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Limelight Networks Inc. (NASDAQ:LLNW)

Q4 2013 Results Earnings Conference Call

February 13, 2014; 04:30 p.m. ET

Executives

Bob Lento - Chief Executive Officer

Pete Perrone - Chief Financial Officer

Dan Boncel - Principal Accounting Officer

Analysts

Mike Olson - Piper Jaffray

Michael Turits - Raymond James

Aaron Schwartz – Jefferies

Donna Jaegers - D.A. Davidson & Co.

Operator

Good day ladies and gentlemen and welcome to the Limelight Networks, fourth quarter and full year 2013 financial results conference call.

At this time all participants are in a listen-only mode. At the end of the prepared remarks we’ll provide instructions for those interested in entering the queue for the question-and-answer session.

I'll now turn the call over to Dan Boncel, Limelight's Principal Accounting Officer.

Dan Boncel

Good afternoon and thank you for joining the Limelight Networks, fourth quarter 2013 financial results conference call. This call is being recorded on February 13, 2014 and will be archived on our website for approximately 10 days.

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 related to the 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.

I’m joined today by Bob Lento, Limelight's Chief Executive Officer and Pete Perrone, our Chief Financial Officer. Bob and Pete will be available during the Q&A session at the end of their prepared remarks.

Bob Lento

Thanks Dan and good afternoon. Earlier today we announced the results for our fourth quarter and full year 2013. Let me discuss the quarter’s results and provide you with some insight into our priorities for 2014.

For the fourth quarter we reported revenue of $42.2 million, down 9% from the $46.5 million reported in the fourth quarter of 2012. GAAP gross margin was 36% and net loss was $5.1 million or $0.05 per share. Adjusted EBITDA during the quarter was just below breakeven and we ended the year with $118 million in cash and marketable securities.

Exiting 2013 we achieved many of the goals we set for ourselves. Revenues and margins are stabilizing, customer satisfaction is improving, employee churn is down, we are more focused on our core offerings and making investments to improve them and our balance sheet remains strong. With that said, we recognize we have more work to do in 2014.

In December we closed the sale of the Web Content Management business. The sale helps us focus on our core capabilities, where our market position is strong and we can invest to grow profitability. Importability our WCM employees and customers became part of an enterprise focused on winning with that product.

We’ve also announced that our Broad of Directors has authorized a $15 million stock repurchase program, reflecting the Board’s confidence in our future prospects.

Entering 2014, we are placing a much higher importance on growing existing customers with the highest potential and with a more compelling product suite, we expect to gain traction across our solution offerings. With the same drive we expect to win new customers and demonstrate we can make in roads into the enterprise. Our product portfolio has growth potential, including CDN, which is facing headwinds from the previously disclosed migration of Netflix off our platform.

Let me spend a minute talking about what our people accomplished in 2013. First, the focus on revenues and customers help reduce churn. Customer churn is an expensive problem and as a geographically dispersed global company, customer acquisition cost is high. Net customer churn declined in the second half of 2013 by almost one-third.

Next, voluntary employee turnover dropped from over 20% in the first half of 2013 to the teens in the second half of 2013 and was in single digits by Q4, our best performance in many quarters. In light of the improving employment environment, I’m particularly pleased with this metric.

We also made investments in our solution offerings. We increased our focus on product management and software development and look for opportunities for tighter integration between the two. We enhanced our software development efforts by better understanding what customers require and agreeing it as a team on what we will pursue. We aligned our product road maps to a clear long-term vision.

We moved some development capacity to lower cost geographies and will continue to look for opportunities in this regard. As a result, our development discipline and productivity went up. To improve customer satisfaction, we deployed a new customer service platform to unify ticketing, automated communications, build an enterprise knowledge base and drive efficiency.

During the year we made a series of management moves, bringing talent from outside like Kurt Silverman, our new Senior Vice President of Development & Delivery and George Vonderhaar, our new Chief Sales Officer, promoting some from within like Joe DePalo, to Senior Vice President responsible for our network and infrastructure and asking Pete to join us as Chief Financial Officer from his previously position as Board Member. With all this, employee pride is returning and visible in what we do.

