Akamai Technologies, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the third quarter 2020 Alkermine Technologies, Inc. earnings conference call. At this time, all participant lines are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star then 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then 0. I would now like to hand the conference over to your speaker today, Tom Barth. Please go ahead.

Thank you, Operator. Good afternoon, everyone, and thank you for joining Optimize Third Quarter 2020 Earnings Conference Call. Speaking today will be Tom Layden, Optimize Chief Executive Officer, and Ed McGowan, Optimize 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 risk and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. The factors include uncertainty stemming from the COVID-19 pandemic and any impact from unexpected geopolitical development. Additional information concerning these factors is contained in Optimized Violence 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 October 27, 2020. Optimized claims any obligation to applicate 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. And 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 third quarter. Revenue was $793 million, up 12% year-over-year and up 11% in constant currency. Nongap operating margin was 32%, up three points from Q3 of last year. Nongap EPS was $1.31 per diluted share, up 19% year-over-year and up 18% in constant currency. These very strong results were driven primarily by the continued strong performance of our security products and high traffic levels on our edge platform. We're very proud of how Akamai has continued to deliver fast, intelligent and secure online experiences for billions of users around the world as we support our customers during these challenging times. We're also very pleased that our hard work to improve operating efficiency and profitability has put us in an excellent position to exceed our goal of 30% operating margins for the year. Our media and carrier business continued to perform very well in Q3, benefiting from high traffic levels for video streaming and gaming software downloads. In fact, one giant video on demand service increased their traffic on our platform by a factor of four last quarter. As more entertainment moves online, Akamai has continued to prove that our unique edge platform scales to meet the unprecedented demand for streaming video, popular gaming releases, and complex API transactions. We can do this in part because we positioned more than 325,000 servers in more than 4,000 locations in over 1,000 cities. At Akamai, we position content very close to end-users, and we make sure it's available when and where it's needed. In addition, our highly advanced internet mapping algorithms route traffic around congestion to maintain excellent application performance for our customers. Our unique edge platform also allows our customers to perform a wide variety of computational tasks close to end users, resulting in faster performance, instant scalability and lower cost. For example, A leading social networking company uses Akamai's Edge platform to manage API requests for their recommendation engine. A leading apparel company uses our platform to supply health information to users based on their fitness tracker. Several major companies use Akamai to provide critical weather updates based on local conditions, as well as geographic information such as nearby points of interest or locations of desired services. Many of the world's largest OTT companies use Akamai to help manage the critical components of their architecture on the edge, including functionality for user authentication, content recommendations, and payment processing. Some of the world's largest credit card companies use our platform to assist with authentication and authorization of payments via digital gateways. Several of the world's largest gaming companies use Akamai's Edge to assist in managing user profiles and registration, as well as event leaderboards. And the ad tech ecosystem uses applications running on the Akamai Edge to assist with ad calls, bidding, and placing consent cookies to remain compliant with data privacy regulations. It's important to note that while some CDMs are talking about edge computing or serverless computing as if they're somehow new technologies, Akamai has been providing these services to thousands of customers for well over a decade. And already this year, we've handled well over 100 trillion API requests on our Edge platform. The vast capacity of our platform, combined with our unparalleled security intelligence and machine learning algorithms, has also enabled Akamai to defend many of the world's most important enterprises against the largest and most sophisticated cyber attacks. This capability has proved to be especially important during the recent wave of ransom DDoS attacks. Since August, we've been approached by dozens of major businesses around the world that had received extortion letters, threatening them with massive DDoS attacks if they didn't pay a ransom. In response, our security experts performed emergency integrations of our Perlexix service, which enabled these enterprises to continue or resume business operations without experiencing any service disruptions from the attacks. As a result, we've added many new enterprises to our Perlexic customer base, including several global banks and insurance companies, a leading travel website, and two national stock exchanges. In addition to Perlexic, we also continue to see strong growth from our market-leading Kona site defender and bot manager services. Bot Manager has been especially valuable in stopping account takeover attacks, which have greatly increased in scale and sophistication. In fact, the number of malicious login attempts by bots that we blocked in Q3 was more than double the number we handled in Q2. I'm also pleased to report that our recently launched Page Integrity Manager solution, which is designed to identify and thwart Magecart attacks and malware and third-party scripts, is off to an excellent start with strong customer interest and bookings. In another sign of our leadership in cybersecurity, Forrester recently named Akamai as a leader in zero trust with the highest possible scores for network security, workload security, APIs, zero trust advocacy, and market approach. And just last week, Gartner recognized Akamai as a leader in its 2020 magic quadrant for web application firewalls for the fourth year in a row. Overall, Q3 revenue from our cloud security solutions was $266 million, up 23% year-over-year in constant currency, and accounting for 34% of Akamai's total revenue. To further build on our growth in security, we were pleased to announce today that Akamai has acquired Azavi, a leader in securing mobile access for enterprises. Azavi partners with some of the world's largest mobile network operators to enable enterprises to connect, manage, and secure communication among cell phones and other IoT devices without the need for client software on the device. These capabilities are critical for organizations with mobile workforces or large numbers of connected devices. By integrating Azavi's solution with Akamai's unique edge platform and arming it with Akamai's vast array of real-time security data, we plan to enable enterprises to greatly improve the security of their operations while also improving the performance of their internal applications. Azavi will complement our security product lines with a cellular-specific security offering, which is an important step in our strategy to capture the emerging opportunity in 5G. It is also synergistic with our Enterprise Application Access product and complements our IoT Edge Cloud solution, allowing enterprises to improve the reliability and consistency of real-time communications with IoT devices, and to easily secure those endpoints to avoid compromise. As we look to the future, we believe that the deployment of 5G and IoT applications can provide significant opportunities for Akamai. 5G technology improves the performance of the last mile, providing higher throughput and lower latency, and the potential to connect a lot more people and things. And that could spawn the creation of new applications, such as ultra-low latency video, augmented reality, IoT applications and analytics at a massive scale, deep threat intelligence for attack mitigation, and much more that we can't even imagine yet. The impact of 5G on innovation could be similar to the way broadband enabled new social networking apps that few could have imagined before. As 5G networks come online, we believe that end users and connected devices will demand faster performance and greater scale than cloud data centers can provide, and thus that our edge architecture will become more important than ever. In fact, Gartner estimates that by 2022, more than half of enterprise-generated data will be created and processed outside of traditional cloud data centers. The breadth of our edge platform means that we're incredibly close to billions of end users. And being so close means that Akamai is in a unique position to provide the near-instant response times, very high-quality video experiences, serverless computing capabilities, and the market-leading security services that our customers are demanding. In summary, we're very pleased with our performance so far this year. We believe that our strong growth, profitability, and cash generation provides us with the financial firepower to continue investing in the innovation, network capacity, novel products, and world-class talent needed to fuel our future growth. Now I'll turn the call over to Ed for more on Q3. and our outlook for the fourth quarter. Ed?

