Tom Barth - Akamai Technologies, Inc. Frank Thomson Leighton - Akamai Technologies, Inc. James Benson - Akamai Technologies, Inc..

Brad Alan Zelnick - Credit Suisse Securities (USA) LLC Michael Turits - Raymond James & Associates, Inc. Colby Synesael - Cowen & Co. LLC Mark Mahaney - RBC Capital Markets LLC Heather Bellini - Goldman Sachs & Co. LLC Vijay Bhagavath - Deutsche Bank Securities, Inc. James E. Fish - Piper Jaffray & Co. Ugam Kamat - JPMorgan India Pvt Ltd. James D.

Breen - William Blair & Co. LLC Keith Eric Weiss - Morgan Stanley & Co. LLC Sameet Sinha - B. Riley FBR, Inc. Jeff Van Rhee - Craig-Hallum Capital Group LLC Brandon Nispel - KeyBanc Capital Markets, Inc..

Good day, ladies and gentlemen. And welcome to the second quarter 2018 Akamai Technologies, Incorporated earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Tom Barth, Head of Investor Relations. You may begin..

Thank you very much and good afternoon and thank you for joining Akamai's second quarter 2018 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 risks and uncertainties and involve a number of factors that could cause the 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 31, 2018.

Akamai disclaims any obligation to update these statements to reflect future events or circumstances. As a reminder, we'll be referring to some non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found in the financial portion of the Investor Relations section of akamai.com.

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

Thanks, Tom, and thank you all for joining us today. Akamai delivered excellent results in the second quarter. Revenue was $663 million, up 9% over Q2 of last year, with continued very strong performance for our Security products and continued improvement in our Media and Carrier Division.

Q2 non-GAAP EPS was $0.83 per diluted share, up 34% year over year. This, very strong result, was driven by our solid revenue growth, the impact of the cost reductions that we made in the two prior quarters and a lower tax rate. EBITDA margins in Q2 improved to 39% and non-GAAP operating margins improved to 26%.

We expect further improvements in margins by the end of the year as we realize the benefits of projects underway to improve our operational efficiency. And we're continuing our work to find a path to achieve non-GAAP operating margins of 30% in 2020, while maintaining investment in the development of new products intended to fuel our future growth.

Our Security portfolio was, again, the fastest-growing part of our business with Q2 revenue of $155 million, up 33% over Q2 of last year. We've been very pleased with the performance of our Security business, which has received accolades from several leading analyst firms over the last few months.

In April, Frost & Sullivan recognized Akamai for market leadership in bot risk management and in May they recognized us for market leadership in holistic web protection.

In June, Forrester ranked Akamai highest among all competitors in web application firewalls and we were the only company to receive Forrester's top score possible for zero-day attack capabilities.

Also in June, IDC issued a new vendor profile of our Security capabilities that said Akamai has had the strongest and broadest Edge security offering for quite some time. And all this comes on top of Gartner's recognition last year of Akamai as a leader in its Magic Quadrant for Web Application Firewalls.

Our Security products were an important contributor to the revenue in our Web Division in Q2. Overall, Web Division customers generated $351 million in revenue in the second quarter, up 11% over Q2 of last year. This is a little lower than what we'd like to see from the Web Division.

And as we talked about during our Analyst Day last month, we've taken several steps to drive a stronger growth rate going forward.

Most notably, we've added new leadership in Global Web Sales, increased our inside sales and sales development functions to drive new customer acquisition, simplified our pricing and packaging bundles for multi-product sales, focused effort on accelerating customer adoption of our mobile solutions, and we're improving our ability to cross-sell our new products into the existing customer base.

We continue to see strong traction for our new products in Q2, including mPulse, Image Manager, Bot Manager, Enterprise Threat Protector and Enterprise Application Access. Revenue from our new products exited the quarter with an annualized run rate of about $170 million, more than tripled the run rate from Q2 of last year.

Revenue for our Media and Carrier Division in Q2 was $312 million, up 8% over Q2 of last year. This much-improved performance is a result of our successful integration of Nominum and the work that we've been doing to improve our traffic share in the top 250 global media accounts.

Traffic growth on the Akamai platform continued to accelerate in Q2 with especially-strong growth in our OTT and gaming sectors. Downloads of the new Fortnite game set a record for a single video game release with over 22 terabits per second of traffic delivered for a single customer at the peak.

I think it's worth noting that this customer moved from one of the world's largest cloud platform providers to Akamai in the months leading up to the release.

Not just because of our scale and global reach, although that's really important when you have a game of this size and an audience of this magnitude, but also because we achieved a five times reduction in error rates, which provided a much better experience for their end users. We also set traffic records for streaming the World Cup.

Akamai served 55 broadcasters from around the world during the tournament and there were several days when our total World Cup traffic exceeded 20 terabits per second. To put this amount of traffic into context, 20 terabits per second is more than 10 times the aggregate border capacity of some major countries.

On the other hand, it's not hard to imagine that the demand for online traffic someday could grow to a 1,000 times this amount. Delivering traffic at scale is very hard to do and it's something that the Akamai Edge platform is uniquely good at.

That's because we place our servers in thousands of locations close to end users, well beyond the bottlenecks in the core of the Internet, where cloud data centers are typically located.

The competitive takeaway of the Fortnite traffic I mentioned earlier and the well-publicized failures of two of the world's largest cloud platforms during the World Cup provides strong proof points as to why we believe that Akamai's unique architecture is so important and also why we think it will become even more critical as traffic levels on the Internet increase.

In summary, I'm very pleased with our results in Q2. We continue to see very strong performance in our Security portfolio, improvement in our Media and Carrier Division, improvement in our margins and very strong growth on the bottom line.

Before turning the call over to Jim, I'd like to mention that Akamai has a significant milestone coming up in the next month. August 20 will be the 20th anniversary of our founding.

