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Limelight Networks, Inc. (NASDAQ:LLNW)

Q3 2008 Earnings Call Transcript

November 6, 2008, 5:00 pm ET

Executives

Paul Alfieri – Senior Director of Corporate Communications

Jeff Lunsford – Chairman, President and CEO

Doug Lindroth – CFO and SVP

Analysts

David Hilal – Friedman, Billings, Ramsey

Greg Ueshara [ph] – Jefferies & Co.

Michael Turits – Raymond James

Sri Anantha – Oppenheimer & Co.

Derek Bingham – Goldman Sachs

Rai Archibold – Kaufman Brothers

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Limelight Networks’ 2008 third quarter results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. At that time, we will provide instructions for those interested in entering the queue for the Q&A.

I would now like to turn the call over to Mr. Paul Alfieri, Senior Director of Corporate Communications. Go ahead, Paul.

Paul Alfieri

Good afternoon and thank you for joining the Limelight Networks’ third quarter 2008 financial results conference call. Speaking today will be Jeff Lunsford, Chairman and Chief Executive Officer, and Doug Lindroth, Chief Financial Officer.

This conference is being recorded on November 6, 2008, and it will be archived on our website for approximately one week. Some portions of this conference call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are all statements that are not strictly statements of historical facts, such as statements regarding future events or future financial performance, including, but not limited to, statements related to Limelight Networks’ market opportunity and future business prospects, guidance on 2008 financial results and statements concerning anticipated future growth and profitability, as well as management’s plans, goals, strategies, expectations, hopes and beliefs.

These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those contained, projected or implied in the forward-looking statements and reported results should not be considered an indication of future performance.

Factors that could cause actual results to differ are included in the company’s periodic filings with the Securities and Exchange Commission. I would now like to turn the call over to Jeff.

Jeff Lunsford

Thank you, Paul, and thank you all for joining us this afternoon. Limelight Networks achieved strong sequential growth during the third quarter of 2008. We generated record revenue of $33.1 million, which is a 9% sequential increase from the second quarter, an 18% growth from third quarter 2007 non-GAAP revenue and above the high end of the guidance we provided on last quarter’s earnings call.

This over performance in revenue led to adjusted EBITDA before litigation costs and stock-based compensation of approximately $5 million, with which we are pleased. My comments today will cover five areas.

Limelight’s customer base, number one, where quality is now outpacing numeric growth; number two, Limelight Networks’ scale, which is now capable of providing broadcast-quality content to broadcast-quantity audiences; number three, general market trends; number four, a short update on our ongoing litigation; and, lastly, number five, Limelight’s competitive positioning in the market and how we view the current economic turmoil as a significant strategic opportunity window during which we can invest and further distance ourselves from our many existing and emerging competitors.

First, Limelight’s customer base; during the quarter, we saw the overall value of our customer relationships grow, as average annualized revenue per customer grew from $94,000 last quarter to $102,000 this quarter. Our customer count was previous slightly from last quarter, at just over 1,300 active customers. In the quarter, we continued to invest in expanding our service suite, growing our network capacity and increasing our go-to-market resources in the enterprise space.

We expanded relationships with many of our large customers, most of whom have healthy growing online traffic and we continue to add new strategic relationships with key enablement partners. We racked up wins during the quarter, competing head to head with multiple competitors of all shapes and sizes, and winning the business of some of the largest Internet and technology companies in the world.

A few examples, Limelight was selected by Metropole Television Group, one of France’s leading broadcasters, to stream live and on-demand content for their M6 Internet portal’s new Catch Up TV service. Limelight was also selected by Nintendo of Japan to deliver content to the popular Wii gaming platform, securing Limelight a key position as a CDN provider to all three major gaming platforms.

Limelight’s download business also continued to grow this quarter. We were chosen by AVG, the antivirus and PC-security company, to provide daily virus definition updates to their customer base. Limelight also continued to grow our presence in the interactive agency and ad-serving sector, adding or expanding relationships with Tremor Media and iWonder.

Limelight also continued to gain traction in the small object and enterprise sectors, adding customers such as Blue Cross, Sonic, and Unisys and, finally, Limelight also had the opportunity to help power what some have referred to as the largest event in the history of the Internet, the online coverage of the 2008 Beijing Olympics. This was an event that truly transformed the way publishers and consumers view Internet content consumption.