Thank you, Tom. As Tom outlined, Akamai delivered another excellent quarter in Q3. We were very pleased to exceed the high end of our guidance range on revenue, operating margin, and earnings. Q3 revenue was $793 million, up 12% year-over-year, or 11% in constant currency. Driven by another quarter of robust security growth, continued strong performance from our media and carrier division in a weaker U.S. dollar. Revenue from our web division was $418 million, up 8% year-over-year or 7% in constant currency. Revenue growth for this group of customers was again led by our security business, and to a lesser extent, we also benefited from lower-than-expected security COVID-related credits to customers. Revenue from our media and carrier division was $375 million, up 16% year over year. The overachievement in Q3 came from higher than expected OTT video and gaming traffic, along with continued momentum and security. We were pleased to see traffic remain at elevated levels, which helped offset the approximately $15 million negative impact from India's ban of 59 Chinese apps that we discussed on our last quarter's call. Revenue from the internet platform customers was $51 million, up 15% from the prior year and above our expectations due to higher traffic. Security revenue for the third quarter was $266 million, up 23% year over year. driven by continued global demand for our web and enterprise security solutions. And as Tom mentioned earlier, we also saw strong demand for DDoS protection from our Prolexit product in Q3. Foreign exchange fluctuations had a positive impact on revenue of $10 million on a sequential basis and positive $4 million on a year-over-year basis. International revenue was $355 million, up 20% year-over-year, or 18% in constant currency. We have strong performance internationally despite the sequential headwinds in India that I previously mentioned. Sales in our international markets represent 45% of total revenue in Q3, up three points from Q3 2019 and up one point from Q2 levels. Finally, revenue from our U.S. market was $437 million, up 6% year over year. Now moving to costs. Cash gross margin was 76%, in line with our expectations. Gap gross margin, which includes both depreciation and stock-based compensation, was 64%. Non-gap cash operating expenses were $252 million, roughly flat with Q2 levels and in line with our guidance. Now moving on to profitability. Adjusted EBITDA was $351 million. of $51 million for 17% from the same period in 2019. Our adjusted EBITDA margin was 44%, up two points from Q3 2019. Non-GAAP operating income was $251 million, up $43 million for 20% from the same period last year. Non-GAAP operating margin came in at 32%, up three points from Q3 last year. Capital expenditures in Q3, excluding equity compensation and capitalized interest expense, were $200 million, in line with our guidance range. Gap net income for the third quarter was $159 million, or $0.95 of earnings per diluted share. Non-gap net income was $216 million, or $1.31 of earnings per diluted share, up 19% year-over-year from of 18% in constant currency and 7 cents above the high end of our guidance range due to higher than expected revenue. Taxes included in our non-GAAP earnings were $37 million based on a Q3 effective tax rate of approximately 15%. Now I will discuss some balance sheet items. We continue to have a very strong balance sheet. As of September 30th, our cash, cash equivalents and marketable securities totaled approximately $2.6 billion, up approximately $163 million from the end of Q2. After accounting for the $2.3 billion of combined principal amounts of our two convertible notes, net cash was approximately $254 million as of September 30. This increase was driven by a number of factors that include an exceptionally strong cash collections quarter. Now I will review use of capital. During the third quarter, we spent $13 million to repurchase shares, buying back approximately 120,000 shares. We ended Q3 with approximately $644 million remaining on our previously announced share repurchase authorization. Our long-term plan remains to leverage our share buyback program to offset dilution resulting from equity compensation over time. In summary, we are very pleased with our Q3 results. Before I provide guidance, I wanted to take a moment to remind everyone of several factors that will impact Q4. First, seasonality plays a large role in determining our fourth quarter financial performance. We typically see higher than normal traffic for our large media customers, and from seasonal online retail activity for our e-commerce customers, which are both difficult to predict, especially in the current economic environment. Also, as Tom mentioned earlier, today we announced the acquisition of Azavi. In the fourth quarter, we expect the acquisition to add approximately $4 million of revenue and to be diluted by approximately one penny of non-GAAP EPS. It is also worth noting, as I mentioned earlier, that our Q3 revenue was negatively impacted by approximately $15 million due to the actions taken by the Indian government to ban 59 Chinese-based web applications in India. Our Q4 guidance assumes the ban in India remains in place for the balance of 2020. In addition, the U.S. government has taken a similar stance with respect to some of these applications. An absent court action or a change in policy, those bans are scheduled to take effect in mid-November. As a result, our Q4 guidance assumes an additional $4 to $5 million negative impact to revenue sequentially based on the U.S. ban going into effect in mid-November. In the unanticipated event, these 59 applications were subject to a total global ban. The total additional negative impact to our revenue would only be approximately 3%. To be clear, this represents an extreme assumption that we do not currently expect to occur and we are not modeling in our current outlook. However, I wanted to provide you with additional color for added transparency and to make the point that our customer base remains well diversified across many customers, industries, products, and geographies. Finally, at current spot rates, foreign exchange fluctuations are expected to have a positive $2 million impact on Q4 revenue compared to Q3 revenue, Q3 levels, and a positive $6 million impact year over year. Taking all of these factors into consideration, we're projecting Q4 revenue in the range of $812 to $837 million. We're up 4% to 8% in constant currency over Q4 2019. To frame our guidance further, we would expect to be towards the lower end of the range if we see a more modest quarter for OTT and gaming traffic. If e-commerce activity is weaker than expected, the impact of the COVID pandemic leads to an inability of our customers to pay for our services, and the US dollar strengthens and creates foreign exchange headwinds. Conversely, we would expect to be at the higher end of the range if we see If we experience a more robust than normal online holiday shopping season, and we see stronger than expected demand for OTT video and gaming traffic, including potential upside from two highly publicized new game console releases expected later this quarter. At these revenue levels, we expect cash gross margin of approximately 76%. Q4 non-GAAP operating expenses are projected to be $268 to $279 million. with a sequential increase primarily due to higher commissions-related expenses from sales compensation accelerators kicking in during the fourth quarter, given our very strong performance this year relative to our plan. Factoring in the gross margin and operating expense expectations I just provided, we anticipate Q4 EBITDA margins of approximately 43%. Moving now to depreciation, we expect non-GAAP depreciation expense to be between $106 to $108 million, reflecting our accelerated server deployment in Q3. Factoring in this guidance, we expect non-GAAP operating margin of approximately 30% for Q4. Moving on to CapEx, we expect to spend approximately $193 to $199 million excluding equity compensation in the fourth quarter. And with the overall revenue and spend configuration I just outlined, we expect Q4 non-GAAP EPS in the range of $1.28 to $1.32 or up 2% to 5% in constant currency. This EPS guidance assumes taxes of $36 to $37 million based on an estimated quarterly non-GAAP tax rate of approximately 15%. It also reflects the fully diluted share count of approximately 165 million shares. In light of the Q4 guidance I provided and our strong performance through the third quarter, for the full year 2020, we now expect revenue of $3.164 to $3.189 billion, which is up 10% year-over-year in constant currency. We expect non-GAAP operating margins of approximately 31% And we expect non-GAAP earnings for diluted share of $5.16 to $5.20, which is up 15% to 16% year over year. In summary, we are very pleased with how our business has continued to perform during a very challenging time. Thank you. Tom and I would be happy to take your questions. Operator?

