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Executives

Gillian Reckler

Robert A. Lento - Chief Executive Officer, President and Director

Peter Perrone

Analysts

Michael Turits - Raymond James & Associates, Inc., Research Division

Samad Samana - FBR Capital Markets & Co., Research Division

Aaron Schwartz - Jefferies LLC, Research Division

Donna Jaegers - D.A. Davidson & Co., Research Division

Limelight Networks (LLNW) Q3 2013 Earnings Call November 5, 2013 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Limelight Networks Third Quarter 2013 Financial Results Conference Call. [Operator Instructions] I'll now turn the call over to Gillian Reckler, Limelight's Director, Investor Relations. You may begin.

Gillian Reckler

Good afternoon, and thank you for joining the Limelight Networks Third Quarter 2013 Financial Results Conference Call. This call is being recorded on November 5, 2013, and will be archived on our website for approximately 10 days. At the end of this call, we will post an updated investor presentation online, and you can find it in PDF format within the Investor section of our website.

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 fact, such as statements regarding future events or future financial performance including, but not limited to, statements relating to Limelight Networks' market opportunity and future business prospects, guidance on financial results, statements concerning anticipated future growth and profitability, as well as management's plans, goals, strategies, expectations, hopes and beliefs, and statements concerning the anticipated effects of pending or completed business combinations or other strategic transactions.

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, including the inherent risks associated with litigation, particularly, intellectual property based litigation.

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.

The following financial results that we will be discussing are for continuing operations. For more information regarding discontinued operations, please see our Form 10-Q that will be filed in the next couple of days.

Joining me on the call today are Bob Lento, Limelight's Chief Executive Officer; Pete Perrone; and Doug Lindroth. Doug will be available during at the end of the prepared remarks.

Robert A. Lento

Thanks, Gillian. This afternoon, we announced our third quarter results. In summary, we reported revenue of $42.7 million, flat compared to last quarter and down 5% year-over-year. For the third quarter, our GAAP gross margin was 37% and our GAAP loss from continuing operations was $10.9 million or $0.11 per share. We achieved breakeven adjusted EBITDA during the quarter and ended the period with $112 million or $1.15 per share in cash and cash equivalents and marketable securities. Thanks to the hard work, dedication and focus of our employees, the quarter was, overall, generally in line with our expectations and we took another step forward in our turnaround and simplification plan.

This quarter, we continue to make progress toward our 3 strategic intents of creating long-term customer relationships, growing revenue and profitability, and becoming the employer of choice in our markets.

With our focus on account management and initiatives to grow profitable revenue, we held quarter-over-quarter revenue flat despite a significant and expected decline in Netflix traffic. Let me give you some quantification of the challenge. In 2012, Netflix accounted for close to $20 million of our total revenue. In Q3, we saw Netflix revenue decline sequentially by $1.3 million and approximately $825,000 on a year-over-year basis. We anticipate continued sequential declines in Netflix revenue from now until our existing contract expires in early 2014. During this period, we are providing continuing support for Netflix's existing traffic and insisting with migration efforts to ensure top-quality viewing experiences for their customers. We believe that if Netflix traffic comes off our network and frees up capacity for our other customers, we will be well-positioned to bring on more profitable traffic, our revenues will be less dependent on any one customer and our underlying growth will become clearer.

This quarter, we were pleased to see our more strategic customers absorbing capacity and growing their business with us, some very significantly. I'm encouraged by the reduced customer churn on both fronts, customer count and associated revenues. During Q3, customer churn was the lowest it has been in several years.

At the beginning of the year, we told you about the inaugural Voice of the Customer survey we launched to gauge the needs and satisfaction of our customers. The results from this independent survey set a baseline against which we began our course of corrective action. We are running our second Voice of the Customer survey now, and preliminary results show that we are making progress and our customers value the investments we have made in our business.

Our commitment to our customers through product and operational excellence is unwavering, with significant continued investment in network capacity, software feature functionality and customer service. This quarter, we invested over $10 million in the Orchestrate Platform to add additional CDN and storage capacity and to improve our software capabilities. Our customers are asking for and benefiting from these investments. For example, in the U.S., the improvements we've made to our network helped us deliver flawless NFL game coverage for DIRECTV and we helped achieve broadcast quality live event streaming of the Pixies concert in Germany for ARTE Television, one of our large European customers during the quarter.

