Ladies and gentlemen, thank you for standing by, and welcome to the Akamai Technologies Q2 2020 Earnings Conference Call. Please be advised today’s conference call is being recorded. I would now like to turn the conference over to your host Mr. Tom Barth, Head of Investor Relations. Sir, you may begin..

Thank you, operator. Good afternoon, everyone, and thank you for joining Akamai’s second quarter 2020 earnings conference call. Speaking today will be Tom Leighton, Akamai’s Chief Executive Officer; and Ed McGowan, Akamai’s Chief Financial Officer.

Before we get started, please note that today’s comments include forward-looking statements including statements regarding revenue and earnings guidance.

These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results differ materially from those expressed or implied by such statements. The factors include uncertainty stemming from COVID-19 pandemic and any impact on unexpected geopolitical developments.

Additional information concerning these factors is contained in Akamai’s filings with the SEC, including our Annual Report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking statements included in this call represent the company’s view on July 28, 2020.

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

With that, let me turn the call over to Tom..

Thanks, Tom, and thank you all for joining us today. I’m pleased to report that Akamai achieved excellent results in the second quarter. Revenue was $795 million, up 13% year-over-year and up 14% in constant currency. Non-GAAP operating margin was 32%, up 3 points over Q2 of last year.

And non-GAAP EPS was $1.38 per diluted share, up 29% year-over-year and up 30% in constant currency. These very strong results were driven by a continuation of the high traffic levels we’ve seen since the onset of the pandemic, very strong demand for our Cloud Security Solutions and by our ongoing focus on operational efficiency.

Akamai was founded with the vision of enabling the internet to scale, so that it could support millions of enterprises and billions of people everywhere. Our mission has been to make all digital experiences be fast, reliable, and secure, a mission that is especially important now amid a devastating pandemic.

In our 22-year history as a company, there’s never been a time when Akamai’s importance and value to daily life has been more evident.

Due to the incredible work of our highly talented employees, we believe that Akamai has become an indispensable part of the internet, supporting remote work, home entertainment, the learning online banking, home deliveries, logistics, security systems, and commercial transactions of all kinds, for billions of people around the world as they cope with a pandemic.

The Akamai Intelligent Edge Platform has grown to include over 300,000 servers in over 4,000 locations and nearly 1,500 network partners at the edge of the internet. The edge is where the end users are and where the content and applications need to be.

The edge is where connected devices and the internet of things are located where 5G networks will become pervasive and increasingly where security needs to be to stop the many distributed attacks whose size and sophistication continued to increase.

4,000 locations spanning 135 countries is a powerful offering for global customers and goes far beyond the deployments of other CDNs, even if you were to somehow put them all together.

Our unique edge platform has provided enormous capacity to meet the unprecedented demand due to the impact of the pandemic, the launch of several OTT services and the release of numerous electronic games. Peak traffic on the Akamai platform exceeded 100 terabits per second every day in the second quarter. That’s a lot of traffic.

Of course, many CDNs claim to have lots of capacity, but none get close to Akamai when it comes to the actual delivery of content. As a result of our unparalleled scale and industry-leading performance and reliability, Akamai gained traffic share in Q2, on both an overall basis and at several of the world’s largest media companies.

Akamai now works with more than 220 of the world’s largest OTT and broadcasting companies, as well as with 24 of the world’s 25 most popular video game publishers. The enormous capacity of our unique edge platform has also enabled Akamai to defend the world’s most important enterprises against the world’s largest and most sophisticated attacks.

The size and sophistication of attacks has risen dramatically since the pandemic began. As threat actors take advantage of the distraction and vulnerabilities created by employees working remotely. Data from our Enterprise Threat Protector service shows that employee visits to sites with malware rose nearly five-fold in Q2.

And just last month we defended a major bank and a major internet service provider against two of the largest attacks ever seen. In Q2, we released our new and highly innovative Akamai Page Integrity Manager, which is designed to protect websites and end users from malware infected content that resides on third-party sites.

Nearly half of the content on a typical website originates from third-parties and attackers are embedding malware in this content to steal user’s credit cards and other personal data. Page Integrity Manager provides visibility and intelligence to help organizations stay ahead of this rapidly growing attack.

And it has received strong positive feedback from early adopters. The well over 2000 customers who use our web application firewall products are perfect candidates for this new solution. Theft of login credentials is another growing problem that customers increasingly seek our help in stopping.

We blocked more than 53 billion credential abuse attempts last quarter, more than four times the number we saw in Q2 of last year. This increase is one reason why our Bot Manager service is now used by more than 600 of the world’s major enterprises.

Overall, Q2 revenue from our Cloud Security Solutions grew by 28% year-over-year in constant currency and achieved $1 billion run rate on an annualized basis. This is an important milestone that’s been reached by only a handful of cybersecurity businesses.

Our Cloud Security Solutions are now relied upon by thousands of enterprises, including 30 of the world’s top 35 banks, 17 of the world’s top 20 e-commerce sites, 8 of the world’s top 10 asset managers and the majority of the world’s largest airlines, hotels, insurance firms, and consumer goods companies.

The strong demand we saw in Q2 for our security and media services, more than offset the reduced revenue growth we saw from sectors of the economy that have been hit hardest by the pandemic, namely travel, hospitality [Technical Difficulty] by the pandemic.

That’s one of many reasons why Akamai customer loyalty has remained very high and that our churn rate in the quarter stayed below 1% of annualized revenue. As we’ve grown our business over the last several years, we’ve worked hard to improve our operating efficiency and profitability.

As a result, we were especially pleased to see our operating margins exceed our target of 30% in Q2. And also to see our non-GAAP earnings per share reach a $1.38 more than double what we achieved three years ago.

Our profitability and cash generation is important, because it gives us the financial fire power to continue to invest in innovation, network capacity, go-to-market capabilities and world-class talent to fuel our future growth.

Before turning the call over to Ed, I want to thank our nearly 8,000 employees for their very hard work on behalf of our many customers and the billions of internet users around the world.

Despite the pandemic, Akamai employees have continued their can do attitude and customer first mindset, enabling our platform to manage more traffic, more web transactions and more cyber attacks than ever before. Their creativity, teamwork, and tenacity are key to what makes Akamai such a unique and strong company.

