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Akamai Technologies, Inc. (NASDAQ:AKAM)

Q4 2006 Earnings Call

February 07, 2007 04:30 pm ET

Executives

Sandy Smith - Director of IR

Paul Sagan - President & CEO

JD Sherman - CFO

Analysts

Harry Blount - Lehman Brothers

Katherine Egbert - Jefferies

Aaron Kessler - Piper Jaffray

Tom Watts - Cowen & Company

Rod Ratliff - Stanford

Tim Klasell - Thomas Weisel Partners

Todd Raker - Deutsche Bank

Brent Bracelin - Pacific Crest Securities

Robert Stimson - WR Hambrecht

Steven Freitas - BMO Capital Markets

Darren Aftahi - ThinkEquity Partners

Presentation

Operator

Good afternoon. My name is Jeremy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Akamai fourth quarter and full year 2006 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

Thank you. Ms. Smith, you may begin your conference.

Sandy Smith

Great. Thank you. Good afternoon and thank you for joining Akamai's investor conference call to discussion our fourth quarter and year-end 2006 financial results.

Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer and JD Sherman, Akamai's Chief Financial Officer.

Today's presentation contains estimates and other statements that are forward-looking under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions that are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially.

Additional information concerning these factors is contained in Akamai's filings with the SEC including our annual report on Form 10-K. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our estimates change. And therefore you should not rely on these forward-looking statements as representing our estimates as of any date subsequent to today.

During this call, we will be referring to some non-GAAP financial measures that we believe are helpful to a better understanding of our financial results and operations. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principals. You can find definition of these non-GAAP terms and reconciliation of these non-GAAP terms to the most directly comparable GAAP financial measures under the news and publications portion of the Investor Relations section of our website.

Now let me turn the call over to Paul.

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Akamai is the leading global service provider for accelerating content and business processes online. Thousands of organizations have formed trusted relationships with Akamai, improving their revenue and reducing costs by maximizing the performance of their online businesses. Leveraging the Akamai EdgePlatform, these organizations gain business advantage today, and have the foundation for the emerging Web solutions of tomorrow. Akamai is "The Trusted Choice for Online Business."

View our news releases and learn more about our company and services at www.akamai.com.

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Paul Sagan

Thank you, Sandy and thank you all for joining us today. The fourth quarter, another record quarter, capped off Akamai's best year ever.

In 2006 we grew revenue more than 50%, making it the fourth straight year of accelerating revenue growth. Our consolidated results for the fourth quarter include revenue of $125.7 million, a 13% increase over the third quarter and a 52% increase over the fourth quarter of 2005. Normalized net income of $47.5 million or $0.27 per diluted share, a 14% quarter-over-quarter improvement and an 82% increase over normalized net income from the fourth quarter of the prior year.

For the full year, we grew revenue 51% year-over-year to $428.7 million. And we generated normalized net income of $154.5 million or $0.88 per diluted share, that's a 94% increase over our normalized 2005 net income results. With these fourth quarter results we've reached an annual run rate of more than half a billion dollars on the topline which places us over halfway to the billion dollar revenue milestone we talked about at out analyst summit last fall.

Overall, 2006 was outstanding at Akamai and we look forward to 2007. We are more excited than ever about the opportunities for growth in the marketplace for both our content delivery and application acceleration services.

I'll be back in a few minutes to share some thoughts about these growth opportunities as well as our strategic acquisition of Nine Systems late last year and the deal we announced just this week to acquire Netli.

Now, let me turn it over to JD, to review our 2006 results in detail. JD?

JD Sherman

Thanks, Paul. As Paul just highlighted, we had a great fourth quarter, rounding out the company's strongest year ever. During the fourth quarter revenue grew to 13% to $125.7 million, marking our fourth straight quarter of double-digit sequential growth.

As expected, we saw the benefits from another healthy online holiday shopping season, as well as continued strong growth across the business. These consolidated results include 18 days of impact from the Nine Systems acquisition, or about $800,000 of incremental revenue in the quarter. We expect some minimal churn from the Nine Systems customer base, so overall this implies an annual revenue run rate in the range of $15 million for the Nine Systems business.

During the fourth quarter, Akamai's international sales represented 23% of total revenue, one point higher than third quarter levels and resellers represented 19% of total revenue, down a point from the prior quarter.

As we have noted over the past few quarters, we continue to see very strong demand from our existing customers which again drove solid ARPU growth. In the fourth quarter, before factoring in our Nine Systems acquisition, average revenue per customer or ARPU was $18,900, up 8% sequentially and 29% higher than the fourth quarter of last year.

On an organic basis we added 78 net new customers in the quarter and with the Nine Systems transaction, we added an additional 125 customers. This brings the total number of customers at year end to 2,347. Once again, no customer accounted for 10% or more of our revenue in the fourth quarter or for the full year.

Our GAAP gross profit margin was 77% for the quarter, about a half a point lower than the prior quarter and cash gross margin also dropped about a half a point to 84% in line with our expectations. GAAP operating expenses for the quarter were $70.7 million, up from $64.8 million in the prior quarter. These GAAP numbers include depreciation, amortization of intangible assets and equity-related compensation charges. Excluding these non-cash charges our cash operating expenses for the quarter were $53 million, up from $47.5 million in the prior quarter.