We also took steps to flatten the organization and simultaneously increase focus on our R&D, product management, operations and service organizations. As a result, we eliminated the role of Chief Operating Officer. Joe DePalo, a 7-year veteran of Limelight, now leads our network operations and customer service organization. Kurt Silverman, new to Limelight leads our R&D, Product Management and Professional Services organization. Joe and Kurt will both report directly to me.

Separately, as you know, we strengthen our management ranks with the addition of Pete Perrone at the beginning of the quarter as Senior Vice President. Pete had earlier served as a member of our Board of Directors for several years. I'm confident that the leadership in place is capable of capturing the market opportunity and improving the company's value.

The other aspect of workforce management has been our effort to reduce employee turnover, which was running higher than we would like during the first half of this year and negatively impacting the productivity of our sales and R&D teams. As we discussed with you last quarter, we put in place hiring and performance management systems to assist managers in identifying, hiring and retaining top producers. I am pleased to see our employee engagement efforts leading to lower turnover and some stabilization in Q3.

Turning to the impact of our efforts on the customer base. I believe this was a positive quarter that reinforces the trends we are beginning to see in our business results. Examples include Hotpoint Media and Cadence Design Systems, 2 of our existence Limelight Orchestrate Video customers who deepened their relationships with us during the quarter to include Limelight Orchestrate content delivery services so that they can deliver optimal digital viewing experiences to their customers. Meanwhile, Houghton Mifflin Harcourt Publishing and Carrefour Organization are both examples of the continued progress we are making selling value-added services to our existing customer base. Houghton Mifflin Harcourt increased their a relationship with us through our web acceleration solution, Orchestrate Performance, so that they could improve the health and speed of their websites while Carrefour, a European customer, who initially purchased our content delivery solutions in 2010, expanded their relationship with us during the third quarter by signing a multiyear agreement for several additional value-added services.

Limelight also welcomed many new customers this quarter, including several customers who purchased multiple solutions. During Q3, we saw new customers purchase an average of 1.9 products as they establish their initial relationship with us.

As we transition from a pure-play content delivery network to a provider of integrated cloud-based digital presence management solutions, an indicative measure of our success will be our ability to move this metric higher in the coming quarters.

In summary, the quarter was generally in line with our expectations. We are investing in product and capacity enhancements and seeing early signs of success with our customers. We are dealing with the rapid decline of our Netflix business, and employee turnover trends are improving. The organization is flatter and we have added significant talent to lead critical functions. Most importantly, we are making these and other investments while preserving our balance sheet strength.

With that, let me now hand the call over to Pete to review the financials in greater detail.

Peter Perrone

Thanks, Bob. Before I get into the financial results, I did want to say a few words about why I'm excited to join the team here at Limelight. It really starts with the market. The CDN market is large and growing and it's fueled by fundamental changes in digital media consumption that we all see around us every day. Limelight has been an innovator and market leader since it was founded in 2001, with the mission to deliver rich media over the Internet based on a unique technical [ph] approach. Today, the company operates one of the world's largest IP networks and serves a marquee customer list that include names like Sony, DIRECTV and Channel 4. And we also hold a large and growing portfolio of intellectual property and know-how in cloud services. I think that we have the opportunity to take advantage of these assets and our market position to drive better financial performance and shareholder value. We are well on our way in making, what I believe, very significant improvement to our operations, and I have confidence in the new leadership here at Limelight. I'm excited to join the team to help implement some of those changes.

During the third quarter, Limelight Networks's recorded total revenue of $42.7 million. Our GAAP gross margin was 37% and we achieved breakeven adjusted EBITDA. My focus coming in as CFO will be on significantly improving these 3 key metrics. I believe that these measures move closer to industry averages. We will drive strong shareholder returns, and we'll lay out more specific targets and growth rates and margins for you in 2014.

Directionally, our total revenue was down 5%, year-on-year, and flat, sequentially. However, excluding Netflix from both periods, revenue grew approximately 3% sequentially. Diving into more detail, content delivery net revenue for the quarter was down 1% sequentially and declined 8% year-over-year. The year-over-year decline was a combination of several factors including the decline in Netflix, but also a significant decline in transit and co-location revenue. And as we have discussed in previous quarters, transit and co-location revenue was a large component of our 2012 revenue that we have chosen not to pursue on a standalone basis going forward.

In addition, we were also negatively impacted by foreign currency exchange rates, so on a constant currency basis, our revenue would have been approximately $600,000 higher than the reported number.

Customer losses in the quarter were the lowest that they have been in several years and new customer adds were up sequentially from the second quarter. As Bob mentioned, we are focused on improving customer satisfaction and we believe these positive trends will continue.