It has certainly been an eventful 20 years, as we've grown from the early days as an MIT startup to become the world leader in content delivery, application performance, and cloud security. And I want to thank all our employees for their sustained track record of innovation and hard work and also our customers for their partnership and trust.

We've accomplished a lot together over the last 20 years, but I really do believe that the best is yet to come.

In part, that's because I believe that Akamai's current business is very well positioned to benefit from major market tailwinds, as large volumes of media move online, the scale and sophistication of cyber attacks grow, and more applications move to mobile devices, where near-instant performance is the expectation.

I'm also excited by our progress in the development of an entirely new generation of services to support our customers' future needs in the areas of blockchain, the Internet of Things, and zero-trust security architectures.

Predicting the future is never easy, but as I look forward to the next 20 years, I see very bright prospects for Akamai and our shareholders. With that, I'll turn it over to Jim to review our financials and guidance for the rest of the year.

Jim?.

Thank you, Tom, and good afternoon, everyone. As Tom outlined, Akamai delivered strong second quarter on revenue, margins, and earnings.

Q2 revenue came in at the high end of our revised guidance range at $663 million, up 9% year over year or 8% in constant currency, and up 10% in constant currency if you exclude the six large Internet Platform Customers. Notably, this is the second straight quarter of double-digit revenue growth outside the Internet Platform giants.

Revenue was solid across most of the business, highlighted by continued robust growth in our Security Solutions from both of our divisions and another quarter of strong traffic and revenue growth acceleration in our Media and Carrier Division.

Revenue from our Media and Carrier Division customers was $312 million in the second quarter, up 8% year over year or 7% in constant currency, and up a healthy 12% in constant currency excluding the large Internet Platform Customers. Revenue from the Internet Platform Customers was $44 million in the second quarter, unchanged from Q1 levels.

Q2 revenue outside these Internet giants was strong across all geographies and industry verticals, exceeding our projections for the quarter. Traffic growth accelerated for the fourth straight quarter and was particularly robust from our video delivery and gaming customers.

And as Tom mentioned, we also had several notable events in the quarter that contributed to the strong traffic and revenue growth, with soccer and cricket events seeing record-breaking online audiences.

Our Media and Carrier Division management team remains focused on capturing more traffic share and improving the quality of delivery for the top 250 media customers that account for most of our traffic and revenue.

Because of these efforts over the past year, traffic growth continues to accelerate and we have seen the associated revenue acceleration that we expected when we initiated these actions. Moving now to our Web division, revenue for this set of customers was $351 million, up 11% year over year or 9% in constant currency.

This growth rate came in a little bit below what we expect for this business due to some pricing compression within our delivery-based performance solutions.

We are confident in the Web division growth strategy we outlined at our Analyst Day, specifically focusing on expanding the portfolio through new product development and acquisition, selling additional solutions into the installed base, simplified pricing and packaging bundles for multi-product deployment, and implementing go-to-market enhancements that we believe will accelerate new customer acquisition.

And as Tom highlighted, we continued to see strong uptake in our new product areas in the first half of the year, namely Image Manager, Digital Performance Management, and Bot Manager, as well as strong growth in our core Kona and Prolexic cloud security solutions.

We believe continued execution in all these areas will enable low double-digit revenue growth in this division.

Turning now to our results for our Cloud Security Solutions, second quarter revenue was $155 million, up 33% year over year or 31% in constant currency, and yet another quarter of tremendous revenue growth and customer adoption for our Cloud Security Solutions globally.

We're particularly pleased with the recent uptick in Security Solutions purchased by our media customers. Entering the third quarter, our Cloud Security business now has an annualized revenue run rate of roughly $640 million and represents nearly a quarter of our total revenues.

We believe security continues to present a significant growth opportunity for us, and we plan to continue to invest in this area, with a focus on further enhancing our product portfolio and extending our go-to-market capabilities.

Moving on to our geographies, sales in our international markets represented 38% of total revenue in Q2, up 1 point from Q1 levels. International revenue was $250 million in the second quarter, up 21% year over year or 18% in constant currency, driven by continued strong growth in our Asia-Pacific region.

Foreign exchange fluctuations had a negative impact on revenue of $5 million on a sequential basis and a positive impact on revenue of $8 million on a year-over-year basis. Revenue from our U.S. market was $413 million, up 3% year over year and up 6% excluding our large Internet Platform Customers.

Moving on to costs, cash gross margin was 77%, consistent with Q1 levels and up 1 point from the same period last year and in line with our guidance. We are pleased with our continued execution on our platform efficiency initiatives.

GAAP gross margin, which includes both depreciation and stock-based compensation, was 64%, roughly consistent with Q1 levels and slightly below our guidance, as we introduced more capitalized software projects onto the platform throughout the quarter.

Non-GAAP cash operating expenses were $248 million, slightly below the low end of our guidance and down about $11 million from Q1 levels, due to continued traction with our operational efficiency efforts and the restructuring benefit from our first quarter reduction in force.

Moving now to profitability, adjusted EBITDA for the second quarter was $262 million, up $6 million from Q1 levels and up $40 million or 18% from the same period last year.

Our adjusted EBITDA margin came in as expected at 39%, a 1 point improvement over Q1 levels, primarily due to the strong revenue achievement and the additional operational efficiency gains I just mentioned.

Non-GAAP operating income for the second quarter was $170 million, up $3 million from Q1 levels and up $25 million or 17% from the same period last year. Non-GAAP operating margin came in at 26%, up 1 point from Q1 levels and at the high end of our guidance range.

I am very pleased with the margin expansion we have seen as a result of our ongoing efficiency efforts, and we believe our continued hard work can drive further operating margin improvements.