Thank you. Ladies and gentlemen, if you wish to ask a question at this time, please press star then 1 on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from the line of Tim Horan with Oppenheimer. Your line is open. Please go ahead.

Thanks, guys. Good quarter. Can you talk about EDGE a little bit more? Maybe how do your service offerings compare to your peers, and what do you think your win rate is, you know, on pitches for EDGE?

Well, Edge refers to our platform, which really is unique in the sense that, you know, we're in 4,000 locations. We're in 1,000 cities. We are uniquely close to the end users out there, the billions of end users around the world. You know, other companies talk about Edge, and they might be in a couple dozen locations, you know, a factor of 100 less. And because we're close... That's really important because we're going to give better performance. If you're closer, the latency is less, and it's going to be faster. Also, if you're close, you've got access to the bandwidth and the scale. And, you know, that's why we have so much more scale than the other CDNs. And that's really important to customers that have a lot of traffic, you know, the big OTT providers and the big software downloaders. And that's why so much of their business comes to Akamai. Also, you know, being in those locations gives us a huge advantage on cost because in the large fraction of those 4,000 locations, we don't pay for bandwidth and colo and power. You know, and so it's free for us, you know, with the infrastructure. We pay for our CapEx. But our competitors aren't there. Our competitors are in big data centers, and that is the most expensive real estate in the world. And so we're in a position that we can provide, you know, compelling pricing, you know, to the major enterprises out there. And our competitors, if they're going to do that, they have to do it losing money. And that's not sustainable. Now, any one of the many competitors we have out there, you know, all generally speaking much, much smaller, at any given time they could take on some traffic and show some, you know, high percentage growth on very small numbers. But it's hard to sustain that when you don't really have a sustainable advantage. And then you see that happen is the traffic, you know, some of the traffic share moves around among the smaller players. Now, in addition, it's not just about CDN and delivering traffic, it's accelerating the traffic, it's providing functionality on the edge close to the end user. And I talked about a lot of examples that were, you know, where we're doing that today. And of course, processing a lot of the API transactions which are, you know, tied to functionality, over $100 trillion so far this year. And then you have the security aspect, which our CDN competitors, by and large, don't have. They may partner with other companies or startups to have some, you know, security story. But that's now a billion-dollar business for Akamai and growing at, you know, over 20%. And security is just really vital for our customers, and it works well. in tandem with the application acceleration, with the edge computing. All is one service, all on one platform. And if you're not on the edge, there's no hope to withstand the large attacks that we're seeing today.

Thank you. And our next question comes from the line of Colby Smithel with Carolyn. Your line is open. Please go ahead.

Great. Thank you. Just going back to security, I'm just curious – Would the security results thus far this year have been much different had COVID-19 not have happened? I'm just curious how you would quantify the impact that COVID-19 has had on the security business, whether good or bad. And then secondly, the long-term operating margin of 30%, I think you've messaged that that should remain flat target. But can you just remind us why that is and why we won't continue to see increased operating margin leverage? Thank you.

