Akamai Technologies Inc Q1 FY2022 Earnings Call

Good day, and thank you for standing by. Welcome to the First Quarter 2022 Akamai Technologies Earnings Conference Call. I'd now like to hand the conference over to your speaker today, Tom Barth, Head of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining Akamai's first quarter 2022 earnings call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer; and Ed McGowan, Akamai’s Chief Financial Officer. Please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. These factors include any impact from macroeconomic trends, uncertainty stemming from the COVID-19 pandemic, the integration of any acquisitions and any impact from 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 May 3, 2022. Akamai disclaims any obligation to update these statements to reflect new information, future events or circumstances except as required by law. As a reminder, we will be referring to some non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the Investor Relations section at akamai.com. And with that, let me turn the call over to Tom.

Thanks, Tom. And thank you all for joining us today. Our Q1 revenue was $904 million, up 7% year-over-year and up 9% in constant currency. This solid result was driven by the continued rapid growth of our Security and Compute businesses. Q1 non-GAAP operating margin was 30%. Q1 non-GAAP EPS was $1.39 per diluted share, up 1% year-over-year and up 4% in constant currency. As Ed will discuss later, EPS came in at the low end of our guidance range, primarily due to an adverse tax impact of $0.03. Since our last call with you on February 15, we've seen the development of several major global events and financial headwinds. It’s remarkable how quickly the world has changed with the war in Ukraine, the significant strengthening of the U.S. dollar, escalating inflation, increasing concerns about a recession and a moderation of internet traffic growth, as many countries remove mask mandates. Since these developments are all fairly recent, they had a relatively small impact on our Q1 results, but it's prudent to assume that they'll impact our results more meaningfully for the rest of the year. For example, at current spot rates, the strengthening dollar will adversely impact full year 2022 revenue by about $100 million. About $55 million of that impact has come since we issued guidance on February 15. As we disclosed in our 8-K filing on March 7, about 1% of our revenue comes from Russian companies or is derived from delivering traffic into Russia. We have since terminated our business with several majority state-owned Russian companies and our traffic delivered into Russia and Ukraine on behalf of other global customers has declined dramatically since the war began. As a result, it's reasonable to assume that we will no longer generate most of the revenue that had been associated with Russia and Ukraine. Lastly, data from some of our large customers in the media and commerce verticals suggest that they may be transitioning from an environment of above normal online consumption, fueled by COVID-related restrictions, to an environment with more macroeconomic uncertainty, which could moderate their traffic growth in the near term. Discussions with many of our large carrier partners across the world have reinforced the view that traffic growth rates may be moderating across the internet as a whole. In particular, they've told us that they've recently seen a moderation in their year-over-year traffic growth, and that the current levels of traffic on their network are less than what they'd expected. This is consistent with what we've recently seen. Traffic is still growing at a fast pace on the Akamai platform, but at a more moderate pace than we've observed over the last few years. As a result of these largely external factors and to be conservative in our outlook, we feel it’s prudent to lower our expectations for the full year. Ed will provide more detail shortly. That said, and this is important to emphasize, Akamai’s business continues to be very strong and highly profitable. Traffic growth on our platform remains substantial. And the data we've received from customers and carrier partners indicates that our market share remains stable or is modestly increasing. In addition, our customer churn levels continue to be at record lows. Lost annual revenue from churned accounts in Q1 amounted to less than one half of 1% of total annual revenue. And churn due to competitors was much less than half of that already small amount. As a result, our market leading delivery business continues to generate substantial cash and to power our unique edge platform. Our security business has reached an annual revenue run rate of over $1 billion and continues to grow over 20% annually in constant currency. And we believe that our Compute business is poised to achieve about $400 million in revenue this year with a growth rate of over 60%. And perhaps most important of all, the combination of our security and compute businesses now represents the majority of our revenue. We expect these businesses to generate about $2 billion of revenue this year with a growth rate of about 27% in constant currency. I'll now talk about each of our three major business lines, starting with Security, which we believe will soon become our largest business line. Our security solutions generated revenue of $382 million in Q1, up 23% year-over-year and up 26% in constant currency. This very strong growth was driven primarily by our flagship security products, Kona Site Defender and Bot Manager, and also by our new Guardicore micro-segmentation solution to stop ransomware. In Q1, we finalized the largest deal in Guardicore’s history, valued at more than $10 million over the next three years, expanding our longtime relationship with one of the largest banks in the world. The size and scope of the deal illustrates why we're so excited about our opportunity in micro-segmentation. Financial services firms in particular are frequent targets of ransomware and malware and large banks with security risks face financial penalties from regulators if they fail to address them. So from a compliance perspective, adopting micro-segmentation can reduce risk and prevent large fines in the process. By reducing spending on their legacy static firewalls, the bank that's adopting our micro-segmentation solution will free up resources to implement stronger defenses as they move to a new zero trust security architecture. And by converting to our more flexible software-based solution, they can achieve greater agility to compete with fast-moving FinTech services. This example demonstrates how Guardicore can help Akamai expand longtime relationships with customers to become a more valuable strategic partner in the future. Guardicore is also helping us win new accounts and verticals such as critical infrastructure. For example, one of the largest railroads in the world recently became a multimillion dollar Guardicore customer. On April 20, cybersecurity authorities in the U.S. and other