Capital expenditures in Q2, excluding equity compensation and capitalized interest expense, were $102 million and below the low end of our guidance for the quarter, primarily due to the timing of some planned network investments and facility projects that shifted into Q3.

Moving on to earnings, non-GAAP net income was $143 million or $0.83 of earnings per diluted share, coming in $0.02 above the high end of our guidance range, driven by slightly lower operating expenses and a lower tax rate.

Taxes included in our non-GAAP earnings were $33 million based on a Q2 effective tax rate of 19%, which equates to a year-to-date effective tax rate of 19.5%. This tax rate is roughly 1 point lower than our guidance due to a higher mix of foreign earnings.

Moving on to our GAAP earnings, there was a large and noteworthy item excluded from our non-GAAP results but impacting our Q2 GAAP results that I'd like to provide some color on. We were proud to endow the Akamai Foundation with a onetime $50 million grant in the second quarter.

The associated $50 million charge is classified as an operating expense in the G&A line of our GAAP P&L. We believe this onetime endowment is important for several reasons, because it, one, solidifies our ongoing commitment to support STEM initiatives for underrepresented population in the technology industry today.

Two, enables consistency in charitable giving from one year to the next, regardless of fluctuations in economic cycles or annual profits. And three, is reflective of our values and we believe initiatives like this have a very positive impact in employee recruiting and retention efforts.

And lastly, it resonates with investors' corporate responsibility expectations. Factoring in this onetime GAAP-only item, GAAP net income for the second quarter was $43 million, or $0.25 of earnings per diluted share. Now, I'll review our use of capital.

In May, we closed a $1.15 billion convertible debt offering concurrent with a $500 million revolving credit facility, further strengthening our balance sheet for additional strategic flexibility.

We believe these cost-effective transactions will support our overall operating cash requirements, as well as previously-announced capital return initiatives, while at the same time maintain our ongoing strategic flexibility to be opportunistic with M&A. We continue to focus on the importance of returning capital to our shareholders.

During the quarter, we spent $166 million on share repurchases, buying back roughly 2.2 million shares. As I mentioned last quarter, we plan to spend our current share repurchase authorization of $750 million by the end of 2018.

Given our strong balance sheet and cash generation, beyond 2018, we intend to continue our share repurchase activity but at a lower spend level and with the objective to offset dilution from our equity compensation plans and, at times, to opportunistically repurchase more shares depending upon business and market conditions.

As always, our overall aim is to deploy our capital to achieve favorable returns for our investors in a manner that we believe is in the long-term interest of the company and our shareholders. 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 across the company and we believe we are making good progress on our operational efficiency and margin expansion efforts. Looking ahead to Q3, we are expecting another solid quarter on the top and bottom lines. As we outlined at our Analyst Day in June, the strengthening of the U.S.

dollar over the last several months continues to negatively impact our revenues. In fact, these foreign exchange headwinds have worsened by couple-million-dollars just since that event.

At current spot rates, foreign exchange fluctuations are expected to have a negative impact on Q3 revenue of over $6 million compared to Q2 levels and a $5 million impact year-on-year.

Taking into account these foreign exchange headwinds, combined with typical summer traffic seasonality, which has historically resulted in sequential declines in our Media business, we are projecting Q3 revenue in the range of $656 million to $668 million.

At these revenue levels, we expect cash gross margins of roughly 78% and GAAP gross margins of 65%, both up from Q2 levels. Q3 non-GAAP operating expenses are projected to be $249 million to $254 million, up modestly from Q2 levels and reflecting the seasonality of our annual merit increases.

Factoring in the cash gross margin and operating expense expectations I just provided, we anticipate Q3 EBITDA margins of 39% to 40%, consistent to slightly up from Q2 levels. Moving now to depreciation, we expect non-GAAP depreciation expense to be between $93 million to $96 million.

Factoring in this depreciation guidance, we expect non-GAAP operating margins of 25% to 26% for Q3, roughly consistent with Q2 levels. And with the overall revenue and spend configuration I just outlined, we expect Q3 non-GAAP EPS in the range of $0.80 to $0.86. This EPS guidance assumes an estimated quarterly non-GAAP tax rate of roughly 20%.

This guidance also reflects a fully-diluted share count of 169 million shares. On CapEx, we expect to spend $115 million to $125 million, excluding equity compensation in the quarter. This is an uptick from Q2 levels, primarily due to facility build-outs in Bangalore, Costa Rica and the early phases of our new Cambridge headquarter building.

We expect increased facility-related spend for our new Cambridge headquarters to continue into Q4 and 2019. Looking to the full year, we are anticipating revenue of $2.68 billion to $2.705 billion, up $5 million from the low-end of the range, EBITDA non-GAAP operating margins of 39% to 40%, and 25% to 26%, respectively.

And factoring in these revenue and margin levels in a non-GAAP effective tax rate of roughly 20%, we anticipate non-GAAP earnings per diluted share of $3.26 to $3.38 for full year 2018. And at the midpoint, this is an increase of $0.07 from our prior guidance.

As a helpful reference, we will post our Q3 and full year 2018 guidance ranges on the Investor Relations section of our website after this call. In closing, we are very optimistic about the opportunities ahead for Akamai.

We are confident in our ability to continue innovating to drive further revenue growth, while at the same time driving margin and earnings expansion for 2018 and beyond, which we believe will add significant shareholder value over both the near-term and long-term. Thank you. And Tom and I would like to take your questions.

Operator?.

Thank you. Our first question comes from Brad Zelnick of Credit Suisse. Your line is now open..

Great. Thanks so much for taking the question. I wanted to ask specifically on the Media Division relating back to the pricing actions and contract restructuring in Media from a year ago concentrating more on the top 250.

Where are we in terms of the benefit? How much longer should we expect that that lasts? And how much of the traffic this quarter would you describe as being more event-related versus predictable and ongoing?.