Now I’ll turn the call over to Ed for more on Q2 and our outlook for the second half.

Ed?.

Thank you, Tom. Today, I plan to review our exceptional Q2 results, discuss the impact COVID-19 is having on our business and provide guidance for Q3 and the full year. As Tom mentioned, we delivered a great quarter on both the top and bottom line.

Q2 revenue was $795 million, up 13% year-over-year or 14% in constant currency, driven by extremely robust traffic growth in media, and another quarter of very strong results from our Cloud Security Solutions. Revenue from our Media and Carrier Division was $390 million, up 19% year-over-year and 20% in constant currency.

The outstanding performance of our Media and Carrier Division was a result of very strong traffic growth in OTT video, gaming and software downloads. This was a continuation of elevated traffic we saw in late March as shelter-in-place orders were issued in most countries around the world.

Revenue from our Internet Platform Customers was $51 million, up 10% over Q2 of last year. Revenue from our Web Division was $404 million, up 7% year-over-year and 8% in constant currency. Revenue growth from web customers was driven once again by security.

Revenue from our Cloud Security Solutions totaled $259 million, up 27% year-over-year and 28% in constant currency. Cloud security revenue represented 33% of total revenue in the quarter, compared to 29% in the same quarter a year ago.

It is worth noting that approximately $7 million of security revenue in Q2 came from one-time license sales to several carrier customers. And we do not expect to see licensed sales at this level in Q3. Moving on to revenue by geography. International revenue was $351 million, up 22% year-over-year or 25% in constant currency.

We are very pleased with our strong international performance, especially in APJ and Latin America. Foreign exchange fluctuations had a negative $1 million impact to revenue on a sequential basis and had a negative $8 million impact on a year-over-year basis.

Sales in our international markets represented 44% of total revenue in Q2, up 3 points from Q2 2019 and consistent with Q1 levels. Revenue from our U.S. market was $444 million, up 6% year-over-year. Moving now to costs. Cash gross margin was 77% consistent with Q1 levels.

GAAP gross margin, which includes both depreciation and stock-based compensation was 65%, also consistent with Q1 levels. Non-GAAP cash operating expenses were $253 million in line with expectations. Adjusted EBITDA was $355 million, up $29 million from Q1 and up $63 million or 21% from Q2 2019.

Our adjusted EBITDA margin was 45%, up 2 points from Q1 and up 3 points from Q2 2019. Non-GAAP operating income was $258 million, up $29 million from Q1 levels and up $54 million or 26% from the same period last year. Non-GAAP operating margin was 32%, up 2 points from Q1 levels and up 3 points from Q2 of last year.

Capital expenditures in Q2, excluding equity compensation and capitalized interest, were $196 million in line with our guidance range as we began to catch up on supply chain and travel disruptions that impacted our network build out in Q1. Moving on to earnings.

GAAP net income for the second quarter was $162 million or $0.98 of earnings per diluted share. Non-GAAP net income was $227 million or $1.38 of earnings per diluted share, up 29% year-over-year, up 30% in constant currency and $0.14 above the high end of our guidance range.

As Q2 results really demonstrated the leverage of our platform and operating model. Taxes included in our non-GAAP earnings were $38 million based on a Q2 effective tax rate of approximately 14%. Now I’ll turn to some balance sheet items. We continue to believe that our balance sheet is very strong.

As of June 30, our cash, cash equivalents and marketable securities totaled $2.4 billion. During the second quarter, we spent $27 million to repurchase shares, buying back approximately 300,000 shares. We have approximately $658 million remaining on our previously announced share repurchase authorization.

We plan to continue to leverage our share buyback program to offset dilution resulting from equity compensation over time. In summary, we’re very pleased with our performance in the second quarter. And before I turn to our Q3 and full year guidance, I wanted to provide you an update on some of the things I discussed last quarter regarding COVID-19.

On our last call, I shared with you details about web verticals that were most impacted by the pandemic during the first quarter, specifically, travel and hospitality and commerce and retail. As you would expect, our customers within the travel and hospitality vertical continue to be challenged in Q2.

And although some retail customers experienced notable increases in e-commerce activity, the uptick was tempered in some cases by bankruptcy and continued disruption to those customers that have a heavier reliance on brick and mortar. Many global brands in both of these verticals rely heavily on Akamai.

We plan to continue to work closely with them as they cope with near-term financial pressures and look beyond into a post COVID-19 world. As a result, Q2 was negatively impacted by approximately $14 million related to a combination of contract restructurings and elevated bad debt reserves. This impact was in line with our expectations.

I’d now like to provide our outlook for Q3 and for full year 2020. For Q3, we are projecting revenue in the range of $760 million to $785 million for up 7% to 11% in constant currency over Q3 2019. The sequential decline in revenue embedded in our Q3 guidance reflects three items. First, we expect the recent actions taken in India to band 59.

Chinese based web applications will negatively impact Q3 revenue by approximately $15 million sequentially. We deliver traffic for approximately 30 of those applications in the second quarter. Our guidance assumes the ban will remain in place for the balance of 2020.

Second, we expect to see our typical seasonal summer traffic moderation, because people begin to spend more time outside in a way from their devices.

And third, we expect internet platform customer revenue to decline by approximately $4 million to $5 million in Q3, primarily due to two of our largest platform customers renewing at new pricing levels in June.

At current spot rates, foreign exchange is expected to have a positive $6 million impact on Q3 revenue compared to Q2 levels and no impact on a year-over-year basis. At these revenue levels, we expect cash gross margins of approximately 76%. Q3 non-GAAP operating expenses are projected to be $249 million to $260 million up slightly from Q2 levels.

Factoring in the cash gross margin and operating expense expectations I just provided. We anticipate Q3 EBITDA margins of approximately 43%. Moving now to depreciation, we expect non-GAAP depreciation expense to be between $99 million to $101 million. We expect non-GAAP operating margin of approximately 30% for Q3.

Moving on to CapEx, we expect to spend approximately $193 million to $203 million, excluding equity compensation in the third quarter. And with the overall revenue and spend configuration, I just outlined, we expect Q3 three non-GAAP EPS in the range of $1.20 to $1.24 or up 8% to 12% in constant currency.

This EPS guidance assumes taxes of approximately $34 million to $35 million based on an estimated quarterly non-GAAP tax rate of approximately 15%. It also reflects a fully diluted share count of approximately 164 million shares.