The event established a new technological and creative benchmark for digital production and captivated and fascinated tens of millions of users across the US. For the first time in history, the audience was able to view Olympic events when, where and how they wanted. Limelight Networks was one of the key enabling partners, along with Microsoft, NBC and others, in delivering that experience.

Limelight delivered over 70 million video streams, over 10 million hours of live, on-demand, highlight packages and background pieces, over a 21-day period. We believe this event stands as an irrefutable proof point that Limelight Networks’ advanced, high-performance delivery architecture is differentiated from our many competitors and is the best platform in the industry for delivering live events to broadcast-quantity audiences on a global scale.

Finally, regarding customers, we discussed last quarter a proactive, conscious shift away from market share as counted by customer count and toward market share as counted by wallet share within the large and healthy content publishers around the globe.

We delivered on this proposition this quarter by growing our average annualized revenue per customer by 8% sequentially, by focusing on deepening our relationships with those large and very strategic customers. Regarding network scale, our average traffic levels continue to rise.

Over the last month of the quarter and into the beginning of Q4, in fact, we set new records for peak traffic levels throughout our network. This is the result of both organic growth within our customer base and solid execution by our sales, account management and network operation teams in a very difficult market.

Three weeks ago, we formally announced that we had surpassed two terabits per second of total egress capacity, which we believe makes Limelight Networks the operator of not only one of the largest content delivery platforms in the world, but also one of the largest general data delivery platforms in the world.

To put this scale into layman terms, two terabits per second is roughly the bandwidth capacity required to deliver standard-definition video to 2 million to 3 million simultaneous Internet users when taking network overhead into account. This would be the equivalent of two to three Nielsen points of audience.

We believe this milestone is a game changer for CDNs. It is no longer just about achieving broadcast-quality deliveries to small audiences. It is now also about supporting broadcast-quantity audiences and starting to make the Internet a viable alternative to traditional broadcast distribution.

Regarding general market trends, at Limelight’s second annual Digital Media Innovation Forum, held three weeks ago in Phoenix, we gathered over 300 executives and members of the digital media community to talk about the significant growth opportunity that lies ahead for our industry. You can view content from this forum at www.dminnovationforum.com.

At this conference, the general belief was that the growth of online digital media will continue to be strong, even within the context of the current economic challenges. Industry leaders from Accenture Digital Media Services, Adobe, Fox Interactive, Microsoft and others presented their thoughts on content and audience fragmentation, the concept that viewers can increasingly access content in time increments convenient to them from multiple devices, such as TVs, PCs, mobile phones, set-top boxes, gaming consoles, net books and other emerging form factors.

Serving content in this dynamic new consumer marketplace will be incredibly complex and will require supporting broadcast-quantity audiences aggregated over multiple devices and locations in varying content formats, all while consistently delivering a brilliant experience for every connection, every time and in every location.

We believe that with Limelight’s unique competitive advantages of scale and platform capabilities, we are the best-positioned content delivery network to help enable these experiences and thus capture market share as this long-term trend unfolds.

Regarding the business environment, we’ve received many questions about how the current economic environment might impact our customer base. We have not to date seen any substantial slowdown in online activity or a lessening in demand for our services, but we remain cautious. It is our belief that consumers are unlikely to sever their Internet connections in challenging economic times and that they are potentially more likely to consume online content, the bulk of which is free.

To be clear, however, we are not indicating that our business is immune to the effects of a tough economy. The two primary factors we believe we will experience are, number one, increased churn in our smaller, less-well-capitalized customers, and, number two, a request for more economic efficiency from our larger healthy customers that are still growing but are feeling budget pressures.

We believe that regardless of the business climate we will continue to experience two trends, a shift of media distribution toward IP-based networks and a shift of ad spending into the online world. Limelight operates at the intersection of these two sustainable long-term macro trends.

As you can see from our Q3 results, we are monitoring conditions closely and operating in a disciplined manner, while still investing in the key areas of our sector where we see the brightest opportunities.