Good question, Brad. So, as we talked about, for the last several quarters, we really initiated a much more aggressive posture around going after traffic share, and that began in late Q2 of last year.

And as you can imagine, some of that meant opening up contracts earlier, some of it meant that we applied some more creative pricing for contracts that were coming up for renewal.

But I would say, largely speaking, that we'd anniversaried a lot of that and so you're going to have renewals every quarter, but most of the actions that we were going to take we've already taken over the last year.

So, I think what you're in for now is a continued focus on us maintaining traffic share and, obviously, there's new customers to be had and where we can grab more traffic share from customers, we're certainly doing that.

But I would say the bulk of those actions are completed and now we're back into business as usual, which is basically ongoing renewals that happen every quarter..

Thanks. That's helpful. And I just had one more follow-up on the Web Division, where you've spoken about several initiatives to help drive growth into double-digits going forward. And some of them seems like go-to market and go-to-market leadership, some of them seemed around pricing and packaging.

Can you maybe just expound a bit more on pricing and packaging and innovation? What specifically is there to be done and how do you think that that's going to play out?.

Yeah. Let me offer some comments and then if Tom has anything else he can offer. Obviously, what we have been doing and we shared this at the Analyst Day, company's done a fantastic job of introducing new products and developing new products. And so we've already been doing a fair amount of that.

We talked about the new products that we've introduced in the last 18 months, actually have generating an annualized revenue run rate now of almost $170 million, so there's been a lot of work on, call it, the development side.

And you're right, there's certainly been work on the go-to-market side, because if you got to develop products, you have to sell them. The sales force has done a very good job of selling these products into the installed base. We have more work to do there but I'd say good early signs.

And the comments around pricing and packaging are less about we're going to do something like on the Media business, where we effectively went in and we creatively priced to grab more traffic share. The Web Division is not about traffic share. The Web Division is about bookings.

What we mean by that is packaging offerings that we can bundle some our solutions around Security and Performance and other areas in a much simpler way for customers to consume, so they can buy multiple products from Akamai as opposed to buying individual products à la carte, bundling products to make it easier for customers to buy more of our portfolio so there's more creative things that we're doing there which makes – they're really more packaging and promotional-related activities, really to introduce the customer to more of what Akamai has to offer.

And, Tom, I don't know if there's anything else you'd add..

No, I think you characterized it well, and our ability to package together the world's leading Security capabilities with the world's leading Performance is very powerful, and that helps us retain and grow the Web customer base. It's the person who owns the website needs it to be secured, needs it to be fast.

And if they can go to one vendor and get the best of both, that's just an incredibly powerful combination..

Thanks very much for the color..

Thank you. And our next question comes from Michael Turits of Raymond James. Your line is now open..

Hey, guys. Good evening. First of all, I'd like to congratulate Akamai and, of course, Tom and the founders on that 20-year anniversary. I hate to admit how many of those years I've actually been following the company, but it's a big number. Anyway, congratulations. Two questions.

One, maybe you could parse for us the drivers of the traffic acceleration in the quarter.

How much of it do you think was wallet share versus organic customer growth in traffic? And where do you think that – do those trends continue or do those both flatten out at this point?.

Yeah. I think it's both. We are, I believe, increasing traffic share and you can see that from the rate of traffic growth, which has accelerated now for four straight quarters, well beyond any published estimates of Internet traffic growth, and that means that we're gaining share.

And we see that at times when there's big events when companies turn to Akamai, of course, to do that and in the cases when they don't, there can be failures and other things happen, poorer quality, which helps Akamai gain share. At the same time, there is more viewing online.

When you look at the aggregate traffic levels for events like the World Cup, far more viewing online than four years ago. You look at the big gaming downloads, like Fortnite, much larger traffic levels than you would see for gaming downloads even a year ago. So, it's a combination of both.

The tide is rising as a whole and there's the potential for a lot more of that as we've talked about and I think we're gaining share at the same time..

So, it sounded, Jim, like you were saying that you were going to focus on maintaining share.

So, of that component of acceleration that had to do with more share gains, should we be less focused on that at this point?.

Yeah. Obviously, as you can imagine, for customers that multi-source, we're always looking to maximize our share. So where there's a chance to maximize more share, we're certainly going to do that. So we're not content maintaining share with a customer that is splitting their traffic.

We've made a fair bit of headway on that, and we'll continue to work on that with customers. I don't want you to think that it's job over, that maintaining share is what we're looking for. We're always driving to maximize as much share.

What I was trying to imply is that, the work that we began late last Q2, we've largely gone through most of those customers and we've made great traction, and that traction actually is now manifesting itself in the performance that you're seeing that the revenue growth outside of the Internet Platform Customers grew 12% in the Media and Carrier Division.

This is really a function of what we said was going to happen when we embarked on these efforts, and so we executed well and we're actually seeing the benefit of that now in revenue acceleration..

Great. Thanks, Tom. Thanks, Jim..

Thank you. And our next question comes from Colby Synesael of Cowen & Company. Your line is now open..

Great. I think in your remarks you noted that you continue to be interested in potentially bolting on via M&A to the Security business, both from a technology and a go-to-market perspective.

I was just wondering if you could add some more color around what you're thinking potentially from a go-to-market, obviously, not companies but what exactly it is you're looking for. My understanding is those types of companies are relatively expensive.

Should we be preparing for a transaction that could ultimately end up being dilutive to the company in the near term? And then secondly, as it relates to the Web division, you mentioned a lot of different initiatives you're doing to improve the trajectory of revenue growth. When do you think we'll start to see that show up in the numbers? Thanks..

So in terms of M&A and Security, that's an area where we're always looking for acquisitions. We've done several over the last few years. You are correct that often companies that we would look at have pretty wild valuations sometimes and you're not going to see us do anything foolish.

