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Akamai Technologies, Inc. (NASDAQ:AKAM)
Q3 2018 Earnings Conference Call
October 29, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Q3 2018 Akamai Technologies, Inc. earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press * then 0 on your touchstone telephone. As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Tom Barth, Head of Investor Relations.

Tom Barth -- Head of Investor Relations 

Thank you, Gigi. Good afternoon, everyone and thank you for joining Akamai's third quarter 2018 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 revenue and earnings guidance. These forward-looking statements are subject to risk and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. 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 29th, 2018. Akamai disclaims any obligation to update these statements to reflect future events or circumstances. As a reminder, we'll be referring to some non-GAAP financial metrics during today's call. A detailed reconciliation of GAAP and non-GAAP metrics can be found under the financial portion of the investor relations section of akamai.com.

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

Tom Leighton -- Chief Executive Officer

Thanks, Tom. And thank you all for joining us today. Akamai delivered excellent results in the third quarter. Revenue was $670 million, up 7% over Q3 of last year and up 8% in constant currency, with continued very strong performance for our security products and continued improvement in our media and carrier division.

Q3 non-GAAP EPS was $0.94 per diluted share, up 47% year over year. This very strong result was driven by our solid revenue growth, the impact of cost reductions made over the past year, and a lower tax rate. EBITDA margins in Q3 improved to 41% and non-GAAP operating margins improved to 27%. This marked the fourth consecutive quarter of improving margins and we expect further improvements by the end of the year.

Looking farther ahead, we're now confident that we can achieve non-GAAP operating margins of 30% in 2020, while continuing to invest in innovation and new products to drive our future growth.

In Q3, our security portfolio was, again, the fastest growing part of our business, with revenue of $169 million, up 39% over Q3 of last year in constant currency. Our security business accounted for 25% of our total Q3 revenue and exited the quarter at a run rate of nearly $700 million per year, making Akamai one of the world's largest cloud security providers.

Our security products received accolades from two leading analyst firms last month. Gartner named Akamai as a leader in its magic quadrant for web application firewalls for the second year in a row. And Forrester named Akamai as a leader in its new wave for bot management, giving Akamai their highest rating possible for attack response, threat research, reporting and analysis, roadmap, and market approach.

In a world where lots of claims are made by competing companies, it's gratifying to receive this level of recognition for the world's leading industry analyst firms. There are several reasons why Akamai is a leader in cybersecurity. Our track record of innovation and emphasis on R&D combined with smart and accretive acquisitions, our Edge platform's enormous capacity and close proximity to users and devices, the insights and real time data we gain from protecting so many of the world's leading enterprises, and our team of experts that provide exceptional customer service and support.

Many of our customers have told us they simply have too much at stake to risk their business on anything less. Most of our security revenue today is based on protecting public-facing websites and applications from denial of service and application layer attacks. We've also been developing novel products to protect internal enterprise applications. And I'm very pleased to report that these new products have been gaining traction.

Bookings in Q3 for our enterprise application access and enterprise threat protector service were up 30% over Q2 and up more than fourfold over Q3 of last year. Our new enterprise security customers include leading companies, such as one of the largest banks in the UK, a $10 billion travel company, a $4 billion luxury fashion brand, two of the world's leading consulting firms, and a $30 billion media company.

We believe that our new enterprise security offerings are gaining traction because they provide the core capabilities needed for a zero trust security architecture. It's called zero trust because enterprises can no longer assume that any device or employee on their internal network is trustworthy. That's because employees sometimes click on the wrong link and accidentally import malware, which can then lead to a very costly data breach.

As a result, we've seen growing interest in new architectures that protect internal applications by granting access at the application layer instead of the network layer. This approach avoids exposing corporate networks through a VPN and eliminates the need to manage complex network firewall rules. As the value of such a disruptive solution becomes apparent to more customers, we expect the adoption of our new enterprise security services to continue their rapid growth.

We've also integrated our market-leading Kona Site Defender technology into our zero trust solution so that if an employee or internal device is compromised, we can help prevent the infection from spreading to other enterprise applications or from gaining access to sensitive data. And as an added benefit for global companies, we can also integrate our Ion solution to substantially improve the performance of enterprise applications for employees around the world.

Turning to our divisional results for the quarter, web division customers generated $357 million in revenue in the third quarter, up 9% in constant currency over Q3 of last year, with continued strong traction for our new products, such as mPulse, Image Manager, and Bot Manager. We've been seeing positive results by offering bundled solutions to customers that want the ability to leverage multiple Akamai products. Bundles that combine our security and performance products have proven to be especially popular. They also provide a strong advantage over competitors that have only point solutions or rudimentary security capabilities.

Revenue for our media and carrier division in Q3 was $313 million, up 7% in constant currency over Q3 of last year. Traffic growth remains very strong in our OTT and gaming sectors and was higher than published reports to the internet as a whole. Growing traffic faster than the internet as a whole means that we continue to gain share. In fact, to meet the increasing demand from our customers, we added about as much traffic in the past year alone as the total capacity claimed by many of our competitors.

As you know, some of these competitors are preparing to go public or trying to be sold. In such circumstances, it's not uncommon for a company to take pot shots at the established market leader, which in this case, of course, is Akamai. This kind of activity has been such a regular occurrence over the last 15 to 20 years that some analysts have referred to these companies as YAAKs, which stands for Yet Another Akamai Killer.

To be clear, we take all our competitors very seriously and we strike to take the high road when it comes to talking about the competition. In that spirit, I want to take a few minutes today to set the record straight on some of the things we understand competitors have been saying about us.

One claim being made by the competition is they're taking customers away from us. Of course, when you have many thousands of customers and well over $2.5 billion of revenue, there always be some level of customer churn. But at Akamai, our churn rate is very low. In fact, our total competitive churn over the past year has amounted to a very low single-digit percentage of revenue.