Sure. I think, you know, we see strong security growth with or without COVID. There are some of our products that, you know, are really helpful for enterprises as they have more of a remote workforce. And so we did see uptick in bookings there. So I think there's, you know, some help. The attack rates have gone way up. And I do think some of that has tied to COVID. Now, whether we see the ransom DDoS attacks that, you know, are widespread just in the last couple months, you know, we might have seen that anyway. Maybe there's an increase because the prize is bigger now. You know, if you're attacking a commerce company that had 90% of their business in brick and mortar, well, they care about the 10% for sure. But when all of their business is online, now they really, really care. So there is a bigger prize, and maybe that's incented. the attackers to up, you know, the attack level, or maybe that's just the world we're living in where we're going to be seeing more and more attacks, even if we get COVID under control. And, you know, I can tell you, you know, we see a lot of attacks in Asia Pacific, just like we do here and in Europe, even though in APJ, COVID is largely under control there and operations are largely returned to normal. And yet the attacks, the ransom DDoS attacks, you know, are increasing just as fast over there. In fact, one of the national stock exchanges that was taken offline that is now an Akamai customer was in Asia Pacific. In terms of the 30%, we do think that's a good place to operate the company over the longer term. And, you know, that said, we're going to do everything we can to operate as efficiently as possible. And you see that this year. You know, we – You know, this year we've been doing over 30%. And so if we can do that and, you know, continue to make the investments we want to make to achieve long-term growth in the business, then, you know, we will. You know, but I think the right way to think about it is 30% is a good baseline, and when we can overachieve that, we're going to do that.

And I guess just one quick follow-up to the security question. I mean, given what sounds like some upside, arguably, Do you think that you're in a position to sustain that 20% TUS growth rate over the next few years?

Certainly, we'd like to do that. You know, we're seeing very strong growth in Kona Site Defender and Prolacsec. Kona Site Defender is our web app firewall product. Bot Manager doing very well, and the next generation of that will be even stronger at preventing account takeover. Security services business we've talked about is doing very well. And I think with the increase in attacks and the sophistication of attacks, we're seeing even more demand for our security services. It's just too hard for even major enterprises to keep up. And then you have the newer solutions, you know, our enterprise services, enterprise application access, enterprise threat protector, now equipped with the first version of our secure web gateway. We're going into beta with our multi-factor authentication service next month. As we talked about, our page integrity manager, which sits on top of Kona, off to a great start. You know, we'd like to see that track the way that bot manager did getting out of the gate. And, you know, of course, we announced today, and I'm really excited about the as of the acquisition. You know, I think that opens up a whole new category for us that We'll see accelerated growth as we get more 5G deployments, as you see more IoT applications out there. And what that does is it sends all the cellular traffic safely and directly to Akamai before it gets onto the Internet. And in that way, we can really protect enterprises and their cellular devices. And I think that's a market that is very exciting for the future.

Thank you very much.

Thank you. And our next question comes from the line of Sterling Audit with JP Morgan. Your line is open. Please go ahead.

Yeah, thanks. Hi, guys. So wondering, you made the comment that one of the big video providers you saw 4X increase in traffic. That would seem to be more than just a COVID-related. I'm just wondering what else you saw in that particular account, and is that something that's happening in other accounts as well?

Yeah, as we talked about, you know, we're continuing to gain share. If you exclude the 59 Chinese apps where obviously government regulation has, you know, lessened the traffic we're delivering there. And that's based on, you know, our scale and performance and, you know, ability to offer market competitive prices, you know, for our customers. And so I think you've seen that, you know, trend. You know, over the last couple of years, we've talked about it. We've put a lot of effort, you know, into continuing to improve performance, continuing to improve our scale and on a global basis. And that puts us in a great position against the competition in the market. And you're right, 4X is obviously not COVID. COVID did improve traffic. There's no question about that, but nothing like 4X.

That's great. And then one follow-up. You touched upon it in your prepared remarks and your guidance, which is e-commerce heading into the holiday season. It's been a little while since you've updated us. Can you give us a sense of where do you sit in terms of your customer base within like that e-tailing 100 or, you know, that 100 largest e-commerce sites and vendors that are out there?

Very, very strong. You know, well north of 90% of the You know, the top commerce companies, you know, rely on Akamai for application acceleration and also, importantly, increasingly importantly, security. And as I mentioned before, now that these companies, a lot of them, most all their business is online. And so security really, really matters now. And we're obviously the go-to supplier there.

Excellent. Thank you.

Thank you. And our next question comes from the line of James Fish with Piper Sandler. Your line is open. Please go ahead.

Thanks for the questions, guys. Tom, you sound really excited here on these new security solutions again. I guess how are you thinking about the web security gateway market, and do you need more investment in an enterprise security sales team to get this product more penetrated and beyond just the CDN install base?

Yeah, in fact, a lot of our customers for the enterprise products are new to Akamai and, you know, hadn't, you know, bought our preexisting product line. And that's because, you know, our web products of delivery and, you know, web app firewall were primarily to a subset of the Fortune 500, maybe a third of the verticals to a half the verticals. But enterprise security is something that pretty much all the Fortune 500 would need. And so that has, you know, increased our market. And we have, you know, put effort into, you know, our specialist teams that, you know, help the sales force. I would say that all of our sales force now is very adept at selling the, you know, the traditional Akamai security products. And most of them are actually pretty good now at the newer products with enterprise security, page integrity manager. Swig is just new out there, so very early on. But I think we'll be in good shape there. And Azavi, of course, that's sold by carriers, as is our SPS solution. And so we would sell to the world's or Azavi and now Akamai sell to the world's major carriers and provide a solution that they then take to enterprises. And I think that's a model that we're very excited about. And increasingly, you'll see with our enterprise security projects, products will be led by channel partners and carriers being the majority of that.

Got it. Just as my follow-up, you know, we're starting to see a new wave of applications get to size again like we did last decade with Netflix and YouTube being two examples. I guess what are you guys hearing from customers regarding their own potential CDM build-outs for some of the applications that they have? one of your customers, for example, hit their five-year goal within one year.

Wait, so are you asking about what are we seeing in terms of DIY or what are we seeing in terms of big OTT players and their market penetration and success?

Both.

