Akamai Technologies, Inc.
Q3 2013 Earnings Call Transcript
Published:
- Operator:
- Good day, ladies and gentlemen, and welcome to the Third Quarter 2013 Akamai Technologies, Inc. Earnings Conference Call. My name is Regina, and I'll be your conference operator for today. [Operator Instructions] Today's event is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Tom Barth. Tom is the Head of Investor Relations. Please go ahead.
- Tom Barth:
- Thank you, Regina, and good afternoon, and thank you, all, for joining Akamai's third quarter 2013 earnings conference call. Speaking today will be Tom Leighton, Akamai's Chief Executive Officer; and Jim Benson, Akamai's Chief Financial Officer. Before we get started, please note that today's comments include forward-looking statements, including statements regarding the revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our annual report on Form 10-K and quarterly reports on Form 10-Q. The forward-looking statements included in this call represent the company's view on October 23, 2013. Akamai disclaims any obligation to update these statements to reflect future events or circumstances. As a reminder, we will be referring to some non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the News & Events portion of the Investor Relations website -- section of our website, excuse me. With that, let me turn the call over to Tom.
- F. Thomson Leighton:
- Thanks, Tom. It's good to have you on board, and I'd like to take this opportunity to thank Natalie for her many years of service in Investor Relations and to wish her the best for her new role at Akamai. Q3 was another great quarter for Akamai on both the top and bottom lines. Revenue in the third quarter was a record $396 million, up 15% year-over-year and up 19% when adjusted for the ADS divestment and foreign exchange headwinds. This result exceeded the high end of our guidance range due to better-than-expected growth in our Media business and a couple of significant non-recurring deals within our Performance and Security Solutions. We generated non-GAAP net income of $90 million or $0.50 per diluted share, also exceeding the high end of our guidance range due to higher-than-expected revenue and a favorable change in our tax rate. The tax rate change had a $5 million or $0.03 per share impact on non-GAAP net income that was not included in our guidance. Jim will provide more details on the tax benefit in a few minutes. Cash flow generation continued to be very strong, with $158 million of cash from operations in the quarter and $390 million year-to-date. I'm also pleased to let you know that our board has authorized a new share repurchase program for $750 million. Our goal with this program is to put in place a multi-year capital allocation plan to offset dilution from our equity compensation plans and to provide us with the flexibility to return cash to shareholders, as business and market conditions warrant. I'll be back later to talk about some highlights from our recent customer conference and some specific achievements in the quarter. But first, let me turn the call over to Jim for the details on Q3 and the outlook for Q4. Jim?
- James Benson:
- Thank you, Tom. Akamai had a great third quarter. Before I get into the details, I'd like to remind you that the ADS divestiture and the depreciation methodology change for our network assets continue to impact our 2013 reported results and growth rates. In addition, there was a third discrete item this quarter that positively impacted our Q3 GAAP and non-GAAP net income and EPS. It was not factored into our guidance. This item is related to a retroactive income tax deduction benefit that I will outline further when we discuss taxes and earnings. Where appropriate, I will point out the impact of these items, so you can better understand the operational performance in the quarter. As Tom mentioned, revenue came in well above the high end of our guidance range at $396 million, up 15% year-over-year or up 19%, if you adjust for the ADS divestment and foreign exchange headwinds. The overachievement was largely due to stronger-than-expected growth in our media delivery solutions, most notably a bigger impact from the significant software release we mentioned in our last call. We also came in better than anticipated in our Performance and Security Solutions, driven by 2 significant non-recurring engagements
- F. Thomson Leighton:
- Thanks, Jim. It's been a great 9 months, and we're on track for a great year. Our financial results demonstrate that the fundamentals across our business are solid, and we remain confident in our strategy and the market opportunity for our products over the long term. Our optimism is reinforced by the enthusiastic feedback that we received at our Sixth Annual Customer Conference held earlier this month. We had roughly 1,500 attendees from over 30 countries, and it was our largest event ever. Conversations with several media customers in the conference made it clear that they believe that vast quantities of higher quality video are poised to move online over the next several years. Not only is more media viewing moving online, but the emerging formats like 4K or ultra HD require much higher bit rates to satisfy the growing user demand for quality. This is good news for Akamai since it suggests that media traffic levels could accelerate going forward. To meet this anticipated traffic demand, we are continuing to invest in our platform to provide high quality and reliability at scale. In September, traffic levels on the Akamai platforms surpassed 21 terabits per second. This record is 40% higher than our previous peak in June and highlights the ability -- our ability to scale our platform to handle unprecedented volumes of traffic while maintaining industry-leading levels of performance. We are also investing to improve the performance of our media services. In September, we released the first version of our new FastTCP technology across the entire Akamai platform. Leveraging the FastSoft technology acquired in Q4 of last year, FastTCP is designed to optimize the throughput of video and other digital content, resulting in faster and higher quality experiences for end users around the world. Our performance testing indicates