Moreover, our competitive churn rate declined over the past year. And in cases, where we have lost cases to a competitor in the past, we found that many subsequently returned to Akamai because of our superior capabilities, such as a $10 billion retailer who came back to Akamai after experienced web performance issues and had security concerns with credential stuffing when using a competitor's services.

Another claim we've heard is that our competition can offer comparable service for less. The reality is our competitors can't match Akamai when it comes to reliability, performance, and scale. Just consider the way delivered the recent World Cup tournament, where three of our largest competitors had glaring and well-publicized failures.

Few of our competitors have security capabilities and we believe that none have the level of breadth and protection provided by Akamai. We don't rush features to market while making excuses like one competitor did last month, when they acknowledge their web gateway and browser extension needed more time to mature into a secure and reliable platform.

Akamai customers don't want to wait for a secure and reliable platform and they don't have to. As noted by independent research firm IDC, Akamai has had the strongest and broadest edge security offering for quite some time.

To deflect attention away from the immaturity of their platforms, some competitors say that our edge architecture is outdated or that their centralized data centers are somehow superior. The reality is that we believe our edge architecture, with the 240,000 servers that we've positioned in 3,900 locations in more than 1,000 cities across 143 countries deliveries vastly superior scale, performance, and security. Our competitors simply don't have the scale or the reach to serve customers at the edge the way we do. You just can't do what we do with a few dozen or even 100 points of presence.

Our reach at the edge is why so many of the world's leading enterprises choose Akamai when it comes to delivering their media, accelerating their application and protecting their most important assets. We also believe that the competitive differentiation provided by our unique edge architecture will become even more important in the future.

As traffic volumes increase by a factor of 10 to 100 or more, as billions of devices get connected, and as cyber attacks increase in size and sophistication. The core of the internet just doesn't have the scale or proximity to end users and devices to keep up with ever-increasing demands. The edge of the internet is where our customers connect with our end users and that is where their digital experiences must be fast, intelligent, and secure.

It's gratifying that the analyst community is now embracing the importance of our edge architecture. Gartner recently published a report titled "The Edge Will Eat the Cloud," which predicts that while cloud providers will extend their models closer to the edge, the architecture of the edge will be driven more by technologies that already have physical edge footprints. Akamai pioneered the edge platform and we've been building upon it for 20 years, giving us a physical edge footprint that we believe it virtually impossible to replicate.

For years, our competitors have been saying that being at the edge didn't matter. Now, some have started using the word edge in the naming of their solutions. There's an enormous difference between saying you're at the edge and actually being there. It shows up in the quality and security of your solutions. In our view, no amount of renaming can change the fact that our competitors are bound by the limitations of their centralized models.

Some new entrants claim to have leapfrogged us in terms of their technology. The reality is that Akamai has a tremendous track record when it comes to technology leadership and market transforming innovation. Akamai pioneered edge computing as part of our Edge Suite service over 15 years ago. We've extended our edge platform to the client and added the capabilities necessary to support the internet of things. Today, we're building a blockchain platform that's designed to perform more than a million transactions a second.

The amount we invest in R&D on an annual basis is more than many of our competitors' annual revenue. We have more engineers innovating than most of our competitors have in total headcount and we've also made smart acquisitions that we believe have enhanced our offerings and have delivered strong value to our customers and shareholders, including Cyberfend in bot management, Nominum in security, Soha in enterprise security, and Soasta in performance management.

We've also made it much easier for developers and admins to use our services and to build amazing digital experiences for their customers. Over 1,000 developers in 24 cities attended our recent DevOps World Tour, where we received very favorable feedback for the significant enhancements we've made in our developer experience.

Competitors don't invest as much as we do in innovation. So, we've been told that they say our infrastructure is costly and inefficient. The reality is that each business at Akamai runs on the same Akamai Intelligent Edge platform, which gives us excellent leverage in terms of cost. For example, we decreased our overall spend on bandwidth and colo while delivering significantly more traffic than we did a year ago.

Our advances in software have helped us to reduce the amount we spend on network CapEx to less than 6% of revenue. In Q3, our gross margins were 77%. EBITDA margins were 41%, and operating margins were 27%. We challenge any competitor who calls our platform inefficient to show you anything close to our margins and profitability.

I don't see anyone on the marketplace I'd want to trade places with. It's not even close. We're the market leader in media delivery, application acceleration, DDoS prevention, web application protection, and bot management.

But rest assured that we know that we can never be complacent and we will never stand still. We're committed to providing superior customer value in everything that we do. We intend to continue our great track record of innovative R&D, our success in bringing disrupted technologies to market, and to providing our customers with exceptional services and support.

In summary, I'm very pleased with our Q3 results, including the very strong performance in our security business, the continued improvement in our media and carrier division, the expansion of our margins for the fourth quarter in a row, and the excellent growth on the bottom line.

I'll now turn it over to Jim to review our financials and guidance for the rest of the year. Jim?

James Benson -- Executive Vice President and Chief Financial Officer

Thank you, Tom and good afternoon, everyone. As Tom outlined, Akamai had another strong quarter, exceeding the high end of our guidance on revenues, operating margins, and earnings and delivering substantial operating margin improvement for the fourth consecutive order. We continued to execute well and demonstrate the leverage in Akamai's operating model. We have growing confidence we both have a path to and can achieve our goal of 30% non-GAAP operating margins in 2020.

Moving to our strong third quarter results, revenue came in above the high-end of our guidance range at $670 million, up 7% year over year or 8% in constant currency and up 10% in constant currency if you exclude the six large internet platform customers. Notably, this is the third straight quarter of double-digit revenue growth when you exclude the internet platform giants.

Revenue growth was solid across the business, with the primary over-achievement compared to guidance, driven by an acceleration in growth for our security solutions and higher media traffic volume than we anticipated going into the quarter. Revenue from media and carrier division customers was $313 million in the third quarter, up 6% year over year, or 7% in constant currency, and up a healthy 12% in constant currency, excluding the large internet platform customers.

