Akamai Technologies - Q2 2023

Transcript

Operator (participant)

Good day, welcome to the Akamai Technologies second quarter of 2023 earnings conference call. All participants will be in listen-only mode. If you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. Now, I'd like to turn the call over to Mr. Tom Barth, Head of Investor Relations. Please go ahead, sir.

Tom Barth (Head of Investor Relations)

Okay, thank you everyone for your patience. I'd like to reintroduce our CEO, Dr. Tom Leighton. Tom?

Tom Leighton (CEO)

Thanks, Tom, and thank you all for joining us today. I am very pleased to report that Akamai delivered strong results in the second quarter, with revenue coming in near the high end of our guidance range, and earnings exceeding the high end of our guidance range by $0.07. Revenue grew to $936 million in Q2, up 4% year-over-year, both as reported and in constant currency. non-GAAP operating margin was 29%, and non-GAAP earnings per share was $1.49, up 10% as reported and up 11% in constant currency. As you can see, and as Ed will explain in his portion of the call, our actions to increase profitability are delivering good results.

I'll now say a few words about each of our three main product areas, starting with security, which is our largest source of revenue. Security revenue grew to $433 million in Q2, up 14% year-over-year, both as reported and in constant currency. The improvement in our security growth rate was driven by multiple products, with especially strong growth for our market-leading segmentation solution. We entered the segmentation market with our acquisition of Guardicore in Q4 of 2021, and we're nearing an annualized revenue run rate of $100 million. At this scale, segmentation is having a bigger impact on our overall security growth rate. Customers are adopting our segmentation solution to help defend against ransomware and data exfiltration attacks, which have become more frequent and damaging.

For example, last quarter, we signed a three-year, $8 million segmentation deal with one of the world's largest carriers. Large carriers and banks want to protect their consumer data from losses that can damage their brands and trigger large fines from regulators. They also appreciate spending less on legacy firewalls that no longer provide adequate protection. We also saw strong growth in Q2 for our market-leading web app firewall and bot management solutions, where we continue to fare well against the competition, due in part to their challenges with reliability and performance. For example, we recently took business away from a competitor at one of the world's largest micro-blogging platforms. Outages on their former provider's platform made the customer seek a more reliable partner, so they switched to Akamai for their global expansion plan in Europe and Asia.

In another example, a leading Asian financial institution recently returned to Akamai also because of reliability challenges with this competitor's platform. As we look to the future, we're also excited about our new API Security solution that we announced last week, enabled in part by our acquisition of Neosec in May. API Security is rapidly emerging as a critical need for major enterprises. That's because as enterprises modernize their infrastructure to create better digital experiences, they're making increasing use of APIs to improve developer agility and end user performance. The problem is that these APIs are often not adequately secured, and they open up new vectors for attack. Our new API Security product leverages AI-based analytics and threat hunting capabilities to discover APIs, analyze their behavior, identify vulnerabilities, and help customers defend against attacks.

Customers who thought they had 1,000 APIs might turn on API Security and discover hundreds more they never knew they had, with vulnerabilities lurking within legacy infrastructure or new applications. This is why banks are establishing API governance groups today, and it helps to explain why IDC and Gartner project that the API Security market will surpass $1 billion by 2027. Like our segmentation solution, customers can buy our API Security product without being an Akamai CDN customer. These security solutions are CDN agnostic, demonstrating how we can go to market as a security provider first. We also continue to make good progress on the cloud computing front. Akamai is taking a fundamentally new approach to cloud computing, making it fully distributed, with many more points of presence than are available with traditional solutions.

By leveraging Akamai's unique platform and capabilities, we believe that we can offer enterprises better latency, better performance, automated scalability and portability, and reduced costs, especially for applications that incur high egress fees with the hyperscalers. Since our call with you in May, we've gone live with three new cloud computing sites in Washington, D.C., Chicago, and Paris, and we plan to open 10 more later this year. These new sites are part of our plan to connect, compute, storage, database, and other services into the same platform that powers our Edge network today, a massively distributed footprint that spans more than 4,100 locations and 130 countries.