Adjusted EBITDA for the fourth quarter was $53 million, up 13% from the prior quarter and our adjusted EBITDA margin was 42%, consistent with the third quarter and up 5 points from the same period last year. Total depreciation and amortization for the fourth quarter was $11.8 million, up from $10.5 million in the third quarter. These charges include $8.3 million of network-related depreciation, $1.5 million of G&A depreciation and $2 million of amortization of intangible assets.

Net interest income for the fourth quarter was $4.6 million. Moving on to earnings, GAAP net income for the quarter was $20.6 million or $0.12 of earnings per diluted share. As a reminder, our GAAP net income includes non-cash charges for equity compensation related to the FAS 123(NYSE:R) and book tax charges at an effective annual rate of 42%. However, because of our significant deferred tax assets we expect to pay cash taxes on an annualized rate of about 2%.

During the fourth quarter, our equity related compensation expense was $14.9 million or $0.08 per share on a pretax basis. You can review the break down of our equity compensation charges by operating department in the supplemental metrics sheet posted on the Investor Relations section of our website. Additional non-cash items in GAAP net income for the quarter include $2 million from amortization of intangible assets and a $9.9 million non-cash tax charge.

Excluding these non-cash items, our normalized net income for the quarter was $47.5 million, up 14% over last quarter and 82% higher than our normalized net income for the same period last year. In the fourth quarter we earned $0.27 per diluted share on a normalized basis, that's a penny better than our expectations as higher than expected revenue in the period helped the bottomline. Our normalized diluted earnings per share for the fourth quarter is based on a normalized weighted average diluted share count of 181.3 million shares.

With these fourth quarter results we finished the year at $428.7 million in revenue, an increase of 51% over 2005. For the year, revenue from international accounts increased to 22% of total revenue, and reseller accounted for 20% of total revenue. Full year GAAP gross margin came in at 78%, 2 points lower than 2005 levels. Cash gross margin was 85%, 1 point lower than the prior year. Full year GAAP operating expenses were $251.5 million including depreciation, amortization of intangible assets and equity-related compensation charges totaling $61.1 million. You can see the full breakdown posted in the press release.

Excluding these non-cash charges, operating expenses for the quarter for the full year were $190.4 million. Our full year adjusted EBITDA margin was 40%, up 4 points from our 2005 margin level. GAAP net income was $57.4 million or $0.34 of earnings per diluted share for 2006. I should also mention to avoid confusion for year-over-year comparisons that our 2005 GAAP earnings included a one time benefit of $1.65 per share for the release of our tax valuation allowance.

Excluding non-cash items, our normalized net income for the year totaled $154.5 million or $0.88 of earnings per diluted share, that's a 94% increase over last year's normalized net income and a 69% increase over last year's normalized earnings per share. For the full year of 2006, we had 179.5 million normalized weighted average diluted shares outstanding.

Now let me review some balance sheet items. We ended the year with $434.5 million of cash, cash equivalents and marketable securities, up from $314.1 million at the end of 2005. For the full year, our cash from operations was $132 million or 31% of revenue, up significantly from $82.8 million in 2005.

During the quarter, we generated $22.6 million of cash from operations. That's down from the third quarter, due to timing impacts on operating cash items. These include an extra payroll period in the fourth quarter, our semi-annual interest payment on our 1% convertible bond and some working capital changes such as an increase in receivables after a strong fourth quarter and the Nine Systems acquisition. Capital expenditures excluding equity compensation totaled $69.3 million in 2006 or 16% of annual revenue in line with our expectations.

For the fourth quarter, we invested $22.5 million in capital expenditures. Days sales outstanding for the quarter were 56 days, up 2 days from Q3 levels as we picked up all of Nine Systems receivables but only about a half a month of their revenue.

Overall, 2006 was a year of impressive growth for Akamai, both on the top and bottomline. Demand from existing customers contributed significantly to ARPU growth, helping us drive impressive topline expansion and as we grew revenue we delivered on operational efficiencies that drove strong bottomline performance. With these results, we are entering 2007 with a lot of momentum and optimism about the year.

Additionally, we completed the acquisitions of Nine Systems in mid-December and we anticipate closing the recently announced Netli acquisition in late March. As I mentioned, the Nine Systems business adds a run rate of about $15 million to our topline. We expect the annual run rate from Netli to be about the same, although we will only realize about nine months worth of benefit in 2007, assuming we complete the acquisition within the expected timeframe. The combination of these two acquisitions should add about $25 million to $30 million to our topline in 2007.

With that said, as you'll recall, we provided you with some early thoughts on 2007 during our October call. At that time we expected revenue growth of roughly 32% to 36% and normalized net income growth of at least 40%. We now expect revenue to grow to $610 million to $625 million for the year, which translates into a range of 42% to 46% revenue growth year-over-year. That's a $50 million increase to our previous guidance.

For the full year, we now expect normalized earnings per diluted share of $1.26 to $1.30 or roughly 43% to 48% earnings per share growth. This EPS range implies normalized net income growth of more than 50% year-over-year. As for our margins, we anticipate the same directional trends that we've seen in 2006.

We expect our gross margins to decline as network depreciation costs increase and as we sign larger deals with related volume discount. However, we expect to offset any gross margin declines with continued operating efficiencies and scalability. Specifically, we anticipate the GAAP gross margins will come down about three points, but that adjusted EBITDA margins will improve by about four points for the full year.

Near term for the first quarter of this year, we're expecting revenue to be in the range of $136 million to $140 million. At the midpoint that represents about 10% growth quarter-over-quarter and a 52% increase year-over-year. And we're expecting normalized earnings per diluted share of $0.28 in the first quarter. That's a 65% increase year-over-year.