So when we make acquisitions, we're very disciplined, and we've been really happy with the acquisitions we've done, particularly in the Security space. Now in terms of boosting our go-to-market presence, I think that's of more interest on the Enterprise Security side, and it's a factor that we think about when we look at potential acquisitions.

That said, we're getting very good traction now with our Enterprise Security sales. Q2 was very strong there and growing. So it's not something that it's a have-to-do, but if we can find an acquisition that makes sense financially, can add product capabilities for our customers, having an improved go-to-market presence is just a plus there.

And, Jim, do you want to take the second question?.

Colby, I think obviously the Web division is a bookings-driven business, as we talked about at the Analyst Day. And so it's a business that is going to take a while to move up or down, to be frank. We're just a tick below the double digits that is our objective for this division.

So it's very possible you're back to double-digit growth in Q3, to be very frank. I think we're going to be in that range of high single digits to low double digits here in the near term.

I think all the efforts that we outlined between adding more products, penetrating more of these products into our installed base, better packaging and pricing, enterprise license agreements, and one thing we didn't really comment on specifically, at least in the Q&A, is really making a concerted effort to do more in new customer acquisition.

We've done a very good job as a company of selling more into our installed base. We have work to do around new customer acquisition, and we saw some early progress on that in Q2. And certainly, our new Web Sales leader, Scott Lovett, this is a big priority for him to get the new customer acquisition engine moving.

And I think all those areas are going to really be the catalyst that drives the company to maintain double-digit growth in the division..

Great, thank you..

Thank you. And our next question comes from Mark Mahaney of RBC Capital Markets. Your line is now open..

Thanks. You talked about in the Web Division seeing some pricing compression and then all the offsets you had against that.

Could you spend a little bit of time on that pricing compression? What are the drivers of that? Is that cyclical, structural, competitive, and the likelihood of that pricing compression staying there for the foreseeable future? Thanks a lot..

It's a good question. I think we talked about the – in the Web Performance product area before that certainly when offerings come up for renewal, customers always expect the price of technology to go down, and it's varied based on customers that push a lot of traffic versus customers that don't.

It varies based on customers that see a lot of value in the performance sensitivity of their traffic. And so it's not new. I would say what's heightened is there are certain industry verticals. A notable industry vertical where pricing pressure is pronounced is in commerce or retail.

As you can imagine, that's an industry phenomenon that there are some large disruptive players in the retail space, and many of our customers are competing with them. And when they're looking at their P&L, they're looking at areas that they can go reduce costs. And so we've not seen really any increase in churn.

As a matter of fact, churn is actually at a low for the company. So we're not losing customers at all. It's just in the Web Performance space there are certain verticals, with retail/commerce being a big one, that customers are very, very price sensitive because their business models depend upon being competitive against some of these large players.

And so I don't expect that to abate, to be frank. I think we're going to continue to see that. I think the strategy that we've been embarking on is the right strategy, which is new product penetration, broadening your products, and then penetrating your products into the installed base and actually getting more traction on new customers.

So that's really the recipe for improving performance. I don't think you're going to see the Web Performance area, though, abate as far as the pricing competitiveness..

Okay, thank you, Jim. And congratulations, Tom. That's a hell of an accomplishment; 20 years. Thank you..

Thank you..

Thank you. And our next question comes from Heather Bellini of Goldman Sachs. Your line is now open..

Great, thank you. I just wanted to follow up on Mark's question a little bit in regards to the pricing pressure that you mentioned in the Performance Solutions Group. I was just wondering.

How do we think about the level of price declines you saw in the quarter versus, say, the average over the last three to four quarters? And how do we think of the headwind going forward and how do we think about the headwind to revenue in the second half 2018 and looking beyond in 2019? Thank you..

To follow on to what Mark said, I would say that you've probably seen an uptick a bit here over the last, call it, six to nine months. But as I said before, the Web Performance products, we've always had that depending upon the nature of the customer.

And so you can view it as it's already in our run rate, so the fact that we grew about 9.5% in constant currency in Q2, I don't expect it to worsen in the sense that I think it's already embedded in the run rate. I think the work we have ahead is to continue to make traction in the areas that I outlined.

Those traction in the areas outlined, we've already made traction in those areas....

Okay..

...are really going to be what is the catalyst to get us to maintain double-digit growth. Is Web Performance going to get worse? I don't think it's going to get worse. I think we're seeing pricing sensitivity with particular verticals.

I think that that will remain, and I think the areas that we're doing – and I think some of the pricing and packaging is a good way to offset that, where you can sell your Web Performance product, you can sell Digital Performance Management, you can sell Image Manager, you can sell Security, a lot of the things that Tom talked about that actually make you much stickier with customers and actually allow you to maintain more value with those customers, the entire – all the solutions that's you're selling them..

Okay, so you don't see it spreading beyond the retail customers, is that what you're saying? Or are you saying the level of pricing for everybody as the pricing pressure has gone up a little bit across-the-board?.

No. As I said, it's more pronounced in certain verticals and I specifically commented on the retail vertical because I think it's a notable vertical where we're seeing it.

But I think, in general, the price of technology comes down, customers expect better value for the offerings that they get and so what we're doing is we are accommodating that but, at the same time, we are leveraging, selling them more products, and so we're able to retain more value with the customer and actually have more products when the sales cycle is completed..

Great, thank you..

Thank you. And our next question comes from Vijay Bhagavath of Deutsche Bank. Your line is now open..

Thanks, good afternoon. My question, Tom, is on the U.S. business. It's been underperforming low-single-digit. The overseas business is outperforming. What are your thoughts on what might be the catalyst or fundamental drivers for reaccelerating growth in the U.S. business? Thanks..

Well, of course, the U.S. business includes the giant platform, cloud platform companies, which helps depress the growth rate there. And we made a lot of investments overseas and particularly in APJ, have a lot of success, overseas revenue growing at a very good clip.