major countries warned that the war in Ukraine raises the risk of cyber attacks. Their recommended defenses aligned well to Akamai security solutions from micro-segmentation, DDoS protection and web application firewall. Web application attacks experienced by customers grew by nearly 200% year-over-year in Q1, the largest increase we've seen in several years. Web app attacks are a critical vulnerability for any company moving to the cloud, building microservices or integrating third parties via APIs, which is why app and API protection is a critical priority for major enterprises. Akamai is a leader in Gartner's Magic Quadrant for Web App and API Protection. In Q1, Akamai received the Gartner Peer Insights Customers' Choice distinction for Web App and API Protection for the third year in a row. Also in Q1, Forrester named Akamai a leader in its New Wave for Micro-segmentation. As we discussed during our last call with investors in February, we will be reporting on our delivery and compute product lines separately going forward. In Q1, our delivery products generated revenue of $444 million, down 6% year-over-year and down 4% in constant currency. Revenue for our compute product group was $78 million in Q1, up 32% year-over-year and up 35% in constant currency. As I mentioned earlier, traffic on our platform has been growing at a substantial rate. In fact, just last week, we set another record when we delivered over 250 terabits per second of peak traffic, more than 20% higher than our previous peak reached in February. The Akamai Edge platform continues to be the top choice for large media companies worldwide due to its unique scale and performance. In a recent review of CDN vendors worldwide, IDC said Akamai's balanced and comprehensive portfolio spanning media and web delivery, emerging edge applications, extensive security capabilities, and programmable edge addresses the needs of all enterprise segments and the developer community. The report also noted how Akamai's appetite for innovation is showcased by the fact that it continues to expand its services and capabilities beyond CDN to address new areas. Akamai is the market leader in delivery by far, and the income generated by our delivery business helps to fund our investments in the fast growing areas of security and compute, including our game-changing acquisitions of Guardicore and Linode. Our compute product group includes Akamai’s capabilities in compute, storage, cloud optimization, developer tools, edge applications, and now Linode, which joined Akamai on March 21. We are encouraged by how customers and industry analysts have responded to our acquisition of Linode. In fact, several have used the word transformational to sum up the potential impact of our combination. The CEO and co-founder of Macrometa, a Linode partner that enables web and cloud developers to run and scale data-heavy real-time cloud applications, has called Akamai’s acquisition of Linode a watershed moment for the cloud because it fundamentally reconfigures the landscape in many ways. Those are his words and he says that Akamai provides that layer of reach and distribution in a way that cloud providers are very challenged to be able to do. I'm excited about that, he said. Of course, we're excited too. Linode was an early pioneer in creating the market for alternative clouds, offering developers a platform to build new applications in ways that are simple to use and affordable, with high performance, competitive, transparent and predictable price points, and backed by strong customer support after the sale. Today, nearly three quarters of enterprises are pursuing multi-cloud strategies, which means that new workloads will be cloud-agnostic and portable, free to move and choose the best place to be. In fact, IDC just issued a report on workload deployment optimization that urges buyers to consider suppliers of Infrastructure-as-a-Service beyond the hyperscalers. Our acquisition of Linode was the first alternative IDC highlighted as an example that can offer better cost and performance while retaining the level of redundancy and coverage demanded by enterprises. In the coming years, we expect that customers will have a growing need for a continuum of compute from the cloud to the edge, to be closer where billions of end users are and where tens of billions of connected devices will be, especially as 5G and IoT take hold and grow. Building the bridge that enables developers to move from the cloud to the edge and have one place to build, run and secure apps is a key reason why we're expanding our offering with Linode. At our Analyst Day, coming up on May 18, we'll talk more about the potential for substantial future growth in this new and exciting part of Akamai's portfolio, as we become the cloud company that powers and protects life online. The soundness of our overall strategy was validated in visits I had with dozens of Akamai customers across EMEA and APJ last month. Common concerns expressed by customers and prospects included the war in Ukraine, the heightened level of cyber attacks, as well as risk to trade and supply chains, energy costs, and currency devaluations. Customers expressed very strong interest in our security strategy and Guardicore, in particular. As you can imagine, their boards are asking them how they can prevent a crippling ransomware attack. And Guardicore is the perfect solution. They know that malware always finds a way in; the key is identifying it and stopping its spread before it can cause serious damage. And that's exactly what Guardicore is designed to do. Most of the customers I met with were also interested in exploring our cloud compute offering as a more affordable and easier way to build, run, and secure their new applications. The tight labor market, employee attrition, and the desire of employees to work remotely were also top of mind for customers in every location. Several companies I met with are reducing their real estate footprint. One of them told me they could only do this because they secured their remote work environments with Akamai's Enterprise Application Access. Here at Akamai, we face the same macro trends as our customers, but in spite of the headwinds, we feel good about the growing demand from customers for our security and compute solutions, the expertise of our team in the addition of capabilities and talent from Guardicore and Linode, and how all of this gives Akamai not one, but two, rapidly growing and highly synergistic businesses, further diversifying our revenue. We've also performed well on the retention of our talent; employees appreciate our flexible workplace policy and culture of teamwork. Akamai scores very high on third-party rankings of the Best Places to Work. I'm proud of the way that our employees have managed, and I want to thank our extended team around the world for doing such a great job for our customers. They are truly making life better for billions of people, billions of times a day. Now over to Ed for more on Q1 and our outlook for Q2 and the rest of the year. Ed?