that the new technology improves average throughput levels to end-users by 15% in North America, 22% in Europe and 105% in China. These higher throughput levels mean faster download times for large files and higher-quality viewing experiences for end-users watching video online. Conversations with our B2B and B2C customers at the conference made it clear that they expect more applications and online transactions will be moving to the cloud. They also recognize that the frequency of online transactions being handled by mobile devices is rapidly increasing, which creates greater challenges with performance. That is good news for Akamai since the goal of our web acceleration business is to achieve near-instant response times for dynamic websites and applications no matter where the user is, what device or browser they are using or how they are connected to the Internet. Last quarter, we shared with you the benefits of our real user monitoring, or RUM, capabilities, which are designed to help customers understand their true web performance across the many environments being experienced by their end users. We now have 100 customers who are leveraging our RUM capabilities, and the data we have seen validates the performance benefits of our new Ion web acceleration service for both land and cellular devices in many countries around the world. We believe that our web acceleration services are unparalleled in terms of their speed, reliability and compliance with security standards, such as PCI, and it is this performance and quality differentiation that makes Akamai unique. A top concern of customers across all our verticals at the conference was that cyber attacks are dramatically increasing in size and sophistication, requiring a distributed approach to defending a website and the data behind it. Akamai's web security services leverage our global platform to provide a large and powerful layer of defense for any website or web application, and we believe that our flagship Kona Site Defender service is unique in its ability to defend major websites against large scale targeted attacks, while preserving site performance and availability. As a result, web security continues to be our fastest-growing solution line across all of our geographies. At the end of the third quarter, over 700 customers globally are using our security products. As we continue to evolve our offerings, we believe that leveraging managed security service providers will be increasingly important to our security strategy. I'm very pleased with yesterday's announcement that IBM has chosen to partner with Akamai to integrate Kona Site Defender into its cloud security services portfolio. At the Customer Conference, we also made an exciting announcement about our plans to work with Cisco on hybrid cloud optimization, an emerging segment within our Performance and Security Solutions. Our hybrid cloud optimization service is designed to provide acceleration and last mile offload for all IP activity and branch offices, including retail stores, hotels and any other remote location. By integrating Akamai technology and software into Cisco routers, we believe that we can help enterprises offload existing network links and improve performance for web and business-critical applications across the land, as well as the Internet. Many of our network partners were also at the Customer Conference. Carriers have always played a critical role in our platform strategy since our servers reside deep within their networks, enabling us to provide unparalleled performance for our customers, while also reducing costs for our carrier partners and the entire ecosystem. Going forward, we anticipate developing new capabilities within our licensed and managed CDN solutions so that we can work even more closely with our carrier partners. Our long-term goal is to have every major carrier standardize its content delivery, acceleration, offload and security capabilities on Akamai technology. In this context, I was very pleased to announce our new Open Platform Initiative at this year's Customer Conference. Akamai Open is designed to help customers and partners work with Akamai more easily. The set of programs and APIs that comprise Open is intended to create more opportunities for community collaboration and innovation and provide deeper visibility into and greater control over how enterprises interact with our technology. In summary, the world around us is rapidly evolving. Everyone and everything is getting connected, creating a remarkable new environment known to some as the Internet of Things, to others as the Internet of Everything and to still others as the Hyperconnected World. Whatever you choose to call it, we are becoming a world in which billions of people, tens of billions of machines and countless petabytes of information are all interlinked and in which instantaneous and intelligent access becomes the expectation. At Akamai, our objective is to meet this expectation using innovation to deliver on the promise of a Hyperconnected World, improving and transforming online experiences for everyone and everything, wherever and however they are connected. Thank you for your time today. Now Jim and I will take your questions.
- Operator:
- [Operator Instructions] Gentlemen, your first question today comes from the line of Jennifer Lowe with Morgan Stanley.
- Jennifer Swanson Lowe:
- Maybe just a first question, I wanted to touch on the commentary around the renegotiation of the contract and -- as we think, in the past, we've seen some of these -- have pretty big. I'm thinking 2 years ago, I think, or 3 years ago when there was the 8 of the 10 largest or some big number of the 10 largest that all came up for renewal at once and had a pretty material impact on the growth trajectory in the Media business. It sounds like, in this case, it's really just one customer. So as we think about the magnitude of what potentially we could see as an impact from this renegotiation versus where we saw a number of renegotiations in 1 quarter, is it potentially something of that magnitude or is this going to be a little bit more moderated since its one, not multiple? How should we sort of contextualize it versus some of these transitions that we've seen in the past?