Now, a brief update on ongoing litigation. Regarding the Akamai litigation, our next court date is in mid November. This date will be to hear our pending equitable defense motions. We also have a motion pending before the court for reconsideration for judgment as a matter of law based upon a new federal circuit court ruling that occurred after the judge’s original decision.

For Q3, approximately 11% of our revenue is generated from methods that are alleged to infringe. As of November 1st, we are happy to report that we have concluded we need no longer accrue for potential damages related to alleged infringement on the patent at issue. We have been making significant investments and implementing changes to our CDN architecture in order to implement our services in a manner we believe does not infringe, should the ruling not be favorable to Limelight, and should the plaintiff seek an injunction.

Due to the ongoing litigation, we cannot discuss with you any of the specific factors which led to this conclusion, and we should also advise you that this situation could change in the future. Regarding the Level 3 Communications patent lawsuit, a trial is now set to start on January 5th. The Markman ruling is expected to be issued by the court prior to that date. Other than schedule, we will not comment further on this in-process litigation.

Finally, two positive notes during the quarter. Number one, we settled our patent dispute with Two-Way Media, LLC during the quarter and acquired a nonexclusive license to their patents. Number two, in August, the federal court in Phoenix dismissed the shareholder class-action lawsuit and entered judgment in favor of Limelight. The plaintiffs have filed a notice of appeal.

As we have said previously, we believe the litigation that has been filed against Limelight Networks is without merit and we will continue to vigorously defend these matters and commit energy and resources to do what we firmly believe will ultimately be successful conclusions.

With that update, I’ll now turn the call over to Doug Lindroth, a former member of Limelight’s Board of Directors, whom I am excited to introduce as our new Chief Financial Officer. Doug?

Doug Lindroth

Thanks, Jeff. During the third quarter, we recorded revenue of $33.1 million, up 18% compared to non-GAAP revenue from the same period last year and a net loss per basic share of $0.18. We reported third quarter adjusted EBITDA before stock-based compensation, litigation costs and damage accrual of $5 million, compared to $3.9 million for Q2 and $5.9 million for the third quarter last year.

We also reported non-GAAP net loss before stock-based compensation, litigation cost and damage accrual of $0.5 million, or $0.01 per basic share, compared to a non-GAAP net loss of $1.6 million and $0.02 per basic share last quarter and to non-GAAP net income of $2.3 million and $0.03 per share for the same period last year.

Please refer to the tables included in our press release for the reconciliation of GAAP measures to these non-GAAP measures. During the third quarter, Limelight’s international revenue represented 16% of total GAAP revenue, which was flat with the previous quarter.

Gross profit margin, which includes both depreciation and stock-based compensation, held steady at approximately 35% for Q3. Cash gross margin was 57% for Q3, also level with 57% for the last quarter.

In the fourth quarter, we anticipate a potential decline in gross margins of a few points. Factors that are likely to contribute to that decline in gross margins include continued network build out, lower event-based revenue and the potential impact of pricing activity within the marketplace. A steady margin performance in Q4 would likely require over performance on forecasted revenue.

Operating expenses were $26 million in Q3, up $5.9 million from the second quarter and compared to $16.8 million for the same period last year. Third quarter operating costs exclude the provision we have made for potential additional damages and interest accrued in Akamai litigation.

Our operating expenses increased during the quarter, primarily as a result of litigation costs. During the third quarter, we recorded a provision of $2.3 million for additional potential damages and accrued interest associated with the alleged infringing revenue.

Approximately 11% of our revenue for the quarter was generated using a delivery method that is alleged to infringe the patent at issue, down from approximately 37% for the last quarter.

We expect damage accruals in Q4 to be approximately $750,000, plus accrued interest. As Jeff mentioned, we have concluded that as of November 1st, we no longer need to accrue for ongoing potential damages related to alleged infringing methods.

Beyond Q4, we expect to accrue only for potential interest. Total depreciation and amortization for the third quarter was $7 million, up from $6.5 million in the second quarter and up from $5.9 million in the same period last year.

Depreciation and amortization in the current quarter reflects $6.6 million of network-related depreciation. Stock-based compensation expenses for the quarter were $4.3 million, compared to $4.3 million last quarter and $4 million for the same period last year. Third quarter interest earnings were $1.2 million, compared to $1.3 million for Q2 and $2.5 million for the same quarter last year.