Moving onto annual guidance, with increased visibility to Q3 and the remainder of the year, I’m very pleased to reinstate guidance for the full year 2020. While, our ranges are a bit wider than usual, we want it to be as transparent as possible about how we see the remainder of the year shaping up.

We currently expect revenue of $3.125 billion to $3.175 billion, which assumes our security business contributes more than $1 billion. Adjusted EBITDA margins of approximately 43%. Non-GAAP operating margins of 30% to 31%. Non-GAAP earnings per diluted share of $50.2 to $5.12. This represents year-over-year growth of 12% to 14%.

This non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 15% and the fully diluted share count of approximately 164 million shares. Finally, full year CapEx is expected to be 22% to 23% of revenue. In summary, we continue to be very pleased with the performance of our business.

We believe our excellent Q2 results demonstrated the profitability of our business model and scalability of our platform, our revenue diversification, deep enterprise customer relationships in our strong balance sheet and cash flow. Thank you. Tom. And I would be happy to take your questions.

Operator?.

[Operator Instructions] Our first question comes from James Breen of William Blair. Your line is open..

Great. Thanks for taking the questions. There’s a couple on the customer side, you talked about a couple of renewals this quarter. Can you just give us a little bit of color into how those contracts work going forward and/or is there any other anticipated renewals in the back half of the year.

And then just commentary around the security side, obviously, it’s a large business and continue to see you continue to grow in the high 20% range. I think a lot of us have anticipated something in the lower 20% of the beginning of the year.

So can you just talk about some of the products there, maybe some of the new products that are driving it and then just give a little more color on the overall picture? Thanks..

Hey, Jim. This is Ed. I’ll take the first one and then Tom, you can take the second one. So in terms of the renewals, in terms of major renewals for the back half of the year, I don’t – we don’t expect anything large for the internet platform customers. There will be no more renewals this year and in terms of the contracts pretty standard.

The good news, I guess, is a couple of them are no longer term in nature, but not all of the – we will have some renewals next year, but very pleased with how those contracts turned out.

Tom?.

Yes. The revenue and security was driven by our flagship services, Kona Site Defender, which provides web application firewall capabilities, stops the attackers from taking over a website or corrupting it or stealing data. There are [indiscernible] service capabilities. That stops the big attacks. You have Bot Manager doing extremely well.

And that keeps adversaries from taking over accounts from stealing customer information. We also have a very strong security services business, and those folks have been very busy, as you can imagine, with major IT shops now trying to support, remote work and work from home on a sudden basis, where they really need security help.

Closely related, but a smaller business is our Enterprise Security offerings. And we do have new capabilities there. We now have a Secure Web Gateway that’s available. And coming up later this year, multifactor authentication. We also have a new service I talked about called Page Integrity Manager.

And this works the – one of the latest attack vectors that’s becoming pretty rampant out there where the adversary puts malware into a third-party side or third-party code that’s used by the primary site.

And what happens there is the user comes to the main site and the main site links to third parties for their apps and other things that are useful, usually. And the browser follows those links. And before you know what the browser is getting malware from one of those third-party sites.

And that malware is designed to cause the browser to give up the user’s personal information like their credit card. There are some very famous breaches there resulting in large fines and Page Integrity Manager stops that and notifies our customer that they got a problem in terms of where they’re linking for their third-party content.

Also we have Akamai Identity Cloud, which provides capabilities around the user and their profile and history, making sure that user data stays safe and compliant with local regulations. So really a lot going on in our security business, and we’re seeing very strong growth there, obviously..

Great. Thank you..

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

Great. Thank you so much and congrats on all the success. Tom, I wanted to ask you about the Edge Computing opportunity.

There’s a lot of buzz out there around the Edge and what some are the use – I’d be curious to hear just from you, what are some of the use cases that convince you it’s very real? Over what time line does it materialize? And how is Akamai positioned to win in capturing this?.

Yes. We’re the largest provider of edge computing services by far. We have been doing it for close to 20 years. And the idea that this is how somehow something new is just not true.

It’s – most of our customers are using our edge computing capabilities for a variety of applications to A, B testing for how users like their site, to do things locally about what content actually gets delivered to the user, what ads get delivered to the user. Keeping track of how a user goes through a site.

The security services use an extensive compute power at the Edge. We don’t break it out as a separate revenue item, but if you use the definitions, we see that a lot of folks in the analyst community are using, I would say already, it’s over a $2 billion business for us. We don’t report it that way.

But most of our customers are using the computing in some form or another, and also when it comes to Edge, I think this is really important. We’ve been talking about the Edge and the importance of being at the Edge really again, 20 years, and recently it’s become popular as a buzzword.

And that’s because the Edge is really important, but to be at the Edge, that means you got to be in thousands of places, close to the users, really close, and we’re in 4,000 points of presence now.

A lot of the other CDNs, who talk about doing Edge or Edge Computing, maybe they’re in a couple of dozen cloud core data centers, which is really not the Edge. In fact, you could take probably about maybe even all of our CDN competitors put them together and they don’t get anywhere close to the Edge presence that Akamai has.

And what’s the future of Edge Computing, I think it’s very large, you look at 5G coming and that’s going to utilize a lot of capabilities at the Edge. With 5G, you get a lot more devices connected. IoT becomes much more possible. You have much lower latencies in the last mile.

And then that means it’s even more important to do the computer delivery from the last mile. If you’ve got a huge latency in the last mile, okay, the latency you’ve introduced going from the Edge of the core is not as bad, but you really now it becomes noticeable with 5G. Also you have a lot more bandwidth to 5G.

So I think that’s an important driver, a future revenue for Akamai. Also with IoT, we already have an IoT Edge Connect platform that our customers are using. It’s unique among CDNs. It uses different protocols.

Not ACTP, by and large, which is what powers a lot of the web today, but MQTT, it uses the pub sub model, which is a whole different communication paradigm. That’s a lot more efficient. And again, users not only compute at the Edge, but data stored at edge, key value pairs and databases at the Edge. And Akamai is in an unique position to provide that.

But again, I just want to be really clear Edge Computing is not a new phenomenon. It’s got recent buzz with a couple of IPOs on the street, but we’ve been doing that at scale for a long, long time..