Revenue from the internet platform customers was $43 million in the third quarter, roughly consistent with Q2 levels and in line with our expectations. It is important to note, the internet platform customers now only represent 6% of total Akamai revenues. The lowest level of such customer concentration and memory and a testament to our continued progress on diversifying our revenue base across customers, solutions, and geographies.

Media division revenue and traffic outside the internet giants continued to be strong across the core install base, with particularly robust growth coming from our gaming and video delivery verticals. Our media and carrier division management team remains focused on capturing more traffic share and delivering the quality of deliveries for the top 250 media customers that account for most of our traffic and revenue.

We continue to be pleased with the revenue acceleration associated with our traffic capture efforts over the past several quarters. In addition to traffic gains in media, we are also very pleased with the continued security growth in the media division. As Tom highlighted in his earlier remarks, security is a key differentiator versus our competition and that is true in the media division as well.

Moving now to our web division, revenue for this set of customers was $357 million, up 8% year over year or 9% in constant currency and consistent with Q3 growth levels. We continue to see a very strong uptake in our new product areas, namely Image Manager, Digital Performance Management, and Bot Manager, as well as further strong growth and adoption of our core Kona and Prolexic cloud security solutions.

Turning now to our results for our cloud security solutions, third quarter revenue was $169 million, up 37% year over year, or 39% in constant currency. And yet, another quarter of tremendous revenue growth and customer adoption of our cloud security solutions globally. We are particularly pleased to see accelerating revenue growth in our security offerings in Q3 from both the web and media division customer base.

Entering the fourth quarter, our cloud security business now has an annualized revenue run rate of nearly $700 million and represents over a quarter of our total revenues. We believe security remains a significant growth opportunity for us. We plan to continue to invest in this area with a focus on further enhancing our product portfolio and extending our go to market capabilities.

Moving on to our geographies, sales in our international markets represented over 38% of total revenue in Q3, up slightly from Q2 levels. International revenue was $257 million in the third quarter, up 21% year over year or 24% in constant currency, driven by continued strong growth in our Asia Pacific region and a solid quarter in our EMEA region.

Due to the continued strengthening of the US dollar, foreign exchange fluctuation has had a negative impact on revenue of $6 million on a sequential basis and $5 million on a year over year basis. Finally, revenue from our US market was $413 million, consistent with Q2 levels.

Moving on to cost, cash gross margin was 77%, up slightly from Q2 levels and up over a point from the same period last year. We continued to excel well on our platform efficiency initiatives. For the first time in memory, our bandwidth and colocation expenses on an absolute basis declined year over year, despite the significant increase in traffic over the same period.

As we highlighted at our June analyst day, we have several ongoing platform initiatives in place intended to drive further improvements from current levels. Gap gross margin, which includes both depreciation and stock-based compensation was 64%, roughly consistent with Q2 levels and up slightly from the same period last year.

Non-GAAP cash operating expenses was $244 million, below the low end of our guidance and down above $4 million from Q2 levels due to continued traction with operational efficiency efforts. Notably, we are seeing some early progress in our cross-transformation actions to better optimize and reduce third-party spend, particularly in IT. We expect additional improvement in this area, as well as the other efficiency areas we outlined at our June analyst day.

Moving now to profitability, adjusted EBITDA for the third quarter was $273 million, up $11 million from Q2 levels and up $42 million or 18% from the same period last year. Our adjusted EBITDA margin came in one point above the high-end of our guidance range at 41%, a 1-point improvement from Q2 levels and 4 points from the same period of last year, with most of the strong achievement coming from the operational efficiency actions taken over the last 12 months.

Non-GAAP operating income for the third quarter was $181 million, up $11 million from Q2 levels and up $34 million or 23% from the same period last year, and growing nearly three times the rate of revenue growth. Non-GAAP operating margin came in at 27%, up over 1 point from Q2 levels and also 1 point above the high-end of our guidance range.

I am very pleased with the four consecutive quarters of margin expansion we have seen as a result of our ongoing efficiency efforts. We believe our continued hard work will drive further operating margin improvements in Q4. Furthermore, we feel confident we can achieve our 30% non-GAAP operating margin goal in 2020, while continuing to make the required investments to drive both growth and further scale and leverage in the business.

Moving now to CapEx, capital expenditures in Q3, excluding equity compensation and capitalized interest expense were $125 million and in line with our guidance. As we mentioned when we said our guidance in July, Q3 included large facility buildout in Bangalore and Costa Rica. Integral investments in support of our ongoing efficiency efforts to align work to these lower cost centers of excellence. We are also in the early stages of our new Cambridge headquarter buildout and we expect facility-related spend for that project to increase for Q4 and 2019.

Moving on to earnings, non-GAAP net income was $158 million, $0.94 of earnings per diluted share, and growing 47% over the same period last year and coming in $0.08 above the high-end of our guidance range. These strong earnings results were driven by strong topline execution, continued operating expense improvement, and a lower tax rate.

Tax is included in our non-GAAP earnings, with $31 million based on a Q3 effective tax rate of 16.5%, which equates to a year to date effective tax rate of roughly 18.5%. This Q3 effective tax rate is 3.5 points lower than our guidance, due primarily to a higher mix of foreign earnings and the resulting year to date true up in the quarter.

Moving on to GAAP earnings, GAAP net income for the third quarter was $108 million or $0.64 of earnings per diluted share and growing 73% from the same period last year.

Now, I'll review our use of capital. We continue to focus on the importance of returning capital to our shareholders. During the quarter, we spent $440 million on share repurchases, buying back roughly 6 million shares. For the year, we have spent $626 million of our $750 million 2018 authorization, which has resulted in our share count declining from $171 million shares at the beginning of the year to $168 million shares in the third quarter.