Last month, we also announced a doubling of the capacity of our object storage solution, a new Premium Instances for large commercial workloads that are designed to deliver consistent performance with predictable resource and cost allocation, and our plan to launch in beta the Akamai Global Load Balancer later this quarter. This new integrated service is designed to route traffic requests to the optimal data center to minimize latency and ensure no single point of failure. We believe that the Akamai Connected Cloud will be ideally suited for applications that benefit from being closer to end users. For example, in e-commerce, our customers want to tailor their online shopping experience to the individual user. They also want the better performance you get by being closer to the end user. That's because better performance translates into higher conversion rates.

In video and gaming, our customers want the game engine closer to the end user to reduce latency and to tailor experiences based on the user's device type and connectivity. In AI, the basic models will be generated and trained in the core, but the inference engines, which generate alerts and responses to queries, will be more efficient to run at the edge, where and when they're needed. As cyber attackers exploit advances in AI to create more forms of malware and more dangerous bots, more security will be deployed at the edge to intercept attacks before they can reach and swamp a customer's data center in the core. In all these areas, our customers also want the ability to spin up instances to handle flash crowds on demand, something that's very hard to do with competing cloud solutions.

In summary, we believe that next-generation applications will need next-generation cloud infrastructure, and Akamai is charting the course for this next decade of cloud computing, when more of the compute will be done closer to the end user, and where we believe our platform will have an important edge over more centralized models. Turning now to content delivery, I'm pleased to report that we continue to be the market leader, providing industry-leading performance and scale as we continue to support the world's top brands by delivering reliable, secure, and near-flawless online experiences. We enjoy a strong synergy between our delivery, security, and cloud computing offerings as we power and protect life online.

The synergy is both on the top line, as longtime delivery customers buy our security and cloud computing products, and also on the bottom line, as we realize the cost benefits of using a single infrastructure to provide security and compute services as well as delivery. Overall, I'm pleased to see that Akamai performed well in the first half of the year. Despite the macroeconomic challenges, we've continued to invest in the key areas that we expect to drive our future growth, while also taking actions to improve our profitability. I'll turn the call over to Ed for more on our Q2 results and our outlook for Q3 and the full year. Ed?

Ed McGowan (EVP and CFO)

Thank you, Tom. Today, I plan to review our Q2 results and provide some color on Q3, along with our increased full year 2023 guidance. I'm pleased that Q2 was another strong and very profitable quarter. I'll have more to say about our double-digit EPS growth in a moment. First, let's discuss revenue. Total revenue for the second quarter was $936 million, up 4% year-over-year. In the second quarter, security revenue was $433 million, growing 14% year-over-year. As Tom mentioned, security revenue was driven by strong demand for our WAF, bot management, and segmentation solutions. Moving to compute, revenue was $123 million, growing 16% year-over-year, as reported, and 17% in constant currency.

On a combined basis, our security and compute product lines represented 59% of total revenue, growing 14% year-over-year and 15% in constant currency. Shifting to delivery, revenue was $380 million, declining 9% year-over-year as reported, and 8% in constant currency. International revenue was $456 million, up 7% year-over-year and 8% in constant currency, and now represents approximately half of our total revenue. Foreign exchange fluctuations were flat on a sequential basis, and negative $6 million on a year-over-year basis. Moving now to profitability. Non-GAAP net income was $228 million, or $1.49 of earnings per diluted share, up 10% year-over-year and up 11% in constant currency.

These strong EPS results exceeded the high end of our guidance range by $0.07 and were driven primarily by higher revenues, savings from the headcount actions we took earlier in the second quarter, and continued progress on our cost savings initiatives. As a reminder, those cost savings initiatives include third-party cloud savings, rationalization of our real estate costs, depreciation expense, and other operating costs associated with lower CapEx related to our delivery business, disciplined spending with vendors, and tighter travel and expense policy management. With respect to third-party cloud spend, I'm pleased to report that for as long as we have tracked this expense, Q2 was the first quarter where total third-party cloud spend declined year-over-year.

While the decline was relatively modest, it reflects disciplined vendor management as well as the beginning of savings related to the migration of our workloads onto our own cloud platform. This migration effort to move away from third-party clouds is in the early stages. We are seeing promising signs. For example, our bot management solution is now running production workloads for hundreds of customers on our own cloud computing platform. As a reminder, we anticipate that the amount of savings we will be able to achieve will start to ramp through the end of 2023 and into 2024 as we bring online the needed capacity and features. Moving to margins, our cash gross margin was 73%, adjusted EBITDA margin was 41%. Our non-GAAP operating margin was 29%, slightly ahead of our guidance. Moving now to cash and our use of capital.