Thank you so much, Tom. That’s it for me and congrats again..

Thank you..

Thank you. Our next question comes from Sterling Auty of JP Morgan. Your line is open..

Yes, thanks. Hi, guys.

So, Ed, you kind of give us a couple of the parameters that will impact Q3, but as I think about the full year guidance, how have you layered in perhaps some of the positive impacts that we would see from a more full rollout of some of the new OTT solutions, as well as the presidential election?.

Hey, Sterling, thanks for the question. So I’ll start with the presidential election. I’d say, this year – coming into the year, we’re expecting probably a bit more robust debate scheduled, where a lot of competitors going out to the democratic seat that sort of ended quickly. So I’d say it’s probably going to be a bit more muted this year.

Just because there – I think there’s only three debates scheduled, it’s not as much activity as I would have expected at this time. So nothing outside of a little bit of revenue associated with that. So nothing really significant. On the OTT launches, obviously, we just had one go a couple of weeks ago.

It’s still early days and I don’t want to go in May. So still pretty early there. I think we’ve got, you saw the media revenue, obviously, very, very strong expect to see another strong quarter. Despite the fact that I talked a bit about the dynamics in Q3 and for the rest of the year with those applications in India being banned.

But we’re seeing good growth there and expect that to continue into the balance of the year..

All right, great. And then one follow-up. How should we think about the contract restructurings, and maybe in particular, excuse me, into the e-commerce vertical in the back half of the year, maybe in light of a question that I’m getting a lot right now is, probably not a lot of foot traffic going to the malls.

Could we be setup for just a massive e-commerce holiday season this year and traditionally that’s been a big benefit for Akamai..

Yes. Good question. So you can imagine, there’s an awful lot of debate internally on that. What I would say with contract restructurings, I mentioned, that we had about a $14 million a headwind here in Q2. Most of that was in travel, retail we did see about 10 bankruptcies roughly this quarter.

And you look at the economic data, it’s mixed, there are some, some numbers that are doing better than others. So as we go and look at the Q4, you’ve seen, we’ve given quite a wide range, and if you do some math on kind of the mid points, it’s kind of suggests a bit softer than we saw last year.

Maybe we go to the high end, it could be a bit better, but it’s still tougher to call.

I will say, when I talked about the web vertical or web division, excuse me, last quarter, I expected it to be flat to down a bit, probably a little bit better than I expected in Q2, mainly because we’ve seen a lot of our customers, both in retail and travel be able to access the capital markets and stabilize their businesses a bit.

But I still think it’s going to be pretty rocky going into Q4 as we get into the fall season, who knows what happens with the pandemic. But the thesis is correct. There’s not a lot of people going to the stores, you could see a lot of online retail activity. We see a bit of a, kind of a mixed bag.

We see some that are doing much better than expected, in terms of traffic growth and others that are kind of in line. And you’ve got some that are still struggling with just their legacy business and in financial difficulty. So we’ll see, but that’s why we provided a wide range.

There’s a couple of different ways, different outcomes that could happen here in Q4..

Got it. Thank you..

Thank you. Our next question comes from Colby Synesael of Cowen. Your line is open..

Great, thank you. Two questions if I may. I guess, for Ed, I just wanted to follow-up on Jim’s question, regarding security. And Tom, appreciate the various sub-segments that you broke out.

Can you help us just a bucket from a revenue perspective, some of the bigger drivers maybe either in dollars or percentage as we start to focus more on that security business. I think it’d be helpful just to give it more color on where the revenue is actually coming from. And then secondly, you guys haven’t really done any tuck in M&A in some time.

Is that just a function of a disconnect with valuations? Or is it something else and trying to get a sense, if we should expect to see that kind of start to come back into the full, maybe the next few quarters. Thank you..

Yes, sure. So as far as security goes, I think it’s a bit more of the same. We saw good strength with Kona Site Defender, that’s obviously our largest product and drives the most revenue. We’re starting to see a nice uptick in Prolexic. That was a good surprise for the quarter. Bot Man continues to be probably our fastest growing product.

Security services are going along pretty well. So it’s really sort of strength across the board. And I think as I look into the future, Tom talked a bit about Page Integrity. That’s the product that we’re really excited about. When you think about the KSD base as really good customer base to go and upsell that.

We’re hoping that, that has very similar characteristics of Bot Man, which is a nice addition on to Kona Site Defender. And Bot Man got to 100 million pretty quickly. Hopefully we can see the same with Page Integrity..

Does Kona, for example, 50% of revenue, is it 60% of revenue of the security business, any color there?.

So we haven’t broken it out yet. I’d say it is the largest percentage. We’ve got four products over 100 million. I don’t know that it’s over 50%, but it’s probably close to that. That’s a reasonable for proxy..

And on the M&A question, we’re continuing our efforts there, at the same pace is always. But we’re also very disciplined buyers. And when you’re in the midst of a pandemic, it is a little harder to conduct diligence. And if we were to close an acquisition, maybe a little harder to integrate it with the travel restrictions we have now.

So probably that’s a damper. And I wouldn’t say, there’s huge bargains that have been created as a result of the pandemic, at least not yet. And we’re very careful about what we buy to make sure it makes good financial sense, but we’re continuing with our efforts there full speed ahead..

Great. Thank you..

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

Hi, this is Josh Baer on for Keith. Just wondering, if there’s any way to quantify the benefit to OpEx in Q2 and maybe in Q3 from more limited travel, entertainment and expenses related to COVID.

And then more broadly, as it relates to margins, how should investors think about margin expansion in the years to come beyond the 30% to 31% for this year?.

Yes, sure. I’ll take the first part and say a few words on the second part. Maybe Tom, you can chime in on that as well. In terms of the travel, it’s not a huge expenditure for us, using a couple million dollars a month. So we did see obviously a lot less travel this quarter. And we’ll see a little bit in Q3.

So not a huge amount of savings there, but that did help operating margins. I think what really benefited the operating margin line was, obviously, extremely strong traffic, running the network at, probably hotter than we’d like. That’s why you see us building out a lot more CapEx.

The network performed fantastically well, but you do want to make sure that you’ve got a lot more capacity to be able to handle big spikes and take advantage of opportunities when other competitors may have some struggles and it’s good to have that extra capacity. But when you do run the network, how do you see the drop to the operating line.