There's a lot of people and major businesses there, a lot of potential to grow further.

And, Jim, would you like to add anything to that?.

No, I don't think so. I do think that what you outlined is right, that we made a lot of investments. We're getting traction in the overseas market. I think the U.S. market grew kind of outside the Internet giants, I think we said it grew in kind of the mid-single-digits. I think we can do better than that, Vijay, to be frank.

And I think that, obviously, there's some work to be done there. As Tom said, the overall growth is impacted by the giants but some of the area that we've seen slowing in the Web Division has come from our kind of U.S. market, and there's a lot of work to try to improve on the growth rate in the U.S..

Thanks. A quick follow-on, Jim, in terms of OpEx efficiencies. Anything we could expect on that front through year-end, like any consultant activities, cost-cutting initiatives? Thanks..

Yeah, I mean, it's ongoing, right? So there's work that we've been doing. We did a restructuring in Q4 and another restructuring in Q1. We've seen the benefit of that. We saw it over the last couple of quarters. There's a bunch of areas we're going to drive further efficiency.

I think I said in the last call that this is a company that we're not in any level of distress, we want to make sure that our operational efficiency actions are very measured and that we're doing things that allow us to better scale costs going forward. This isn't just reducing cost. This is about being able to scale cost as the business grows.

And so, there's a bunch of areas that we've done that with. We outlined some of them as areas around facilities that we've closed, there's some third-party spend reduction initiatives. We have had a consultant in to help us identify areas, so that work is underway.

We're kind of at the first phase of that effort and now we're in the next phase, which is trying to go operationalize these actions. Operationalizing these actions means standardizing processes in certain areas, automation in certain areas. And as I mentioned at the Analyst Day, we'll probably make some investments here in the near-term.

So, we're going to see margin expansion for the company throughout this year and you'll probably see modest margin expansion in 2019 but it won't be significant in 2019 largely because we're going to make some structural investments that are going to help the company better scale. But I think we're on a good path.

I think the work that we're doing is very measured, very responsible, and really keeping in mind making sure that we take the right actions while, at the same time, investing in the areas that are going to drive revenue growth for the company..

Thanks. Very helpful..

Thank you. And our next question comes from James Fish of Piper Jaffray. Your line is now open..

Hey, guys. Thanks for the questions here.

I guess just maybe how much is OTT traffic now as a percentage after this quarter? And can you just clarify what the pricing discount of OTT traffic is compared to sort of the average Internet traffic that hits Akamai's network today?.

Yeah. OTT traffic is the largest source of traffic for us, and it's approximately half of our total traffic. The pricing depends on the volume of traffic from any given customer.

And the major broadcasters and media folks tend to push a lot of the traffic and they would get the most competitive and lowest pricing per bit because of the volume discounts..

Okay.

And then, maybe just to go back to some prior questions here, just on the comments around the Web pricing, that was primarily due to essentially the cloud service provider competitors? Or was that due to any private competitors out there like a Cloudflare, Fastly?.

Well, no. As Jim mentioned, the customers themselves demand lower pricing. That's very common in technology. Some of the customers themselves are under competitive pressure from cloud giants. And we always had a wide variety of competitors. You have the cloud giants, some of them have been in the business of delivery now for over a decade.

You've got start-ups and you've got the CDNs that have been in business for well over a decade. So, a wide variety of competitors there, and I don't think there's been any fundamental change in that landscape..

Great. Thanks for the color..

Thank you. And our next question comes from Sterling Auty of JPMorgan. Your line is now open..

Hey, guys. This is actually Ugam Kamat on for Sterling. So, in your prepared remarks, you mentioned about traffic which is accelerating and OTT and others being really streamed across your network. And in the past you had mentioned that when traffic accelerated, it takes about six to nine months before it actually manifests into revenue.

So, seeing this particular traffic acceleration in 2Q and if it is secular, should we think about that revenue in the Media should actually grow at a healthy clip after two or three quarters?.

Yeah. This is Jim.

Really what we're referring to is when we go through a pricing renewal with a customer, which is effectively we began late Q2 last year and aggressively going after share, when you do that and you're repricing a customer, the comment about six to nine months is usually when you reprice a customer and you drop prices for them to a certain magnitude, it usually takes six to nine months to see revenue acceleration from that.

So we're already seeing that. It's not necessarily a case where traffic accelerates and then you see revenue growth. It's really coupled with the renewal but we're pretty bullish in the Media business that we've done good work.

Obviously, the Media business is certainly more variable than the Web Division set of customers because it's traffic-based and traffic is not linear.

Secular trends would suggest traffic is going to continue to grow rapidly but from one quarter to the next traffic grows more rapidly due to more gaming releases or less gaming releases, sporting events or less sporting events, things of that nature, less seasonal viewing in the summer, more seasonal viewing in the winter.

So, I think, in general, the Media business, there's a lot of things that drive traffic volumes and we're very bullish about the prospects of traffic volumes long-term.

Quarter-to-quarter, you're going to see variability and we're pretty optimistic in the near-term from the actions that we've taken that we're doing all the right things, which is focusing on the right set of customers, trying to maximize share.

And one thing that I want to make sure didn't get lost is one of the things that the media sales team did a great job of in the first half of the year is selling Security now to our Media customers, where I would say we've done a good job in the past of selling Security to our Web customers.

They've done a very good job now of not just selling Media products to Media customers but also selling our Security products to Media customers. So, again, they're buying more of the portfolio. So good progress in Media overall..

Thanks. That's helpful color, Jim. And just as a follow-up, you mentioned about the renewals, so let me hit on that.

So, any of the top six Internet Platform Customers that are expected to come up for renewal this year that we should expect should drive down the pricing for the next two quarters or something?.