The reduced interest income is associated with lower market interest rates and a lower cash balance from both last quarter and the same quarter last year. Moving on to the balance sheet, our combined cash and investment balance on September 30th was $176.7 million, down from $184.5 million in the second quarter. The reduction in cash is primarily related to payments for capital expenditures and the payment of substantial legal expenses.

Capital purchases for the third quarter were $6.8 million, up from $5 million in the previous quarter and down from $7.3 million in the year-ago period. Days sales outstanding for the quarter were 85 days, up from 66 days in the previous quarter and up from 59 days in the third quarter last year.

Please note that two-thirds of this increase was the result of a large one-time payment from a customer that was received shortly after quarter end, so as we operate today we are back towards more normal DSO ranges.

Regarding guidance, for Q4, we expect to achieve revenue in the range of $33 million to $34 million. Stock-based compensation expenses for Q4 are expected to be approximately $5.5 million to $5.6 million. Capital expenditures are expected to be in the range of $4 million to $5 million for the fourth quarter. With that, I’ll turn it back to Jeff.

Jeff Lunsford

Thanks, Doug. We get a lot of questions regarding competitive positioning and whether or not the CDN sector is getting commoditized as major telcos try to get involved in our business, so I thought, as part of this wrap-up, that we should provide some insight on that topic, as well.

Regarding competitive positioning, content publishers select CDN partners on five basic criteria – scale, performance, platform capabilities, service levels and price. We believe that when weighing all these factors, Limelight Networks is the best-positioned CDN in the industry to continue growing and gaining market share. If anything, we believe the current environment and our well-capitalized position will allow us to invest and further separate ourselves from the pack.

Regarding the commoditization risk, we think a better understanding of what we actually do for our customers will help you understand why we believe this business is not at risk of commoditization. Building and operating a full-service enterprise-class CDN is an incredibly complex undertaking that requires highly specialized technologies and skill sets, as well as a substantial amount of capital.

A full-service CDN does much, much more than just deploy servers and data centers around the world and then string them together with bandwidth contracts. To address the market’s demanding and changing needs, a CDN must be able to handle a constantly evolving mix of delivery modes, format types, encode rates, data transmission protocols and geographies, all to an incredibly diverse set of screen types on PCs, PDAs and mobile phones.

Even within the same customer account, delivery modes can shift between live, on demand, streaming and progressive download. Format types can shift between flash, Windows Media, Silverlight, Move Networks, QuickTime, SHOUTcast and others. Encode rates can shift between small formats, standard definition, high definition, even variable-rate definition modulated based on network congestion and targeted optimal device types can shift between large screen, normal computer screen and handheld device screen.

A CDN must expertly handle all of the various permutations of these and other factors and do it across the globe in all geographies and with different digital rights managements technologies in place.

You must also provide for geographic fencing based on IP addresses to help publish or satisfy royalty restrictions. The software layer and operational expertise required to do all of these things for demanding broadcast, game and technology industry customers who are used to the dependability of traditional broadcast systems is not to be underestimated.

Only a select group of engineers around the globe, as an example, have the experience and know-how to work with content publishers to deliver the largest sporting or live media events in the world, working 24/7 for days at a time to stage and produce these events.

And even the smartest engineers can’t do their jobs well if they don’t have a scalable, proven and robust platform upon which they can rely. This, based on our experience, is not a commodity business. It is a high-tech, high-touch and incredibly complex business that changes daily. Looking ahead, we believe that we will see continued traffic growth in our targeted market segments throughout the remainder of the year and we continue to build out our infrastructure to accommodate it.

As we said earlier, we are however running a disciplined business given current economic conditions. We believe Limelight Networks is well positioned with the right service platform to compete, expand our addressable market and gain share within existing markets over these next few years, as capital, world-class customer service, platform breadth and operating efficiency become mandates for success.

In partnership with our expanding ecosystems of customers and partners, we are proudly dedicated to advancing the way people live, work and play around the globe by enhancing their digital experience. Operator, at this time, we’d like to open the line for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes for the line of David Hilal with Friedman. Please proceed.