In terms of margins, we’ve said in the past that we plan on operating at 30%, we want to continue to make investments in the business. We added a couple of hundred heads this quarter, and in the areas of research and development product and go to market, we think there’s still a lot of room for growth here.

So we want to make sure we balance that appropriately..

Got it. Thanks..

Thank you. Our next question comes from James Fish of Piper Sandler. Your line is open..

Well, and appreciate the added color this quarter. I just have one, it’s on web proxy. It’s been in beta and been freely available to some customers out there, given your goodwill.

Why not accelerate the modernization of the product and accelerate the investments and enterprise security to really step on the gas on a high profile area?.

Well, yes, we are working very hard in terms of both product delivery and with a sales effort. And we were very pleased to see substantially increased bookings so far this year. And we very much would like to continue to accelerate the penetration in that business..

Thanks..

Thank you. Our next question comes from Will Power of Baird. Your line is open..

Great. Thanks. Let me – a couple of questions very quickly – here. I wonder if you could just comment broadly on what you’re seeing in terms of enterprise sales cycles, broader pipeline, are you continuously benefits from COVID. Or are you starting to see any potential headwinds economic pressures.

And then my second question, just coming back to the media, is there any way to kind of help break apart the sources of upside there, obviously, really strong results.

Any particular outliers between video, gaming, et cetera?.

Yes, this is Tom. I’ll take the first question. I would say, it’s a mixed bag with COVID.

On the one hand, there is a much greater need for our security products, not just enterprise products with remote workforces, but pretty much all the security products because the attack volumes and vectors have increased so much with the threat actors trying to take advantage of the situation. So that’s a good tailwind.

And I think you saw the benefit of that so far this year. On the other hand, sales are a little harder, because you can’t visit customers. Everything is remote now. That said, I think our teams have done a very good job adapting with virtual conferences and meetings. And so I think we’re dealing with that situation very well.

On balance, I think we’re in a much stronger position with our security offers, in terms of the customer’s need for our products. And I think Ed will take the question on media upside..

Yes. So the good news is, it was really strength across a number of areas. I’ll dig into a couple for you. I would say one area in particular that stands out in my mind is gaming.

We saw a ton of gaming activity and so a lot of major publishers do some smart things, including running some promotions to promote their games and offer attractive incentives for folks to leverage their portfolio. During the time that you’ve got people locked up in a pandemic.

So we saw not only just a more robust game release quarter, we just saw some really smart things by the game publishers and that drove a tremendous amount of traffic. So that was an area of particular strength. And then obviously no surprise video, OTT video from a lot of the existing providers, some of the newer providers added as well.

And that was strength pretty much across the board. It was both here in the U.S. and internationally. Our internet platforms obviously provided some nice upside for the quarter. That’s been a theme we’ve talked about a lot, they’ve kind of been in that stabilization in the $45 million range.

And every once in a while, we get some upside from those customers as well. And then also social media. We saw – we carry a number of social media platforms and it’s not much of a surprise that people are locked up in their homes and not traveling and going out to dinner and things like that spending more time online, including social media.

So the good news is pretty much across the game, but if I had to point out one thing in particular that jumped out will be gaming..

Okay. That’s great. Thank you..

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

Hi. This is Caroline on for Heather. And thank you for taking my question. My first one is really just on the security business. I was wondering if you could give more color on what is the split between new business from the existing customers versus like a completely new Akamai customers.

And then if you are a new to Akamai, is there an opportunity to set upsell a CDN and other products to that security customer. And then I just have a quick follow-up..

Sure. No problem. So obviously, our business being a recurring revenue business, you don’t get a ton of revenue right off of that, when you sign up a new customer. So the majority of the business does come from our existing customer base right now about 59% of our customers buy a security product, which is up couple of points from last quarter.

And then about 31% of our customer base is buying more than one security product. So that’s going to be a theme in terms of future growth that, whether it’s your ad, you buy Kona Site Defender, you’re adding Page Integrity or Bot Management or Security Services.

So I’d say for the certainly for the near-term seeing most of our growth coming from our existing customers is where we’re going to see the majority of the growth is that customers take on more security products.

And then as far as when you sign up as a new customer, we do tend to sell a lot of protect and perform bundle, so it’s not unusual to see somebody come in as both a security customer and as a CDN customer, but throughout our history, if you look at our strategy has always been to focus on the largest web properties, largest banks, largest travel, retail customers, et cetera.

And to grow those accounts over time. We talk about how we’ve worked with some of our customers that have been challenged with COVID and restructuring contracts and offering some financial assistance that will pay off in the long run. And that’s always been our strategy.

So our focus on acquiring new customers that have a lot of growth opportunity, this has paid off over the last 20 years. And that’s where we’re going to continue to focus..

Got it. And then – sorry, go ahead..

I said you had a second question..

Yes. So the other one is just on OTT, you talked about how you’re continuing to drive share gains. And last quarter, I remember you also said that as well. So I’m kind of curious, like what exactly is, kind of enabling you guys to gain more share in traffic.

Is there something on the competitors? Or is it more so your guys is doing the product innovation side..

Yeah. I’d say there’s probably three key areas. The first one is around performance. So what a lot of the OTT providers or really any large scale media customer will do is they’ll have their own set of performance metrics. And pretty much now most large providers of media content will split with CDNs. And usually it’s the one with the best quality wins.

Pricing is pretty efficient in the market. So it’s not as much about price anymore. Occasionally, you’ll see that, but it’s really about performance. That’s the one thing. I’d say the other thing is around the capacity that you have outside of the U.S. in particular, we tend to do much better in places that are harder to deliver.

And then I say the last thing is just having, scale is another area that depending on the type of application, you can see, real big peak demands, whether that’s in gaming or live sporting events and such like that. So having capacity in the right places, the best performance and having the scale is really what drives the share gains..

Got it. Thank you so much..

Thank you. Our next question comes from Amit Daryanani of Evercore. Your line is open..

Thanks for taking my question, guys. I have a two as well. First off, I guess when I think about the revenue performance this quarter on the CDN side, especially. I’m curious, did you see a normal drop-off in usage patterns in the month of June, the summer season kicked off.

I’m asking that broadly, because given the fact that shelter in place remains broadly across the globe.