- James Benson:
- No, that's a very good question. You're right. It was Q1 of 2011 that we talked about kind of 8 of our top 10 media customers renewing. I think the way to frame it is, it is our largest media customer. We don't have any 10% revenue customers, but we have kind of disclosed in the past that we have had a 10% receivable customer. And so, you can -- we have a very large customer, this is that large customer that's renewing. This customer has not renewed in a few years, so you can imagine that their pricing is dated from a few years ago. I can't give you any specific details on, obviously, the pricing. We're going into the renegotiation with them now, but that gives you a little contextualize [ph] of roughly kind of how big could the customer be. The customer hasn't repriced in a few years. So the timing of when the renegotiation takes place, whether it's Q4 or Q1, will have an impact on the company's growth rates. Having said that, we talked to you in the past that, that is the nature of the media business. The media business has traffic spikes and traffic dips at times. We go through pricing renegotiations with customers. This happens to be a large customer. We certainly have optimism that the media delivery business has very strong growth opportunities for all the reasons that Tom outlined. So again, this is a common renewal process, which happens to be with a large customer. Hopefully, it gives you a little color around roughly the size, so you can kind of maybe model it without us giving you some of the specifics. But again, it will happen either in Q4 or Q1. We think it's going to happen in Q1, but what we did in our guidance range was make sure that if it did occur in Q4, that we widen the range here on the low end to make sure that we gave you that context as opposed to surprising you later.
- Jennifer Swanson Lowe:
- Great. That's helpful. And I just wanted to touch base on the repurchases, too. And, Tom, in your remarks, you sort of hit on some of the ambitions to return capital to shareholders and all the good stuff that we like to hear. And I know, in the past, Akamai's repurchase activity has tended to really concentrate around some of the opportunistic troughs in the stock. And usually when the stock's at these levels, the repurchase activity has been a little bit more modest. As we think about sort of the magnitude of $750 million, that's pretty big versus some of the repurchases you've done in the past, is it going to continue to be sort of that same type of opportunistic cadence, or do you see scenarios where you could even really be materially buying back stock with the stock where it is today?
- James Benson:
- So, Jen, it's Jim. I'll take that. So just to clarify, our prior share repurchase programs have really been exclusively focused on offsetting dilution from the company's employee equity programs. It was only once that we asked for an incremental authorization from our board to opportunistically buy back more shares when the stock price was at a pretty low level. So our objective in the past has been annually to have a program that offsets dilution. What we're signaling here is that, given the company's cash balance, given the company's cash flow generation, we believe we have an opportunity now to not only offset dilution, but to also have the flexibility to opportunistically buyback more shares. Obviously, it will depend upon business conditions and market conditions. We continue to have and will have a very active M&A pipeline. So you can imagine the reason we outlined it for 3 years is that if the M&A pipeline is large and we think there's some transactions, obviously, we'll probably moderate the buyback. But if not, you can expect that we're going to continue to operate it as we have in that we're going to have it continue under a 10b5-1 plan that we repurchase quarterly. It will -- and it will continue to have kind of tranches. But you can expect that we're going to do more than offset dilution from equity programs. That's really the objective of this. It's really more the timing of it will depend upon the business and the overall market conditions.
- Operator:
- Your next question is from the line of Mark Kelleher with D.A. Davidson.
- Mark Kelleher:
- I wanted to touch on your partnerships with IBM and Cisco in light of some of the ebbs and flows on the media side. This is on the other side. Can you give us maybe some sizing or some scope or some feel for where those relationships might develop to and the timing? I know you've had some announcements with partners in the past, but can you talk about where these 2 might go?
- F. Thomson Leighton:
- Sure. Both are early stage, but both are very important to us and I think have in the longer-term significant potential. With IBM, that is to help sell our Security Solutions. They are integrated into IBM's managed security service solutions, and it gives us a great channel and it's just in the very early stages, just being announced. And so, it's obviously not material yet, but we hope that it will become so. Cisco is even earlier stage. At our Customer Conference, we demonstrated Akamai software for branch performance optimization. We're working on a Cisco router. That's a demonstration, and we'll be looking forward to work with Cisco this year to get that out as a Cisco product that hopefully would be sold through their channel, and that's what we're working on with Cisco now. So there's no revenue there today. But it's something that we hope, over the next several years, could generate meaningful revenue for both companies.
- Mark Kelleher:
- And while I'm asking about some of the partnerships, is the partnership with Orange on track where you expect it to be?
- F. Thomson Leighton:
- Yes, that's going very well and is one of the flagship accounts for us with our carrier strategy. And so, again, we're -- it's in the early stages, but proceeding according to plan and we are very optimistic in the future of that relationship. Not only in France, but they operate in many countries around the world and gives us a chance to get into those markets with Orange as our partner.
- Operator:
- Your next question is from the line of David Hilal with FBR.
- Samad Samana:
- This is Samad Samana in for Dave. I wanted to follow up on the hybrid cloud optimization product. Has that become generally available, or could you update us on the progress of the beta and when you expect that to be fully available to the customer base?