Thank you, Tom. As Tom mentioned, Akamai delivered a solid quarter in Q1. Q1 revenue is $904 million, up 7% year-over-year, or 9% in constant currency. Revenue was led by continued strong growth in security and compute. The strength was partially offset by a significant strengthening U.S. dollar and a slight moderation in traffic growth rate in our delivery business during the last month of the quarter. Security revenue grew 23% year-over-year and 26% in constant currency, led by a reacceleration of growth in our application security business and continued very strong performance from Guardicore. Security represented 42% of total revenue in Q1, which is up 5 points from Q1 a year ago. Guardicore delivered revenue of $19 million in the quarter; included in our Guardicore results was approximately $7 million of term license deals from four customers. As a reminder, while the majority of Guardicore deals are Software as a Service and revenue is recognized monthly under ASC 606, some customers, specifically financial services and healthcare, from time to time require on-premise deployments. These deployments result in term license accounting treatment, where we are required to recognize a significant portion of the revenue upfront when the product is delivered or spread the revenue over the contract term. It’s worth noting the impact of these deals resulted in a pull forward from Q2 to Q4 into Q1 of approximately 1 percentage point of revenue growth. Compute revenue in Q1 was $78 million and grew 32% year-over-year and 35% in constant currency. As Tom mentioned, we were very pleased with the initial performance of our Linode acquisition, which closed in late March and contributed revenue of approximately $3.5 million in Q1. Delivery revenue was $444 million in Q1 and declined 6% year-over-year and 4% in constant currency. As discussed last quarter, several of our top customers are expected to renew in the first half of 2022. Our first quarter revenue was impacted by the renewals of half of these customers; we expect the remaining customers to renew by July 1. So far, the pricing for the renewals has been in line with our expectations. Additionally, we started to notice the growth rate of traffic on our network moderate a bit in March, specifically in gaming and OTT verticals, as some pandemic-related restrictions were lifted in countries throughout the world. Sales in our international markets represented 47% of total revenue in Q1. International revenue grew 11% year-over-year or 16% in constant currency. The negative impact of foreign exchange on our Q1 results increased by approximately $2 million from our February earnings call as the U.S. dollar continued to strengthen significantly in March. Foreign exchange fluctuations had a negative impact on revenue of $4 million on a sequential basis and negative $18 million on a year-over-year basis. Finally, revenue from our U.S. market was $481 million and grew 4% year-over-year. Now moving on to costs. Cash gross margin was 76% in line with our expectations. GAAP gross margin, which includes both depreciation and stock-based compensation, was 63%. Non-GAAP cash operating expenses were $295 million. Now moving on to profitability. Adjusted EBITDA was $391 million. Our adjusted EBITDA margin was 43% in line with our guidance. Non-GAAP operating income was $270 million and non-GAAP operating margin was 30%. Capital expenditures in Q1, excluding equity compensation and capitalized interest expense, were $116 million. This was slightly better than our guidance range as we continued to see greater efficiency on our network. GAAP net income for the first quarter was $119 million or $0.73 of earnings per diluted share. Non-GAAP net income was $225 million or $1.39 of earnings per diluted share, up 1% year-over-year and up 4% in constant currency. Non-GAAP earnings per share was negatively impacted by approximately $0.03 in Q1 due to a higher than expected non-GAAP effective tax rate. Taxes included in our non-GAAP earnings were $43 million based on a Q1 effective tax rate of approximately 16%. This was approximately 1.5 points higher than we had expected due primarily to three reasons. First, a higher than expected mix of U.S. revenue with foreign exchange rate fluctuations, a significant contributing factor along with the addition of Linode revenue. Second, an unfavorable change to foreign tax credits in Q1 based on the most recent treasury guidance. And third, a refinement of our previous assumptions related to R&D tax law changes from the 2017 U.S. tax reform that became effective in Q1 2022. Moving now to cash and our use of capital. As of March our cash, cash equivalents and marketable securities totaled approximately $1.3 billion. During the first quarter, we spent approximately $103 million to repurchase shares, buying back approximately 900,000 shares. In addition to share repurchases in March, we spent approximately $900 million to complete our acquisition of Linode. We ended Q1 with approximately $1.7 billion remaining on our current repurchase authorization. Our intention is to continue to buy back shares to offset dilution from employee equity programs over time, and to be opportunistic in both M&A and share repurchases. Before I provide our Q2 and 2022 guidance, I want to highlight several factors. First, our guidance now includes Linode. We expect Linode to contribute revenue of approximately $100 million and add approximately $0.05 to $0.06 to non-GAAP EPS in 2022. This is unchanged from the assumptions we shared on our last call. Second, the dollar has continued to strengthen meaningfully since we reported in mid-February. As a result, we currently expect a much greater foreign exchange headwind for the remainder of 2022. At current spot rates, our guidance assumes that foreign exchange will have a negative $100 million impact on revenue on a year-over-year basis. This compares to our prior guidance of a negative $45 million impact to revenue. This change in FX from our prior guide will also negatively impact non-GAAP EPS by approximately $0.16 for the full year 2022. It’s worth emphasizing that currency markets have been extremely unsettled and about as volatile as I have ever seen; as a result, it is impossible to predict whether and how the impact could change going forward. Third, we now expect our non-GAAP effective tax rate for 2022 to be approximately 16%, which is approximately 1.5 points higher than our prior assumption. Based on the items I mentioned before, the change in tax rate will also negatively impact the full year 2022 non-GAAP EPS by approximately $0.11. Fourth, as Tom discussed regarding our business in Russia and Ukraine, it is reasonable to assume that most of that revenue goes away. Finally, as mentioned earlier, our traffic growth rate moderated a bit in March, and we’ve seen that trend continue in April. While traffic continues to grow at a strong rate and is at record levels, the growth rate is lower than we originally expected. Therefore, we are taking a more conservative approach to forecasting our traffic and corresponding revenue for the remainder of the year. That said, we do not believe this trend is a permanent consumer shift or due to us losing share, but rather is likely driven by some of the significant external factors we are seeing in the marketplace and geopolitically. Said another way, we believe that traffic growth and online activity will return to more historical norms at some point. So with all those factors in mind, turning to our Q2 guidance. We are now projecting revenue in the range of $890 million to $905 million or up 4% to 6% as reported or 8% to 10% in constant currency over Q2 2021. Foreign exchange fluctuations are expected to have a negative $14 million impact on Q2 revenue compared to Q1 levels and a negative $30 million impact year-over-year. At these revenue levels, we expect cash gross margins of approximately 75%. Q2 non-GAAP operating expenses are projected to be $282 million to $289 million. We anticipate Q2 EBITDA margins of approximately 43%. We expect non-GAAP depreciation expense to be between $129 million to $130 million. And we expect non-GAAP operating margin to decline to approximately 29% for Q2 largely due to the change in FX and some node integration costs. Moving now to CapEx, we expect to spend approximately $150 million to $155 million, excluding equity compensation and capitalized interest in the second quarter. This represents approximately 17% of projected total revenue. A significant portion of the increase in the spend this quarter is related to Linode, in anticipation of significant demand. With the overall revenue and spend configuration I just outlined, we expect Q2 non-GAAP EPS in the range of $1.28 to $1.33. This EPS guidance assumes taxes of $40 million to $41 million based on an estimated quarterly non-GAAP tax rate of approximately 16%. It also reflects a fully diluted share count of approximately 162 million shares. Looking ahead to the full year, we now expect revenue of $3.62 billion to $3.67 billion, which is up 5% to 6% year-over-year as reported; we’re up 7% to 9% in constant currency. We expect security revenue to grow at least 20% or greater for full year 2022 in constant currency. We now estimate non-GAAP operating margin to be approximately 29% based primarily on the impact of FX and some of the internet traffic dynamics I previously discussed. We now estimate non-GAAP earnings per diluted share of $5.32 to $5.44. This non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 16% and a fully diluted share count of approximately 161 million shares. Finally, full year CapEx is anticipated to be approximately 14% of revenue. It is worth noting our CapEx assumption now includes Linode that we talked about last quarter, partially offset by lower network CapEx given the slower traffic growth rate that we now project. In closing, while the macroeconomic environment has become more challenging since our last earnings call and the U.S. dollar continues to be a major headwind for us, we remain very optimistic about the opportunities in front of us, especially in Security and Compute. As Tom mentioned, I look forward to seeing you at our Analyst Day in New York City on May 18. Thank you. Tom and I would be happy to take your questions. Operator?