As of June 30th, our cash, cash equivalents, and marketable securities totaled approximately $1 billion. During the second quarter, we spent roughly $137 million to repurchase approximately 1.6 million shares. We now have about $700 million remaining in our previously announced share buyback authorization. Our approach to capital allocation remains the same: to opportunistically buy back shares to offset dilution from employee equity programs over time, while maintaining sufficient capital to deploy when strategic M&A presents itself. Finally, I'm pleased to announce that Akamai has obtained investment-grade credit ratings from Moody's and S&P. These ratings are a part of a broader financial policy to further reinforce our business and financial strength, not only with investors, but also with customers, vendors, and other parties that we engage with from a commercial perspective.

The credit rating also broadens our financial toolkit, allowing us to evaluate all available financing instruments, to determine what's best suited for our financial goals. Finally, as a reminder, Akamai currently has two convertible debt instruments outstanding, $1.15 billion due in May 2025, and $1.15 billion due in September 2027. Before I provide our Q3 and full year 2023 guidance, I want to touch on some housekeeping items. First, our annual merit-based wage increases became effective July 1st. This will result in an additional net operating cost of approximately $12 million per quarter. Second, in late July, the IRS released a notice that granted temporary relief for determining eligibility of foreign tax credits. This will result in a lower than expected non-GAAP effective tax rate in Q3 and for the full year.

Finally, the guidance I will provide assumes no change, good or bad, to the current macroeconomic environment. With those factors in mind, I'll turn to our Q3 guidance. We are now projecting revenue in the range of $937 million-$952 million, or up 6%-8% as reported, and 5%-7% in constant currency over Q3 2022. The current spot rates, foreign exchange fluctuations are expected to have a positive $1 million impact on Q3 revenue compared to Q2 levels, and a positive $10 million impact year-over-year. At these revenue levels, we expect cash gross margins of approximately 74%. Q3 non-GAAP operating expenses are projected to be $297 million-$302 million. We expect Q3 EBITDA margin of approximately 42%.

We expect non-GAAP depreciation expense to be between $121 million-$123 million, and we expect non-GAAP operating margin of approximately 29% for Q3. Moving on to CapEx, we expect to spend approximately $162 million-$170 million, excluding equity compensation and capitalized interest in the third quarter, which represents approximately 17%-18% of our projected total revenue for the third quarter. Based on our expectations for revenue and cost, we expect Q3 non-GAAP EPS to be $1.48-$1.52. The EPS guidance assumes taxes of $42 million-$45 million, based on an estimated quarterly non-GAAP tax rate of approximately 16%. It also reflects a fully diluted share count of approximately 155 million shares.

Looking ahead to the full year, we have increased revenue to a range of $3.765 billion-$3.795 billion, which is up 4%-5% year-over-year as reported and in constant currency. At current spot rates, our guidance assumes foreign exchange will have a negative $4 million impact to revenue in 2023 on a year-over-year basis. We are also raising our security revenue growth expectations to 12%-14% for the full year 2023, and we continue to expect to achieve approximately $500 million in revenue from compute in 2023. Despite a significant year of investments, we are estimating non-GAAP operating margin of approximately 29%.

With all that in mind, we have raised our estimated non-GAAP earnings per diluted share to a range of $5.87-$5.95. Our non-GAAP earnings guidance is based on a non-GAAP effective tax rate of approximately 17% and a fully diluted share count of approximately 155 million shares. Finally, our full year CapEx is expected to be approximately 19% of total revenue. In closing, we are very pleased with our financial achievements for the first half of the year and our ability to increase our overall revenue, security revenue, and non-GAAP EPS guidance for the full year. We believe that Akamai is a special class of businesses that have the ability and discipline to invest in future revenue growth, while continuing to be extremely profitable and generate significant cash flows. With that, we now look forward to your questions. Operator?

Operator (participant)

Thank you. I'll now begin the question and answer session. To ask a question, please press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. This time, we'll pause momentarily to assemble the roster. First question will be from James Fish, Piper Sandler. Please go ahead.

James Fish (Managing Director)

Hey, guys, congrats on the quarter and the security re-accel. Speaking of security, you know, how should we think about the bookings heading into Q3 for this segment or the bookings related to [Lush]? Really the crux of my question is just trying to understand the sustainability here and understanding we're raising by 2 points for the full year. Just trying to give some color around the confidence for the years is really what I'm asking.