As we've seen in the past, our operating expenses are generally higher than normal in the first quarter of the year as a percentage of revenue due to our global sales meeting and the reset of our FICA payroll taxes. Additionally, we'll be absorbing a full quarter's impact of the incremental shares from the Nine Systems transaction.

Overall, while we expect Nine Systems to be accretive to normalized earnings for the full year, it will not materially impact EPS in the first quarter. Again, as a reminder, we expect the Netli transaction to close in late March and be immaterial to our first quarter results.

As for capital expenditures, on a full year basis we expect CapEx to remain roughly consistent with 2006 levels as a percentage of annual revenue or about 16%, excluding equity, capitalized equity compensation. Similar to last year, we're planning to frontload our network investments to take advantage of volume purchase opportunities and continue to optimize our network.

As for non cash items, we expect equity compensation charges to be around $0.35 on a full year pretax basis and we're anticipating a book tax rate in the range of 41% to 43% in 2007. As for amortization of intangible assets, we won't be able to forecast the number for Netli until the transaction closes. But excluding Netli, we expect amortization of intangible assets to be approximately $10.7 million, including $3.3 million related to the Nine Systems acquisition.

Overall, we're extremely pleased with our fourth quarter and full year 2006 results. Our momentum coming out of the year has given us the confidence to raise revenue and earnings guidance for 2007 which we expect to be another record year for Akamai.

Now let me turn the call back over to Paul.

Paul Sagan

Thanks, JD. As you've just heard, 2006 was a banner year here at Akamai. Increased demand for our services resulted in revenue growth of more than 50% over 2005, with very strong performance across all of our important verticals. Media and entertainment led the way with a surge in the consumption of digital online content as end users listened to more songs and watched more video. And much of this was supported by a flood of rich media advertising to the web.

The rapid expansion of user-generated content was another exciting development on the web last year. And Akamai's advanced capabilities proved to be of enormous value to many sites that have pioneered social networking. As the social networking space evolved from fringe to mainstream and these sites began to focus on monetizing their traffic, seven of the top 10 user generated content sites turned to Akamai in 2006 for fast, reliable and secure content delivery. I'm very pleased to be able to announce today that we recently expanded our relationship with MySpace, the largest social networking site on the web.

Also late last year the acquisition of Nine Systems brought us a great set of client relationships including the NBA, the NHL and Anheuser-Busch among others. We also acquired a great group of skilled employees. And the deal helped to accelerate our development of rich media tools that many of our media and entertainment customers can use to better manage their broadband content. For example, Nine Systems syndication tools will allow our customer to distribute their content across the web while maintaining control over when and where it's viewed and which ads appear with it.

Software distribution also remained a very strong contributor to our business in 2006 as software publishers look more and more to online models for their products. We saw rapid growth in Internet-based distribution of applications and operating systems software as well as online game software. This past December we were pleased to announce new relationships with two of the leading innovators in the gaming industry, notably, Sony for the PlayStation Network and Nintendo, for the Wii Virtual Console.

We're also very excited about our relationship with Adobe, which has grown much stronger recently. We have expanded are commitment to further support flash with our engineers working closely with Adobe's developers. At the same time, Adobe is now standardizing on our global network for distribution of Adobe software products, and I believe we will find even more ways to collaborate going forward.

In the eCommerce sector we continue to experience strong demand for Akamai services. ComScore noted that online holiday shopping was up 26% over last year and Akamai certainly benefited from that trend.

In addition to the impressive growth we experienced in our content delivery business last year, we continued to gain traction with our Web Application Acceleration solutions. We now have more than 125 enterprises using these services, including more than 50 customers who signed on in just the past six months.

And now with our pending acquisition of Netli, we expect to increase our pace of innovation and sales in this evolving area, one that Gardner estimates is a market -- is part of a market that will grow to over $3 billion in three years. So as we look forward to 2007, we're very excited about developments in both the content delivery and application performance services market. This is in part because the underlying secular trends that drive demand for our services remain very strong.

Broadband proliferation is the most important driver of our expanding opportunities and Forester estimates the total number of US households with broadband will grow 42% by 2010. And PWC believes global broadband adoption will increase by 86% over the same period. At the same time, the size of the pipes going into many homes worldwide will continue to expand. So we don't believe consumer appetite for rich media content and robust eCommerce will level off any time soon.

We expect this trend will continue to drive demand for the online content and critical applications that our customers rely on us to deliver and accelerate over the Internet. More and more businesses will be competing for audience attention online. And we believe these enterprises will increasingly value performance, reliability, scalability and security, the hallmarks of Akamai services.

At the same time, we're not standing still. Our success in handling Web 2.0 social networking sites as well as accelerating complex, mission critical Internet applications demonstrates our continued commitment to provide leading edge solutions. Solutions that we believe are unmatched by any other service provider.

Some of our new services come from internal developments in Akamai labs and we will continue to invest in R&D and measure the results against our sales expectations. We will also pursue strategic acquisitions where we believe we can improve our time to market with solutions our customers need now.

That's why we acquired Nine Systems late last year. With that deal we significantly increased the number of tools we can offer our media customer to help them to better monetize their digital assets. And with our Netli announcement, we expect to be able to add to our Application Acceleration solution, helping enterprises accelerate critical business processes over the Internet with a service rather than expensive hardware.