- F. Thomson Leighton:
- Yes. So we are on our own in beta with a relatively small number of customers. We've had early trial results from retail stores in major cities around the world. The trial results were -- I would characterize them as very successful, showing both offload and improvements in latency for users in the store. And the informal feedback from the customers has been that the users in the store were very happy with the capabilities of the service. And so, that's at the very early stages, looking very good and that is the technology that now we're embedding into the Cisco router. So it's the same technology. Now as we go forward, our hope is that the Cisco relationship will prove very successful and that, that could be a fabulous go-to-market opportunity for Akamai. Obviously, Cisco, much larger company, much larger presence with their routers in the branch offices on a global basis, and that's a real opportunity for Akamai to leverage that.
- Samad Samana:
- And then, a question on the security side. So in 1Q, you had about 500 customers that jumped to 650 in 2Q. The jump was a little bit slower in 3Q to 700. I was wondering, are you seeing a little bit of a slowdown there? Is there more competition with Google talking about potentially launching a DDoS application? Could you please talk about that a little bit?
- F. Thomson Leighton:
- I'd say the competition levels are pretty steady. We had very good traction with our Kona Site Defender service, which is our flagship service. We added 40 units during the quarter to get to a total of 180 customers. So very strong growth in the quarter. The Google offers something pretty much unrelated to what we do, and I don't see any really direct competition with the Google offer.
- Operator:
- Your next question is from the line of Colby Synesael with Cowen and Company.
- Colby Synesael:
- I have 2 questions, if I may, for Jim. The first one, Jim, I'm sure you could anticipate one of the questions that's going to come out of this call, is there another shoe to drop as it relates to customer renegotiations? So I was wondering if you can give us any color on what you see on the horizon and maybe to kind of put some people's minds at ease. The other kind of question tied to that is, is your customer concentration you'd argue increasing or decreasing if you kind of look now versus maybe a year ago? I know you've talked about how there's really no 10% customer, but just trying to get a sense of customer concentration. And then, just -- my second question has to do with the sales ramp. I think, Jim, you talked about, about a year ago, how sales will be a little bit light in 2013 because you really didn't get the sales force in place the way you'd wanted to in 2012. You've added a lot of people this year. Is it fair to assume that we could see an acceleration in sales simply because of the increased distribution you have out on the street now?
- James Benson:
- Sure. So I'll take your first question that's really around kind of renegotiations. You're right that we have pricing renegotiations with our media customers all the time. Certainly, in Q1 of 2011, you had a period where you had 8 of your top 10. This happens to be our largest customer. I would characterize that, obviously, this one will be notable because it is our largest customer. And even though they're not a 10% revenue customer, they are a very large customer. And when you have a very large customer that has not been repriced in a few years, you're going to see an impact on that. I think, beyond that, you're going to -- every quarter, you have large media customers that renew. And so, I would say -- in the horizon, I would say that nothing else is notable. You're always going to have big customers renew. This happens to be a very large customer. As far as concentration, there really hasn't been any concentration change from year-to-year. As far as the mix profile and whether we're more weighted to a handful of customers. That's not the case at all. And then, relative to the sales ramp, we're very pleased with the sales ramp. We're actually a little bit ahead of plan around sales hiring through Q3. You may recall that we came out of Q1 a little bit light. We recovered in Q2. And we're actually a little bit ahead of plan now. But having said that, it takes a while for the sales force to on board, get trained, become productive. And then, there's obviously a lag period between once they become productive for that turning into revenue. So I think, right now, the early indications are that we're on track for the staffing. We've been tracking the productivity of the new reps, and they're tracking according to plan. Admittedly, their productivity is a lot lower than a tenured rep, but we expect that. But they're tracking in line with what we would have thought. And so, our expectation is that we'll end the year, as we said, with the increase in the sales force. And once we get them productive in 2014, we're hoping that kind of in the back half of 2014, that you'll start to see these tenured reps start producing and then have that convert into accelerating revenue growth, in particular, for those solutions that grow with sales reps, which is our Performance and Security Solutions, obviously, not so much our media solutions.
- Operator:
- Your next question is from the line of Ben Rose with Battle Road Research.
- Ben Z. Rose:
- Tom, one of your most significant competitors recently had a service outage on the media delivery side, and I'm curious to know whether that's translated into an opportunity for renewed discussions with some of their customers that may have been affected.
- F. Thomson Leighton:
- I think, whenever a competitor does have a major outage, that helps go to our value proposition that we are the most reliable provider out there and we provide the best performance, and it really hits home to a potential customer when that kind of thing happens. This versus any of the others that have taken place, I wouldn't say, make a material difference, any one of them. But the pattern of outages like that do make a difference over time, and I think customers do appreciate Akamai's great track record of reliability.