I'll take both. Okay. Well, yeah, OTT is certainly increasing and a lot of the offers are seeing substantial success. Obviously, some are doing better than others, but I do think You know, OTT is here to stay. Obviously got tailwinds from the pandemic. You know, but I think people are, as they view more online, that becomes more the pattern, and that will outlive the pandemic. Of course, I think we'd all like to get back to a world where you can go out and see a movie. Probably not going to be anytime soon, you know, here in the Americas or in EMEA. And I think more and more of the movie watching and TV shows will be, you know, watched online. DIY is something that, you know, that we exist in a few of the largest, you know, content providers. And, you know, I don't think we've seen a huge, you know, shift there. You can sort of track that with the cloud giant customers, which has been, you know, fairly steady. you know, over the last year or so. You know, it's really hard to build out something like that for yourself. It costs hundreds and hundreds of millions of dollars, if not more. You end up spending more than you would with Akamai, and you don't get the quality you'd get with Akamai. And not only that, if you're a global company, you've got to do it, you know, all around the world. That's just – it doesn't make sense. Now, some of the biggest companies do it, and I think you'll continue to see that. but there's not been a real fundamental shift there.

Appreciate the call, Tom. Thanks, and congrats on the quarter. Thank you.

Thank you, and our next question comes from the line of Brad Zelnick with Credit Suisse. Your line is open. Please go ahead.

Hi, this is Ray McDonough for Brad. Thanks for taking the questions. First, Tom, if I could, I wanted to ask about gaming, and as you mentioned, We're approaching a new console cycle with both Sony and Microsoft coming out with new consoles. And from what I understand, they've made some changes to how games will be downloaded. With the caveat that downloads and gaming files are becoming larger and more ubiquitous, how should investors think about the contribution of gaming? How much does it represent today? And, you know, how big of a growth driver do you think it can be into next year?

I'm going to hand that one over to Ed.

Yeah, so obviously gaming has been a business that's changed for us quite a bit over the last couple of years. You see the multiplayer gaming has changed the dynamics. And, you know, if you think about the consoles that are coming online, obviously two major players, it's been, say, four or five years since we've had a major upgrade cycle. So, you know, I would say you can kind of throw history out. This is sort of a new chapter. I think it could be a good source of upside for us, you know, in terms of its contribution. We don't break it out specifically, but I would say it's probably the second largest contributor in our media business next to video. So, you know, as I talked about in the guidance section, that this could be a source of upside. And, you know, it's hard to tell. We'll know when we get there, but this could last, you know, into the early part of next year as, you know, some of the publishers come up with new games and, you know, the consumers are buying them. They have to update the system with firmware and then catch up with all the old games that they had. So, I think this is a pretty good trend for us. You know, it's hard to predict whenever you have something this large. And as you, Brittany, pointed out, the game downloads, the frequency and the size are only increasing.

Yeah, that makes a ton of sense. I appreciate that, Keller. And if I could, just a quick follow-up. Coming out of the first half of the year, you know, there seems to be some supply constraints industry-wide. you know, understanding that every region is a bit different. How is capacity industry-wide trending? And, you know, how should investors think about your capital expenditure plans into next year?

Yeah, great question. So, obviously, this year was a pretty big year for CapEx. And, you know, we've really been on the journey here for the last, call it, 18 months where we've increased the capacity of the network. And I'm glad we did. I think, you know, Tom and the team made a great decision to do this. You know, obviously, we couldn't have predicted the pandemic, but we had a lot of New OTT launch is coming. And, you know, as we talked about just a few minutes ago on gaming, you know, that's becoming more and more challenging because, you know, customers want to get their games at the same time. And that requires a lot more capacity. And so we spent quite a bit on CapEx. You know, we actually took advantage of some bulk purchases here at the end of the year. We've added a tremendous amount to our capacity. So I would expect next year to be back in sort of the normal state. level of tap backs and down several points from what we're seeing today.

Great. Thanks for the call.

Thank you. And our next question comes from the line of Will Power with Baird. Your line is open. Please go ahead.

Okay, great. Yeah, thanks. I'll ask, I guess, a couple here. Maybe first, I'd love to get some perspective on what you're seeing in the international and I guess really despite the challenges you were facing in India, continued to see strong growth. So maybe just if you can just touch on what the sources of those strengths were kind of outside of India.

Yeah, sure. So, yes, you're right to point out it's actually not India that was impacted. It was actually China because the customers that were impacted, the 59 Chinese staffs, we serve about 30 of them, those were actually customers in China. So China, you know, revenue obviously was a bit more challenging for them. Actually, India was actually one of the areas of strength. What I was encouraged by is I saw many different countries in all different geographies. So Latin America, Brazil, and Mexico. Over in Europe, we saw strength in the UK, Germany, and the Netherlands. And then over in Asia, we saw strength in Australia, Indonesia, and continued strength in Japan. So it was really across the board. You know, we're very pleased with international growth. And if you think about coming into a quarter where you're losing $15 million of revenue from your international customer base and to be able to still grow sequentially and grow 20% year over year. So it's very impressive. And as I've talked about in other calls, you know, I think we have a unique advantage in the industry. From an international perspective, we made the investments early on in sales and building out our network and our capabilities. I think it's a huge advantage for us, and we've done remarkably well, not only in just delivering media, but also in security.

Is that international strength concentrated in any particular products or solutions, or is it more broad-based?

I'd say it's more broad-based. Certainly, in the early days, it was all about media delivery and application acceleration. The U.S. market was the first to adopt the security solutions, but now security is – becoming a really nice growth engine for us internationally.

Okay. And then kind of my second core question, just around M&A, notwithstanding the acquisition announced this morning, maybe you can just update us on, you know, appetite for M&A as we exit this year and into 2021, maybe any color around areas of focus and potential size, kind of what you're seeing out there in the market.

Yeah, we continue to be very active in looking at potential deals. You know, obviously it's a little trickier with the pandemic because travel is restricted, but that's not preventing us, you know, from doing transactions as you saw from today's announcement. You know, I would say so far the pandemic really hasn't impacted market caps, you know, very much. You know, that may happen at some point depending on what happens with the global economy. So I would say it's business as usual right now.

Okay. Thank you.

Thank you. And our next question comes from the line of Keith Weiss with Morgan Stanley. Your line is open. Please go ahead.