One year into our turnaround let me tell you about what we will focus on in 2014. We will invest in getting cost efficiencies and delivering new software, features and functionality. Some of the features slated for 2014 are enhanced adapted format streaming for mobile devices, updated digital rights management, instant global purge capabilities and further enhancements to our industry leading cloud storage offering. Many of these capabilities are scheduled for release in the first half and show results in related revenues in the second half of the year.

We are reengineering our entire quote-to-cash process. With multiple acquisitions and disparate systems our current processes are high touch and inefficient. Through systems and process integration, we will move to a highly automotive environment and remove the inefficiencies. We are making a sizable investment this year and we expect a quick payback for our efforts in the form of increased customer satisfaction and operating efficiencies.

Let me also give you a quick update on Netflix. In the quarter Netflix remained our largest customer. They also remained committed to moving off our platform around mid-year. We expect volumes will stay strong until they migrate, as evidence in our 2013 revenues with Netflix, which were about flat from 2012 levels. We expect organic and new customer growth to offset Netflix’s decline and we expect revenue to ramp during the year.

Let me tie what we’re talking about to real customer wins. As I said, one of the product features getting attention is our support for additional forms of digital rights management. In the quarter we won business from Library Ideas, a leading media company that provides music, videos and e-books to libraries around the world.

Library Ideas chose Limelight Orchestrate Video to replace their incumbent video solution. Through Orchestrate Video, Library Ideas can transcode, store and deliver music from Sony and over 10,000 other music labels to public libraries across the country and have a unified solution for managing their video and deliver needs. One of the key reasons that Library Ideas chose Limelight as their technology partner was the support that we provide for large volume digital rights management.

One of our top 100 customers and a leading provider of movies over the Internet increased their commitment for cloud storage and delivery during Q4, and as a result of their continuing business growth. Their growth plans require 500 to 1,000 of their most popular movie titles to be replicated in our Orchestrate Cloud Storage. It was a great example of how we are expanding services in our core customer set.

A medium sized enterprise electronic company recently purchased our website acceleration services to improve responsiveness of their website and to address their growing needs for mobile device access. As a result of deploying our solutions, this customer has experienced increased conversation rates and higher revenues.

In a high profile European win, Soundcloud the world’s leading social sound platform chose Limelight Orchestrate Delivery, so that their customers can upload music and know that their music will be delivered flawlessly using a global, high performance delivery network. They use a dual CDM strategy and we replaced one of our primary competitors there.

These success stores and many others like them give me confidence that we are on the right path. Let me now hand the call to Pete to discuss the financials.

Peter Perrone

Thank you, Bob. In the fourth quarter, Limelight Networks recorded total revenue of $42.2 million. Our GAAP gross margin was 36% and adjusted EBITDA was just below breakeven. Revenue was down 9% year-over-year and 1% sequentially. The Web Content Management business sale reduced December revenue by approximately $250,000 and currency exchange rate had a 1% negative impact on revenue compared to prior years at approximately $400,000.

Average selling price for our content delivery network was effectively flat on a sequential basis. This is the second quarter in a row where we have seen stable pricing trends, which we believe reflect better industry dynamics, as well as our decision to pass on customers who do not value quality. We will continue to be disciplined in our business and customer selection in 2014.

Cash gross margin in the quarter was 49%, flat from Q3 2013 and down from 54% in 2012, largely reflecting lower utilization levels of our network. We have made significant investments in capacity this year, and believe that as traffic increases on our network that will provide improved gross margins.

Led by reductions in G&A, GAAP operating expenses dropped by $3.3 million in Q4 2013 compared to Q4 2012, and declined $1 million from Q3 2013. As a percent of revenue GAAP operating expenses declined to 58% versus 60% a year ago, despite a slight increase in our R&D spending. We used approximately $1 million in cash to fund our operations in Q4 2013, but we generated positive cash flow from operations of $5.6 million for the entire year.

GAAP net loss was $0.05 per share for the fourth quarter of 2013 compared to a net loss of $0.12 per share for the fourth quarter of 2012 and $0.11 per share net loss in the third quarter of 2013.