David Hilal – Friedman, Billings, Ramsey

Great, thank you, a few questions. Jeff, on the call, on the last call, you had alluded to some big customers, I think in your pipeline that may switch over from a competitor or at least maybe dual source, and I wanted to see if any of that came to fruition in the quarter.

Jeff Lunsford

Yes, Dave. I guess just first the general situation at the height of the market is that as we said before, most of the largest content providers on the planet, whether it’s video or game software or software downloads work with multiple CDNs and as you can see in the RPIC increasing, we’ve been focusing on those larger customers and deepening our relationships there. So the short answer to your question, though, is yes. Some of that activity did occur.

David Hilal – Friedman, Billings, Ramsey

Okay and today’s call, I think, Jeff, you had talked about economic efficiency, and Doug talked about pricing activity as one reason gross margins would be down. So it sounds like the pricing environment may get a little tougher simply because of the economic times we’re in. Are you referring to customers as they come up for renewal, or do you anticipate some customers who are within their contracts who try to come back and renegotiate?

Jeff Lunsford

More so the former, as well as just large new deals that we sign up as we work on some of these larger accounts. You get a lot more scale but possibly lower unit margin in those deals, and there’s just a lot of uncertainty out there. Usually we can exert the same leverage on our suppliers as our customers can exert on us and we had talked about the potential margin compression in Q3, which did not come to bear because of the over performance in revenue.

So, as Doug mentioned, that could happen this quarter as well, but there’s just so much uncertainty that we certainly think it’s prudent to model what we suggested.

David Hilal – Friedman, Billings, Ramsey

Right, okay and then on the environment, October was certainly an interesting month for a lot of people and Cisco last night went specific that October was definitely worse than the month of September, and I know October is part of your Q4, but have you seen things worsen in the month of October?

Jeff Lunsford

So, as a run rate, looking at traffic, we said at Digital Media Innovation Forum that we set a traffic record. We set a new traffic record in September and then we set another new traffic record in October. So we are still seeing traffic growth.

We have seen business decision making slow down in the form of new bookings. People are being more diligent, they’re taking more time, but we also see that when we’re sitting there with a more efficient network, sometimes there’s a stronger incentive for people to move towards us, but, all in all, if you net it out, I would say that things were a little slower from a booking standpoint in October than they would have been in a normal economy.

David Hilal – Friedman, Billings, Ramsey

Okay, and then my last question. I think in your closing remarks, Jeff, you said disciplined business and should we interpret that as any cost cuts or headcount reductions? Or am I interpreting that incorrectly.

Jeff Lunsford

No. We have nothing along those lines planned. This is a growth company and we have amazing growth planned for within our existing customer base, as well as signing up more of these larger customers.

I mean, if anything, you might see us moderate the pace of hiring and the pace of build out, but the traffic, as I said, we are not seeing traffic reductions. People aren’t disconnecting from the Internet and they’re certainly watching a lot of news, like the elections, like this crazy market turmoil, online, and we see a lot of that traffic.

David Hilal – Friedman, Billings, Ramsey

Okay, thank you.

Operator

Our next question comes from the line of Katherine Egbert with Jefferies. Please proceed. Ma’am, your line is open.

Greg Ueshara – Jefferies & Co.

Hi, this is Greg Ueshara [ph] for Katherine. One of the things I just wanted to do a follow-up and get a better understanding is on the CapEx front, on the one hand, you mentioned that it’s not a commoditized business and it’s basically going to be increasingly difficult for smaller competitors to compete in, yet the CapEx requirements are still significantly large.

At what point do you expect that some of the benefits of being a stronger player in this market will come to bear in terms of reduced CapEx as a percent of revenue, and improved cash flows?

Jeff Lunsford

Well, if you look Greg, at the 2006, 2007 and 2008 CapEx as a percentage of revenue, you see a pretty dramatic decline. So the efficiency that you just asked about is happening and it’s very clear in the numbers.

Greg Ueshara – Jefferies & Co.

Okay, so we should expect that that’s a trend that will continue through next year?

Jeff Lunsford

Well, what we’ve told folks, we believe that our target model, which we expect to achieve in a $300 million to $400 million sort of revenue run rate, at that time we would expect CapEx to be 15% to 17% of revenue.

Greg Ueshara – Jefferies & Co.