Ed McGowan (EVP and CFO)

Yeah. Hey, Jim, thanks for the question. This is Ed, I'll take that one. I would say we had two back-to-back very strong quarters of bookings, so that was very encouraging. We also saw strength, and if I look at my sequential growth quarter-over-quarter, we actually saw all three major product lines accelerate. We saw growth in API and app protection. Segmentation was very strong. Guardicore was extremely strong in the quarter, and even the infrastructure business still had some hangover effect from the KillNet attacks we saw earlier on. All those product lines grew sequentially quarter-over-quarter.

In terms of the customer penetration, you know, if I go back to Q4 and look at where we are now, we saw about a 2.5% increase in customers buying a security product, we're up to about 75.5%. We're seeing great penetration in the, in the install base. Just one other soundbite for you. We now have about 700 customers who are buying four or more products in security. We're seeing really good strength with new customer additions, bookings across all products, product lines. Just another thing on segmentation. When we're seeing renewals with segmentation, we're seeing those renew very favorably and generally with expansion orders included.

James Fish (Managing Director)

Helpful. Then, Tom, maybe for you on the compute side, how are you guys looking to invest behind the GPU as a service side of Linode? Is this something your customers, particularly your large media customers, are looking to deploy with you? Do you see that as more reserved for, for the hyperscalers, and so you're gonna be more focused on that AI inference opportunity? Thanks, guys.

Tom Leighton (CEO)

Yeah, we, we do support GPUs today. It's not our primary focus, and that's just a financial decision. I would say gaming is more where you'd see that. With our big media customers doing video and media workflow, CPUs are just fine and much more economical and attractive there. You know, in, in terms of AI, you know, I think over time, probably that migrates, at least in terms of the inference engines, migrates to CPU as well. I think that over time, as we talked about, probably something you wanna be doing at the edge. We're fully capable of supporting GPUs. We do that some today, really based on demand from our customer base and financials.

Operator (participant)

Thank you. Next question will be from Keith Weiss, Morgan Stanley. Please go ahead.

Keith Weiss (Managing Director)

I wanted to follow up on the security question and the security business. We got a re-acceleration this quarter. I just wanna understand, like, some of the drivers behind that, whether you're seeing a better spend environment, sounded like the bookings were pretty solid. Is it sort of sales execution, or are you seeing sort of like newer offerings like Guardicore, sort of reach material scale to drive that sort of dollar growth on a year-over-year basis? Just wondering if you could sort of unpack the strengths and security and what it could portend for future quarters.

Tom Leighton (CEO)

Yeah, Ed, Ed talked to that somewhat. Let me just give some additional color there. You know, it's still a challenging spend environment in general. You know, so that I, I wouldn't say that's changed a lot. We are getting strong sales execution, and, you know, security is, is really important. As we've talked about before, in this environment, you know, financial institutions, they just can't afford to, you know, have a glitch. This is where our reliability really helps and stands out against the competition. They can't afford to get hacked. Again, we stand out there, 'cause we have the market-leading solutions, you know, for web app firewall and for bot management. You know, with Guardicore, really seeing strong growth, as, as Ed talked about.

I think, you know, what, what we're seeing in the marketplace is, there's good tailwinds there. You know, particularly now, you, you have Gen AI, and already the tools are out there, the variants of that, to produce, you know, more malignant bots, to morph malware, so it's harder to detect. You can train the bots pretty easily to get around a lot of the firewall defenses. I, I think what you're gonna see is even more penetrations of the traditional defenses. At that point, what you really need is, is Guardicore, to identify when you are penetrated and where, and to proactively block the spread. I think you're gonna see more demand, you know, for segmentation, is, is the really the critical defense, going forward.

Strong, you know, as Ed talked about, strong execution and performance across all three pillars. Then you look to the future, you know, API Security is gonna be, I think, a very important market for us. Very early days, but I, I think really critical. Which really pleasing to see the momentum that we've been building in the first half of the year with security, and that can, I think, help drive us forward.

Keith Weiss (Managing Director)

I appreciate the thoughts, Tom. Just as a follow-up, sort of, toggling to the delivery business, just wanna get an update, and you guys have talked about this before, but I just wanted an update on sort of the operating principles and the operating philosophy around the delivery business with respect to sort of, you know, managing for sort of revenue share versus harvesting for profit to fund investments in the, in the, in the compute business, given the, you know, the ambitious roadmap you have there. What, what's sort of the right way we think that you guys are gonna strike that balance between those two objectives?