So we believe we are heading into 2007 with a strong wind at our back in all of our important verticals, digital media, online commerce, software distribution. This momentum should drive market demand for both more complex content delivery as well as application performance services.

I believe this is the most exciting time to be in our business, especially with the assets that Akamai brings to the market.

Now JD and I will be pleased to take you questions. Operator, the first question, please.

Question-and-Answer-Session

Operator

[Operator Instructions].

Your first question comes from Harry Blount with Lehman Brothers.

Harry Blount - Lehman Brothers

Hey, guys, just --

Paul Sagan

Hi, Harry.

Harry Blount - Lehman Brothers

How are you doing?

Paul Sagan

Good.

Harry Blount - Lehman Brothers

Just wanted to talk a little bit more on the ARPU side of the equation. You saw another strong sequential quarter on the ARPU improvement. I was wondering if perhaps you could give us a little bit more characterization as to where that growth is coming from.

In the past you said it's been pretty much across the board in across multiple products. So just wanted to get a sense if that was still the case this quarter and what your thoughts are as you look out over the next 12 months as far as you can see?

JD Sherman

Yes. Sure, Harry. This is JD. So we've been seeing about 7% ARPU growth over the last couple of quarters, peaked up to 8% this quarter. It's probably a little bit helped by the holiday bursting. We did, you know, as expected, see some holiday bursting.

But in general, we are really pleased to see that across all of our segments. We saw the same kind of momentum that we've seen over the past few quarters. And I think it really kind of validates what we've been seeing in terms of our success in driving revenue growth in our strong existing customer base. So same trends we've seen over the last couple of quarters I would say.

Harry Blount - Lehman Brothers

Great. Thank you.

JD Sherman

Thank you. Operator?

Operator

Your next question comes from Katherine Egbert with Jefferies.

Katherine Egbert - Jefferies

Hi. Good afternoon. Just a quick --.

Paul Sagan

Hi.

Katherine Egbert - Jefferies

Hi. Just a quick clarification on the guidance. Does the 610 to 625 range include the 25 to 30 million from Nine systems and Netli?

Paul Sagan

Yes, it does. So we took the guidance up about 50 million from our last call, including 25 to 30 million from our acquisitions.

Katherine Egbert - Jefferies

Okay. And then similar question on the EPS line. I know you said Nine was accretive for the year. Does that $1.26 to $1.30 include the accretion from Nine Systems?

Paul Sagan

Yes, it does.

Katherine Egbert - Jefferies

Okay. Great. And then, Paul, you know, you mentioned that you're nearly $0.5 billion in revenue now. And you had said last September that your growth of 25% to 35% will get you to $1 billion. I mean, can you give us an update on that? I mean it seems like you're tracking to the higher end of that range now.

Paul Sagan

Well, we certainly -- you know, we were 50%, over 50% last year. So my goal is to get there this decade, and we're getting there faster. We've given you guidance from the year, which is substantially ahead of the model that we talked about.

And really what we said was we saw expanding opportunity in the market. We thought we could capture a lot of that. But if the secular trends continue to be very strong in dollars, we could do better.

And that's a lot of what we saw last year and think we'll keep seeing this year, which is just the growth of broadband, the growth of digital media, the growth of advertising, the growth of B-to-B. Frankly, we've been as surprised by the growth of the application space in the second half of the year as we were about the media space.

There is just a flood of activity of businesses to the Internet, whether it's B-to-consumer or B-to-business. And what we see is that as they really start to measure their business and they start to understand the levers that drive their profitability and growth, whether they're selling something, promoting something, entertaining you or informing you, or dealing with a partner, they fought to quality.

And I think we saw that with the kinds of customers we continue to pick up, the kinds of relationships that we continued to expand that when they really get serious, they focus on the quality and the differentiation that we can provide and that's where we put our investment into, making sure that we continue to innovate in the space.

Katherine Egbert - Jefferies

Okay. And then just quickly on Netli, do you expect to increase capital expenditures to build out their network? And then secondly, do you think Netli will be accretive to ARPU or the ASP is a little bit lower?

Paul Sagan

We expect not to have to add CapEx to build out their network. Our integration goal -- and obviously we have to close the deal and finish the integration planning today. We're still two separate competitors, but our initial read from due diligence is that we will try to transfer over their protocol onto our platform for scale.

We think that there is a lot of similarity in the architecture and that we can move their protocol and capability and accelerate what we do even more for our customers and merge their customers onto our network over the right kind of interval, so there won't be an incremental cost.

It will drive incremental revenue, which we talked about in the guidance. Our view is that for the partial year this year, it will be neutral to earnings. And the guidance we gave you on EPS reflects that. And we think that it will be accretive next year and help drive profit growth in the second year of that.

And we've seen very strong ARPU in the app-acceleration space. You know, we don't break out ARPU by product line, but we think that that's both a strong initial sale, very profitable and a very resilient relationship, because we're getting embedded in mission critical processes.

So we're very, very bullish on the app space. And frankly, that was why as we got to know Netli, we were so enthusiastic. We're really the two companies that understand that a lot of application performance problems is at the network layer across the Internet. It's not in the data center.

And we're the two that had a service model approach that we think is very different than what people had really had the only choice to look at before the last year or so, as we and Netli really got our offers into the market, and we're starting to explain them.

So we're very excited about the market opportunity and our ability to put best of breed together, not just in technology and early customers, but the personnel on both sides. We had a lot of open positions this year to expand in that space. We're going to fill them with Netli personnel. We've met them. We think they're terrific, and they're really going to accelerate, I think, our ability to grow in that market.