Nice one. Thank you guys for taking the question, and nice quarter. A lot of the questions I had were covered, so a couple kind of more detailed questions, if you will. One, on that gaming theme, a lot of what people are talking about for gaming on Go4Dates is the shifting to more streaming to game subscriptions, and it's not just Microsoft, but like other vendors have their platform for game streaming. Can you talk to us about how Akamai is positioned for that potential shift towards more of a game streaming? It sounds like something that would be kind of right up your alley.

Yeah, so it depends exactly what you're referring to, Buddy, if it's a You know, a gaming tournament where a lot of people are watching, yeah, we do that already, and, you know, that creates a fair amount of traffic. If it's a situation where an individual's game and their screen is being streamed, we, you know, don't do that very much. We will handle the metadata and the security around that. You know, the economics around streaming individuals, you know, what they would see on their screen is, That's pretty challenging. You know, people have been working at that, the big gaming companies, for well over a decade and haven't really gotten the economics to work. But we would handle the metadata, the security, the logins, you know, the leaderboard, all that kind of stuff, you know, we handle. It's just the individual stream is not so economical.

Got it. Got it. That makes sense. And then one detailed question on the security solutions. In particular, access is a solution that you guys have rolled out, and it's something that we hear a lot from a lot of different vendors across the spectrum, whether it's guys coming from, like, the security perspective, like a Zscaler or Citrus has their access solutions. Can you talk to us about sort of how the competitive environment in there is shaking out for you guys? Where do you guys see yourselves doing well, and who do you run up against most often?

Yeah, we compete, you know, well with Zscaler there. I would say that the vast majority of the competition is the traditional, you know, CPE vendors and the traditional ways of doing things. And, you know, our value proposition is that we can do it, you know, in the cloud. That's a lot easier and more secure. And, you know, once we have it and we're providing the access, we can layer in, you know, Kona Site Defender and our other technologies, which, you know, the other companies don't have. And that makes it, you know, a superior service. So I'm optimistic, you know, about the future growth there. And even though we compete, you know, with Zscaler and compete well, really the two of us are out there competing against, you know, the traditional way of doing things.

Got it. Excellent. Thank you, guys.

Thank you. And our next question comes from the line of Amit Dayani with Evercore. Your line is open. Please go ahead.

Hi, this is Lexi. I'm for Omid. Thank you for taking the question. So I guess the December quarter guide implies that sales are up around 7% year over year, and that's kind of a strong deceleration versus the 12% to 13% range we've seen over the last few quarters. I guess the India and U.S. bands account for 20 million or 200 basis points of drag, but Beyond that, what do you see as kind of the headwinds there?

Yeah, so I think if you look, you know, the last couple quarters, certainly Q2 was a big jump due to the pandemic and the additional traffic that we got. I know the good news is we've been able to maintain that traffic and even, you know, fill in the divot that was caused by the $15 million in Q4. And you're right to point out the fact that that revenue is gone, and, you know, I talked about an additional – $4 million if this U.S. ban goes into effect here coming up in mid-November. Last Q4 was an exceptionally strong quarter, quarter over quarter. There's a few things if you want to look at kind of comparing the jump that we normally see from Q3 to Q4. We just talked about those applications, the Chinese applications as one piece. If you recall in Q2, I talked about some license revenue. It was about $7 million that we saw from our carrier business. that traditionally we see in Q4 and we saw in Q4 last year. We're not expecting that again, so that's a piece of it. And then the other thing that is a little bit different this year, if you recall back in Q2 of 2019, we had our customer conference, and we introduced a zero overage offering to our web division customers. And that was really a response to customers who were looking for a more predictable spend with Akamai. You can imagine retailers are the ones who mostly – go for this offering. And, again, it's just a web customer. It's not for media customers. And that's to smooth out some of the different holidays and various peaks that they have in their business. Now, that's been in the market now for about 18 months, so we're starting to see some pretty good uptake on that. What that means is you just see a little bit of a flattening out in your seasonality.

Got it. Thank you so much.

Thank you. And our next question comes from the line of James Green with William Blair. Your line is open. Please go ahead.

Great. Thanks for taking the questions. Just one on security. Can you just give us a little color around the 23% growth and, you know, how much of that came from existing customers taking new products? And maybe on that point, if you have a security customer taking three of your products and they take a fourth, I believe most of that business is contractual. How does that manifest itself into the relationship or the contract with the company at the time? And then just secondly on CDN and media, you know, traditionally we see a little bit of a step down in volume from the third quarter as more people are outside in July and August. We didn't see as much last year in this timeframe. It doesn't seem like you saw it this year. Just your overall thoughts on that and, you know, OTT sort of overtaking some of the linear television, et cetera. Thanks.

Yeah, great question. So I'll start with the second one. You know, you're right, we didn't see as much of a seasonal dip. I did see a little bit in Europe towards the end of the quarter. You know, you've got to remember that we also have been in, you know, kind of a partial lockdown for, you know, most of the summer. So I would say that that probably adds to it. You know, we do typically see a seasonal dip here in Q3. But, again, outside of a little bit in Europe, I didn't really see much across the world. So that was a good trend for us. And your first question was around security growth at 23% and what's making it up. I think the question was around new versus existing. Primarily, the biggest growth is from existing customers. You know, today we have about 61% roughly of our customers buy security from us. And, you know, our new customer acquisition is led by security, but in a recurring revenue business in any given quarter, new customers aren't going to add a ton to the revenue pile. So it's typically your existing customers. And then the other question on as customers contract with us for multiple services, it tends to be sometimes it can be demand driven. So if you have something like a ransomware attack, you have an emergency integration, you just add that to your contract. In other times, it can be upon renewal where you're adding functionality. So somebody might be a Kona site defender customer, they want to add bot manager. We're seeing some really good early uptake with customers that are Kona site defender customers that are adding page integrity. And that can be done mid-contract if you go in and just add it to your contract. Typically, you have some form of an MSA with your customer, and you can just add products fairly easily.

