there because they'll drive a lot of the future revenue growth.

What does Page Integrity actually do for customers?

Okay. So the example would be the British Airways hack. There's been thousands of them, where the client goes to the website and as a result, the browser injects all the code on the website, follows the links to third parties -- follows the links in the third parties to fourth parties, and it really goes down 5 or 6 parties deep. And the bad guys have injected malware somewhere along the way. And the person who owns the website has no idea. And then the malware comes to the browser and causes the browser to give up the personal information and send it to the bad guy. And this is how you lose credit cards and all that kind of stuff. In fact, BA got hit with an enormous fine in the EU, $0.25 billion fine. What we do is we place our script on the page as we deliver it. Our script takes precedence over everything else that the browser is doing and watches it. And it looks to see, hey, is the browser going to do something dangerous here. Is this software that a Java script that I downloaded from a third-party site or even maybe the main site, is it trying to access the credit card or personal information? And even worse, is it trying to send it to a botnet or something that we know as a botnet. And we'll stop it, keep it from happening and notify the customer in real time so that they know they've got a problem. We tell them where the problem is. And then they can eradicate the situation and clean it up. It's been very successful. We've caught all sorts of things so far. And not just malware, we've caught situations where a major website would have a major partner that was, without them either side knowing it, taking credit cards and other kinds of information. And because they didn't know they were taking the PI, weren't protecting it. And now you've created a serious breach of -- the things like PCI compliance and stuff like that. So really, really important capability. And we're unique at this point in terms of bringing it to market. And it just fits right on top of Kona, just check the box and it works for you.

No, that sounds great. The Secure Web Gateway, the SWG, that you mentioned, that I think about 2 aspects of that market typically. One is the branch office and access to the Internet and doing it in a secure way. And I also think about remote access. So I think about companies like Zscaler, in particular. Is that the type of market that you're looking to enter?

Exactly. I'd say Zscaler is the leader in Secure Web Gateway as a service today. And this will be a very competitive product there. I think Akamai has a big lead in terms of enterprise application access and our capabilities there. We also fold that into our -- with our Kona Site Defender service and Ion, so that -- and those are capabilities that Zscaler wouldn't have. And so when you look at the package, I think we have a very compelling and competitive offer now for enterprise security.

So when you look across your overall customer base, where are you in terms of penetration? What percentage of the overall Akamai customer base take at least one security product?

Go ahead, Ed.

Yes, sure. I'll take that one, Tom. So right now, we've got about 57% of our customer base in Q1, has taken 1 security product. That's up 2 points from Q4 and 7 points from last year. So there's still a long way to go, and we've made a nice initial penetration into that base. So that's just buying 1 product. In terms of 2 products, about 29% of the base, so a little less than 1/3 of the customers today take on more than 1 product, that's up 4 points from last year. So a long way to go. And as Tom talked about, something like Page Integrity is a very natural extension of what we're doing with Kona Site Defender. So a very rich set of customer base to go after with this product.

So you've made a couple of acquisitions over the last couple of years in security. Help investors understand, if you were to look at the organic constant currency growth in security, what has abandoned? And what have you kind of included in your outlook?

Yes. So far, the inorganic growth this year has been minimal, about 2 points, I think, in last quarter. In terms of our outlook going forward, we haven't assumed any acquisitions coming into the fray here. And by now, we've already anniversary the security acquisition that we did a year ago. So everything, moving forward, will be organic. And then obviously, when we -- when and if we do a big security acquisition, we'll certainly call that out and give you both numbers.

Tom, with the disruption, we've seen a lot of volatility in markets and valuations. And I'm sure it's probably happening on the private side as well. Does this open up opportunities for further consolidation? And what are you looking for at this point in your targets? Obviously, not looking for what the targets are. But just structurally, what are you looking for when deciding on an M&A consolidation at this point?

We look for products or technology that we could embed in our solutions for the benefit of our customers. Cyberfend is a good example. Go back farther in time, Prolexic was a great example. Of course, the price has to be reasonable. We're not going to do anything crazy. We're very successful, and there's -- should never overpay for something. In terms of pure-play consolidation, every once in a long time, we do that as the finances work. But generally, we're looking for smart people with the new capability that we think is going to be important and that we can embed in our platform and provide to our customers. With the pandemic so far, I wouldn't say that prices have really changed a lot in the start-ups, the companies out there. NASDAQ as a whole is maybe even up a little bit on the year. The travel restrictions make it a little harder to do M&A. You can't visit and due diligence right now. If you were to buy them, integration will be a little harder if you can't travel to be at the facility. Not impossible, and we're always looking. But we're very disciplined, and we want to make sure it really is a high-quality company at the right price.