Thank you. Our first question comes from Keith Weiss with Morgan Stanley. Your line is open.

Excellent. Thank you guys for taking the call and a lot of great information in there for us to better understand what's going on with a lot of moving pieces in the environment. Of course, I’m going to ask you about more on that. So in particular, when you see the slowing network traffic and some of these increasing pressures, is there any kind of geographic specificity to it? Is it more in Europe than the U.S. or is it more evenly spread? Number one. And number two, on the security side of the equation, is there any counterforce, if you will? Meaning, it sounds like it’s a pretty bad threat environment out there. You guys have a great solution portfolio for those types of threats. Are you seeing any sort of increasing demand on that side of the equation that can offset some of those potential headwinds on the delivery and compute side of the equation? Thank you.

Yes, this is Tom. Great questions. The traffic growth moderation seems to be pretty much global and that coincides with a pretty much global reduction in things like mask mandates and quarantines and so forth, except for China. And we don’t do domestic-to-domestic delivery in China, so we wouldn’t be able to see that. So there’s no particular geographic dependence there. You're on a great point about counterbalance through security. Obviously, we’re negatively impacted in terms of traffic and a few customers because of the war in Ukraine. On the other hand, attacks have gone way up, the volume of attacks, and that’s an area where we can really help our customers. And so there could be some counterbalance in terms of the security business. As I mentioned, customers are really worried about ransomware attacks and malware, and we’ve got a great solution for that with Guardicore. And as we talk about the macroeconomic challenges and fears of a recession and inflation, customers are probably increasingly concerned about saving cost going forward and that could provide some counterbalance as well, with our Linode solution. We’re in a really good position to help major enterprises decrease their cloud spend. We find that many of them have seen that spend increase dramatically, and now they can use Linode for applications, especially enterprises that are already set up in a multi-cloud environment. They’ve got their applications in containers or VMs, and they could easily move those to Linode and save money. So there could be some counterbalance here as we go forward. That’s a very good observation.

Got it. And if I could sneak one in for Ed on the other side of the equation. You talked to us about how sort of CapEx is coming down a little bit versus what we were talking about immediately after Linode based on lower network traffic. Are there any adjustments that you guys are making to your OpEx side of the equation? So the level of investment that you guys are going to be making throughout the year given a more kind of difficult environment. Or is it steady investment as it goes, if you will?

We’re not able to hear Ed. So I guess we’re having a trouble with the operator with Ed maybe — okay. Could you ask the question again, please?