We plan to be quite active in repurchasing shares in Q4 and spending at least the remaining $24 million by the end of 2018. Additionally, today we announced that our board has authorized a new $1.1 billion share repurchase program running from November until the end of 2021.

Going forward, we intend to continue returning to our shareholders a significant percentage of our free cashflow through share repurchases, balanced against preserving our flexibility for other strategic opportunities. We believe this approach will allow us to continue to drive shareholder value through investing organically in the business, and returning capital to stockholders via share repurchases.

In summary, we are very pleased with our strong execution in Q3 and year to date. Looking to the fourth quarter, we are expecting another strong quarter on the top and bottom lines. As always, holiday seasonality plays a large role in determining our financial performance for the fourth quarter, driven by online retail activity for our e-commerce customers and traffic for our large media customers. As a result, the fourth quarter remains the hardest to predict.

In addition, we expect further foreign exchange headwinds in Q4 from the continuing strengthening of the US dollar, which has been notable in the last two weeks in particular. At current spot rates, foreign exchange fluctuations are expected to have a negative impact on Q4 revenue of over $3 million compared to Q3 levels and an $8 million impact year over year.

Taking into account these foreign exchange headwinds combined with typical holiday seasonality. We are projecting Q4 revenue in the range of $692 million to $709 million. To frame this guidance range, which was slightly wider in Q4 due to seasonal variability, if the online holiday season is exceptionally strong, we would expect to be near the higher end of the revenue range. If the online holiday season is not as strong, then we would expect to be at the lower end of the range.

At these revenue levels, we expect cash gross margins of roughly 78%, up one point from Q3 levels, and GAAP gross margins of 66%, up 2 points from Q3. Q4 non-GAAP operating expenses are projected to be $254 million to $259 million, up from Q3 levels due primarily to typical year end incentive compensation expenses. Factoring in the cash gross margin and operating expense expectations I just provided, we anticipate Q4 EBITDA margins of 42%, up 1 point from Q3 levels.

Moving now to depreciation, we expect non-GAAP depreciation expense to be between $94 million to $96 million. Factoring in this depreciation guidance, we expect non-GAAP operating margins of 28% for Q4, up 1 point from Q3 levels, up 4 points from Q4 2017 and our fifth consecutive quarter of margin expansion. And with the overall revenue and spend configuration I just outlined, we expect Q4 non-GAAP EPS in the range of $0.97 to $1.03 per share. And at the midpoint would represent 42% growth from the same period last year.

These EPS guidance expectations assume an estimated quarterly non-GAAP tax rate of roughly 19%. This guidance also reflects a fully diluted share count of $165 million shares. On CapEx, we expect to spend $120 million to $130 million, excluding equity compensation in the quarter. This is consistent with Q3 levels as the facility buildout of our new Cambridge headquarter building begins to ramp up. As I said earlier, we increased facility-related spend for our new Cambridge headquarters in 2019.

Incorporating in our Q4 guidance, for the full year, we are anticipating revenue of $2.693 billion to $2.71 billion and at the midpoint, up $9 million from our previous guidance, despite increased foreign exchange headwinds. EBITDA and non-GAAP operating margins of 40% and 26% respectively and at the high-end of the revenue range, non-GAAP operating margin could possibly even around to 27% for the full year, which would be up early 3 points from 2017 levels.

Factoring in these revenue and margin levels and a non-GAAP effective tax rate of roughly 19%. We anticipate non-GAAP earnings per diluted share of $3.53 to $3.59 for full year 2018. And at the midpoint, up $0.24 from our previous full-year guidance. As a helpful reference, we will post our Q4 and full year 2018 guidance ranges on the investor relations section of our website after this call.

In closing, we are very optimistic about the opportunities ahead for Akamai. We are confident in our ability to continue innovating and leveraging the Akamai platform for new customer use cases, to achieve 30% operating margins in 2020 and to execute against the new $1.1 billion share buyback authorization over the next three years, all three which we believe will add significant shareholder value over both the near-term and long-term.

Thank you. Tom and I would like to take your questions. Operator?

Questions and Answers:

Operator

Ladies and gentlemen, at this time, if you have a question, please press the * and the number 1 key on your touchstone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the # key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated.

And our first question is from Keith Weiss from Morgan Stanley. Your line is now open.

Keith Weiss -- Morgan Stanley -- Analyst

Thank you guys for taking the question and very nice quarter. I wanted to dig into the security business. That seems like the real outperformer, the real highlight of the most recent quarter. Two questions for you -- one, how should we think about the sustainability of growth here? You saw a nice acceleration in overall growth, but that had been back on a declining trend line. Do you think we're back on an accelerating trend line today? Is there enough breadth of product to sustain that accelerating trend line?

The second question comes in terms of investment. I think one of the key investor debates is given sort of the drive for higher operating margins, you're going to be able to invest enough in this business in terms of increased distribution, increase products in what is a really competitive space out there. How do we garner confidence that you guys are going to have the flexibility to invest aggressively enough behind this opportunity? Thank you.

Tom Leighton -- Chief Executive Officer

Yeah. So, we're pretty excited about the future potential for the security business. Today, that revenue and almost all the growth is associated with our Kona Site Defender and Prolexic products, now with Bot Management being one of our most successful new products ever. So, that is the existing space. Bot Manager has a long way to go for growth, which is great. Then as we talked about on the call with our approach to enabling a zero trust architecture, that's pretty much brand new.

We're at the early stage of booking, seeing them ramp substantially should start really making a difference with the revenue we report in '19 and '20. In the long run, that has probably more potential than the existing business, which is already driving $700 million annual run rate and growing in the high-30s. So, I think as you look to the future, there's a ton of runway for our security business and we're in a great position there.

Now, in terms of your second question, ability to invest -- yes, I do believe that we can continue to make the margin improvement we talked about, get to 30% in 2020 and still be able to make the investments we need in security. Part of that is being very careful with how we spend our OpEx.