Tom Leighton (CEO)

Yeah, it really comes down to price and profitability. As we've talked about, we have turned down business that we, you know, is very spiky, and we don't get, you know, what we think paid enough to do it. We've left that to others to take. Meanwhile, growing the highly profitable, you know, delivery business, the core business there. You know, I, I think we are starting to see some positive signs there. You know, traffic growth is not where it was before, you know, the pandemic, but getting better.

We're seeing some acceleration, you know, there, which is good. Price declines, you know, I'd say softening a little bit here. You know, I'm optimistic that, you know, but, you know, over the next one to two years, we should, you know, see more of a stabilization of that, of that business. you know, still price pressure, but, you know, I'm, I'm pleased with the progress we're making there and, and strong cash generation.

Keith Weiss (Managing Director)

Thank you for the details, Tom. Appreciate it.

Operator (participant)

Thank you. Next question will be from Ray McDonough of Guggenheim Securities. Please go ahead.

Ray McDonough (VP)

Great. Thanks for taking my questions. Tom, maybe just to, to stay on the security side of things. Last quarter, you mentioned actions you were taking on the go-to-market side in security, but I'm wondering if you could provide more color on the sort of go-to-market changes that, that might be working here. And, you know, we've been hearing that Akamai has been more successful in engaging traditional security resellers recently. Has that helped drive an acceleration and growth here at all, or is that still too early and, and maybe a contributor into the future?

Tom Leighton (CEO)

No, our partners are very important, for security sales. In fact, some of our products are partner only, for example, segmentation. Very pleased to just recently announced a partnership with WWT, that'll be bundling in our solutions for segmentation and API Security. That kind of partnership is, is obviously very helpful for us in driving a lot of the improved execution. We also have dedicated resources for, some of the newer and more advanced security services, like segmentation, and I think that helps, you know, with sales. We're seeing, you know, customers, new customers to Akamai, which is great, and also upselling our solutions into the existing base. As Ed noted, now 700 customers, you know, buying four different security solutions. Ed, do you wanna add anything to that?

Ed McGowan (EVP and CFO)

No, I think you covered it. You know, we've, we've made a lot of the investments already, so there's not a big investment needed in the sales overlay functions. Very happy with that. As a matter of fact, a lot of the new customer acquisition is coming from Guardicore, and they're actually getting penetration in some, some verticals that aren't traditionally strong. Like this quarter, we saw some, some wins in education, state and local government, manufacturing and pharmaceutical, places that typically aren't very big web, you know, properties, that are typical CDN customers. You know, I think we're, we're seeing really good execution across all the parts of security, direct sales, the overlay teams, and the, and the channel.

Ray McDonough (VP)

Great, that makes sense. Maybe as a follow-up, Ed, you know, I, I know Guardicore and, and some of your other businesses, there, there could be some upfront license deals that, that could contribute in any given quarter. Was there anything to call out from an upfront license recognition in the quarter in security, in particular, that, that might not be repeatable, that, that we should just know about? Is there any renewals that might be coming up in the back half of the year that we should be aware of?

Ed McGowan (EVP and CFO)

Yes. Nothing material this quarter, a couple million dollars, but nothing material. If it's over a couple points, I call it out, so nothing, nothing there to call out. One thing I will say, though, with the, with the licensing we do with Guardicore, in particular, it's term licenses, so it's generally two to three years typically, and those license deals renew. One of the comments I made earlier is that we are seeing very strong renewals. When those license deals come up, we are seeing renewals, typically with expansion orders, which is really encouraging. You have somebody who's renewing and then adding on more protection across their internal infrastructure. Nothing to call out this quarter.

Ray McDonough (VP)

Great. Thanks for the color.

Operator (participant)

Thank you. Next question will be from Frank Louthan, Raymond James. Please go ahead.

Frank Louthan (Managing Director)

Great. Thank you. On the delivery business, can you talk to us about any impact you might see from the writers' strike? Is that factoring any of that in, in the decline? Then just comment on the sort of the sequential change in, in the business there. What's sort of the outlook there for the, for the rest of the year? Thanks.