Katherine Egbert - Jefferies

Okay. Thanks, Paul. Congratulations.

Paul Sagan

Thanks you.

Operator

Your next question comes from Aaron Kessler with Piper Jaffray.

Aaron Kessler - Piper Jaffray

Hi, guys. Good quarter and a couple quick questions. First, any chance you can give us an update in terms of revenue by vertical like you gave us at the analyst day and what kind of the Q4 growth rates were?

Also, what change in terms of the organic growth rates -- it seems like the new growth is about 35% to 39% versus 32% to 36% before. Just more visibility into the year. And then on -- finally on the acquisitions, any sense you can give us an ARPU for Nine and Netli? Thank you.

Paul Sagan

Well, let's see. I'll work up from the bottom, because that was in many ways similar to Katherine's question on ARPU. We don't break them out by product line. We think both companies were doing a terrific job of selling in the market and selling value. And we think we'll transition that right into Akamai.

We've seen organic acceleration, organic growth all last year. I think that's both the quality of what we offer the market and frankly just the acceleration of commerce on the Internet. And we've, you know, seen that in the fourth quarter and expect to continue that this year. That's built into the guidance.

We're not going to break out revenue by vertical on a quarterly basis. We did it at the analyst summit to give people a real idea. Clearly, the growth in the media and entertainment space is continuing unabated so far, and that's a very significant contributor.

But the growth in software distribution frankly surprised us in Q4. We expected strong growth in e-commerce, and it didn't disappoint us. And I couldn't be more pleased by the quarter-over-quarter performance in the app-acceleration space sequentially through the year and frankly, even already seeing what we're doing in the early part of this year.

Aaron Kessler - Piper Jaffray

So -- and do you have a customer count? Maybe that would help us for Netli.

JD Sherman

We don't have a customer count yet for Netli. I would just say, you know, based on the customer count we gave you and the run rate for Nine Systems, that one will be slightly dilutive to our overall ARPU. And Netli is likely to be as well, but not substantially.

Paul Sagan

They're newer customers. They always tend to start smaller --

Aaron Kessler - Piper Jaffray

Right.

Paul Sagan

--and grow larger. And those were companies who are at an early stage of selling advanced services, earlier than we are.

Aaron Kessler - Piper Jaffray

Great. Thank you.

Operator

Your next question comes from Tom Watts with Cowen & Company.

Tom Watts - Cowen & Company

Hi. Congratulations on the quarter.

Paul Sagan

Thanks, Tom.

Tom Watts - Cowen & Company

You had mentioned that the deals are going to be accretive for this year. That's after the synergies and taking out some of the cost of those businesses. Would Netli and Nine Systems profitable in '06?

Paul Sagan

Well, just to be clear, we said that Nine systems would be accretive this year in the calendar year and we said that Netli would be neutral this year because we only have partial year. And obviously upfront you don't get the synergies. You get them as the year goes on.

Tom Watts - Cowen & Company

Okay. And then were they profitable in '06 or did it take the synergies to get them there.

Paul Sagan

I don't think we ought to comment on their past business. What matters to us is how they fold into Akamai.

Tom Watts - Cowen & Company

Sure. Also, some of your competitors certainly talked about pricing at a discount to some of your pricing. Could you just comment a little bit on the competitive dynamic, clearly, your ARPUs continuing very strong? What is the basis of competition typically and when they're coming in with a much lower price how does the rest of their bid differ?

Paul Sagan

I think we represent quality and differentiated service and we get paid a premium for a premium offer. When someone is serious about their online business and they really start to measure performance, download completion rates, speed of delivery, reliability, scalability for large crowds or peaks, security against attacks, etcetera, etcetera.

And customers really get under the covers of how or technology is different, we're selling on value. Certainly, there are people who show up and say, "Well, maybe, I'm not as good but I'm a whole lot cheaper." I think people at the end say, "I think I got what I paid for. And if that really matters to my business it's time to make a change." And often we see that.

Fundamentally, the competitive dynamic I don't think has changed much for years. We've sold first against do it yourself. Well, just people say, "Hey, you know, this is just another application, this Internet. Why should I trust you? Can't I do this, okay?" We have to demonstrate our value that we'll add value to their business and do it at lower cost.

And then we compete with outside providers, either full managed service providers or point solution players. And we think we've always done very well in those comparisons because the Akamai architecture and technology is different.

Our deployment is at the edge for capacity, scalability, reliability and frankly security, we think are pronounced in the marketplace. And as there frankly are more and more people who might raise their hand, and say, "We were in CBN too." I think it's easier for companies to look and say, "Wait a minute, you guys are all on one side," and Akamai offers something that's a differentiated technology. And I'm really interested in that and we sell value at that point.

Tom Watts - Cowen & Company

Okay. And just a final question, in terms of, Microsoft's Vista distribution, have they made a decision on how they're going to do that?

Paul Sagan

Well, Microsoft is doing both online and hard copy distribution. Obviously, it's being shipped in new PCs. They do updates online. So I think you should ask them obviously how that's going. I shouldn't speak for them.

We have a great relationship that's as old as Akamai. We've made some statements in the past about supporting vista. I don't think it's appropriate for us to give a quarterly update on what they're doing.

Tom Watts - Cowen & Company

Good. Thanks very much.

Paul Sagan

Thank you.

Operator

Your next question comes from Rod Ratliff with Stanford.