Do you think that Q3 could not see a seasonal drop, because we’re all limited and not able to travel at this point?.

Yes. So you do start to see a little bit of traffic, not accelerating as much, I would say, probably the best way to put it. Coming into the pandemic, something like that really accelerates a trend. So you saw a lot more internet users now adopting e-commerce, adopting – watching video online, cord cutting, et cetera.

So we saw a nice bump from COVID in the pandemic, and we’ve seen that sustained. I’d say traffic was elevated probably longer than we had expected. We’ve never been through one of these, so it’s hard to always call it.

But in terms of normal seasonality, I would expect to see, as the summer months come on, we do expect to see traffic certainly not grow as quickly as we saw the last quarter, but it’ll still be strong. But I would expect some seasonality that’s reflected in our guide..

Got it.

And then if I can just follow-up, how do we think about the security business performing in the back half of the year relative to the top line expectations you’ve given, especially some of the commentary you just had on the new customer part of the equation over here?.

Yes, sure. So one thing I did call out on the call was that we had some license revenue. We do sell every quarter a couple million dollars of license, some of our Nominum products to our carrier business – our target customers, excuse me. And this quarter, in particular, was a bit unusual, just that we had that sort of performance.

I talked about $7 million in the quarter. Typically, you see that purchase behavior in the back half of the year in Q4. It’s a little bit unusual to see that in Q2 or Q3. So I just wanted to call that out. It’s something we want to take into consideration.

And also, as you look at sort of year-over-year growth rates, Q4 of last year, we had a massive sequential growth quarter-over-quarter. I think we were up about $22 million sequentially. So just kind of keep that in mind as you’re doing your modeling, think about kind of your year-over-year growth. We talked about being over $1 billion.

At the beginning of the year when we gave guidance, we talked about doing $1 billion of revenue in security. So this implies sort of low 20% growth rate, which is better than we had expected coming into the year. And then again, as far as new customers are concerned, you’ve got a base this big.

The revenue growth is going to come from that existing customer base. We continue to add new customers every quarter, but it won’t make a material impact on the year. That happens over time.

So it’s – we continue to add customers over time, it will be more of an impact on the overall growth, but it’s going to be the existing customers that really drive the growth..

Got it. Thank you very much..

Thank you. Our next question comes from Mark Mahaney of RBC. Your line is open..

Okay, thanks. Two questions, then. Sports has been, I guess, a non-event. What are you assuming? What is a reasonable assumption for what kind of traffic you could get from sports? And I guess you’ve had such strong traffic the last couple of months because we’ve all been at home but without sports.

And so as sports, hopefully, it comes back and MLB, NHL, et cetera, how material could that be like what if we just learned over the last couple of months, you can have really strong traffic growth without any sports at all? And then the other thing I wanted to ask is you talked about these apps banned in India.

One of those apps could be banned in the U.S. Would that be a similarly material event for you if that app were to be banned in the U.S.? Thank you..

Hey Mark, yes, thanks for the question. I’ll take the second one first, and I’ll talk about sports right after. So the way to think about U.S., if the U.S. were to do something very similar to what happened in India, the number of Internet users in India is much greater than the U.S., it’s about 3 times the overall population.

So you’ll have fewer users, assuming kind of like-for-like. And then also, we tend to have a bit more competition in the U.S. We tend to get outsized share in India. So I would not expect it to be as material. It would be an impact we do for those 30 apps that I talked about. We deliver traffic here in the U.S., but it would not be as material.

In terms of sports, so yes, you’re right. We really haven’t had much sports. We had a little bit of the premier league in the Bundesliga over in Europe.

One thing I was looking for was to see – where we see a much different traffic profile now that you don’t have spans in the stands? And while we have a limited subset, we get a couple of weeks now of major – a week of Major League Baseball and a couple of soccer leagues.

We haven’t seen anything that suggests that the traffic patterns are materially different. I’d say it’s probably more normal and in line with what I would normally expect. So still early, we’ve got the NHL, NBA kicking off here at the end of the week. And then hopefully, the NFL coming on and Champions League and IPL and a bunch of other things.

Now, I talked in the last call that for us, sports in general, is about a little over 1% of our revenue. Now if you get that all in a concentrated period of time, that could add some decent revenue. Still, like I said, early days to see how the behavior changes.

I’ve watched a number of baseball games and seeing it without fans is not as exciting personally. But hopefully, it continues to drive a lot of folks to watch online. But I think about it in that sort of perspective, about over the course of a year, a little over 1% of revenue comes from live sports.

Certainly, the bigger ones being NFL, Champions League, IPL, some of the other sports, not quite as big..

Okay. Thanks a lot, Ed..

Thank you. Our next question comes from Tim Horan of Oppenheimer. Your line is open..

Thanks, guys. Tom, back to the Edge. In the past, I think you were a little skeptical about being able to do kind of gaming as a cloud service just because of the cost of the compute and the latency. Maybe just any more updates on what you’re seeing from that perspective.

And maybe any other applications that you think are perfect for your infrastructure that’s already in place that are new or more Edge based..

Yes. I don’t think there’s any change in the gaming landscape, if anything. I think the thesis that it is less efficient to do all the compute in the cloud probably getting proved out. Companies have been working on that for over a decade. Now we do a lot of business with the gaming companies. So we’re a go-to player for them to distribute software.

And there are things that we can do to optimize the performance as well. But I think doing all the compute in the cloud, it’s not as efficient, just economically.

With Edge Computing applications, pretty much all of our customers’ applications that run on Akamai are doing some kinds of compute, personalization, the selection of the content that goes to the end user, the format it goes in, the images, which image goes, depends on the device, the connectivity in the last mile, all optimized for performance.

So it’s pervasive today, I would say, Edge Computing on our platform, which is a reason why we don’t separate it out. I don’t think you can. And also on the Security side, we are inspecting the details of every single request that comes in and also the content that goes back out.

We’re placing software on the client for all sorts of purposes, most recently for Page Integrity Manager.

As you go to a website that’s protected by Page Integrity Manager, we have our script on the client itself that is looking at everything the browser is being asked to do, to see – for example, is it being asked to access your credit card or stuff that we believe is personal information and send it to a place that we think is bad.