As you can tell, we've made great progress in the efficiency of our platform. We delivered a ton more traffic this year than last year. The dollars we spent to do that with bandwidth and colo actually declined. That generates a lot of cash for us and we're focusing a lot of our investment to grow the security business.

So, I think with careful management of OpEx and fantastic products and capabilities there, we've got a long way to go with security growth.

Keith Weiss -- Morgan Stanley -- Analyst

Excellent. Thank you, guys.

Operator

Thank you. Our next question is from Sterling Auty from J.P. Morgan. Your line is now open.

Sterling Auty -- J.P. Morgan -- Analyst

Yeah. Thanks. Hi, guys. I'm going to go the other way. So, if I look outside the web division and strip out security, the remainder of that segment saw the same kind of performance as we did last quarter down about the same amount sequentially. I think last quarter, you called out competition and a few other items. I'm just wondering if you could go into a little bit more color and detail as to what you experienced specifically there and what you anticipate will happen through the end of the year.

Tom Leighton -- Chief Executive Officer

Yeah. The performance products are performing comparable to last quarter. As we talked about last quarter, there's some pressure on our customers in that segment. Commerce and retail, they've got their hands full with some of the cloud giants in terms of competition for their businesses. That puts pressure in terms of what they can spend. There's price pressure there. We talked about that last quarter with prices coming down a little bit faster than traffic is growing there. So, the performance products, a little bit of a flat business.

We also talked about we're packaging our product security and performance products together and in some cases, that means something that might have been a small amount of performance revenue might now get counted as part of the security bundle because these packages are being driven by our customers' demand for security products.

Jim, you want to add to that?

James Benson -- Executive Vice President and Chief Financial Officer

I think the only other thing that I would add is that we've had, as we talked about on the last call, that one of the go to market areas that we're really focusing on is new customer acquisition. In particular, we actually had a really strong quarter in Q3 in new customer acquisition in the web division, actually up over 30% from Q2 levels. So, we're starting to get traction on new customer acquisition.

As we've talked to you about in the past, we've done exceptionally well as a company of expanding our offerings into the install base, as evidenced by a lot of the new product tracking that we have made. I think in Q2, it was a $170 million run rate business on an annualized basis and it's over $220 million in Q3. So, great progress on selling more to the install base.

The area that we had some work to do was around new customer acquisition and we were quite pleased with the traction that we made in the quarter. So, I think Tom's right. There's always areas in the portfolio that are doing better than others that were pretty optimistic that the actions we have in place between new customers, pricing and packaging, new product upsell, those are the right sets of actions to drive performance improvement for the company.

I think what it also does as we talked about at the investor day is Akamai's revenue streams are so much more diversified now. So, our strategy around investing both organically and through M&A broaden the solution base to broaden the customer base and expand further into the geography I think is a strategy that I think is the right strategy for the company to accelerate growth.

Sterling Auty -- J.P. Morgan -- Analyst

Got it. Thank you.

Operator

Thank you. Our next question is from Sameet Sinha from B. Riley FBR. Your line is now open.

Sameet Sinha -- B. Riley FBR -- Analyst

Thank you very much. A couple of questions -- so, your 30% target for pro forma operating income by 2020, can you talk about the interim? I remember during the investor summit that you had, you spoke about more investments into DevOps tools and internal systems. So, kind of just trying to get a cadence as to how much those will expand into 2020.

Secondly, in the CDN business, can you talk about pricing? I know you were kind of targeting these top 250 customers. You're going to be tactical about pricing. If you can, talk about that with the contrast of what you're seeing in the low-end performance business. Thank you.

James Benson -- Executive Vice President and Chief Financial Officer

Sure. On the margin expansion front, we're very, very pleased. Actually, the progress we've made this year, to be frank, has exceeded our expectations. So, ending Q3 at 27% operating margin, guiding 28% for Q4, we talk a little bit about that at the June analyst day around the area that we're driving.

In a bit of a follow-up to Tom's point around -- I think it was key to ask the question around can we make the investments we think we need -- I think it's important to remember that the areas that we're targeting is some level of improvement we're expecting in gross margins and you're already starting to see that.

But we also talked a lot about the areas we're going after significant margin improvements is really in G&A. It's not in R&D. So, that's not an area that we're going to be scaling back on. There might be some areas of R&D that we can get some better efficiency out of, but the primary areas we're looking for scale are in G&A.

We talked about what some of those areas are. We've already begun to get some traction in third-party procurement spend within our IT function in particular and we expect significant more to be had there. We also expect some improvements in the GoToMarket space as we drive more productivity per dollar we spend in sales and marketing.

I'm pretty bullish about where we're at. So, again, I just think about where we're at. If we hit the high-end of our range here, you could almost be operating at 27% operating margins, which is a 300 BIPs improvement from where we were in 2017. So, we're well on our way to 30. There's a lot more work to be done. We've only begun to see the benefit of some of the actions that we've taken.

And your second question around media, you know, as we've talked about in the past, the pricing environment in the media business is highly competitive. So, that hasn't changed it's a very competitive pricing environment, but the pricing environment hasn't changed really in the last quarter. It remains competitive but not kind of better or worse than it was, say, in Q2.

It varies, obviously, based on customer and the amount of traffic that they push and the expect price point that they're looking for, but in general, the pricing environment is aggressive but unchanged from Q2.

Sameet Sinha -- B. Riley FBR -- Analyst

Thank you.

Operator

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

Jeff Van Rhee -- Craig-Hallum Capital Group -- Analyst

Great. Thanks. So, a couple from me -- just back to the website for a second, we don't have the '19 outlook yet, but is there any way you could frame for us from this 9% constant currency over the last couple quarters, what are the puts and takes to drive that to acceleration? What would it take for that to decelerate? You gave us kind of a great taste for Q4 around the seasonality and how you were thinking behind at a low range, the low-end of the range. I realize it's early, but any thoughts you can give us on how that line should behave in '19?