And just to follow up to that, as you look across your entire revenue base right now, in terms of total revenue, how much of that is contractual versus more volume-driven, like your traditional CDM business?

In that business, I'd say the majority of it is contractual. There are some volumetric components to security, but really when you think about the business in total, the big variable in terms of volumes is in the media business.

And in terms of total revenue, if you look at media and security combined, how much total revenue do you think is more volume driven?

That's a good question. Probably a quarter, maybe a third at the most. It depends on the quarter. Like in a quarter like this, Q4, where you have stronger seasonality, you'll see a little bit more than normal. But the majority of the business is contractual. Great. Thanks.

Thank you. And our next question comes from the line of Jeff Van Rie with Craig Hallam Capital Group. Your line is open. Please go ahead.

Great. Thanks for taking my questions. Most of what I had has been answered. Just a few on the managed security services. I remember a while back you had referenced that. I believe there's 1,000 customers and $100 million in revenue. I don't know that we've gotten an update. Just curious if you could update that. And then any commentary around verticals that stood out pro or con in the quarter?

Sure. So in terms of net security services, you know, don't have a customer number here for you. We'll probably give you a more wholesome security update later when we get to next year. But it's still growing at double digits, which is great. So managed security services has been, you know, actually really a key differentiator for us. What we're finding is while we've built tools for customers to be able to manage their security products on their own, a lot of times they want us to do it for them. For example, Bot Manager, we're finding that there's a lot of demand for managed Bot Manager. It doesn't sound like the greatest product name, but it's sort of descriptive of what's happening. And then On the Kona site defender side, you know, managing firewall rules can be complicated, and oftentimes customers would like us to do that as well.

Yeah, in terms of the verticals, obviously the financial vertical is huge, as you can imagine, for security. You know, commerce, increasingly important as more of their business moves online. And interestingly enough, you know, big media companies, You know, gaming sites are now seeing a lot of attacks. News sites, obviously, especially during an election cycle, are big targets. And OTT sites and protecting accounts there is really important. So pretty much any big brand name, you know, is a big buyer of our security services.

Great. Thank you.

Thank you. And our next question comes from the line of Rasheesh Jaloria with, GA Davidson, your line is open. Go ahead.

Hi, guys. This is Tina Rudolph on for Rishi. Thanks for taking my questions today. So on the acquisition, could you just talk about what overlap there is between you and them both in terms of the actual technology today and then the customer basis?

I didn't catch that question. Can you repeat it, please?

Yeah, on the Azavi acquisition, could you just talk about what overlap there is between you and Azavi in terms of actual technology and the customer Macy's?

Ah, great. No, really good question. There is not a lot of overlap there. Their primary capability is to take the traffic from a cellular device and vector it through the carrier and into what today is their platform. Now, we are going to take that and vector it into the Akamai platform, and then we can layer in our enterprise security capabilities, our application firewall capabilities, you know, secure web gateway, make sure that traffic stays secure so that the device doesn't end up going to a site with malware, and if it does, to make sure that malware doesn't get back on the device. And so there's a very little overlap in capabilities, but very strong synergy. And the really nice thing is that their technology doesn't need to make use of a client. You know, and a lot of the devices out there, especially in IoT, may not be equipped with that kind of capability. They'll just go straight, you know, with a cellular connection. And also, there's no way around it because it's handled with the SIM card layer. So it's not a situation like with a normal device where the user can sort of get around any corporate security and go where they want and then get malware on the device and bring it back into the enterprise.

Great. That's really helpful. Thank you. And then is there anything to call out on this quarter with regard to the Internet platform customers aside from the higher traffic? I know you guys expected a greater sequential decline due to repricing. And then how should we think about growth of this cohort for the remainder of the year?

Yeah, great question. So, yeah, definitely a nice upside surprise for us. You know, as I mentioned on the last call, we did do repricing with two large customers in that cohort. And typically it takes, call it six to nine months to get back to, you know, traffic levels where your revenue sort of gets back to where it started from. We were able to do that and more here in Q3. So that was great, and it was, you know, a big jump in traffic from Q3. a couple of customers. So there's really good news there. And I would say, you know, in terms of this year, remainder of this year, Q4 tends to be a pretty strong quarter. So I'd expect something, you know, in this range, maybe a touch higher. Great. Thank you.

Thank you. And our next question comes from the line of Brandon Niceville with KeyBank Capital Markets. Your line is open. Please go ahead.

Great. Thanks for getting me in. Two, if I could. What are you guys seeing from a traffic perspective thus far in the fourth quarter versus really the third quarter? And taking a step back, how should we think about the higher traffic growth in 2020 translating into some contract repricing situation into 2021? Then on the acquisition, you called out $4 million in revenue. Is it safe to assume that that acquisition is closed today and it's a two-month benefit for this year roughly? And can we annualize that in terms of modeling purposes for next year with some growth expectation? Thanks.

Yeah, so why don't I start with the last one on my way back. So as far as the acquisition goes, yeah, I mean, that's the way the math would work out for this quarter. Just keep in mind that when you go through purchase accounting and you do your, you know, integration costs and things like that, there's some movement there. We'll give you an update on revenue contribution. This will be for next year when we do our next call. But, yeah, you're thinking about it in a way. But in terms of, like, how much growth add-on and things like that, we'll update you as we get a few months into the integration and have a plan fully built out. 2020-21, you talked about pricing and volumes. It's just a standard part of the business. You know, we'll always have – some number of customers that are up for renewal at any given time. Your average contract length is typically 18 months, anywhere from a year to two. Sometimes you get a little longer. So at any given time, you're going to have renewals. I think we've done a good job of calling out when there's anything that's unusual, meaning you have a big group of customers that are all coming up at once or, you know, we talked about last year when we had some big acquisitions of some of our customers acquiring each other. We'll continue to do that, but there's really nothing to call out at this point. and we'll be giving you a full update on 21 in the February call. And then I think your third question was on traffic for the fourth quarter. Are you seeing anything relative to Q3? Obviously, back-to-school fall season, we do see a slight pickup in traffic. We included that in our guidance. I think the only thing to call out is, you know, weekends, we do see elevated traffic, sports have been, you know, a nice source of traffic for us, and that certainly continues this year. Great. Thank you.