Yeah. We don't comment specifically on renewals every quarter. As you can imagine, 25% of our customers roughly renew every quarter. That includes these large Internet Platform Customers. So, there's nothing notable here in the near-term, but just understand that these large customers renew on a periodic basis and there's nothing imminent here..

Awesome. Thank you, guys..

Thank you. And our next question comes from James Breen of William Blair. Your line is now open..

Thanks for taking the question. Just looking at the guidance when implies for the fourth quarter, what gives you confidence on the cost side in terms of moving EPS and the margins up a little bit higher range? And then, secondly, if I missed it, just talk about the buyback in the quarter and how much stock you bought back. Thanks..

Yeah. On the Q4 margins, Jim, as you can imagine, some of what it's going to be is the seasonally you get a big increase in revenue Q3 to Q4. So we'll probably see based on our guidance the implied Q4 sequential growth is I think roughly 6%. All the work we're doing on operational efficiency, you're not going to see 6% growth in operating expenses.

You're not going to see a 6% growth in our cost of goods sold. So, you're going to get some natural lift just because of seasonality of more revenue combined with the operational efficiency actions that we're taking, so that's going to really be the catalyst.

I would say Q4 margins are going to be higher than probably the run-rate leap exiting the year, because, obviously, you don't see the same growth Q4 to Q1. But what gives us confidence is the actions we're taking, we have good line of sight to them the back half of the year.

We have good confidence that we're going to have a solid Q3 and a strong Q4 based on the guidance. So, we feel pretty bullish about that. And on the buyback, I think we spent about $166 million in buyback for Q1. I think we spent about $20 million in Q1.

So, we spent, call it, $190 million or so for the half and we'll spend the remainder to achieve our $750 million in Q3 and Q4..

So, there's just over $500 million left in the buyback. And then just one question on the guidance. What kind of assumptions are you making around FX as you're looking toward the full-year guidance? Thanks..

So something I made on FX is that I think I'd share with you guys at the Analyst Day what the impact was. And from the Analyst Day to today, for the full year, FX has worsened by about $3 million to $4 million, a couple million dollars in Q3, a couple million dollars in Q4.

So call it the total from the last time we guided it, we provided you a guidance I think at our Analyst Day in June towards it by about $4 million..

Great. Thanks..

Thank you. And our next question comes from Keith Weiss of Morgan Stanley. Your line is now open..

Excellent, thank you, guys, for taking the question. I hate to beat a dead horse here, but I feel like I lost the thread on what you guys were trying to get across on the Web business. So you called out that the Web business performance was worse than expected.

But then you're saying that the competitive environment hasn't really changed, so that's not a part of it, that new solutions, a lot of that that goes into Web Performance guys, are selling really well and they're ahead of your expectations. But the answer is packaging and pricing.

So can you just pull it all together for us? What's the main message that you're trying to give us in terms of what's been negatively impacting the Web Performance business and what's going to change on a going-forward basis?.

I think you got the points right there, and it's good to keep in mind that we've got a lot of the revenue in the Web Division is performance, and there's traffic delivery sensitive. And so that's where you see the price compression, which is a natural phenomenon. And really important to remember, and Jim mentioned this, that our churn is very low.

And in Q2, in fact, it's one of the lowest quarters we've had in a long time. So it's not a situation where we're losing customers to any kind of competitor out there. There's just natural price pressure against the delivery products in the Web Division for those customers.

Now, you also noted very correctly we're doing a great job with the new products and selling those, ramping the revenue from that up quickly. We're doing a fantastic job on the Security products, growing well over 30% and now at a pretty significant amount of revenue.

And so that is driving the growth of the division and becoming an increasing part of the product mix, which is why we're optimistic about the future of Web Division growth, while we're dealing with some of the natural price compression in the delivery-based products in the division.

Jim, do you want to add to that?.

I think you outlined it well. We weren't trying to imply, Keith, that there isn't competitive pressures in the business. As Tom outlined, there are. I think the question that someone asked is are we seeing this from the large cloud platform players.

And I think what Tom was trying to outline is we see competition across those guys, startups, and then CDNs that have been around for a while. So we're seeing it in that space and we're seeing it notably in verticals that are particularly price sensitive given some of the industry dynamics.

And so it's really a combination of all those factors that you're starting to see maybe more pricing compression in that business than maybe we've seen in the past. And again, we outlined all the things that we have been doing and will continue to do to drive the business forward so that we can maintain double-digit growth in the Web Division..

Got it, that's helpful. And then, Jim, one for you. In terms of the EPS guide, I think we added $0.06 between the Analyst Day and today, despite the fact, like you're saying, that FX is moving against you guys a little bit.

Can you pinpoint for us where the increased efficiency is versus the Analyst Day come into that EPS line?.

We're probably going to do a little bit better on gross margins than what we had outlined at the Analyst Day. We're continuing to do – I highlighted that in my comments about continued progress around the platform efficiency initiatives. So we'll probably do a little bit better on gross margins than we had outlined.

And again, we continue to drive very purposefully operating expenses. So probably notably cost of goods sold and then, call it secondarily, efficiencies within operating expenses.

In particular, just making sure that areas that we're investing in are pretty prescriptive, and then the areas that we're scaling back on, whether they be third-party spend in other areas that you get more visibility to that every day as you go through inspecting that in more detail..

Got it. Thank you, guys..

Thank you. And our next question comes from Tim Horan of Oppenheimer. Your line is now open. And, Tim, if your phone is on mute, please unmute. And our next question comes from Sameet Sinha of B. Riley. Your line is now open..

Yes, thank you, a couple questions. So let's talk about the traffic acceleration (56:12) acceleration. As you had indicated previously in response to a question, as traffic accelerates, revenue starts to accelerate. So would you say that these are annual contracts? I'm just trying to figure out.