- Ben Z. Rose:
- Okay. And then, just a follow-up question. I know that you've also stated a desire to be disciplined on the acquisition side. Specifically, in the security area, are you beginning to see some of the valuations perhaps become a bit more reasonable?
- F. Thomson Leighton:
- Well, we're looking across all of our areas for acquisition. We always are. Last year, we did close 4 deals. The year before, we didn't do any. We haven't done any yet this year. But we're always looking and we're always working on it in all the major areas, from media to acceleration to security and to hybrid cloud optimization and carrier products, where we made an acquisition at the end of last year. So it's something that's a constant and ongoing effort, and we are disciplined about it. We want to make sure that we buy companies that really -- that we can leverage to add value to our customers.
- Operator:
- Your next question is from the line of Heather Bellini with Goldman Sachs.
- Sonya Banerjee:
- This is Sonya Banerjee on for Heather. Just thinking about guidance for 4Q, if the customer roll-off puts you at the low end of the range, what are the levers that could drive out performance? And in particular, how are you thinking about software downloads impacting results in the quarter?
- James Benson:
- Good question. So I covered that a little bit in my opening remarks that the way to, kind of, think about the guidance range that I provided is a $412 million to $430 million is -- you're going to be at the lower end of the range if 2 things happen. One, that renegotiation takes place in Q4, but that's not the only reason. The other driver that would get you down to the low end is if the e-commerce season and traffic there is light. So that's what would drive you to the lower end of the range. What'll drive you to the higher end of the range is, one, the renewal doesn't take place -- the renegotiation doesn't take place until Q1. You have a very robust holiday season. And to your point around downloads and traffic, we're expecting that in our -- kind of the higher end of our range, even at the midpoint of our range that we're expecting to have a strong holiday season. We're expecting to have a strong traffic season for downloads and things of that nature. So it's -- the way to really think about it is you'll be at the low end if the e-commerce and media season is a little bit light and the renewal took place. You'll be at a higher end if the media and the e-commerce season is strong and the renewal pushes to Q1.
- Sonya Banerjee:
- Got you. And then, just separately, thinking about the media business generally, can you speak to the rate of pricing declines at this point? And I know it's still somewhat early, but how are you thinking about pricing dynamics evolving next year?
- James Benson:
- That was a good -- I mean, we -- obviously, we talk -- that's a question that we get asked every quarter. The rate and pace of pricing is very consistent with what we've seen in previous quarters. It's a very competitive environment. We continue to see, kind of, prices go down. But the rate and pace of pricing erosion is no different now than it was, really, for the last couple of years. We've seen a very consistent pricing environment, and we expect to see that going forward.
- Operator:
- Your next question is from the line of Richard Fetyko with ABR Investment Strategy.
- Richard Fetyko:
- The e-commerce vertical growth was about 8.5% year-over-year. It's been, sort of, in the high-single digits for the last couple of quarters and I know we had some tough comps year-over-year. But just curious if we should expect that to reaccelerate at some point? I mean, it's well below the historical levels.
- James Benson:
- Yes, that's exclusively driven by our ADS divestment. If you pull out the ADS divestment, it's been growing in the low-20s. So it's been very consistent. We grew in the low-20s last year with ADS. It's growing low-20s without ADS.
- Richard Fetyko:
- All right. And then, if I may, a follow-up on the Aqua Ion, sort of, upgraded product that you rolled out. What kind of take rates are you seeing there?
- F. Thomson Leighton:
- We're having success with Aqua Ion. A lot of great case studies now with the real user measurements that I talked about, showing substantial performance benefits. And not only on a global basis, but also even within regions. So that you might have, say, a customer whose origin is hosted in Tokyo and users are primarily in Tokyo and all within Japan. And really, that's a great opportunity now for us with Ion because we can show performance benefit, whereas DSA had less of a benefit, small geography. Also, Ion has a lot of features now designed to optimize mobile performance on cellular networks where the challenges are really quite large and that becomes important now that more and more of the online transactions are being done over cellular networks. And the real user measurements, which we now can get for cellular users, show excellent performance gains. So we are having good success with Ion, and it's showing substantial performance improvements over the flagship DSA service.
- Operator:
- Your next question is from the line of Aaron Schwartz with Jefferies.
- Aaron Schwartz:
- I asked this question earlier in the year, but maybe I'll ask it again since you're further into the year. Given the strength in the media business year-to-date, how are you looking at potential for early renewals or managing those contracts through the year? It just seems like a lot of your sort of run rate customers may be sort of at their higher end of the way they planned for traffic this year.