Rod Ratliff - Stanford

Hi, guys. Excellent quarter.

Paul Sagan

Hi, Rod. Thank you.

Rod Ratliff - Stanford

Paul, Akamai sell space, competitively so far how do you feel you're doing against the box vendors. Because I mean, since you're acquiring Netli, those are basically the only two network applications in the space.

Paul Sagan

You know, I think it's pretty interesting, Rod, because from my knowledge and experience, we don't go in and -- we're not in a shoot out.

Rod Ratliff - Stanford

Got it.

Paul Sagan

I got this RSP, I got three boxes, I got your service, tastes great, less filling, let's try to decide. What we often find is they're pulling their hair out because they got a backend application. They may have done it on a private network. Maybe, it was the backend that their people used in a call center, a fax order system or something.

Then some smart person said let's put this on the web, right. Let's get rid of the call center, get rid of the fax center. This Internet thing, it's great. And then they go to all that trouble. They go to their partners and say, "Okay, don't call any more, use the portal."

And it just stinks. They're scratching their head. They are tuning their hardware. They may buy more appliances. And then frankly they find us somehow. Part of it's, you know, we've worked on our marketing over the last year. A year and-a-half ago nobody thought of us in this space.

And they had a discussion with us and it's often, "well, you're that Internet content delivery company. So why is this relevant?" Not too far into the conversation there's that, "I could have had a V8 moment," where they say, "I get it. It's about network layer performance." And we are highly differentiated there.

So we're not against them tuning their data center. You've got to do that. And you've got to make the data center piece work really very well. And you got to have the database piece running really well. But if you're going say your partners or your customers or your prospects or your remote employees, "Access this application over the Internet."

The data that Internet take over and we believe that unless you use the kind of service that we have the control QoS on the Internet, you're really at the mercy of Internet performance. And you could get lucky that all your users are across the street and it works. But if they're across the country or across the world or frankly even sometimes across the street, they just can't reach your site or your application grinds to a halt.

So we actually think that we've got a really great Greenfield opportunity because there's a lot of money being sent on apps and apps performance. There's a lot of pain in the market and we think that we particularly in combination with Netli's people and their technology, just have a completely different approach.

It's in many ways like what we did with CDN early on, which was to come forward and say, "You can keep piling hardware in the data center but you are not going to solve the problem." You bits may not get out the door of the data center they're going to hit congestion points across the Internet. We've got a service solution and you can just sleep at night knowing that we're going to solve those problems wherever they crop up and we think we can do the same for app acceleration.

Rod Ratliff - Stanford

One more market question for you, Paul. And then I've got a quick cost question for JD. You mentioned the strength in e-commerce and software downloads. It was -- talk to me a second about the e-commerce market.

Are you just -- is this simply another step in the growth of the market being pulled through by the proliferation of faster and faster pipes going into homes, do you think?

Paul Sagan

Well, I certainly think that's a driver because it's just easier to do these kinds of things on a broadband connection. You don't want to do a lot of shopping on dial-up if you can help it. But I think also, businesses are getting better and better about how to promote online, how to find buyers, how to fulfill them, how to have a good experience that's as good or better than going to the store for certain kinds of products.

And these businesses as the online commerce piece grows are measuring performance more, understanding that conversion rates are critical, abandoned rates are critical, fine tuning of your website, improving a few basis points can mean millions and millions of dollars if you're selling enough. And I think that's helping to pull us through in that area.

Rod Ratliff - Stanford

Do you think that the robust online advertising is helping out there as well?

Paul Sagan

Well, I think that that's helping not on the commerce side. Well, it may be attracting more people to commerce sites. The robust online advertising is clearly helping to make the business model work for content sites not for commerce sites. But I think the more robust advertising is probably driving more people to commerce sites for sure.

Rod Ratliff - Stanford

Thanks. One last one for JD. Good cost management in the quarter. Do you think that was just a function of the revenue growth and the scale/leverage against fixed costs?

JD Sherman

I think we've seen that over the past several quarters that as we grow, we've been able to achieve that scalability. And I think we'll continue to do that into 2007 as we reflect in our guidance. I do as I said believe that as we invest in the network and as we sign these larger deals, you'll see a bit of a decline on our gross profit margins. But we're very confident we'll be able to leverage that growth into better bottom line margins.

Rod Ratliff - Stanford

Thanks, guys. Congratulations again.

Paul Sagan

Thank you.

Operator

Your next question comes from Tim Klasell with Thomas Weisel Partners.

Paul Sagan

Hi, Tim.

Tim Klasell - Thomas Weisel Partners

Hi, guys. Congratulations on the queue. How often did Akamai and Netli bump into each other? I know you had different solutions but you were, sort of, competing against wallets here. How often did you bump into each other out on the field?

Paul Sagan

Sometimes. Not on every deal for sure. You know that's a really new space. There are just so many opportunities. And so I think often we were chasing completely different market opportunities and evangelizing in different places.

I think that's one of the exciting things about bringing the two marketing teams together to figure out what really works. How do you find the best prospects and the people who have a pain problem now that can you go in and solve. So I think the opportunity to not just take the technology but their marketing expertise and their field expertise and marry it to ours.

Because we have had a team working on this for more than a year as well and doing increasingly well every quarter. I think it's a great opportunity and it wasn't a situation of a small market where there were a few opportunities and we were both in each one and everyone together.