Okay, 15% to 17% and then in terms of the growth of online media, has there been any change in the media mix that you’re seeing? Is it still video that’s primarily driving the growth online?

Jeff Lunsford

What we’re seeing is a migration of audience to premium content. I hesitate to see migration, but we’re seeing the most growth of viewer-ship around premium content and we are seeing our customers that are the most healthy from a business standpoint are the ones that either own or have access to that premium content, because they can get much higher CPMs in there commoditization practices and that is where the viewers are, it’s where the higher CPMs are.

There’s also a lot of activity in the games sector, and file sizes only get larger as resolution rates get higher. There are more and more devices that use operating systems being shipped every day and software updates are growing. So you sort of have to ask that with a specific traffic type in mind, but if you’re asking about video, then we’d say premium content’s growing the most.

Operator

Our next question comes from the line of Michael Turits from Raymond James. Please proceed.

Michael Turits – Raymond James

Hey, guys, good evening, a couple of questions. First of all, the upside to revenue this quarter, it sounds like it was volume driven, based on events. Is that correct, and can you point to any events or groups of events that came in at higher traffic than you expected?

Jeff Lunsford

Well, we don’t get into specific events Michael, and I think the words used were volume based on events. I would say that there were definitely large events in Q3 and our sales team’s job is to go out and find more of those in Q4 and beyond and I wouldn’t get into any specific commentary around any specific events.

The obvious question people ask is about the Olympics, and NBC issued a press release that had a lot of really good statistics around the Olympics that you can find online. I’m sure we can have Paul send it to you if you’re interested.

Michael Turits – Raymond James

And then is that, again, you just said fewer events that might drive upside in the fourth quarter, because you’re basically guiding flat into the fourth quarter.

Jeff Lunsford

I’m not sure we’re guiding flat, but I guess the low end would be flat, but there definitely were some one-time events in Q3 that had specific revenue around them that if I was modeling the business, I would back those out as sort of run rate growth and then the sequential growth into Q3 would be a little lower, then sequential growth Q3 to Q4 would be higher, obviously.

Michael Turits – Raymond James

And then you guys had said that you thought that the cash gross margins would drop back down to first quarter levels, which were more like 53%. Instead, they were even with 2Q at 57% and I think you said that happened because of the volume upside, and it begs the question of what portions of your COGS are variable and what are fixed?

It seems very positive, as if there was more fixed in there than we would have thought and you get some nice leverage out of it. Can you put some rough percentages around that to give us some idea of the fixed and variable cost and COGS.

Jeff Lunsford

Yes. I would say that, conservatively, 75% of our COGS are fixed over the short term and 25% are variable. Again, this is just within if you’re looking at sort of a snapshot of a quarter. So if we had over performance on revenue just within that quarter you might see 75% margin contribution from those incremental dollars and then if that becomes steady state run rate, then you have to end up building the COGS components in the out quarters, which include rack space and people and depreciation.

But in the snapshot of one quarter, if you over perform, you’re obviously not also building out more footprint, you’re just getting higher utilization out of the network itself, and so then you get probably $0.75 of every dollar drops to the bottom line.

Michael Turits – Raymond James

Okay, that’s very helpful, and then the last question, it would be around the ads, which nets out to about 13 for the quarter, much lower than we’ve ever seen from you guys. Can you give us some sense of what gross ads were and if churn was really high and why you had that very small numbers in nets and just kind of rough numbers on what might be some expectations going forward?

Jeff Lunsford

I don’t have the exact numbers in front of me, but I understand the nature of your question, so gross ads were well over 100.

There was definitely more churn and the bulk of that you can see in the RPIC, it was in smaller accounts that are I’d say non-core, non-strategic type accounts for Limelight.

Michael Turits – Raymond James

Any thoughts on what these metrics might be like going forward? Do you feel like you’ve churned out a lot of this and do you get back to the 60-ish nets, or is it going to be significantly lower?

Jeff Lunsford

Honestly, for this quarter, I don’t have any thoughts about customer count. We have our sales team out there and they’re focused, as we have been, on the large enterprise accounts and establishing a foothold in the e-commerce and small object sector, where we see very bright opportunities for this business.

Michael Turits – Raymond James

Okay, great, guys. Thanks very much and welcome to Doug to the call and to working with us.