At what point do you break even on these contracts? Obviously, you don't for the first couple of quarters. And my second is on the topic of performance, where you've seen the pricing pressure. Can you help us think about the exposure that you have in the retail segment? I guess that's retail and e-commerce, you pointed that out.

I imagine it's probably a big piece, but can you help us think about what sort of exposure you have there?.

Sameet, you broke up a little bit, to be frank. I think I got the two questions, I believe, which is you were wondering about traffic and revenue acceleration and the contract period that we have with customers. It varies. There are some customers that are annual. There are some customers that are multiyear.

There's no one equation that I could give you that ties traffic and revenue acceleration with the contract cycle.

I can tell you that certainly when we go through pricing renewals, we have traffic in mind when we're giving them a price point, and we have value in mind around what the margin profile is that we're looking to garner from a customer over the period. And we're not just looking necessarily at the year if they happen to have an annual contract.

You're looking at a customer over multiple years because you want to make sure you are the provider of choice, not just for their current traffic but going forward. So I can't really give you an equation there other than to say you're starting to see progress in the Media Division. You're starting to see growth acceleration. It grew 4% in Q1.

Media and Carrier grew 7% in Q2, so we're making very, very good progress. And as I said, the Media business has variability to it, so sometimes you have to be careful when you try to build an equation into it because a lot of things can affect traffic.

And relative to performance pricing, there's not much more I can offer than what I already shared, which is it is a fact that the Web Performance delivery products, as Tom outlined, we are seeing some pricing compression there, and we outlined some of the things that are driving that. It depends upon the vertical. It depends upon the customer.

It depends upon the type of traffic that is being served, whether it's really performance-sensitive traffic or whether it's traffic that is maybe less performance-sensitive. So all those variables come to play. I think it's fair to say that the Web Performance business is not like the Media business in some regards.

There's certainly a more bookings-oriented business that does have a traffic component to it. But it certainly is something that the customer values based on the performance acceleration that is being given for whatever their traffic profile is, but there's not much more I can offer on performance pricing other than what I had already provided..

Okay. Thank you..

Thank you. Our next question comes from Jeff Van Rhee of Craig-Hallum. Your line is now open..

Great. Just two left from me. I guess just one, Jim, on the CapEx side for the year and into next year you commented about the Cambridge facility. Just maybe a little expansion on how much of an upward bias that's going to put, what the numbers are around the Cambridge facility, and what kind of upward pressure that means next year.

And then, second, within the Web Division as well you commented on the cross-sell as one of the key initiatives.

What's the key metric that you're watching there that we should sort of use as the yardstick to see if you're making progress on the cross-sell?.

So, on the CapEx front that we've just begun, so the Cambridge – actually, the CapEx uptick in Q3 is not just our Cambridge headquarters. There's actually some work that we're doing for Bangalore, which is a large center for us, in Costa Rica which is another large center of excellence for us.

But relative to headquarters, in particular, we're just at the early phases of the project and it will continue throughout 2019. You'll actually see the bigger impact on CapEx in 2019 and it will grow. Our CapEx as a percent of revenue model is about 15% to 17%.

We'll be a little bit above that, more than likely, in 2019 as a result of the Cambridge headquarter building. I don't want to provide a specific number because there's a range that that could be and there's a bunch of things that could affect that.

But the way you should think about it is it will probably be a bit above the high-end of our long-term model but it's only one-time. It will go down again in 2020..

Yeah. In terms of the second question, customers that buy more than one product is really important for us. We do a lot better in those accounts of course. And, for example, customers that would buy an acceleration product and then combine it with Image Manager, Digital Performance Management, one of our Security Solutions for example.

the Kona Site Defender platform or the Prolexic platform. We're now packaging those together. And then as we go forward, as I mentioned, we're starting to get some pretty strong traction with our Enterprise Security products and we'll probably talk a lot more about that on the next Street call, but that will become a factor as well.

We're also looking at Enterprise license agreements where you get the whole package and we've had some really outstanding recent success there.

So, it's the keeping track of what the customers are buying in aggregate and obviously it's beneficial for us when customers use more of the Akamai platform and they buy some of our other market-leading capabilities..

Operator, I think we have time for one more question..

Thank you. And our last question comes from Brandon Nispel of KeyBanc Capital Markets. Your line is now open..

Hey, great. Thanks for squeezing me in. I'm curious, how would you guys characterize growth from your existing customer base over the last year versus maybe new customers in the last year? Is there anything that you can quantify for us? I know you had mentioned Epic Games as a new customer.

And on a housekeeping basis, what was the contribution from Nominum in the quarter? Thanks..

So, it's hard to give you a specific on growth from existing customers versus new. I would tell you that we've done a better job over the last couple years in aggregate in selling more to our installed base set of customers. That's fair.

We're working hard to get more of the new customer traction and actually that's much more of a Web Division phenomenon that even though we certainly are acquiring new customers in Media. That is a less customer acquisition intensive kind of division. We've had some notable wins there, obviously, Epic being one.

So, in the Web Division, we've actually made good – we've made good progress. It's been an area that we struggled in in the past. We made very good progress in the second quarter and we're optimistic that some of the go-to-market change that's we made are going to show continued new customer improvements in the back half of the year.

And relative to Nominum, we're not specifically calling out what the revenue contribution is. We've kind of embedded those offerings into our core offerings with our recursive DNS business. So I think that what we said at the time of the acquisition was that the business was a $30 million to $40 million annualized business.

So you can kind of generally think that's roughly the contribution that you're getting on an annual basis..

Thanks, Jim..

Okay. Well, I guess, in closing, I want to again thank everyone for joining us today. We will be presenting at several investor conferences in August and September and details of those can be found on the Investor Relations section of akamai.com, and we wish you all a wonderful evening. Thank you very much..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day..