Ed McGowan (EVP and CFO)

Yeah. Hey, Frank, this is Ed. From, from the writers' strike, I wouldn't anticipate any major impacts from that. You know, certainly not hearing anything from our customers there. Obviously, that would potentially impact new releases, which could take two years to get out, but not seeing anything there. In terms of, you know, the second part of the question, what are some of the fundamentals and what we're seeing, you know, Tom talked about, we are seeing traffic growth rates improve. It's going up 2 points a quarter. Pricing is still a bit challenging in some, some of the old web performance verticals and commerce and a little bit in travel as well. We are seeing with the larger customers, the big media, traditional media customers, pricing starting to abate a bit there.

Still, pricing declines are not nearly as, as steep. I think as traffic continues to improve, you know, we obviously have Q4 coming up, you know, in a few months we'll be in Q4, and that always tends to be a generally strong quarter for the internet as kids go back to school and, you know, new gaming consoles are sold and connected devices and all that stuff. It also tends to be, you know, pretty popular with new TV series and sports and whatnot that, you know, we're optimistic that, you know, traffic should continue to, to, to improve. You know, as Tom talked about, you know, hopefully, we get this business back to stable in the next year or so.

Frank Louthan (Managing Director)

Great. Are you seeing any more vendor consolidation like we saw earlier this year with some of the larger media companies?

Ed McGowan (EVP and CFO)

There was, you know, one probably real notable one that went from five vendors down to two, and we were the leading provider there and did pick up some additional shares from one of the, the ones who won there, but nothing really notable this quarter. That was, that happened, I think, at the end of last quarter.

Frank Louthan (Managing Director)

Okay, great. Thank you.

Operator (participant)

Thank you. Next question will be from Mark Murphy, JP Morgan, please go ahead.

Ari Young (VP)

Hi, this is Ari Young for Mark Murphy. Thanks for taking the question. Congrats on the quarter. To start off, you mentioned earlier that you expect to see stabilization in the delivery market over the next couple of years. Can you just describe what trends you're seeing that kind of lead you to think that? Thanks.

Ed McGowan (EVP and CFO)

Yeah, sure. I'll take this, Tom, and if you want to add something. I think it's really, you know, in the delivery business, it comes down to pricing and, and traffic growth rates. Now we're starting to see traffic growth rates improve and also comps become a little bit easier. The other thing is, we talked about moving away from some of the peakier business. What that'll do is improve the profitability. The delivery business to us is a really strategic asset for us, right? It, it enables us to get really great economics, which will help our cloud business. You know, delivery is a, a function of, of cloud in a, in a lot of ways. Also, for our security business, it, it enables us to get, you know, the reach and the scale and the data for security.

It's, you know, obviously a very strategic business. In terms of, like, the stabilization, I would say we're seeing pricing moderate, especially at the, at the, with the larger customers, which is a good sign. Traffic improving a bit, and if that continues, we should be, you know, back to, you know, hopefully a stable plus or minus.

A couple of points would be, would be great. I think one thing that, you know, the macroeconomic environment is causing a little bit of churn, if you will, or, or, or challenges in some of the traditional web, verticals like commerce. That's gonna have to work itself out as well. That may take, you know, one year or so for that to, to work its way out. I think as we see traffic growth and pricing stabilize a bit more, we should be in pretty good shape.

Tom Leighton (CEO)

Yeah, the, the only thing I'd add-

Ari Young (VP)

Great.

Tom Leighton (CEO)

... is in this environment with, you know, higher interest rates and money is harder to get. There's a little less enthusiasm for investment in, you know, the lots of CDNs out there that are losing money. As Ed noted, Akamai is in a unique position that, you know, we generate a lot of cash from our delivery business. We're the market leader. We do it, you know, better than anybody. You know, the smaller companies that were okay losing money before, well, that's not so easy to do now. I think that, you know, does help maybe the overall environment a little bit, and we'll see how that plays out over the next year or two.

Ari Young (VP)

That's very insightful. Thank you. With regards to Guardicore, it seems like you guys are having a bit of momentum on that front. Any changes in the competitive landscape, win rates, anything along those lines?

Tom Leighton (CEO)

Yeah, it's gotten more favorable for us. You know, our lead over the competition has widened as we've made a lot of investments in Guardicore to improve its capabilities. So now we're recognized by the analyst community as the market leader by a wide margin. That's very good timing because, you know, that capability is an increasing need with, you know, major institutions. I think the competitive environment has become more, more favorable for us because of the work we've done to make it a great product.