Doug Lindroth

Great, thank you, appreciate it.

Jeff Lunsford

Thank you, Michael.

Operator

Our next question comes from the line of Sri Anantha with Oppenheimer. Please proceed.

Sri Anantha – Oppenheimer & Co.

Yes, thank you. Jeff, I’m not sure if you gave this vertical metric, but could you just talk about the total traffic on your network and how much did it grow sequentially and year over year, and, if possible, maybe if you could normalize that for the one-time related stuff.

Jeff Lunsford

Sri, we actually do not disclose the traffic numbers. We do talk sometimes in broad figures about the overall sort of year-to-year growth rates, and we’ve seen traffic growth rates over 100% per year and I think we expect to see that. I think the Cisco Era of Zettabyte report talked about what a 60%-ish overall Internet growth rate, and we think if we’re taking bit share that we should be able to grow at probably 100, which obviously drives a lot of fun requirements for our engineers to go figure out how we can keep doing that, because that compounds pretty aggressively over the years.

Sri Anantha – Oppenheimer & Co.

Got it and, Jeff, given your comments about now focusing on big, quality accounts as opposed to quantity, as we think longer term, should we expect a meaningful change within how your margins are going to expand or decline going forward?

Jeff Lunsford

No, Sri. We have for the last year had a target operating model again, and we think that’s at the $300 million to $400 million run rate of a 50% gross margin business with 40% EBITDA margin and 20% operating margins and you can see that slide on our investor website and the components where we think we’ll get leverage.

We certainly think we’ll get leverage in the gross margin line and we think we’ll get leverage from sales and marketing and G&A as we scale and then the obvious question everyone asks is how are you going to get leverage in the gross margin line? It’s simply by charging for services that we’ve traditionally given away for free as a young, aggressive startup, establishing a toehold in the market.

You always are a little more lenient with support and consulting and those types of things and we’ve now established the practice of getting value for that because we give value when we deliver it. As you grow your network, you fill more valleys, so to speak. The CDN business is about building for the peaks and then as much business as you can do in between those peaks, that almost drops to the bottom line.

And then getting ourselves established in market segments that we believe to be higher margin than the current market segments we’re in today, we talked about e-commerce and government, some good opportunities there and we think those things will all lead to – as well as just the normal R&D innovation where we’re always trying to drive better efficiency through the platform. We think that will get us to that 50% gross margin line.

Sri Anantha – Oppenheimer & Co.

Got it, and one last question; I know in the past you guys talked about diversifying your revenue base. Maybe, if you could update us on where you are with respect to new value-added services, as well as growth within the e-commerce vertical; thank you.

Jeff Lunsford

Sure. The e-commerce and enterprise sector, I think on the last call and this call we’ve given you some example customers of where we’ve established as proof points relationships and are winning head-to-head bake-offs with the traditional CDNs you see in that space.

So I can’t really quantify that for you because we don’t break that out as a separate business line, but I can tell you that we’re pleased with the progress and we also have a roadmap in R&D where there are key things we need to deliver on.

We’ve already delivered on many of them, but we also have some work that remains, whereas you get up into the most sophisticated e-commerce customers, there may be a couple of things we have yet to deliver that we need to get their business.

But we are laser focused on it and building new solutions every day and hiring people that understand that space and have those account relationships and it is absolutely a key focus for us as we look into 2009.

Sri Anantha – Oppenheimer & Co.

Yes, thanks lots. Thank you.

Jeff Lunsford

Thank you.

Operator

Our next question comes from the line of Derek Bingham with Goldman Sachs. Please proceed.

Derek Bingham – Goldman Sachs

Hi, gentlemen, good quarter. I wanted to ask you something actually you alluded to, Jeff, when you were at our conference presenting the other day. You talked about maybe starting to charge for things like consulting, maybe, and reporting, or some other elements of your business that maybe in cases you didn’t use to charge for. I wonder if you could give us a sense of what the revenue implications might be for that, in the third quarter, just reported, and going forward.

Jeff Lunsford

Well, Derek, we don’t really break that out as a separate business line and, again, our account and sales team mandate is to go find more of that business and there’s a very large demand for the know-how that we’ve developed here at Limelight Networks and so we’re hiring folks, we’re leveraging the folks we have in place and we’re seeing a very – a nice pipeline for those services.