Sure. Thanks. So I was just on the call, Ed, you had talked about CapEx coming down a little bit because of sort of lower network traffic. I was just wondering if you guys are making any adjustment to the OpEx for FY2022 given the more volatile macro. Any limitation in any kind of your investments throughout the year, or do the investments stay relatively stable?

No, that’s a great question. And yes, CapEx is much more efficient. Of course, we’re investing heavily to grow the Linode footprint. In terms of OpEx, we’re always working to be more efficient with our OpEx to deliver traffic, and we’re seeing the benefits of that even now. You look at the impact that FX, for example, is having on our operating margin and then having less traffic and yet still we were at 29% to 30% op margin for this year. And now we’ll be, I think, really closer to the low end of that range, but it’s because we’ve been able to be much more efficient on OpEx that we can hold it there and not be lower than that. And of course, we are — also it’s important that we are going to continue to invest certainly in security and compute. We don’t want to be short-sighted with FX inducing us to do something that would hurt us long-term with our growth in security and compute. If you look at our business today, it’s pretty important to note that the majority of our revenue is now security and compute, and that is growing currently at over 25% as reported. So the last thing we want to do is somehow scale back investment there when it’s just a fabulous couple of businesses just because there’s stuff going on with FX and the macroeconomic environment. Ed is trying to get back on, but we can keep going and I’ll do my best in the meantime.

Yeah. So Tom, I’m back, could you guys hear me now?

Yes. No, Tom did a great job. You might have to worry about job security now.

Thank you. Our next question comes from James Breen with William Blair. Your line is open.

Thanks. Just a couple. One, when you look at the old guidance that you gave on the fourth quarter call relative to today, down kind of $50 million below at the high end. Given some of the puts and takes you gave, it seems like the Russia impact sort of mid $30 million, and then the incremental FX of sort of in the mid $50 million sort of offsets basically the upside from Linode and closes that deal. I’m just trying to think about to quantify it. So is that sort of incremental kind of $15 million difference really what you’re seeing from the lower traffic on the delivery side? And can you just remind us of the delivery revenue this quarter, the $444 million? How we want to think about it annually? How much of that is more volume driven versus subscription based? Thanks.

Yes. Jim, it's Ed. I think you’ve got the pieces right there in terms of the different components, FX being about $55 million, Russia you could say is about 1%, so call it about $30 million give or take. But the rest of it is the delivery. I think one of the things we tried to make clear in our prepared remarks was the Compute business is going great. We only owned the business for a little while, so there’s no change there in terms of our outlook. But certainly good early returns and security did better than we expected this quarter. So it is limited to a delivery issue and is, I would say, primarily almost all volume driven that we’re seeing. So what we did basically is just adjust the growth rate that we expected for the remainder of the year. And then obviously, things can change over time. But based on what we’ve seen so far in the last couple weeks of March and the beginning of April, we just thought it was prudent to adjust that. So you’re thinking about it right in terms of the different pieces.

Great. And then just maybe one for Tom, just the strategy. Linode, you've owned it now for a little over a month. They were focused a lot on the small and midsize business space in terms of computing and storage. Have you seen any traction with that product among some of your larger customers now that it’s starting to get integrated?

Yes, obviously very early days, but we’re really excited about the potential for that traction. I’ll give you just one anecdote. I was in Europe meeting customers last month and met with one of our major media workflow partners. I was going to talk to them about Linode because they have a big cloud spend and we feel that could be really relevant for moving to Linode. They’re very happy Akamai partners and customers. I was going to tell them about the acquisition, but when I get there, we shake hands. First thing he says is, 'Wow, great acquisition.' He's the CEO, but it turns out he has a pass as a developer, knew about Linode, loves them and he's into multi-cloud and he said, 'What we did is we already have our workflow apps in containers. We thought, what the heck, let’s try it.' So they moved over to Linode and he said it worked great and they’re going to save money to boot. It’s really easy to use. We didn’t even know because Linode really is easy to use that we didn’t know this was even taking place. So I do think we’re in an excellent position to not only increase the existing Linode customer base, but provide Linode capabilities to major enterprises. Linode really appeals to developers and increasingly developers are making the decisions or heavily influencing the decisions at major enterprises as in this example.

Great. Thanks a lot.

Thank you. Our next question comes from Rishi Jaluria with RBC. Your line is open.

Wonderful guys. Thanks for taking my questions and appreciate all the details around the moving pieces. First, I wanted to start with maybe better understanding some of the macro factors. I think look, the FX well understood, Russia as well, the moderating traffic with reopenings. But Tom, at the beginning you had mentioned kind of the inflation side, as well as fears of recession being in Western Europe or globally. Can you talk a little bit more about how those macro factors are impacting your business? Is this resulting in longer sales cycles, smaller initial deals, just more hesitation around new deals? Any color there that you can give would be helpful and then I have a follow-up.

Yes. This is Ed. I’ll take that and Tom, if you want to add some color if I missed something here. In terms of inflation and the impact on our business today, we’re not seeing a significant impact from inflation, whether that’s with labor costs or with the costs of our network and that sort of thing. We’re seeing a little bit of higher energy prices in Europe and that sort of thing. But our team does a pretty good job of trying to bake that into their deals when they sign colo deals and that sort of thing. That could obviously change; the labor markets are pretty tight. But I think the biggest macro impact for our business in terms of our change in outlook is really around the change in behavior where we’re seeing mask mandates lifted and people going out more, shopping more in-stores and that sort of stuff. The impact on the traffic growth rate is probably the biggest impact. Obviously if we get a major recession that could potentially have a greater impact, but we’re not seeing that. Certainly in the security business, we’re not seeing customers pulling back. We’re not seeing deal sizes get elongated or anything along those lines. It’s more about that impact on the traffic business.