Tim Klasell - Thomas Weisel Partners

Okay. Have you ever seen customers use both of yours and Netli's technologies and what are the results been, if so?

Paul Sagan

You can't really combine them because you're running on separate networks. There certainly are probable big companies who may have had contracts in different divisions and used us differently, maybe even left-hand, right-hand not even knowing what they were doing, not necessarily conscious effort. But you couldn't use them in combination. We're going to have to do that and bring them together for a better offer.

Tim Klasell - Thomas Weisel Partners

Okay. Very good. And then finally, on the bursting side, I know we're only about halfway through the quarter but we had the Super Bowl, the Vista launch and a few others. Can you give us a color if there's been any change in the 30% you would normally expect in any given quarter for bursting on this quarter?

Paul Sagan

That's pretty consistent. It's been consistent for years. The Super Bowl is a few hour event. That's not going to drive huge change, particularly on the scale of our business today. And that bursting versus fixed number is pretty steady.

JD Sherman

We saw in the fourth quarter as we always do a bit of an upside there because of the more sustained bursting around holiday online shopping traffic. But I think we're seeing the same fundamental trends that we've seen overall, which is a -- we have 2,000 customers, we sign them up, they start to burst. They come to a renewal cycle. We raise the level of commitment and volume and revenue for them. And over 2,000 customers that kind of sustains the roughly 70/30 ratio that we've seen.

Tim Klasell - Thomas Weisel Partners

Okay. And then one final question, as you begin to work more-and-more with the web 2.0 customers, are you seeing any change in the price sensitivity of those guys relative to your -- let's say your more traditional customers.

Paul Sagan

No. I think that's -- its kind of a misnomer that this kind of a cluster of web 2.0 companies. Web 2.0 technology, like Ajax, etc. is being incorporated by sites across the board. I think what we do see is that as sort of new models like social networking goes from hey this is interesting to I've got a business, they get more-and-more serious about measuring things like conversions, abandonment rates and reliability and then they understand that our differentiated service is worth what we charge.

And so we certainly see more of them coming and more of them coming with real business models. But I think you can't lump all web 2.0 technology into one pile and say it's one thing.

Tim Klasell - Thomas Weisel Partners

Okay. So they're maturing just like any other industry?

Paul Sagan

Yes. And on the Internet you mature fast.

Tim Klasell - Thomas Weisel Partners

Very good. Thanks.

Operator

Your next question comes from Todd Raker with Deutsche Bank.

Paul Sagan

Hi, Todd.

Todd Raker - Deutsche Bank

Hi, guys. Nice quarter.

Paul Sagan

Thank you.

Todd Raker - Deutsche Bank

One I was hopefully to give insight in terms of what you're seeing in terms of unit growth versus the pricing impact.

JD Sherman

Well, just talking about the how much -- what volume is doing in terms of--

Todd Raker - Deutsche Bank

Exactly. What's negative growth doing versus --

JD Sherman

So we don't generally break that out. I would say we're seeing kind of the similar trends of a really strong traffic growth and that's driving bigger deals for us and we're very happy to get very aggressive on pricing on the big deals and we leverage those on the bottomline.

And that's what we have talked about that's driven a point or two of gross profit margin but I don't see any major shift in direction on the traffic or the pricing in the quarter.

Todd Raker - Deutsche Bank

As a follow-up, we heard some limited data points in bandwidth pricing that's starting to firm up a little bit. Do you see that, if so does it have any impact in terms of how you guys think of pricing?

Paul Sagan

I've been saying for a year that's network wishful thinking out there. That's tier one providers and backbone thing. If I say it enough times, it's going to hold true. I think we've done a great job of continuing to drive cost out of our business and the fundamental network realities are kind of out there.

Todd Raker - Deutsche Bank

Okay. And last question for you, if you look at CapEx, it's 16% of revenue is your guidance for this year. That's not showing any leverage over what you just did here in '06. Historically, you guys have said you're investing ahead of growth.

Can you give us a sense for what you think the long-term model might look like? And especially the acquisition of Netli, 16%, almost looks like CapEx is stepping up even greater this year than last year. Can you explain that for me?

Paul Sagan

Well, I don't think it's stepping up from last year. Netli shouldn't add to the CapEx demand because we are going to do that business over our network and combine them as we have with other businesses.

I think the really strong thing that we see is that just the pace of growth on the Internet keeps surprising us and we are ahead of what we thought of as the long-term model of 10% to 12% by only a few points, yet we're still growing the revenue much, much faster and the business and we continue to be very encouraged about what we see.

One of the points that we've made that I think is very important for people to keep in mind is that we're not making a five year, billion dollar bet on a plant and by the time it's done maybe we bet wrong. We're mostly deploying more servers or replacement servers or increased storage.

If we wind up getting ahead of ourselves a little bit we take our foot off the gas and grow into that capacity over the next quarter of two. I don't want to be wrong on the other side and turn business away because we weren't ready for it. I think it's wise investment and if we saw (inaudible).

Abnormal growth curve of a more mature industry I think we've move back to a more normalized model. But when you are growing over 50% and your seeing the kind of broadband event driving just incredible levels of traffic of wide streaming, boarding events, news, massive software distribution, huge online music and news, massive software distribution, huge online music and movie events, etcetera, it's worth our making that investment to make sure that we can say to our customers who are a who's who of media companies, software companies and enterprises, we want their business and we're ready for it.

Todd Raker - Deutsche Bank

Okay. And just one clarification. In terms of Netli, you're going to take their physical network infrastructure and just combine it with yours; correct?