So over the last couple of years, you've done a tremendous job expanding the operating margins getting to that 30% level. You commented that you're on track for it. What's next from here? How do you balance kind of the investment for growth versus potential for even more operating leverage and margin expansion?

Yes. We always want to be as efficient as possible. We're in very strong position for 30%. We're really there. It's not impossible we're going to do better. And if we can, we will. But we're also very interested in making the necessary investments to accelerate revenue growth. We'd like to be back in double digits on revenue growth, and that does require investment. And we've got a lot of the things we're interested in, in the security landscape, making investments there, IoT with our EdgeConnect platform, blockchain and continued expansion of our edge computing capabilities, especially around 5G and IoT. So you will see us be very prudent with what we spend. We like being at 30%, and if we can do better, we will. But we're also very interested in revenue growth and trying to get back in double digits.

Looking at your edge compute, I believe that you actually rolled out your edge computing capability -- boy, it feels like almost a decade ago, and didn't really seem to grab a lot of attention or traction. And now more recently, we've seen Cloudflare and others launching their own versions and starting to get traction. Do you feel like your platform was still fresh enough to support the use cases that you're finally starting to see gravitate towards edge computing? Or is there additional investment in innovation that you need to either catch up or try to regain the lead?

Yes. We've been doing edge computing at a large scale for over 20 years. And I think recently, there's a couple of companies, did IPOs that talk a lot about it. It's not, by itself, a meaningful driver of revenue. We do it in support of our other services for customers. I think potentially more interesting area for us with edge compute is in the context of IoT and 5G. And we're unique out there with our IoT EdgeConnect platform, supporting the IoT protocols, MQTT, the pub/sub model. We have several dozen customers using it now. And I think 5G is very synergistic and will help support that. And then the kinds of compute you would do there at the edge, I think, is interesting. And the companies you mentioned, don't do that and don't have those capabilities. And I think often these days, edge has become a buzzword now after 20 years. But we're the only ones really with an edge platform. We're in 4,000 locations. And I think it's important to look under the covers in terms of what's real, and where is the revenue really coming from? Some of the competition will deliver bits for a software download or streaming for OTT, and they'll call it edge compute for an enterprise when, really, we would just call that streaming delivery for big media.

So when we think about the cellular hand-off or kind of delivery across the cellular networks, at least my interpretation or my impression has always been, okay, you've optimized up until you get to the cellular network. Then there was a bit of a hand-off and kind of up to the carrier at that point. What does 5G potentially do to that paradigm? And maybe what other opportunities does it open up for Akamai?

5G is great, because it increases the throughput of the last mile, it decreases the latency, which traditionally is very high in the last mile in the cellular world, especially and supports a lot more connections. All those things drive a lot more traffic for Akamai. I think that there's a chance it will be very much like the distribution of broadband, which dramatically increased our traffic, the need for our services. It also enables new applications. Broadband enabled social networking, things that we didn't even think about before. And I think the same could be true of 5G. So not just the increase in traffic and use of the Internet, but also entirely new applications, especially around IoT. And that also increases our business, and we're doing a lot of development to help enable that through technology.

Geographically, I think about the strength in the Akamai network in areas ranging from Europe to Latin America, et cetera. How has perhaps the geographic competitive position evolved? And is that still a bigger advantage today as it was, let's say, 3 years ago.

Sure. And especially, our customer base are the leading enterprises. And generally, they're global companies. And they want one provider who can handle their delivery and acceleration and security on a global basis, and that's Akamai. Also, we have regional businesses. And so for example, we will sell in a European country, even for delivery just in that country. And we have deep partnerships with all the world's leading carriers as well, and we sell our services. So that's a huge advantage for Akamai over and above the edge architecture, which gives us tremendous scale, very favorable economics. We're unique in the CDN industry where we can handle this enormous scale and great performance. And we're making a lot of money doing it, where the competition is struggling and needs to raise money because they can't generate cash with their business models.

With the last couple of minutes that we have, as we think about the areas that you're in, are there any other adjacencies that are just natural for you to move into? You talked about IoT. You talked a little bit about blockchain. But what are some of the other technology trends that we should be keeping an eye on?

Yes. I think anything that increases the use of the Internet. Anything that needs scale, that needs performance that needs security, and so that's why you think about things like IoT or 5G. I think you'll see us do a lot more in security. There's a ton of growth there. And at the same time, continue our very large market share and growing share in things like OTTs, gaming downloads and the kinds of social platforms that are probably going to be built on top of the gaming platforms.

Excellent. With that, Tom, Tom, Ed, thank you so much. We really appreciate it. Stay safe and stay healthy. Thanks again, guys.

Thanks to you too.

Thanks again.