- James Benson:
- Yes. I mean, it's really no different. I think, obviously, we're going through the renegotiation with our largest media customer. But there's really nothing notable as far as people burning through their commits early necessarily that, like I said, you see large renewals every quarter. We just happen to be going through one that obviously is notable, and we felt it was appropriate to signal that to you so you can understand what it is. But beyond that, really, the way these contracts get structured is they do tend to get staggered. You're right that if you burn through kind of the traffic commitments that potentially they can renew earlier. But my expectation is that the rate and pace of that is not any different than what it's been in the past.
- Aaron Schwartz:
- Okay. And if I could sneak a second one in. I think you mentioned one of the significant non-recurring deals in the quarter was a setup of an LCDN customer, if I heard you correctly. Could you just walk through the economics of what happens at this point? Does that now sort of flip over to a capacity-based license, or how does that work now that, that customer has set up?
- James Benson:
- Yes. It's actually a managed CDN customer. We have licensed CDN customers and managed CDN customers, one is we're licensing our technology to them. That's not what this was. This is literally a managed CDN, where we're helping them build out kind of a managed CDN network within their network. And the way it works is, at least, in this case, that there were some one-time, call it, setup fees that we received for the hardware and getting all of that installed for them or getting it engaged for them. And the way it'll work beyond this going forward is it will vary by engagement. But the way it works, it's more of, call it, a rev share-based model in some cases where they bring on traffic onto their network and we'll share based on that. In some cases, it's capacity-driven. You'll build out enough capacity for them. And as you build out capacity for them, you'll recognize the revenue over the kind of the, call it, the contract life for which the capacity is being served. So we're early stages on a lot of these. We happen to have a notable one in Q3 that really aided our growth rates, which is why we wanted to call it out to you because it's certainly helped the Performance and Security growth rates to be higher than what we had expected them to be.
- Aaron Schwartz:
- And if I could, how long was that in process before you sort of completed the build-out to where you took the revenue?
- James Benson:
- Well, we've been having discussions with that customer for a while. But I -- it probably took a couple of months for it get -- once we've concluded the negotiations with them to kind of get it set up. But it's getting the gear installed and then there's actually getting the network set up. And it depends, call it, roughly a quarter from the time you close one of these to maybe turning them on.
- Operator:
- Your next question is from the line of Gary (sic) [Gray] Powell with Wells Fargo.
- Gray Powell:
- So when you cite a potential strong holiday season as an assumption for the high end of revenue guidance in Q4, how would that compare to the holiday season last year?
- James Benson:
- I would say, last year, if you recall, what we said was that it was an okay holiday season. It wasn't a bad holiday season, but it wasn't a [Audio Gap] holiday season. So I think consider at the midpoint of our guidance, we're expecting a solid holiday season, which was maybe what we see -- saw maybe more like a couple of years ago. Last year was a decent holiday season. So think of that as maybe the midpoint of our guidance.
- Gray Powell:
- Got it. Okay. And then, you all continue to make good gains on the gross margin side and I assume that's probably through better co-location and bandwidth cost control. How should we think about margins going forward? And should we expect you to reinvest gains in gross margin back into R&D or sales and marketing or just something else?
- James Benson:
- I think the answer to that is yes. As we've said, we intend to operate the company in the low-40s EBITDA is, call it, the model. We're operating higher than that right now. We're operating higher than that right now not because we're not making the investments in the business in R&D and sales capacity and things of that nature, it's just as we've been making those investments, you've seen a corresponding continued improvement in our management of cost of goods sold and expanding gross margins. You saw it again. We think we can stabilize margins at the levels that we're kind of at. You're going to see maybe, in Q4, they go up, but that's largely because of some seasonal revenue growth. But think of it as kind of high-70s cash gross margins. If we're a little bit higher than that, we do intend to reinvest it back into operating expenses. The way to think about our plans in managing the company is low-40s EBITDA. We're higher than that now, and we're obviously spending and we're spending because we want to increase the pace of innovation and we're spending because we want to increase the sales capacity to drive a re-acceleration in those solutions that kind of grow with sales transactions.
- Operator:
- Your next question is from the line of James Breen with William Blair.
- James D. Breen:
- Just a couple of questions on some of the, sort of, one-off media events. Last quarter, you'd made comments when you gave the guidance for this quarter that where you came in would depend on the timing of this software download. We had no FX [ph] update yesterday. It's the first time it's been free, that it hasn't been paid for. Do you take that in consideration and on the terms of the range you gave for this quarter?
- James Benson:
- Yes. I mean...
- James D. Breen:
- You did, okay.
- James Benson:
- But the answer is yes, absolutely.
- James D. Breen:
- And then, from an order of magnitude standpoint, as you think about renegotiating with this customer, we have another significant sporting event, the Winter Olympics, coming up in the first quarter of next year. From an order of magnitude standpoint, you know what the impact from the Summer Olympics was. In terms of offsetting the potential repricing given sort of the growth rate impact you saw in the third quarter last year, can you just give us a little color on that?