And to Ed’s point, it’s not direct on us, but there is some concern among our media customers in terms of subscriptions and how their business is doing. So we’re keeping an eye on that in terms of end users reacting by cutting cost and consuming less online. I don’t think that’s a major factor yet, but it’s something we’re keeping an eye on.

Got it. That’s really helpful. Thanks. And then just going back to Linode, I guess number one, if we do the math back of the envelope, it’s about a $3.5 million contribution in Q1 directionally, correct? And number two, when you made the acquisition you talked about incremental investment opportunities to accelerate the growth rate. Can you remind us where you find those opportunities, especially where there’s low-hanging fruit? And what would be an ideal growth rate for the Linode asset? Thanks.

Yes. So, I’ll start off with the housekeeping item. We had about $3.5 million of revenue in the quarter from Linode. As far as the growth rate is concerned, we’ll get into a lot more details when we see you in New York in a couple of weeks, but this is a very fast-growing business; Linode’s growth rate before we acquired them was about 15%. We think we can accelerate that pretty significantly as we introduce more features, more locations, more capabilities, and we start to tap into our enterprise customer base. So, we think that growth rate can accelerate pretty significantly.

Got it. That’s really helpful. Thank you so much, guys.

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

Thank you. Tom, on that point with apps and containers, have we seen many apps ported over to other clouds at this point, and if they are, tying into other value-added products and managed services that the cloud providers have, does it make it harder to move? Or can they still do it relatively easily?

Yes, that’s another great point. The hyperscalers have a lot of managed services and added functionality on their platform, which Linode doesn’t. If you’re the kind of company that likes to do those things yourself, that’s easy to do on Linode. If you’re the kind of company that wants that done by your cloud provider, Linode doesn’t do that today. Over time, we will be adding more and more capabilities there. So today I wouldn’t say that every customer would be in a position to move everything over to Linode. That is certainly not the case. But I think there is a pretty significant segment where it can be done and does make sense to do. Over time we want to grow the kinds and number of applications that make sense to move to Linode. It is helpful that our customer base is already using us for market-leading delivery, app acceleration and security. There’s a lot of synergy there. I think the combination of that synergy, ease of use and cost savings is a pretty exciting combination.

And just on the traffic volumes, could you give us a sense: the last two years in COVID were we like 25% above trend, 50% above trend, and do you think it kind of reverses however much it was above trend? I’m not looking for exact numbers, but just some color.

Yes, it was way above for sure the first year and very strong the second year. I would say compared to historical trend the step down we’ve seen so far is less than the step ups that we’ve seen. A lot of the increased use of the internet for video, gaming, commerce, remote work — a lot of that is here to stay. But right now with restrictions coming off except for China, I think that’s a big part of why we’re seeing a little bit of a decrease in traffic growth rates right now.

Thank you.

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

Hey guys, thanks for the time. Wanted to first start on the delivery side where frankly, we’re not surprised to see slowing traffic given our tracking of what’s going on in space, but it seems like it was a little bit worse for you guys. Can you help break down where the main weakness was between web delivery versus media delivery this quarter? It sounds like media was more of a surprise for you guys as it was a former growth driver. It’s slowing and you guys had a bunch of renewals there while we didn’t have the recovery in web despite travel and hospitality traffic coming back. Can you help triangulate where we are between some of the underlying verticals?

Hey Jim, this is Ed. The bigger impact was definitely on the media side. We had renewals concentrated in a short period of time and when you have a slowdown in your traffic rate, it accentuates the impact to revenue. Typically in a normal year, you’d start to get back to flat after several quarters, but we think it might take a little bit longer based on the type of traffic growth rates we’re seeing. In terms of hospitality and retail, we are seeing a bit of traffic increase specifically in travel, a small vertical for us, about 4% give or take. But remember both travel and commerce tend to buy our zero-overage contracts, so less traffic doesn't have as much impact on revenue. In terms of the biggest impact, that’s really on the media side in terms of the change in traffic.

Got it. And switching over to security, how are you thinking about the current balance of term subscriptions versus SaaS for Guardicore now that you've owned it for about one and a half quarters? How do you think this settles down given certain verticals like financial services want those term subscriptions. And lastly, any sense what other large deals for Guardicore could be in the pipeline over the next few quarters that can swing? I think it was $50 million to $55 million expectations for Guardicore this year.

Good question. I called out that about four customers had term licenses and going forward to the extent there’s anything material we’ll call it out. The majority of customers have the more traditional subscription-based model, but there are customers, especially financial services, that like to have the management controller on-premise. That drives the term license aspect and requires us to recognize a significant portion of revenue upfront. The typical term is one to three years, and Tom mentioned we signed a fairly large three-year term deal. So there’ll be some maintenance and whatnot that could spread out, but you do take a fair chunk of revenue upfront for the term license deals. In general, the majority would be SaaS-type deals. As for the pipeline, it's always hard to call when a deal will hit in any particular quarter. I don't see anything significant in Q2; I'm expecting more of a normal quarter. To the extent there’s anything, we’ll certainly let you know.

Thanks, Ed.