Ari Young (VP)

Got it. Thank you. I'll step back in the queue.

Operator (participant)

Thank you. Next question will be coming from Rishi Jaluria of RBC. Please go ahead.

Rishi Jaluria (Managing Director)

Wonderful. Thanks so much for taking my questions, guys. Nice to see the security reacceleration this quarter. I had a two-part question I wanted to ask about the compute business. First, can you talk a little bit about how some of your product investments in terms of getting Linode to be enterprise scale and to be truly competitive with the likes of, you know, AWS and Azure, when you've got features and functionality like Kubernetes, for example, how those efforts are going and, you know, maybe what learnings you've had as you've been migrating your own cloud spend onto that platform?

The second part, and Tom, you kind of hinted a little bit at this earlier, right? When we look at what the hyperscale cloud vendors are saying, they are seeing a big uptick in demand right now as a result of generative AI workloads. You know, how do you think about your ability to capture some of those generative AI workloads as companies are thinking increasingly about adopting their Gen AI strategy? Maybe are there additional investments you need to make in Linode to be able to capture some sort of, some share of this? Thank you.

Tom Leighton (CEO)

Yeah, great questions. We are making really good progress with Linode, Kubernetes. Really, it's about scale, and we talked about that. You know, the build-out will be up to a couple dozen core locations, you know, by the end of the year, with a ton more capacity than we had before. Object storage and the new architecture there, much more capacity and capability. The certifications, you know, we now have PCI compliance for our use, so we can run Bot Manager on it. We have market-leading bot management solution. We have 300 customers now, using that solution on Akamai Connected Cloud instead of third-party cloud. That does take advantage of deep learning technology, so already we have those capabilities, you know, to support that on Akamai's cloud.

You know, I think overall, with the timeline, the way we think about it, you know, by the end of this year, we should be in a position to start taking on more serious bookings or bookings with large customers for really important applications. We have a couple already using it, and then, you know, start generating more revenue next year from major applications. In terms of competing with the hyperscalers, you know, we're not gonna be fully competitive for every application, and we don't have to be.

It's a $200 billion a year market growing at 15%, and we are targeting a subset of that market, primarily initially vertical, you know, media and gaming, followed by commerce after that, where in particular applications where performance matters, so the application is being used in some way by end users or business partners, where you maybe wanna have that application running closer, so it, it has better performance, where scalability, rapid scalability matters, and cost, especially for the applications that involve moving data around or have a lot of hits. You see that in media, gaming, and commerce. That's really what we're targeting, which is a pretty, you know, reasonable subset of the $200 billion.

Within that subset, if you're an enterprise that uses a lot of, you know, the third-party apps that are, you know, available as managed services on the existing platforms, probably it's harder to migrate, and that's not where we'd go first. Fortunately, you know, if you look at media workflow, in the areas where we're targeting, often that's not the case, and it's easier for us to, you know, manage the porting. You don't just flip a switch, so it's not that easy, unfortunately, and we've learned that. You know, at Akamai, you know, pretty much all of our applications are in the process of migrating from third-party cloud onto our compute platform. So it does take some effort, but it is eminently doable, and we're gonna save a lot by doing that.

You know, we're not the biggest company out there. You know, our big media customers spend, well, hundreds and hundreds of millions of dollars a year in the cloud, with often case, their primary competitor. hundreds and hundreds of millions of dollars a year in the cloud, with often case, their primary competitor. So I think we're in a position that, you know, we can now help them, based on our experience, migrate a bunch of those applications to Akamai. Good for us, good for them.

Rishi Jaluria (Managing Director)

Wonderful. Really helpful. Thank you so much.

Operator (participant)

Thank you. Next question will be from Rudy Kessinger, D.A. Davidson. Please go ahead.

Rudy Kessinger (SVP)

Hey, great. Thanks for taking the questions. Just, I know a lot of questions have been asked on security. Can you share the Guardicore growth rate? What, what kind of growth are you seeing in that business?

Ed McGowan (EVP and CFO)

Hey, hey, Rudy, this is Ed. About 60% year-over-year, and as Tom talked about, we should be at a $100 million run rate very, very soon. I would be surprised if we don't get there next quarter.