- James Benson:
- Yes. I mean, I'm not going to provide guidance beyond Q4. But just to give you some general color, it is true that you get a benefit from some of these one-time sporting events that happen over a period of time, meaning, like an Olympics. But the benefit you get from that is not -- certainly not nearly enough to offset given the magnitude of the size of this customer. So I don't want to set an expectation that those things will offset this. Now I will say that we saw very strong growth in our media customer base across our social media customers, our video delivery customers, our gaming customers and software downloads. So all the areas that we've mentioned to you in the past, we continue to see very strong growth. So the business is performing very well across all of those areas. And all of those areas, I think, are going to continue to be growth engines for the company. Again, we're going through a renewal. That happens. It's part of the media business, as we told you in the past. But I think the fundamentals of our media business are extremely strong.
- James D. Breen:
- Great. And then, just one question on traffic -- types of traffic you're seeing. Can you just talk about, on the media side, sort of, the mode of traffic, mobile versus wireline and sort of the different types of customers there?
- F. Thomson Leighton:
- On the media side, most of the bids go to landline or WiFi. Cellular is more congested. On the web experience side or the application acceleration side, about 1/4 of the transactions now, we're seeing on mobile devices. That's up by about a factor of 10 from a few years ago. And we think, within a couple years, probably be the majority of online transactions will be on mobile devices.
- Operator:
- Your next question is from the line of Sterling Auty with JPMorgan.
- Sterling P. Auty:
- One question and one follow-up. You mentioned the non-recurring deals, I think, in the Security and Performance, but you alluded to them pretty quick. Can you give us more color there? And I believe this is the second quarter in a row where we've had either a non-recurring or a one-time type of deal. What does the pipeline for those types of deals look like for the fourth quarter?
- James Benson:
- Yes. So you may recall in Q2, what we talked about was that we had a -- just one of the questions, we saw actually a Q2 growth in our Performance and Security Solutions of 19%, which was higher than we had expected. And we wanted to make sure people realized it was not because the new sales capacity was all of a sudden resulting in an acceleration in our revenue growth for that category, because it was driven really by pretty significant upgrade with our IP accelerator solution category. So it was really germane to one particular solution really with kind of one particular customer. What happened in Q3 was we saw the full quarter benefit of that IP accelerator solution. That solution actually is a recurring revenue solution. So that was as expected. But on top of that, as we told you in the past, we will have projects or custom projects with the federal government and the timing of when those complete vary. We happen to have a very large one that completed within Q3. And I just answered the question from someone that asked about this setup of our managed CDN, and we got some benefit from that. Really, if you kind of adjust for, call it, the non-recurring items, that business is growing more in the mid-teens. And our expectation is we can turn that growth around once we get the sales rep capacity up, ramped and productive. But that's not going to take place until 2014 some time.
- Sterling P. Auty:
- Okay. And then, the follow-up would just be on Europe. I think, in the prepared remarks, you talked about some of the macro squishiness. We're starting to see some of the PMI data out of Continental Europe starting to show some improvement. Wondering if that may be a leading indicator and you expect some improvement here in the fourth quarter and into 2014. Or do you think it's too soon to tell?
- James Benson:
- I think it's too soon to tell. I think it's fair to say that our business, because it's a recurring revenue business, is more of lagging. So our -- the impact to Akamai for macroeconomic headwinds is kind of the longer effect for Akamai, whereas companies that are either selling licenses or hardware, they see an immediate impact from those macroeconomic headwinds. But I think for companies like us that are in a recurring revenue model, we see the impact of that much later. And I'd say that's what you're seeing now. So I'm not -- I think it's -- I don't think you're going to see a turnaround in our EMEA markets any time soon, meaning, in the next quarter or so that -- having said that, we still think there's a significant opportunity for the company because we're not nearly penetrated in those markets, but those markets right now are going through some pretty significant times, in particular, the southern markets of Europe. So hopefully, that provides a little bit of color.
- Operator:
- Your next question is from the line of Ed Maguire with CLSA.
- Edward Maguire:
- I was wondering if you could comment on how the ramp of productivity of your sales hires that began in mid-2012 is tracking and if you're comfortable that each cohort is going to be delivering as you've been expecting.
- James Benson:
- Yes. Good question. So, yes, we track every, we call them, tenure classes. We track every class, and we track their progress based on kind of a benchmark which we set for which is previous reps on average what they've done in their different tenures. And I'd say, on the whole, I think the classes are doing relatively well. And to our expectations, you're obviously going to have 1 quarter to the next that one class does really well and then the next quarter maybe not so well. But I'd say they're tracking to our expectations in general.
- Edward Maguire:
- Great. And just 1 follow-up, and this is really more -- is concerns for external sales, whether some of the disclosures around the NSA revelations have had any impact on the discussions that you have with your international customers?