Moving to the balance sheet, cash and marketable securities were down $10 million to $118 million from year ago levels of $128 million. Day sales outstanding improved to 49 days from 52 days at the end of 2012, reflecting higher quality customers and a better collection process.

During the first half of 2013 we repurchased 2.3 million shares at an average cost of $2.40 per share for a total of $5.5 million. We review our capital structure with the Board on an ongoing basis and at the current time we believe our stock is an attractive investment vehicle to return cash to our shareholders.

This afternoon we also announced as Bob mentioned, that our Board of Directors has authorized a $15 million share repurchase program or approximately 8% of outstanding shares at current prices.

Switching gears let me provide a brief update on the Akamai Litigation. We are delighted that on April 30 this year, the Supreme Court will hear our appeal of the Federal Circuit decision. We believe that with many other industry leaders that the ruling from the Federal Circuit is incorrect, represents a significant change and settle patent case law and expands the threat of frivolous litigation against operating companies.

Because winning this argument is so important for us, many industry leaders such as Google, Facebook, and Cisco have previously filed amicus briefs in support of our position in prior appeal proceedings. We are pleased to be one step closer to end our long core battle with Akamai and we are confident that we are in the right side of this argument.

Looking ahead, let me provide some guidance around 2014 revenue and the impact of the sale of our Web Content Management business. The WCM business was to generate approximately $15 million in 2014 revenue, about $3.5 million to $4 million per quarter. We believe that the consensus analyst revenue estimates when adjusting for this are roughly in-line with our own expectations for 2014 and we are also comfortable with the current GAAP EPS analyst estimates for 2014.

With migration to its own infrastructure expected by mid-year, we anticipate revenue for Netflix to be approximately half of the levels of 2013 and not contribute meaningfully in the second half. We expect that existing and new customer grow will offset the Netflix decline and we expect revenue to ramp during the course of the year.

Also as part of the Web Content Management sale 30 employees were transferred, leaving out total employee account at December 31, 2013 at 482 employees, which is down from 511 employees at the end of 2012. We are investing heavily this year in R&D and operational improvements and we expect to reinvest operating expense savings back into the business to improve our execution and customer deliver. We expect these investments to pay back in the form of improved revenue growth rates and profitability.

We now have four product families which are content delivery, dynamic website acceleration, video asset management and cloud storage. We are focused on driving growth within each product, as well as ensuring that our products are tightly integrated and provide additional value to our customers when purchased together. As such we will no longer be reporting on the distinction of value added services or VAS.

With that I’ll turn it back to Bob.

Bob Lento

Thanks Steve. In summary, we believe we are in a healthy market with competitive products. We are continuing to invest in our products and we are delivering compelling value propositions for our customers. We are reducing customer and employee turnover and are focused on improving customer satisfaction, creating value for our stakeholders.

At this time, we’ll open the lines for questions.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) Our first question comes from Mike Olson of Piper Jaffray. Your line is open.

Mike Olson - Piper Jaffray

All right thanks. Good afternoon. I just have one question. You’ve mentioned a couple of times there that organic growth from normal business and new deal wins will kind of allow you to grow throughout the year. So are you implying that we’ll see a sequential quarterly revenue ramp each quarter in 2014 and that there won’t be necessarily a downtick when Netflix revenue stream goes away later in the year?

Bob Lento

Yes, I think we didn’t give sort of quarter-by-quarter specificity and didn’t imply quarter-to-quarter specificity. The Netflix we expect to transition off in the summer and whether that, the Q2 to Q3 is up or down, is kind of going to be depended on that transition.

Mike Olson - Piper Jaffray

Okay, got it. Thanks very much.

Operator

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

Michael Turits - Raymond James

Hey Rob and Pete, I guess the same kind of question on the math, I mean so I guess $3 million to $4 million for Web Content Management. You had a couple (inaudible) this quarter off, but so I figure you are down $3 million to $4 million sequentially, all other things being on them?