On a geographic basis for the third quarter, Americas revenue accounted for 67% of our total revenue, EMEA was 19% and APAC was 14%. GAAP gross margin was 37% during Q3 compared to 35% in Q2 and flat compared to Q3 of last year. The gross margin increase from last quarter was primarily due to a decrease in network depreciation and a decrease in bandwidth and co-location costs.

On a cash gross margin basis, cash gross margin was 50% for the quarter, flat compared to last quarter and down from 54% during the same period last year. Cash gross margin was down from last year as our cost did not decline with the decrease in our content delivery revenue.

Our total operating expenses were $25.8 million, down approximately $325,000 from last quarter and down approximately $400,000 from Q3 2012. Operating expenses decreased from Q2, primarily due to a decrease in marketing expenses associated with the launch of our Orchestrate Platform 2.0 last May and a decrease in our R&D expenses. It was partially offset by an increase in G&A cost, and the G&A cost increased primarily due to higher consulting expenses and higher non-income tax expenses driven by one-time credits we received during Q2.

We achieved breakeven adjusted EBITDA after a loss of nearly $500,000 last quarter and compared to adjusted EBITDA of approximately $2.8 million in 2012. We believe the operational changes we are making will drive leverage in our business and lead to improvements in our adjusted EBITDA performance over time. We will, however, continue to invest heavily in our platform and capabilities through year-end and into 2014.

With that, we'll open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Michael Turits from Raymond James.

Michael Turits - Raymond James & Associates, Inc., Research Division

Can you talk about the customer competitive dynamics a little bit? Last time, you had mentioned that because of issues around capacity, functionality, that you were facing somewhat tougher negotiations and -- especially to your 2 guys who are starting to put a little bit of pricing pressure and some customer losses. How have those dynamics changed or not changed this quarter?

Robert A. Lento

It's Bob. Thanks for the question. From quarter-to-quarter, I don't think much has changed. We continue to build new feature functionality into the software. Some of that came out in the last quarter, more of it is scheduled to come out in Q4, things that will make a big difference. So from our perspective, the smaller guys are still out there, largely competing on price. They're typically not the people that we compete with every day on every deal that do show up. But I think from a competitive standpoint, the dynamics haven't changed much, quarter-to-quarter.

Peter Perrone

Let me add one more thing. We did have -- as revenue was flat, CDN revenue was effectively flat with some revenue decrease from Netflix, we did see growth in some of our top strategic accounts who came back on the network, and we had some pretty good traffic growth in some of those important accounts. So, it was a good step.

Michael Turits - Raymond James & Associates, Inc., Research Division

So the core CDN -- so CDN revenues, as we measure them, were about flat sequentially, so anything you can tell us about adjustments for Netflix? How much of an impact from Netflix and how much of an impact from the roll off of co-lo?

Robert A. Lento

So I think the Netflix numbers we gave you was $1.3 million down from Q2 to Q3. In 2012, they were about a 20 -- a little less than $20 million in revenue. Our expectation is that by early 2014, think of that as maybe the end of the first quarter, we expect that to be trending towards 0 and we'll see it come down over the next -- in Q4, Q1 and then in Q2. If all goes as planned, it'll be close to, or 0.

Michael Turits - Raymond James & Associates, Inc., Research Division

So 0 by 2Q. And I'm sorry, the impact -- did you say the impact of roll off of co-lo. However you want to give it, dollars or percentages or whatever?

Peter Perrone

No. On a sequential basis, co-lo and transit together didn't really change much, but on a year-over-year basis, it was significant. And it was a lot bigger in 2012 as we talked about.

Michael Turits - Raymond James & Associates, Inc., Research Division

Okay. And then is there any chance CapEx outlook?

Peter Perrone

I think you could think about it along the same lines that it's been in the past couple of quarters.

Operator

Our next question comes from David Hilal of FBR Capital Markets.

Samad Samana - FBR Capital Markets & Co., Research Division

This is Samad Samana in for Dave. In the past, you guys have provided kind of anecdotal commentary around the different pieces within VAS. That business looked like it was up only slightly sequentially. Could you tell us how storage performed in the Limelight Video Platform and content management? Just provide more details on how the growth drivers there were?