- F. Thomson Leighton:
- Yes, it has. There is concern outside of North America that a U.S. company would be prone to giving over-sensitive information to the U.S. government as a result of the PRISM disclosures. Fortunately, for us, most of that activity is stuff that doesn't really relate to our business. So it has come up, but we're not really in the focus of that storm. Probably, Germany is a place where it's been most a topic of conversation. So I don't anticipate major impact there to our business just because we're an American company. We're really not in the sweet spot of that. We don't have the data that was PRISM-like in terms of the press releases there.
- Operator:
- Our next question is from the line of Phil Winslow with CrΓ©dit Suisse.
- Harris Heyer:
- This is Harry Heyer for Phil Winslow. I think you started to touch on bandwidth and co-location costs, but you didn't really get into any sort of detail in terms of pricing trends there versus the previous quarter. I was hoping you might be able to touch on that.
- James Benson:
- Sure. There's really been no change notably. We continue to manage our network costs very effectively. I think we've talked to you in the past that, obviously, the 2 big drivers of our network costs are bandwidth costs and co-location costs. And our network and engineering teams have done a fantastic job of kind of continuing to put platform efficiency initiatives in place that make us a more efficient consumer of bandwidth and a more efficient consumer really of co-location costs. And so, the pricing environment there really hasn't changed in either one of them. It's really more been driven by our execution from our internal teams.
- Operator:
- Your next question is from the line of Jeff Van Rhee with Craig-Hallum.
- Jeffrey Van Rhee:
- Just 2 brief questions. First, just maybe you could dial it in a little better on the sales side in terms of 2 basics
- James Benson:
- Yes. So we ended Q4 of last year with about 215, kind of, direct quota-carrying sales reps, and we ended Q3 at about 300. So -- and we've talked about the fact that we intended to end the year with roughly 100 sales reps added. So that's kind of where we're at on the hiring. Obviously, that hiring has taken place throughout the year, and the way it works, it probably takes 5 quarters for a sales rep to get fully productive. And as you can imagine, that ramps over time. So the question that was asked previously around how people are doing to the various cohort classes, we still have a pretty -- the new sales reps that we have on board are still pretty junior as far as their tenure. They're obviously seasoned sales reps, but they're junior as far as their tenure within Akamai as far as training. So our expectation is you'll start to see the benefit from them becoming productive sometime in 2014.
- Operator:
- Your next question is from the line of Kevin Sazar [ph] with Macquarie.
- Unknown Analyst:
- I wondered if you could talk a little bit about the hybrid cloud products and potential revenue impact in 2014. Are these going to -- products going to be available in time to have a meaningful contribution next year, or should we really think about them as more 2015 opportunities?
- F. Thomson Leighton:
- Yes, I think you should think about that, in terms of meaningful revenue contribution, as 2015. We will be in the market next year with the hybrid cloud optimization, but it's very early stage. You shouldn't be thinking about meaningful amounts of revenue then.
- Operator:
- Your final question comes from the line of Tim Horan with Oppenheimer.
- Timothy K. Horan:
- You've rolled out a lot of upgraded products over the last 12 months, and I think you were going to charge, kind of, a premium for the products. Can you discuss whether you've been able to do that or not and maybe just a little bit more color on the uptake?
- F. Thomson Leighton:
- Yes, we do get a good premium when customers upgrade from DSA to Ion. That's our app acceleration product. We also get a good premiums and higher ARPUs when selling Kona Site Defender, which is our flagship security product that we launched early last year. So when we do bring out the premium products, we are seeing uplift, which is good.
- Timothy K. Horan:
- And just last, on the media customer, it sounds like it was a 3-year-or-so contract. Are these contracts -- do you usually price them down once and that's a set price for 3 years, or do they have kind of quarterly or annual step-downs?
- James Benson:
- Yes. I mean, they vary. You can't generalize them to be the same, but you can -- think of it as they have volumes. And then based on volumes, they have different pricing tiers. And based on those volumes, they move -- you push more volume, you get a lower price. And so, you basically develop a bunch of tiers and throughout. So it isn't as if this customer has not had favorable pricing over time because -- but the pricing was based on the pricing table that was set up several years ago. But they -- certainly, the more volume they push, the better price they get.
- Timothy K. Horan:
- And have you -- have many of the media contracts come due in the last 12 months or 18 months?
- James Benson:
- I mean, as I said before, they come due every month, every quarter. It's -- you're just going through a very notable one here because it's our largest customer. And so, it was appropriate for us to signal that to you.
- Operator:
- And there are no further questions at the queue at this time. So I'd like to turn the call back over to management for any closing remarks they'd like to make.
- F. Thomson Leighton:
- Go, Red Sox. Thanks very much.
- Operator:
- Ladies and gentlemen, this concludes the presentation today. Thank you so much for your participation. You may now disconnect. Have a great day.
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