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

Thanks for taking my question. Two quick ones. One, on the core delivery business, do you think this business just sort of declines 4% or 5% for the rest of calendar 2022? Or do you see a bottom and the decline rate should improve as you go through the year?

I think for the rest of the year you'll see the business in decline because of the renewals that we have. We had half of them hit so far in the first quarter; the other half will hit in the second quarter. So you'll probably see a little bit of a step down in Q3 and then Q4 tends to be seasonally strong, but you also have a tough compare. So I would expect it to be negative for the rest of this year, and it will fluctuate depending on specific traffic levels. Q4 typically sees strong traffic for commerce and media; commerce has a less muted impact these days with many customers on zero-overage contracts. We expect to see a pickup in Q4 traffic, probably a little less than historical norms. That’s what we've modeled in.

Got it. And then, hopefully I have all these numbers correctly; if not, please correct me. As I think about the revisions to the 2022 guide, it looks like sales versus the Street were with all the adjustments coming down by about $100 million, roughly 2.5% to 3% of initial expectations. But the EPS numbers are coming down much more severely closer to 8% to 9% versus what the prior expectations were. Maybe just walk me through why there's a much more sizable EPS adjustment to the full year numbers versus revenue. Is that just the tax rate or other moving pieces that are magnifying the correction on EPS versus the top line?

Yes, sure. Let me walk you through it. The tax impact is about $0.11 and that has no impact on revenue. Then you get the FX impact, which is about $0.16. Then the Russia impact is roughly $0.09, give or take. So about 60% of the EPS impact is related to those external factors and the remainder is related to the revisions we see in delivery volume.

Thank you. Our next question comes from Frank Louthan with Raymond James. Your line is open.

All right. Great. So on the traffic thing, just to be clear, this is an end-user slowdown with the pie growing more slowly, or is some of this traffic going elsewhere? If that's the case, who are you losing share to?

You're right. It’s the pie growing more slowly, not the pie shrinking. We believe based on talking to customers and carrier partners that our share of the pie is stable or growing and that we are not, on balance, losing share.

Okay, great. Thank you. And then what sales investments do you need to make for the rest of the year to sell more Linode and more Guardicore? Where are you on that?

The nice thing with Linode is we're not required to make significant additional investments in sales per se. We’re going to bring Linode to our channel partners and our sales reps can sell it. Many of our customers' CDN spend to cloud spend ratio is orders of magnitude larger on the cloud side. So we are talking to the same people that are spending there. Our teams will be trained and ready to sell Linode. On the security side, you tend to hire more specialists. PJ is investing in Guardicore not only with sales reps, but also with technical specialists to help the sales team and professional services folks. So you’ll see investment more on the security sales side, and we’ll get a lot of leverage from the Linode standpoint.

All right, great. Thank you.

Thank you. We have a question from Rudy Kessinger with D.A. Davidson. Your line is open.

Great guys. Thanks for taking my questions. On the OTT or media side, how are your OTT customers attributing that slower traffic growth—between end users eliminating or reducing the number of OTT services they subscribe to, a shortage of new content, or people getting out more with COVID mandates lifted?

From what we're hearing, it's a combination. In some cases there's fewer subscriptions; in others subscriptions are okay but traffic growth is slower than they had anticipated. I think people are out more now. There are also public reports about brick-and-mortar sales increasing and online sales decreasing a bit. It’s a variety of factors, and it’s early days; we'll learn more over the next couple of months.

Got it. And then on delivery, you said the pricing on those large customers that renewed this quarter was about as expected. But more broadly in delivery, how is pricing pressure faring versus years past? I'm trying to understand: traffic growing more slowly but still growing, and your position is you're still gaining share, but delivery revenue is down several points. How is pricing pressure faring in the broader market?

A couple of things. Renewals have been largely as expected. The big change is the rate of growth. Pricing in the market is fairly efficient, especially with high-volume media, and it's really driven by volume. So to the extent customers have less volume, the discounts they receive will change going forward. If customers aren't growing at the same rate, they’re not going to get the same level of discount. We may see that take hold over the next several quarters as more renewals happen.

Got it. That's helpful. Thanks guys.

Thank you. We have a question from Fatima Boolani with Citi. Your line is open.

Hey, good afternoon. Thank you for squeezing me in. A quick one for you in the security business: I think you spent a lot of time flushing out the Guardicore performance, which was substantial. You also mentioned the re-acceleration in application security. But I'm curious if you have any comments or observations around the network security side of the business. Any color there with respect to competitive dynamics or sales dynamics would be helpful. Thank you.

Yes. On the network security side, that would be DDoS mitigation services, which are doing very well. We've seen a lot of attacks over the last year, especially extortion or ransom DDoS attacks, and we've been in a great position to help customers. We also have DNS capabilities that are widely used as part of our network security product lines, which are doing well.

One other thing I would add, Tom: if I look at the product portfolio, Bot Manager continues to do extremely well and is growing at a very healthy clip. We introduced our Account Protector this quarter and saw very high uptake; early returns look great. Obviously it's a newer product, so it'll take time for that to become a material contributor to revenue, but so far the early returns have been very good.

Yes. And those are all part of our app and API protection group, which is where we're seeing the re-acceleration Ed talked about.

Got it. And just a quick one in terms of housekeeping around free cash flow. Appreciate some of the puts and takes on margin. Mostly stable, but curious how we should think about free cash flow given the near-term step up in CapEx, which is expected to moderate based on your guidance over the course of the year. Anything you can help us from the free cash flow margin side given the FX movements as well?