James Benson -- Executive Vice President and Chief Financial Officer

Yeah. We're not going to talk about 2019 on this call. We'll provide a lot more color on 2019 in the February call. But I do think that some of what we outlined at the June analyst day and we talked a bit about just now, which is web growth is about a few areas. It's about new product upsell -- there's a lot more room to grow there. We're not nearly penetrated with the new products that we've introduced. So, there's a lot more room for new product upsell.

Tom mentioned pricing and packaging. This is packaging multiple products to customers. It makes us stickier with customers because you have a value proposition that competitors can't match. New customer acquisition is a big one. That is an area that we have room for improvement. Early days still, but we're getting traction in new customer acquisition.

So, that's really the focus. Obviously, there are new areas that Tom highlighted, internet of things being one, blockchain being another. So, there are enough catalysts between existing products that we have that were not penetrated, new customers, and then new emerging areas to drive growth in the web division.

Jeff Van Rhee -- Craig-Hallum Capital Group -- Analyst

Got it. Then my last -- as it relates to sales and sort of sales structure, sales head count, I think you had talked on the website, particularly I think around security. You were going to be putting money into products and in go to market. Can you just spend a second and just touch on sales and sales structure with respect to where are you with headcount, where are you adding heads? Where are you reallocating heads? Just some sort of context about what the headcount and growth rates look like there.

James Benson -- Executive Vice President and Chief Financial Officer

Yeah. We don't comment specifically on our sales and marketing and sales headcount. I can tell you that in particular for the web division, as you can imagine, we do have a specialty sales force that is there to support our enterprise sales account leaders that have security expertise. They have enterprise security expertise. In some cases, they have expertise in particular domain areas.

So, we have a model where obviously, the enterprise rep needs to be proficient in selling certain offerings and then they have a model of basically specialist support on top of that. That is an area that we actually have kind of an outside consulting firm that's helping us look at tuning the model, tuning the model to drive maybe acceleration in new customers acquisition maybe through a more enhanced new customer motion.

Then in particular, trying to drive more velocity with the existing sales reps that we do have. Some of that has to do with better leveraging the specialty model, possibly consolidating components of the specialty model. So, that's generally what the web division sales force looks like. It's a little bit different on the media side. The media side, obviously, the bulk of the revenue in the media business is traffic-related revenue.

So, less of an overlay model, although they do also get support from security. As I mentioned and Tom mentioned, huge progress on selling security into the media division customer based and we expect that to continue.

Jeff Van Rhee -- Craig-Hallum Capital Group -- Analyst

With respect to the outside consulting firm tuning the model, any quick thoughts on what's a realistic expectation to start to see the results of those changes?

James Benson -- Executive Vice President and Chief Financial Officer

Well, you'll see it show up in a couple ways. One, you'll see it show up in modest improvement with sales and marketing spend as a percent of revenue. And then if we execute well, you'll see it in the form of acceleration of revenue growth. I think you know that the web division is different than the media division, where its catalyst is selling more sales transactions. It's not necessarily having traffic and having the right customers that push traffic and then following that. You've got to sell more to them.

So, it will take more to get web division growth accelerated as far as the timeframe is concerned. If we execute well, both in more improvement with sales and marketing as a percent of revenue and an acceleration in revenue growth.

Jeff Van Rhee -- Craig-Hallum Capital Group -- Analyst

Got it. Thanks for taking my questions.

Operator

Thank you. Our next question is from Michael Turits from Raymond James. Your line is now open.

Michael Turits -- Raymond James -- Managing Director

Hey, guys. Congratulations on a good quarter and a solid guide. Two questions -- what about the CDN product grouping, which did de-cell down to 1% to 3% this quarter. And I know it includes both performance and media as well as talent, so what the drivers were there. And as we go into next year, obviously, you're not giving a guide, but they say you get to talk about both the positives and the negatives because there are some headwinds echoing into next year including getting past Nominum, lapping a lot of the wins of the 250 top customers and more FX.

Tom Leighton -- Chief Executive Officer

Yeah. Certainly, Michael, I'd say growth moderated a bit from Q2 to Q3 in the CD and other category. We talked a little bit about that. We've got a lot of focus on security, as Tom outlined. Some of that also is, as we start packaging products, you know, that it's becoming kind of a little bit of a blurry distinction because you're packaging performance with security as part of some of the offerings and so there's an element of that.

And as we said, we're starting to see the sales force sell more of our security offerings and what tends to happen is when they start to have something that they get traction in, that's what they intend to sell more of and we're starting to see that.

And relative to 2019, we'll share more of that in February. I think you're right, there are some things that you're going to anniversary the Nominum acquisition. That actually happens this quarter, as a matter of fact, that we had them for a month in Q4. And then we know that there's variability in events in the media business that you tend to have more events in even years then you do odd years.

But there's a lot of variability in the media that it's not just events. Events don't drive and while they are a catalyst for some of them, there are a lot of things in the media business that we've talked about that if there's continued secular tailwinds in gaming, continued secular tailwinds with more and more traffic moving online as far as video delivery. So, there's a lot of catalysts for growth in the media business. So, it's kind of -- I'm not going to provide guidance here, but yes, there are some headwinds that you have outlined, but there are also a lot of tailwind opportunities just from a secular perspective in that business.

Michael Turits -- Raymond James -- Managing Director

I don't want to hog it, but at some point, I'd love to hear you talk more about edge and particularly what you guys can be doing to enable activity on your platform. That's an interesting topic to me.

Tom Leighton -- Chief Executive Officer

Yeah. Well, already we now have the capability for developers in parallel at even a given company to make changes on the fly, test them out. We have an edge container for them and they can do it on the edge platform. So, it's a very nice thing in terms of DevOps for our larger customers who have lots of developers making changes simultaneously on their website to be able to do this in a safe and efficient way just in terms of DevOps on our edge platform.