And I can’t tell you how much we’ve already discovered is going on out there. So I would say Edge Computing is just pervasive today. And the Edge being our edge servers in 4,000 locations, which is the real edge. And also on the client, we’re doing a lot of computing there as well. And I do think that is the future.

And as you have richer applications, there’s more use of that. I think the big opportunity going forward is in the IoT arena. I think 5G helps to enable that. And as I mentioned before, that’s a whole different paradigm, uses different protocols and different structures like the pub-sub model and data stores.

And again, being at the Edge helps a lot to reduce the latencies there. Edge Computing is not a new phenomenon. And I think that’s really important to understand..

And just a quick follow-up on security. Ed, I’m assuming the vast, vast majority of Security revenue is kind of recurring or not usage based, but just any clarification there. And can you give us some color, how does it compare to your gross margins of Security versus your consolidated gross margins? Thank you..

Yes, sure. So I’d say the majority is recurring. There is – as I talked about, we do some bundling. So you have a bundle of Protect and Perform. So that can drive a little bit of variability in usage. Sometimes you see that kind of play out in Q4 to Q1, but the majority is recurring in nature. And then your second question was on gross margins. Yes.

So the gross margin on security would be greater than what you would typically see on CDN. And it’s an interesting debate, right, because you’re using the same servers that are delivering a video to one home might be blocking an attack from another home.

And it just kind of shows the power of the model and the leverage that we have that as we build out this Edge, we can build on new capabilities on top. And those incremental capabilities have much higher incremental gross margin and Security certainly falls into that category..

Thank you..

Thank you. Our next question comes from Rishi Jaluria of D.A. Davidson. Your line is open..

Hi guys, this is Hannah Rudoff on for Rishi. Thanks for taking my question. Just one for me here.

Could you talk about how your customer conversations, especially around Enterprise Security Solutions have shifted from when you last talked about three months ago, especially organizations have maybe moved out of triage mode at this point and are thinking more about medium and long-term planning?.

Yes. I think at a high level, the conversations are very similar. But with much more urgency in some cases, I can just give you an anecdote with a conversation with a CEO of a very large company. And the CEO was both happy and worried about how quickly his IT team had enabled the workforce to be remote.

And he was happy because within a week, the entire workforce was remote because basically a shelter in place rules are put in place. On the other hand, he was worried because he always wanted a remote workforce, but was always told by his Chief Security Officer it would take two years to make it be secure.

And all of a sudden, their workforce is remote in a week. And that led to a really good conversation about, okay, how can we really secure it for them. And that’s where our Enterprise Application Access product and our Zero Trust suite of solutions really makes a big difference. It’s a service on our platform.

It does it security at the application layer, not at the network layer. So never mind the pandemic and remote work, it’s just a lot more secure to start with. But now you’re in a position where very quickly we can enable them to have security for a remote workforce that employees can only access apps that they’re allowed to.

And even then, the employee device can’t directly touch the app or the data, it just touches us. And we’re scouring every communication to make sure that malware isn’t being spread and data is not being exfiltrated. And of course, that’s not possible with the traditional approach.

So I think the COVID situation with remote work has certainly enhanced the interest in EAA. The attack rising in general have enhanced interest in Akamai Security Solutions. And of course, you’re right that there’s a lot of scrambling going on out there. And so it is a little more complicated in terms of the sales process.

But on balance, I would say we’re doing better than we expected. And on balance, there’s more tailwinds associated with the pandemic for our business because customers need our help even more than before..

Great, super helpful. Thank you..

Thank you. Our next question comes from Lee Krowl of B. Riley FBR. Your line is open..

Great. Thanks for taking my questions, and congrats on a very solid quarter. Two questions. First, on the impact of the Indian app ban. You quantified the impact, a little bit more detail.

I’m curious if that makes an assumption for a backfill from apps that are still available to consumers as an offset? Or is that just a complete loss of business? And then secondly, can you just maybe talk about CapEx leverage? I assume as we start to lap some of these OTT launches from a year-over-year perspective, is there an ability to see leverage now that you’ve built in some of the capacity? Or is there a working assumption that as we continue to see proliferation of these products, that CapEx will need to kind of match the growth in traffic?.

Yes, sure. So in terms of the India ban, we assume that there’s a complete loss there. Obviously, there’s – users move to other applications to the extent that there’s other options in the market. We’re obviously having conversations with all those customers. In some cases, we were – some of them are customers now, some of them we’re trying to acquire.

So yes, we’re just assuming that there’s really no material impact right now just because it’s an unknown. We haven’t seen any major shift or anything like that. That’s just sort of traffic has disappeared for lack of a better term. This is something we’ve never dealt with before. So we’re kind of in unchartered territory.

So what we did is just wanted to call it out for you guys. And so you could think about it in your models because, obviously, while the Q2 guidance is very, very strong and above where the consensus was, it is a step down, and that is a material reason why. Obviously, if that traffic comes back, that would be great.

I wouldn’t expect it to all come back at once. I think it’d be some kind of a ramp. But to the extent that other players in the market pick up some of this behavior or some of the various things that folks are doing with those apps, we’re going to be right there trying to acquire those customers.

And with our scale and capacity and performance, we should be in great shape to get it. But there’s no assumption that there’s a shift from one to another. As far as CapEx goes, this quarter should be the high watermark for the year. Obviously, we weren’t expecting a pandemic starting off the year.

Or Tom had mentioned doing 100 terabits every day of the quarter. Obviously, it came with a lot more revenue. So what we’re doing now is just kind of retooling and building up more capacity just in anticipation that there could be a second wave of COVID here and maybe another big splice. We want to be prepared for that.

In our capacity planning, we’re going to assume that, that traffic comes back in India. We’re not making the assumption here on the revenue side. If we’re wrong, we’ll grow into it. But as I think about sort of a normal CapEx range, the network CapEx is really wide focused on.

I know you kind of look at that headline number and I sort of look at the software cap being in sort of that 7% to 8% range. We have got a full gross expense in the P&L for R&D. So R&D running at 13%, 14% of revenue is about the right way to look at it. I think that’s a healthy spend.

And then if you look at network CapEx in the 7% to 10% range, it’s kind of a normal range with this year, obviously, being closer to 14% because of the pandemic. I think this is probably the right way to think about it, to the extent that we see the opportunity for significant growth or accelerated core cutting or whatever.