Sure. Q1 tends to be a little lighter on free cash flow, a lot of it has to do with timing of bonuses. If you look year-over-year, it’s sort of in line and will expand as we go throughout the year. One big takeaway is on CapEx: Akamai excluding Linode was originally about 13% to 14%, and Linode would add about two points. We’re able to take advantage of the slowdown in traffic growth to build out some Linode capacity a bit faster, but we’ve also taken down total CapEx. I gave guidance for about 14% of total revenue for the year, which is about 2 percentage points better than what we had expected before. So think of it as folding in Linode CapEx under the original umbrella. That’ll help free cash flow.

Thank you. Our next question comes from Michael Elias with Cowen and Company. Your line is open.

Thanks for taking the questions. Two if I may. First, you’re expecting to hold an Analyst Day later this month. Any color on what we should expect to hear and as part of that, should we expect similar long-term guidance to what you gave at the last Analyst Day including the compute segment? Second, you highlighted inflation and said you aren't seeing major impacts. If inflation did become a bigger issue, what levers could you pull vis-à-vis pricing in order to combat inflation if it manifested itself?

On the Analyst Day, structurally it will look a lot like last year. We’ll look at long-term CAGR objectives. We’ll talk a lot about the compute business and our overall strategy. High level, similar structure to last year, but with new content on our products and the acquisitions — Guardicore and Linode — and more detail on compute potential.

On inflation, a couple of things: inflation can cause rates to go higher, which impacts the U.S. dollar and FX. One advantage of hybrid work is being able to acquire talent from many geographies, including lower-cost areas. Our team has done a great job on the network side with supply chain negotiation and leverage. A lot of our traffic on the network today is free in terms of bandwidth, so we're somewhat insulated. We’ll keep a close eye on labor markets, and what we're doing right now is pulling back a bit on core network CapEx and redeploying resources to Linode where there's opportunity. We’re taking advantage of these opportunities to insulate ourselves from significant inflation impact.

One more point: the nice thing about our business now is the diversification — the majority of our revenue is now security and compute, not delivery. When external factors hurt one side of the business, they can help another. For example, the war in Ukraine is driving security demand and inflation could drive customers to seek cost savings where Linode helps. This diversification puts us in a stronger position.

Great. Thank you.

Thank you. We have a question from Jeff Van Rhee with Craig-Hallum. Your line is open.

Thanks. Just a couple of cleanups. On Guardicore and term licenses, were there any term licenses in Q4?

Nothing material in Q4. There may have been about $1 million or so, but nothing material.

Okay. And then on Linode, how should we think about sales cycles as you bring it into the enterprise base? What would it take for Linode to crack larger customer accounts and how quickly can that happen?

Sales cycles will vary. There are workloads built in containers that are easy to move and those can move relatively quickly. We've started training, rolled out compensation plans, and our sales team is building the funnel. We're having good conversations and building additional functionality — we released managed database capabilities recently and we'll build out more locations. You'll hear more from Adam at Analyst Day about specifics. In terms of meaningful, impactful deal sizes, we should start to see that materialize toward the back half of the year and into next year. Early wins and developer-led moves will happen earlier, but the more significant enterprise deals will take more time.

Okay. Last one: on traffic trends in OTT versus gaming, any notable differences?

I’d say gaming is more seasonal and we saw more of an impact recently because there were fewer major releases than expected. Video is more behavioral — streaming hours per user may be down as people go out more. The video trend is more about behavior; gaming’s impact depends on release cycles.

Okay, thank you.

This concludes our Q&A. Our last question comes from Will Power with Baird. Your line is open.

Thanks for squeezing me in. Tom, I'd love more color on the strength within compute. Anything else you can provide with respect to key drivers in the quarter would be great.

We’ve been working on edge computing for close to 20 years. We have edge worker solutions with functions-as-a-service, thousands of POPs around the world, EdgeKV database capability, and more applications are being built to run at the edge. You get tremendous scalability, instant scaling, and low latency. More customers are using edge capabilities as they move to API models; 5G and IoT will increase demand for lower latency and edge scaling. Linode is exciting because it gives core cloud compute capability so you can take your containerized app and run it end-to-end on Akamai — build on Akamai, run on Akamai, deliver on Akamai, with compute at the edge in thousands of places, wrapped in our security. There is nothing like our global edge network in scale and performance.

Thanks. One quick one on potential M&A given valuation compressions in the market. How does that change the landscape for you, especially after Linode?

We continue to look at possible acquisitions. We’ve done two large ones in a short period of time; I don't expect that to be the norm. We're generating a lot of cash and will reinvest in the business, particularly in security and compute. It’s not impossible over time you'll see other acquisitions, but probably several smaller tuck-ins as we've historically done. Guardicore was the right product to stop ransomware and Linode is a leading alternative cloud that completes the Akamai picture of powering and protecting life online — build, run, deliver, accelerate and secure apps all in one platform.

Great. Thank you.

Thank you, everyone, for joining us tonight. I know we ran a little long, so we appreciate your patience. In closing, we will be presenting at several investor conferences and road shows throughout the rest of the second quarter, including our Analyst Day in New York City on May 18. Details of all these events can be found in the Investor Relations section of akamai.com. Thanks for joining us and all of us here at Akamai wish you and yours continued good health. Have a great evening.

This concludes today's conference call. Thank you for participating. You may now disconnect.