Of course, the edge platform is important for so many other reasons -- the capacity to deliver large amounts of video at high quality, the capacity to absorb giant denial of service attacks, the data that we get at the edge from conducting so many of the world's transactions or named server look-ups, being closed to end users and all the devices, both for application performance, mobile performance, and the internet of things, where you've got to be managing metadata within milliseconds of the devices. The edge is important for all of those reasons.

Michael Turits -- Raymond James -- Managing Director

Great. Thanks, guys.

Operator

Thank you. Our next question is from James Fish from Piper Jaffray. Your line is now open.

James Fish -- Piper Jaffray -- Analyst

Hey, guys. Congrats on a great quarter. Just to start it off, what inning in the web performance and security bundling story are we in. In other words, what is the percentage of customers that have both now and then going back to the margin questions from before, did we still expect a hockey stick-like acceleration and margin expansion between now and 2020 or a more linear one? Thanks.

James Benson -- Executive Vice President and Chief Financial Officer

Yeah. On web performance and security, some of it has to do -- it's actually more recent packaging, to be frank, literally over the last six to nine months. So, I think there's a lot more room to grow as far as bundling security with performance, not just for existing customers, but it's also an attractive option to get new customers on the platform because they get both security and performance at the same time.

So, I think there's certainly an opportunity there. As we talked about at the analyst day, although to be frank, our margin expansion in 2018 really has surpassed our expectations even at the analyst day. We talked a little bit about the fact that it wouldn't necessarily be linear, you wouldn't necessarily see a linear progression from where margins were beginning of 2020. Obviously, you've seen here 300 BIPs possibly of improvement from 2017 to 2018.

So, if you assume we're at 26.5% for 2018, you basically have 350 BIPs to get to 30% in 2020. It probably won't be linear in 2019. Having said that, there will be progress in 2019. So, we will not flatline. We will make continued progress in 2019, but it probably won't be linear, so you probably won't necessarily have a 175-BIP improvement in 2019, but you will get improvement in 2019.

Some of that because a lot of the actions that we're taking are very smart and very measured. We're implementing changes in third-party spend. We're building out a global procurement function and set of capabilities. We're putting a place process standardization and automation in our G&A functions for a critical task. We're kind of revamping our go to market model in specific areas.

These are items that take a little bit of time to put in place. You're going to see that a lot of that infrastructure is going to be put in place in 2019 and you'll get the bigger benefit for that in 2020 to improve efficiency. So, there's a path to get there. The path to get there with varying levels of revenue growth for the company.

So, we're pretty confident in our ability to get there.

James Fish -- Piper Jaffray -- Analyst

Got it. Thanks. Then Tom, appreciate the competitive overview. Is there any way that you guys can provide us any sort of new customer expansion metrics or dollar based retention rates like some of your peers do to just get a better understanding of what's going on there. Really, what I'm trying to get at is how the stickiness of the Akamai platform has evolved since the company took a more aggressive step on the bundling that we've been talking about here.

Tom Leighton -- Chief Executive Officer

Yeah. We don't release the detailed statistics, but as I mentioned earlier, our competitive churn rate is incredibly low, very small single digits on an annual basis and actually declined year over year. So, we're very pleased with our customer retention. Jim, do you want to add to that at all?

James Benson -- Executive Vice President and Chief Financial Officer

No. I think you said it well in your comments.

James Fish -- Piper Jaffray -- Analyst

Great. Thanks.

Operator

Thank you. Our next question is from Jeff Kvaal from Nomura Instinet. Your line is now open.

Jeff Kvaal -- Nomura Instinet -- Managing Director

Yes, thanks very much. I'd like to follow-up on the security growth on the media side of the business, if I could. Would you all mind shedding a bit more light on what has changed in that side of the business to drive security growth and what products are they buying and what should we think about forward and how sustainable is that? Thank you.

Tom Leighton -- Chief Executive Officer

Yeah. They're buying the same products. In fact, we have a couple very large media accounts, some of the first large adopters of our zero trust solutions for the enterprise security. So, I would say media companies are like other verticals in terms of having a real need for security. Of course, a lot of the headlines you read for data breaches, some of those are big media companies.

The only thing that makes media different is there's a smaller number of really big customers that drive media revenue overall and media revenue overall, the majority of that is driven by their traffic, the traffic in the top 250 global media brands. But they are big consumers of security.

Jeff Kvaal -- Nomura Instinet -- Managing Director

Should we expect that piece of the security business to move at the same rhythm and pace as the typicals of performance side of that business?

Tom Leighton -- Chief Executive Officer

I'm not sure of the question there. Our security products aren't traffic-based by and large. So, the dynamic in a media company would be the bulk of your revenue is driven by the traffic and the price of the traffic and the security products can even be about a fixed price nature in some cases. Maybe I didn't answer your question.

Jeff Kvaal -- Nomura Instinet -- Managing Director

No, that was it, Tom. Thank you.

James Benson -- Executive Vice President and Chief Financial Officer

The only thing I would add is we still have a little over 40% of our customers buy one of our security products. That's a total company comment. We are more penetrated in the web divisions. We certainly have a lot more room to grow in the web division. We are not nearly as penetrated on security in the media division. So, they make great traction.

One of the things Tom didn't comment on is that the media division sales team put in place a pretty clever incentive compensation program to really drive security. We're seeing huge benefit from that in 2018. So, I expect further progress in security in the media division here over the coming quarters.

Jeff Kvaal -- Nomura Instinet -- Managing Director

Thank you both very much.

Operator

Thank you. Our next question from Vijay Bhagavath from Deutsche Bank. Your line is now open.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Thanks. Hey, Tom, Jim, interesting call here. Quick question -- Tom, I want to get your bigger picture views on growing topline in particular in performance and in the CDN business, both came in light versus expectations. Then Jim, any concerns that you might be running the business near peak margins, due north 42 points of EBITDA margin on the guidance? Thank you.