But I can’t break out for you sort of how much of the Q3 revenue it was and how much of the Q4 we expect it to be.

Derek Bingham – Goldman Sachs

Now, was that just a change, though, in this quarter? Was this really the first quarter that it was starting to have an impact?

Jeff Lunsford

I’d say Q3 was the first quarter where it was, yes, a reasonably meaningful number?

Derek Bingham – Goldman Sachs

Okay and any nuances in pricing, either in the third quarter or since it closed, in terms of the pace, kind of the typical pace of the clients or what you talked o from last quarter?

Jeff Lunsford

No, what we tell people is if you’re focused on pricing, follow the gross margin and gross margins held steady between Q2 and Q3, and, if anything, the peak of all of the hype in the blogosphere about the CDN price wars was probably at the beginning of Q3 and you see it didn’t really impact our margins there, but this is a highly competitive market. It always has been and it always will be.

There are existing, established companies. There are very substantial new companies like telcos that are entering the space and there are small guys trying to get into the space, establish themselves all the time, but there hasn’t been a step function up in price competition in this quarter that we’ve seen. It’s sort of ops normal.

Derek Bingham – Goldman Sachs

Okay, and one more if I could, on the cash outflow from litigation expense, it seems to kind of jump around, and wonder if you could get some sense of what you’re expecting over the next few quarters.

Jeff Lunsford

We don’t really give guidance on forward litigation expense. It’s just so unpredictable and we think those suits have no merits and we will prevail. We’re going to defend ourselves vigorously.

Derek Bingham – Goldman Sachs

Is it correct it was a bit of a spike in the third quarter, though, relative to prior quarters?

Jeff Lunsford

Yes, it was. There was a trial prep going on in Q3 that was substantial and it was on a rocket docket where they compress a lot of activity in a very short period of time. The good news is, on litigation expense, the one bit of color I will give you is as these things move to the appeals court, they get much less expensive. It’s still lawyers, but you don’t have all the expert and discovery and all that fun-stuff, so it becomes less of a cash flow issue.

Derek Bingham – Goldman Sachs

Okay, thanks very much.

Jeff Lunsford

Thank you.

Operator

(Operator instructions) Our next question comes from the line of Rai Archibold with Kaufman Brothers. Please proceed.

Rai Archibold – Kaufman Brothers

Thank you. I just want to ask a couple of questions on I guess the average revenue per customer, up 8%, and I guess, one, if you could just kind of give us qualitatively, how much of that increase was a function of that you had smaller accounts churning off versus the size, if you will, of new customer fields or renewals at larger contract values.

Jeff Lunsford

Well, Rai, I would say it’s the addition of a couple of large customers into the revenue stream. There was definitely an impact of little, tiny customer churn and then sort of standard growth with the rest of the base, but I don’t really have a percentage breakdown for you.

Rai Archibold – Kaufman Brothers

And it’s also just following that small customer churn and following up I guess on an earlier question, if you were to look at your customer accounts today, what percentage of your customers would you define as small and maybe share what the definition of small is, and how would you expect that behavior to go forward?

Are we looking at sort of a continued churn-off of those customers, and are they churning off because of going out of business or, if you will, you decide that you no longer want to support them? What’s the nature of the churn among the small customer base?

Jeff Lunsford

It’s a little bit of everything. There are some folks in the sort of Web 2.0 space that are struggling financially. There’s a few here and there we might lose to a competitor. If they’re a good, healthy, growing business then we absolutely don’t want to lose them and we’re identifying those guys and trying to provide great service and put the account teams on them.

And then going forward we’re obviously targeting our sales teams, both the inside and the field sales teams on the higher-quality customers that growing businesses and real revenue streams to make user we’re not exposed to that, let’s call it the emerging market segment as the economy becomes a little uncertain.

Rai Archibold – Kaufman Brothers

Very good, thank you.

Jeff Lunsford

Thank you. Operator, at this time, I believe there are no further questions, so we thank you all for attending today and we look forward to any follow-up questions you might have. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. Everyone have a great day.

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Source: Limelight Networks, Inc. Q3 2008 Earnings Call Transcript
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