Rudy Kessinger (SVP)

Great, that is very impressive. As it relates to compute, you know, 17% year-over-year constant currency, that's a fully organic figure this quarter, as you've, you've left that acquisition. The guide implies, you know, depending on how you model the, model the sequentials, maybe 1 point to 2 points of acceleration by year-end. I guess, just how is the pipeline building, you know, for Linode as, as you get some of these sites online? When should we expect to see more material growth acceleration? You know, just, just what are your growth aspirations there, in terms of, of maybe 2024?

Tom Leighton (CEO)

Yeah. When you, you talk about Linode, you know, almost all the revenue there is in their traditional business, you know, developers, small, medium enterprises, low ARPU, customers. That business was a little over $100 million a year when we bought it, growing in the teens. You know, it's growing a little bit faster now, but it, you know, it's not, that's not the game changer. Why we bought Linode was to, you know, be able to use it as the base to create a service for major enterprises with mission-critical applications, very high ARPU, accounts. Today, the revenue there, we, we have actually signed up, you know, a few important cases, customers, and so we do have revenue there now, but it is, it's small, you know, in the millions of dollars.

But that's where the growth comes from, and that's, you know, we're, we're trying to get a 1% of a $200 billion market. Over a period of time, to go from a few million, you know, to a couple billion. We don't have a timeframe on that yet, but we're trying to do that as quickly as we can. That's where the real growth comes from, and it starts from a very small portion of our roughly $500 million compute business today.

Rudy Kessinger (SVP)

That's helpful. Thank you.

Tom Leighton (CEO)

Operators and Tom Barth, time for one more question.

Operator (participant)

Thank you. Our last question will be from Amit Daryanani of Evercore. Please go ahead.

Amit Daryanani (Senior Managing Director)

Yep. Thanks for taking my question. You know, I guess maybe to start on the security side, can you just touch about, as you see the acceleration that's happening there, is that skewing more from new customers or expansion of existing customers? Just any clarity over there would be helpful. Then, was there any licensing revenues that helped you with Guardicore in June?

Ed McGowan (EVP and CFO)

Hey, Amit, this is Ed. So as I talked about earlier, there was really no material license revenue in the quarter. As I said, I'd call it anything if it's, you know, a couple of points of growth or anything like that. Nothing to report there. In terms of the new customers and existing, we are seeing, as I talked about, a pretty good expansion in the existing install base, both with just straight pure penetration rates up a couple of points in the last two quarters to, as I look at customers buying multiple products, like I mentioned earlier, we have over 700 customers now buying four products.

The majority of the revenue growth is coming from the install base buying more, but I'm very encouraged with the new logo acquisition, especially with what we're seeing in Guardicore. Very encouraging to see them be able to attract new customers in verticals that we're typically not very strong in. Again, mostly from the install base in terms of buying more products, which is great. It's very encouraging on the new logo acquisition as well.

Amit Daryanani (Senior Managing Director)

Got it. If I could just follow up on one thing. You know, I, I think you talked about full year operating margins being around 29%. That's about what you have in the first half of the year as well. That would imply that, you know, sales will accelerate in H2 versus H1 from a dollar basis, but operating margins don't go up. Maybe I'm missing this, but what's the offset? Is it the merit increases or is there other offsets to consider in terms of why aren't we seeing better operating leverage in the back half of the year?

Ed McGowan (EVP and CFO)

Yeah. Two things there. One is the merit increases, you called out, but also the depreciation picks up quite a bit because of the CapEx in the first half of the year. Those are really the two main drivers. I, I'm pretty pleased with what we've been able to accomplish on the margin front, making huge, you know, investments in the business and acquisition, the big investments we're making in compute, to be able to deliver 29% operating margin for the year is pretty impressive. Then to deliver, you know, be able to raise EPS guidance, you know, very, very pleased with the team. I think everybody's pitched in and done a great job. Happy with that, and, you know, pleased to see us able to maintain the 29% margins despite the fact that there's increased depreciation and merit increases.

Amit Daryanani (Senior Managing Director)

Perfect. That's helpful. Thank you.

Tom Barth (Head of Investor Relations)

Thank you, Amit, and thank you, everyone. In closing, we will be presenting at several investor conferences and roadshows throughout the rest of the third quarter. Details of these can be found on the investor relations section at akamai.com. Thank you for joining us, and all of us here at Akamai wish you and yours a wonderful rest of the summer. Have a nice evening.

Operator (participant)

Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.