Robert A. Lento

Sure. So there's principally 4 products that make up value-added services. It's our storage product; our performance product, which is the web acceleration; our video product; and content management, right? So the big grower is still video, and we're very pleased with how that is growing, both quarter-to-quarter and year-over-year. And we continue to invest in that with some significant features coming out in this quarter, Q4 and in Q1, that we believe will enable us to maintain that growth. Within storage, we're seeing -- still seeing a shift from our discrete offerings to Agile. Agile is growing and we are doing some additional work in terms of operational stability and software feature functionality there. But we think that, that will continue to be a good product for us. Content management has been pretty stable and so our investments in that continues. Revenue has been pretty stable. It's not the fastest-growing product that we've got, but some very significant customer relationships that are growing, and we're pretty pleased with how that business is performing. Although quarter-to-quarter or year-over-year, it's not been growing rapidly. So we talked about storage, content -- performance is the other area, and that's where I think we have, potentially, our largest opportunity. We just relaunched that product, both internally to our sales force and externally to the world this past quarter, October. And we've done some testing versus our competition using third parties. We're very pleased with the results of that testing, which shows that our product is superior, both for middle-mile acceleration and Dynamic Site acceleration. And so we are pretty aggressively promoting that, not only to our existing customer base, but in all of the new business development initiatives that we're involved in. And the reaction, both from the industry analysts and potential customers, has been very favorable.

Samad Samana - FBR Capital Markets & Co., Research Division

Okay. And then getting back to Netflix. Outside of them, are there any other large customers on the CDN side that are coming up for renewal that could be material, that would lead to another step function decline in CDN revenue? A competitor of yours recently had a media contract that's resetting. Is there anything in your pipeline that looks like that down the road?

Robert A. Lento

Yes, there's nothing that looks like a customer that's as large as our competitor's customer was. For them, that would materially change results of a given quarter. Like that competitor said on their conference call, there are contracts that come up every quarter, some larger than others, and there's always an opportunity for them to either be priced dramatically different or go away. But there's nothing that can impact our results to the magnitude of a Netflix.

Peter Perrone

The only thing -- I'm sorry, the only thing I'd add is that we’re going to continue to make decisions on pursuing business that's profitable for Limelight Networks and that could include hard decisions at renewal time for a number of customers but none of which would be as big as Netflix.

Samad Samana - FBR Capital Markets & Co., Research Division

Okay. And then as I look at the balance sheet with the $113 million of net cash, has the company considered strategic alternatives such as buying their way into a new product area, sudden disparate growth or reinitiating the buyback, which was there a couple of quarters ago?

Peter Perrone

We spend a lot of time with the Board thinking about the appropriate use for that cash that we have. We think the appropriate use is investing in the business and the opportunity that's right in front of us, and that's what you'll see us continue to do.

Operator

Our next question comes from Aaron Schwartz of Jefferies.

Aaron Schwartz - Jefferies LLC, Research Division

I just have a follow-up question. I think you mentioned that new customers, on average, purchase 1.9 products that sort of ticked down a little bit, sequentially, if my numbers are correct here. But it seems that you are pleased with the backfill, x Netflix on sort of new customer traction. On some of the newer customers, I mean, are they purchasing -- looking at individual product lines and maybe in a little bit more size and little less diversified? Or is there any sort of commentary you can add on to those metrics?

Robert A. Lento

Well, the first thing I'd say is we're very pleased that we were able to bring down the customer churn number, right? So it's been several years since we've had customer churn as low as it was last quarters. So one quarter doesn't make a trend, but you've got to start somewhere. So we're very pleased with that. And then if you look at the customers that are coming on as new customers, we are trying to be more selective and bringing on customers that may start with a small relationship with Limelight, but have the potential to grow into other product lines as well as be much larger than the initial contract. So that's been the focus. So as we said before, it's less on numbers of customers and more about aligning with customers that are looking for long-term relationships that are profitable for both sides.

Aaron Schwartz - Jefferies LLC, Research Division

Okay. And a follow-up on Netflix. I mean, if I look at the consensus numbers, it doesn't appear that estimates have that sort of tail-off in revenue modeled appropriately. And it seems that even though you've pointed out the decline here in the quarter, you're still north of $3 million, probably, in the quarter of Netflix revenue, that if you pointed out, will go to 0. So I guess, 2 questions. One, do you feel you can offset that tail-off in Netflix with new customer growth on CDN? Or, I know you're not giving guidance, but should -- are you sort of indicating a little more aggressively here that the Street estimates here should more broadly reflect that decline in Netflix revenue over the next couple of quarters?

Peter Perrone

It's immense, right? I think we feel like we made very good progress on, in this quarter, bringing customers back onto the platform and getting traffic from strategic customers that I mentioned before. So on the one hand, we're pretty optimistic about being able to fill that. On the other hand, it is a challenge in a competitive market and there's other customers, as we talked about, at renewal time, that we're going to continue be disciplined about profitable long-term customers. So it's a mix of those 2 factors.