It sounds like your still ramping more of Netflix also – maybe you’re down again sequentially in the second quarter. So I’m not sure what you mean by revenue will ramp at that point, because I mean its up sequentially each quarter or what does that mean? Because I don’t get the $160 million -- I don’t get to $170 million minus $15 million if I do that.

Pete Perrone

So let me take a shot at it. So if you think about having Netflix revenue in Q1 and Q2 and then largely minimal amount in Q3 and none in Q4, what we’re saying is that in Q3 and Q4, we believe we’ll have sold through enough to replace that revenue. It may not exactly be perfect, but we’ll largely replace the Netflix revenue with growth of existing customers and new wins.

Michael Turits - Raymond James

Okay, so but your not saying specifically that you are up, the sequential growth Q2 to Q3.

Pete Perrone

We’re not saying that.

Michael Turits - Raymond James

Okay. Just a question on what you see going on in terms of demand. Akamai has been putting up some good numbers. Are you seeing any kind of change in the demand environment from kind of on a same store, same sort of sales basis, are individual customers starting to pick up the growth of their bandwidth requirement?

Bob Lento

Generally speaking, we are seeing more demand for the services that we provide. There are some things that we need to do from a development perspective to be able to take on the additional traffic and so that’s why our development plans, software development plan is so important and we’re also using that as an opportunity to optimize our customer base around the combination of price and quality.

Turning to Pete’s point, we saw zero pricing changes between Q3 and Q4. There’s a lot of dynamic behind that. There’s a lot of in and out and movement there, to get us there and what we’re trying to do is position ourselves with customers that have a strong growth profile into the future and so there’s a lot of movement in the number, but in answer to your question, generally speaking we are having conversations. The conversations we are having with customers are about fulfilling their need for growing traffic versus not.

Michael Turits - Raymond James

Okay, thanks very much.

Operator

Thank you. Our next question comes from Aaron Schwartz of Jefferies. Your line is open.

Aaron Schwartz – Jefferies

Hi, good afternoon. Thank you. I have a follow up question on the core CDN. You mentioned the stable pricing sequentially and it sounded like you felt better about sort of your decisions on the customer churn, maybe getting a listing on that front, but it still looks like that business was probably down sequentially.

And so can you sort of reconcile how much of that is just still from your decision to not renew contracts versus do you see growth on the network sequentially, because it doesn’t appear so if pricing was flat and then I don’t know if there’s any way to take a shot at this, but any way to sort of try to talk about maybe sort of the same store sales metric for that business given. You know it seems like some of the customer churn was maybe just decisions you made to not renew.

Bob Lento

Well, let me take a shot at the first part and then maybe Pete can add in some comments. So I think your analysis is correct. Traffic from Q3 to Q4 was essentially flat or maybe even down a couple of percentage points and a lot of that has to do with conscious decisions we’ve made, about the type of customers we want to serve and the type of customers we want to align ourselves with in terms of just satisfying their needs in the future. So there’s a fair amount of…

You know what, the good news is churn was down dramatically in the second half versus the first half, so we’re doing – there’s less of that going on and more of it is happening in our control versus happening to us and I think some of that will continue to happen, but I think we’re getting much better at aligning ourselves with the customers that help can us grow this company for the long term.

Aaron Schwartz – Jefferies

Okay and maybe second question, sort of a follow-up on the earlier ones. But, the WCM business is very straightforward, but if we’re thinking about sort of what you have to do to fill the gap of Netflix in the back half, is there something you’ve already started to see with bookings that gives you visibility on that or are there any sort of product lines that picked up or is this still a lot of work you have to do in the first half with an improvement in bookings to get there. What helps us sort of connect the dots, to have some comfort that that revenue gap can be offset by some of the other areas of the business?

Bob Lento

It is really a few drivers of it. One is, within our existing customer base, more share of the traffic and that’s related to better performance as a company, better satisfaction and lower churn levels, which is – you know its not just disconnects as you all know, its traffic shifts up or down, and the second is a well-increased focus on new bookings and new customers coming on to the platform.

So the first one with respect to existing customers, we serve some very large customers, as you know we have a lot of traffic potential for us and we’re kind of focused on that very aggressively this year.