Tom Leighton -- Chief Executive Officer

Yeah. We very much like our CDN business and it has a lot of room to grow. I think the big drivers there, obviously, OTT, video, seeing very strong growth there, gaming, really strong growth, set major records with the various Fortnite releases. I think there's a lot of room for growth in the CDN business. Of course, on the performance side as you move more absent in the mobile environment, performance is especially challenging there. People want their sites to be more interactive, richer, have video now.

We're broadening our Image Manager product to be a video manager product. So, you can have short video clips on your commerce site. So, performance continues to be a challenge for our customers there. I think in the long run, that can be a very good business for us. Jim, you want to talk about margin?

James Benson -- Executive Vice President and Chief Financial Officer

Yeah. I think the actions we've taken over the last 12 months are manifesting themselves in the results you're seeing. There were some headcount actions for the company in Q4 and Q1. The big focus of that really was a pretty deep inspection around some R&D areas that we weren't generating the level of return that we wanted. So, you're seeing that manifest itself in the P&L. You're starting to see some early traction in some of the efficiency efforts outside of that. I mentioned third-party procurement spend being one. I think I mentioned in the last call facility consolidation being another.

So, I wouldn't say we're operating at peak margin. Obviously, we showed good progress. I think we have a lot more room for expansion. Of course, you've got to make sure you're investing wisely in areas that are going to continue to drive growth and scale for the company. And we think we're doing that. We're making the right prioritization trade-offs. But I still think we can drive further margin expansion and make the investments in the business that are needed.

Vijay Bhagavath -- Deutsche Bank -- Analyst

Thank you.

Operator

Thank you. We have time for one more question. Our next question is from Brad Zelnick from Credit Suisse. Your line is now open.

Brad Zelnick -- Credit Suisse -- Managing Director

Great. Thanks so much for fitting me in and congrats on great results, guys. So, the security results are really impressive. But the stats that you shared around your zero trust solutions are even more impressive. Can you maybe give us a sense of the sales dynamic in the field, the length of these cycles and who do you find yourself most competing with?

Tom Leighton -- Chief Executive Officer

It's very early days in zero trust. So, I would say most enterprises and the CSOs aren't there yet, but you're seeing the first wave. It comes across many verticals, which is really an exciting prospect for us, where you have the early adopters that they get it.

They understand that the traditional model of building the moat around the castle or putting in the VPN and the firewall doesn't cut it. It's just way too easy for somebody to click on the wrong link, even when they're not in the company, when they're on the outside, bring the device on the inside and you're dead. Before you know it, you've got a major data breach.

So, the notion of authenticating somebody at the network layer, I think people are starting to realize it doesn't work. You can't get the security you need. Plus, it's a big overhead with a lot of costs. Instead, by authenticating at the application layer, now, you get access on an app by app basis and then you can add in our Kona Site Defender. That's fantastic -- much more secure and it has some really great proof points among the early adopters of catching infections that were inside, devices on the inside that were infected that were trying to exfiltrate data that they just didn't know about.

So, we're in the early days. We have now over a couple hundred customers, some major brands or bookings really accelerating now. So, we're very excited about the future there. And there's still a long way to go. It's not going to be next year that all enterprises suddenly decide they're going to totally change their security posture, but you are seeing the leaders now start to do that. That's exciting.

Brad Zelnick -- Credit Suisse -- Managing Director

Thanks. That makes a ton of sense for us. if I could just sneak in one last question here -- we've heard folks in the industry starting to talk about customers implementing multi-sourcing strategies in performance, similar to what we've seen in media in the past. To what extent are you seeing this and how do you expect that plays out?

Tom Leighton -- Chief Executive Officer

A little of it. Where we really see it is if there are sites or apps that don't matter, but the customer has. They will sometimes source that with a competitor. But for apps and sites that matter in our base, those would be on Akamai. And in addition, if the app or site matters, you've got to secure it. You can't secure it with most of all the other providers out there or at least not at the level that you'd need to. That's why the bundle is so helpful and a real competitive advantage.

In many cases, the sale is led by security and the delivery or the performance comes with the product or comes in the bundle. So, that, I think, makes a big difference. It's not just an issue. In fact, there are very few cases where you say, "I'm going to split this site with two vendors." You do get that in video and in media. You don't really see that on the website. You'll see some of the apps that don't matter as much or you don't care about securing. Those might be given to a competitor. We'll see some of that out there. Again, bundling could be a good defense against that as well.

Brad Zelnick -- Credit Suisse -- Managing Director

Great, Tom. Thanks again for taking my questions.

Operator

Thank you. At this time, I'm showing no further questions. I would now like to turn the call back over to Tom Barth, Head of Investor Relations, for closing remarks.

Tom Barth -- Head of Investor Relations 

Thank you. In closing, we'll be participating at several investor conversations and events throughout the end of the year. We hope to see you at some of those. Those events and be found on the investor relations section of akamai.com. So, thank you for joining us this evening and have a nice day.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.

Duration: 68 minutes

Call participants:

Tom Barth -- Head of Investor Relations 

Tom Leighton -- Chief Executive Officer

James Benson -- Executive Vice President and Chief Financial Officer

Keith Weiss -- Morgan Stanley -- Analyst

Sterling Auty -- J.P. Morgan -- Analyst

Sameet Sinha -- B. Riley FBR -- Analyst

Jeff Van Rhee -- Craig-Hallum Capital Group -- Analyst

Michael Turits -- Raymond James -- Managing Director

James Fish -- Piper Jaffray -- Analyst

Jeff Kvaal -- Nomura Instinet -- Managing Director

Vijay Bhagavath -- Deutsche Bank -- Analyst

Brad Zelnick -- Credit Suisse -- Managing Director

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