Aaron Schwartz - Jefferies LLC, Research Division

Okay. And the last question. As that customer's lined off completely, would you expect any benefit on the margin line? Is it that type of a drag or is it a little less meaningful for your margin?

Robert A. Lento

Well, I think what's fair to say is that once we replace the Netflix traffic with traffic from other customers, it is highly likely that, that will be at a higher gross profit margin. So the challenge is how long does it take you to fill -- to backfill all of the traffic that you're losing. But to be clear, the traffic that we are bringing on, on an incremental basis is at a higher gross margin than the traffic we're losing with Netflix.

Operator

Our next question comes from Donna Jaegers of Davidson.

Donna Jaegers - D.A. Davidson & Co., Research Division

On the sales force, can you talk a little about what you're starting to see stabilizing in sales force and can you give us any numbers, sort of sales force people that you have out there?

Robert A. Lento

We don't disclose the number of people. What I can tell you is we are starting to invest more aggressively in the training and management of the sales force. We are opportunistically bringing in talent as needed for particular geography or a market. We're pleased with the stabilization that we're seeing from a turnover perspective, and we feel that we'll be able to drive better sales productivity in 2014 based on a combination of the factors that I've just talked about. But additionally, the money that we've invested this year in the network and the software, obviously, gives the sales force a better product to present to customers. And between the skill of the new people coming in, the investments we're making, the training of our existing team, the discipline that we're putting in place, and I think Pete alluded to around pricing, I think we'll be able to drive higher productivity next year.

Donna Jaegers - D.A. Davidson & Co., Research Division

Okay. And Kurt Silverman that you brought in as your new Head in R&D. I just checked [ph] him on LinkedIn recently and, obviously, you had worked with him before at Convergys. What gives you confidence that having come from a billing sort of back -- telco billing background, that Kurt's got the management skills to lead more of a CDN/R&D effort?

Robert A. Lento

So Donna, great question. A little bit of background on Kurt. He's -- both a Bachelor's and Master's degrees in MIT. He was one of the initial founding employees of Keenan Systems, which, as you pointed out, is a billing and rating system. And that was purchased by Lucent. And at Lucent Bell Labs, Kurt had the opportunity to become the Chief Technology Officer and President of their Software Strategy, and so had a tremendous exposure to the network, both at Lucent and Bell Labs and, so brings a lot of experience from his time there. And then worked with me at Convergys, so we know each other well. And I believe he is focused on the right things for Limelight and making quick progress, both in terms of organizing his teams in a way that will yield better productivity and higher quality and driving us quickly, in terms of our ability to drive new feature functionality. So I'm pleased to have Kurt as part of the team. As you pointed out, he's a known entity and quantity to me. But based on the experience he has from his Bell Labs, Lucent Bell Labs days, he understands a lot about how the network works and what it will take to drive efficiency and effectiveness by utilizing our software investments.

Donna Jaegers - D.A. Davidson & Co., Research Division

And just one quick follow-up on Netflix. By the tone of your comments, it sounds like this is not a negotiating ploy. You definitely expect them to be trending to 0 in the first quarter, or do I read too much into that? Could -- if they were open to paying a little higher prices and all their traffic doesn't go on to their Direct Connect product, would you be interested in keeping Netflix on if the profitability is higher?

Robert A. Lento

We are in the business of serving customers that are willing to pay reasonable prices for our service and, certainly, Netflix would be -- would not be turned away at the doors. So to the extent that they need additional help from us throughout 2014 and beyond, if the pricing and terms and conditions were reasonable, we would certainly welcome that. We do expect that when our contract ends, it will go to 0. But if they come back to us and need some additional help, then we will certainly be available and anxious to take that business. But in terms of the perspective of -- from a planning perspective, we are assuming that it will go to 0 when the contract ends in 2014 -- in the first part of 2014.

Operator

[Operator Instructions] I'm not showing any other questions in queue. I'd like to turn the call back over to Bob Lento for any further remarks.

Robert A. Lento

Great. Thank you. I would just say, in summary, we believe we're seeing progress, creating deeper relationships with our customers. We're deploying our people and our physical and financial assets to better serve our customers, while profitably growing our business. The combination of topline growth and profitable revenue and improving operational efficiencies are the foundation for our continuing future success. Thank you for joining us on the call today. I look forward to sharing our progress with you when we report our full-year results. Thank you.

Operator

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

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