We’re going to go after it pretty aggressively..

Got it. Thank you for the details..

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

[Indiscernible] surge in Zero Trust bookings, forgive me if I missed it, but just any comparable comment this quarter in terms of bookings on Zero Trust. And then the other related to Security as well. I think you had said a year ago that the demand for security services was about 1,000 users and a bit over $100 million in revenue.

Is there any update there?.

I missed the first part of the question, but I think it had to do with our enterprise Zero Trust Solutions, and we had a very strong quarter there. We don’t break out the individual numbers for that solution set yet, but we saw very strong growth and we were very pleased with that.

With the Managed Security Services, as you can imagine, this is a time when our customers need us more than ever with that. You have the range of attacks increasing, their sophistication, and now our customers really busy trying to figure out how to securely support a remote workforce.

So very pleased with the results there and the continued very strong growth of our Security Solutions..

Got it, thank you..

Thank you. Our next question comes from Brandon Nispel of KeyBanc Capital. Your line is open..

Great. Thank you for taking the questions. I wanted to get you guys’ thoughts on the CDN business. That business hasn’t grown as fast in over five years and really exceeding where it has the last couple of years.

I guess, is it your view that growth can get – be sustained at these levels? It doesn’t seem like it from your guidance, but how should we think about the target growth rate for the CDN business over the next, call it, 18 to 36 months? Secondly, you made it a point, Ed, to call the balance sheet quick asset for the company.

I was hoping you could outline some of your capital allocation priorities and share your thoughts on potentially any return to capital to shareholders beyond the share repurchase program, which you guys didn’t repurchase that many shares this quarter. But hoping you could share some more details. Thanks..

Sure. I’ll take a step. So just in terms of the CDN business, on several calls ago, we were asked the question of what would it take to get the CDN business to get back to a healthy growth rate like what we have today. I think, well, no one would have predicted the pandemic would be the reason that, that would happen.

I think to sort of kind of step back behind that, you think what behavior did it drive, it was significant adoption of Internet, video, gaming, e-commerce, online banking, just people using the Internet a lot more. And I would say that to the extent that anything drives that acceleration of any of those trends, we stand to gain.

And I think the CDN business is going to always be a little bit lumpy in terms of its growth rate. I don’t think we could sort of go up into the right, just given the dynamics in the business. We obviously have several verticals now that are challenged, travel and hospitality and retail, which has been kind of a challenged vertical for a while.

When you get into the high-volume CDN business, you always have to deal with volume and pricing. I’ve been with the company for 20 years, and that sort of rule has been in place since I started. That as companies grow volumes, unit prices go down.

Our economics work the same way with our vendors and the way we build our network and design our technology to drive costs out. So you always have a little bit of lumpiness.

But really, what you’d have to look at is what are some of the macro trends? How successful are these OTT offerings? What’s the next big trend in something like gaming? Do you get stabilization in your retail and travel vertical? So it’s possible.

I think this was a good test case in showing that it is possible to get back to a healthy growth rate in CDN. But there’s a lot of things to consider with different dynamics, some that are out of our control. The other question was on capital allocation. Yes. So we don’t – we talk about offsetting dilution. We’ve done that in the past.

And over time, if you look at our share count, opportunistically, we’ve used our share buyback program to reduce the number of shares. Back in 2018, we did a large $750 million buyback. We don’t have any intentions of doing that at this time. But it’s something that we always talk to our Board about and always something that we look at.

But right now, as I said in the prepared remarks, we’re looking at just offsetting dilution over time. And we’d love to be able to find some good strategic acquisitions. We’re always looking. We’re very disciplined buyers, active shoppers.

Valuations in some of the spaces that we’re in, in security, in particular, started to correct a bit as we went into the beginning of the pandemic, but they certainly come out of that probably even a bit more stretched than when we went in.

So we’re going to be patient, look for the right opportunity, but M&A will certainly be an area that we look to utilize our capital that for..

Thank you..

Operator, we have time for one more call..

Thank you. Our next question comes from Alex Henderson of Needham & Company. Your line is open..

Hey, thanks for taking my question. This is Roger Boyd on for Alex. Just a quick question on e-commerce. Acknowledging that the broader retail market remains pressured, there’s been a lot of opportunities in that space. I’m just wondering, to the extent Akamai has been able to win new e-commerce logos in the current environment.

And then secondly, given your investments in Botnet and Page Integrity, is it fair to say that is vertical value security a little more than the average customer, and that might be a differentiator for Akamai?.

Yes. So the first one, I didn’t quite catch all the second one, so I’ll ask you to repeat that after I hit the e-commerce question. I think the question was, does this enable us to – does this environment enable us to acquire new customers? Yes, sure. I mean I think it’s an area where we, today, work with many of the large e-commerce customers today.

But certainly, the way I look at it is, as companies are shifting from more brick-and-mortar to online, one of the conversations we’re having with our customers is about that shift and what else, what other products do they need? And how are they planning on making more of a push towards online. So, I think that’s a good trend for us.

And I’d say pretty much every retailer is – get some presence online. But certainly, there are some opportunities there. But for the flip side, there’s also a lot of challenges in that market as well as we’ve talked about.

And I’m sorry, can you just repeat your second question?.

I can answer that. Go ahead. Yes, the second question – with security, that is a huge differentiator for us. We’re the market leader by far with Cloud Security Solutions. And as I mentioned, the vast majority of the world’s biggest e-commerce sites make use of our security solutions.

Today, I would say, in that vertical, sales are led by security, and then delivering acceleration would be an add-on. In fact, we include the basic DSA, Dynamic Site Accelerator services, part of Kona Site Defender. Thought manager is critical today for any commerce site, and we’re really uniquely differentiated with our capabilities there.

So security is very important across not only e-commerce but many verticals today..

That’s perfect, thank you..

Well, again, thank you, Tom and Ed. That wraps up, I think, our questions. So I want to thank everyone for joining us. In closing, we will be presenting at a number of virtual investor conferences and events throughout the rest of the third quarter, and details of those can be found on the Investor Relations section of akamai.com.

Thank you again for joining us. And all of us here at Akamai wish you continued health to you and yours. So have a nice evening..

Thank you. Ladies and gentlemen, this does conclude today’s conference. You may all disconnect. Have a great day..