Aaron Schwartz – Jefferies

Okay, terrific. Thank you.

Operator

Thank you. Our next question comes from Donna Jaegers of D.A. Davidson. Your line is open.

Donna Jaegers - D.A. Davidson & Co.

Hi, a few quick questions. Netflix, was that a 10% customer in the quarter?

Bob Lento

It was.

Donna Jaegers - D.A. Davidson & Co.

Okay. On legal expenses can you give us any, was there any legal expense in the quarter and will that pick up obviously in anticipation of the Supreme Court hearing, the case?

Bob Lento

I don’t think that the legal expenses in Q4 were material or greater than what we experienced in the normal course of business and the Supreme Court case, which will happen in the second quarter, we’ll certainly spend more in legal expenses in that quarter than we did in the fourth quarter or will in the first quarter. But again I don’t think its – we’re not talking huge numbers here.

The Supreme Court case happens on one day. It takes a hour and a half to go through our piece, but its largely a one day event with some obviously preparation and filings that have to go in before that which will create some expense, but we are talking material change to our financials.

Donna Jaegers - D.A. Davidson & Co.

Okay. And then on Clickability or your WCM, can you give us any – was that a profitable division and any sort of information on what Upland Software paid for it?

Bob Lento

It was pretty integrated into our overall company, so it was definitely a positive gross margin operation, but it’s a little hard to piece it apart all the way down to the bottom line.

Donna Jaegers - D.A. Davidson & Co.

And the price that Upland for it, since I’m assuming that will come on in the case.

Bob Lento

That was released at the time of the acquisition, it was $12.5 million.

Donna Jaegers - D.A. Davidson & Co.

Okay, sorry I must have missed that. And then you mentioned that customer churn has gone down, but do you want to give us – since we never knew how bad it was, you want to give us any sort of count as far as number of customers.

Bob Lento

Well I think we did disclose our ending customers, so that’s what we were referring to. That’s what Bob was referring to in his remarks as sort of net. So we haven’t broke out gross adds and gross disconnects, but we tell you what the ending customers are.

Pete Perrone

And I think on a gross basis we were down 50 or 60 in the second half versus 90 to 100 in the first half something like that.

Bob Lento

So that’s favorable.

Donna Jaegers - D.A. Davidson & Co.

Okay, thanks guys. Good luck.

Operator

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

Michael Turits - Raymond James

Hi guys, I’m all set. There was a couple of them. I got them, thanks.

Bob Lento

Okay.

Operator

Thank you again. (Operator Instructions) Looks like we have a follow-up from Donna Jaegers of D.A. Davidson. Your line is open.

Donna Jaegers - D.A. Davidson

Yes, given that you brought in Kurt Silverman last quarter to run sort of product development and delivery, any further turnover in his organization?

Bob Lento

Well Kurt’s brought in some people that have worked for him in the past, to help us get where we need to be from a development perspective and there was some turnover in his organization that in Q3 and Q4 was probably higher than our average, but I mean it hasn’t been a complete overhaul or anything like that. And so Kurt’s reorganizing in ways that I think are really positive for our customers and bring emphasis on productivity and discipline around how we do our software development, and to help him do that. He has brought in some people that he’s worked with in the past, that our experts at this. But from a leadership perspective, there really hasn’t been any departures, there’s just been additions, sort of his direct line of the reports.

Donna Jaegers - D.A. Davidson & Co.

And then on EdgeCast, obviously Verizon bought that during the quarter. How much do you run into them as far as on the competitive front?

Bob Lento

I would say that clearly Akamai is the number one competitor for us and probably for everybody. Probably followed by Level 3 and then EdgeCast and then obviously it varies by region, so obviously we’re watching that closely and looking forward to understanding better what Verizon’s plans for the asset are, but if I look back over the last year, they would sort of be the second, third, fourth competitor in terms of frequency of deals that we’re head-to-heads with them.

Donna Jaegers - D.A. Davidson & Co.

Okay, thank you.

Operator

Thank you. I’m not showing any other questions in queue. I’d like to turn the call back over to management for any further remarks.

Bob Lento

I think we’re good, thank you.

Operator

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

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