Thank you. And our next question comes from the line of Lee Kroll with B. Riley Securities. Your line is open. Please go ahead.

Great. Thanks for taking my questions, guys. Two quick questions. I think you mentioned the web division saw some upside from customer credits. Curious if you could quantify that upside and then if there is a similar contribution in Q4. Sure.

Yeah, sure. So I wouldn't necessarily call it a contribution. I think the way I would describe it is, if you recall, on the Q1 call, we talked about how the negative impact was around 5 million. And then the Q2, we talked about it being 14. So going into the quarter, we had modeled that we would have a further negative impact. You know, it's really hard to predict, you know, what's never been in one of these before. So it's really hard to predict what customers are going to request and ask for. So The good news there is we had very little less than less than a million dollars impact. As a matter of fact, we had a little bit of a positive impact in our bad debt assumptions, as we had assumed, with some customers that had filed for bankruptcy that have come back post bankruptcy, you know, we're a little bit higher up on the, the chain there. So we were able to recover some of that, that money that we had to write off. So, in general, that was a positive surprise. So I wouldn't say that it was a, you know, a pickup of any time that we'd expect in this quarter. I think what I outlined in the guidance section was there's a potential that, you know, if we get into a second wave and we see customers get under a lot of stress, that you could see something similar to what we've seen in prior quarters. We're not anticipating that right now, but that's obviously something as you kind of build your models and handicap that you'd want to think about. The worse the pandemic gets, the more stress the retailers are under, the more stress the travel and hospitality customers are under, there's a potential that you could see you know, a little bit of headwind there if we have to do some things on the restructuring or credit side.

Got it. And then just another question. You guys added a lot of capacity in 2019 and certainly significant capacity in 2020 in response to both streaming media as well as kind of the pandemic-related uptick in traffic. You know, as we lapped those comparisons for both capacity as well as traffic growth and we kind of hit you know, some of the slower quarters with that added capacity. Maybe just talk about the puts and takes between margins and, you know, keeping the servers running hot to offset costs. One of your competitors kind of indicated a little bit of a margin headwind as server capacity overstretched, you know, a pullback in demand. You know, as we lapse some difficult comps over the coming quarters, how do you kind of think about capacity versus the margin standpoint?

Yeah, good question. So, you know, mix is obviously something that you have to take into consideration. The good news for us, you know, if you think about the 20 plus years we've been in this business, we've always seen, you know, unit economics where volumes go up, prices go down. We've been able to do a phenomenal job of driving down costs in our network. And the fact that we're, you know, at such a scale, there's a mix between fixed port contracts versus variable contracts. We get, as Tom mentioned, a lot of our traffic is free. and that sometimes can include both space power and bandwidth. So we have a whole team that is maniacally focused on that, and we continue to make improvements in our server capacity to be able to get more throughput per machine. So, you know, obviously as mix changes you can have a point here or there move, but in general I think we've done a phenomenal job maintaining margins despite, you know, the realities of the high-volume media business. So, you know, I don't know the specifics of what you're talking about with our competitor, but we don't see any significant declines in margins as a result of adding all this capacity. If anything, I think it gives us a tremendous advantage. You know, one of the interesting things that we saw this quarter, well, I saw we lost a lot of traffic in India. We actually picked up a lot of traffic in India from other customers as a result of having additional capacity. You get better performance the more capacity you have. And we were able to benefit and fill in some of that gap of the $15 million we lost, and some of it was in the India region.

Got it. That's helpful. Thanks for taking my questions, and congrats on a good quarter. Thanks.

Thank you. And our next question comes from the line of Mark Mahaney with RBC. Your line is open. Please go ahead.

Okay, thanks. All of my business questions were asked. I'll just ask, in the event of a change in administration next week, and you think about the implications for your business in terms of everything from R&D tax credit policies, immigration issues, corporate tax rates, what do you think will be the biggest impacts on your business were there to be a change in administration?

Well, you know, maybe just settling down the overall environment out there would be good. Stress levels are obviously pretty high in the country, in this country right now, and it would be good to get past that. Obviously, taxes might rise. I don't think that changes the operation of the business in any way. Obviously, there would be a one-time reset on EPS if the tax rate were to go up. And Ed can talk more to that. But I don't see the fundamentals of our business changing one way or another, depending who wins. Ed, what thoughts do you have about that?

Yeah, good question, Mark. So I would say, you know, in terms of taxes, you know, obviously a lot of our earnings come from outside the U.S. So, you know, it's rumored that there's a 7% increase or whatever may come at some point. And who knows if it comes in 21 or they wait a year and put it in 22. So that would have some impact on us. But, you know, like I said, a lot of our earnings are outside the U.S. A couple other things to keep an eye on, though. interest rates. So with the Fed being very accommodative and interest rates that near zero, think about our reinvestment of our marketable securities. So you're going to get a lower interest rate in terms of return. So that's going to impact your GPS or touch. And then, you know, the last thing would be around foreign exchange. So depending on what type of stimulus you have, if the dollar gets weaker, because as a result of us printing more money, then obviously, that could be a benefit for us. Because the way to think about our international business is we've got We're profitable outside the U.S. and, you know, nearly half of our business is outside the U.S., so that can be a benefit potentially if the dollar were to get weaker. So those would be sort of the three areas financially that sort of jump off the page at me.

Okay. Great. Thanks, Tom. Thanks, Ed.

Well, thank you, everyone. In closing, we will be presenting at a number of virtual investor conferences and events throughout the rest of the fourth quarter. Details of these can be found in the investor relations section of Akamai.com. Thank you for joining us. All of us here at Akamai wish you continued health to you and yours, and have a very nice evening.

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