Paul Sagan

We're going to take their technology, their protocol and incorporate it into our server technology. But we have a much larger, much more distributed network that they may have a few that make sense. We'll look at that. We look to get a little bit closer to close to do that.

We are separate companies. But they have a much smaller foot print. Our scale and the number of places we our ability to route intelligently around more and more congestion and to provide optimal performance. Try to reuse that hardware in our network but it wouldn't be that we would be adding it on top as an incremental capital expense. Understood.

Todd Raker - Deutsche Bank

Okay. Thanks, guys.

Operator

Your next question comes from Brent Bracelin with Pacific Crest Securities.

Brent Bracelin - Pacific Crest Securities

Thank you. Most of my questions have been answered. But Paul, could you walk us through the logic. I mean, you've made two acquisitions now in the span of two or three months here. What does that say about the state of the industry, maybe about the competitiveness of the industry, are these acquisitions kind of a grab for patents?

Does it better position with you to meet customer demand or is this somewhat of offensive move relative to the competition, just kind of frame the logic of the acquisitions here for us and frame it as relative to the industry.

Paul Sagan

I think what it says is about -- I think what it says is it validates -- could you mute on the back end. I'm getting a back echo now.

Brent Bracelin - Pacific Crest Securities

Okay.

Paul Sagan

I think what it says is -- somewhere there's an echo. I think what it validates is all along this was a company that could innovate but wasn't married to just what we invented and that we would look at what was out there and when we found things that we thought could speed our deployment of services that would benefit our customers we would buy instead of build.

At the same time we continue to make significant investments in R&D. We never backed off R&D in Akamai. In the case of these two acquisitions we saw two interesting companies that had a service model that had customers that we thought would benefit from a combination and had technology or developments that we also thought would be extremely beneficial to our offer and speed up our ability to bring out new offers rather than building it ourselves.

Many of the things that they were doing were on our road map one way or the other, maybe certainly not identical, but similar idea. It just speeds that up, and so in this case especially when we can do it immediately accretive or accretive very quickly, to me that makes all the sense in the world.

With one caveat, doing acquisitions is tough. We probably all read the same literature. The vast majority of M&A failed. And I think that people don't do their homework. They aren't disciplined buyers and they don't really understand, whether the company they're buying has a compatible culture and business model. So we work really hard to find the companies that we really think can fit together.

And then we integrate functionally. So the employees from the acquired company fit in and find a spot inside Akamai very quickly and then their data of seniority becomes the Akamai seniority date. They become Akamai people and we Akamai them really quickly and you know put arm around them and make them feel part of the place and let them contribute to the overall success.

So we go into these, knowing that acquisitions usually don't work. So we have to work really hard to make them work. We were thrilled with how successful the Speedera acquisition was. All indications so far is that, nine systems is going to be really successful as well. We have some time now as one company. And our pre close interactions with the Netli team are positive in a similar way.

So you know, I think we've got a great streak going here. Does it mean we'll find another one? We might. We might not. We don't have a quota in that category and we just work really hard to find things that we think will benefit our customers more quickly.

Operator

Your next question comes from Robert Stimson with WR Hambrecht.

Robert Stimson - WR Hambrecht

Yes. Hi, Paul. Hi, JD. How are you?

Paul Sagan

Good.

Robert Stimson - WR Hambrecht

Hey good quarter. Couple quick questions for you. You did make a comment, earlier maybe it's because of acquisitions on the direct versus indirect. Is Internet doing what it was always doing with you guys, in terms of what's happening in that area? I guess is my first question. Then I have a quick follow-up.

Paul Sagan

So the Internet relationship as you probably know is being wound down, so we're in the process of winding down the Internap reseller relationship. We still have a very strong reseller program. We're really pleased with how that's going. But Internap won't be a reseller in the future.

JD Sherman

And that's not going to have any material impact, on our business at all. Frankly, I think the fact that resellers overall as a percentage, trended down a little bit had nothing to do with or very little to do with that.

It really had to do with so much strong organic growth in our direct customers, who know us so well and really know how to leverage the platform is really a case of -- not that channel didn't keep up. It's just the organic business and the direct relationships and our ability to up-sell there, I think we really tuned that well and just very, very strong.

Robert Stimson - WR Hambrecht

Yes. Great. And then you guys made the comment on MySpace.com, I think that was a great comment. So you renewed that contract. Was there a portion of revenue that came out of VitalStream that was converted over in the December quarter from that acquisition?

Because isn't that one of the reasons that Internap bought them and they basically brought the business over to Akamai? If was there a chunk of business?

Paul Sagan

Bob, there call's on March 1st. You probably ought to ask them. I can't really comment on loses in there business or whatever is there.

Robert Stimson - WR Hambrecht

Okay. Okay, all right, great. Well, thank you very much.

Paul Sagan

Okay. Thanks.

Operator

Your next question comes from Steven Freitas with BMO Capital Markets.

Paul Sagan

Thanks. We'll take about two more and then let everybody go off to the next call.

Steven Freitas - BMO Capital Markets

Hi. Good afternoon.

Paul Sagan

Hi, Steve.

Steven Freitas - BMO Capital Markets

Just regarding Netli again, I'm just wondering how they price? Is it on an application basis or is there a user type of pricing, can you just talk about that a little bit?

Paul Sagan

Well, again, they're a separate company today. I can't speak to their business model. I don't think that will be appropriate. I can talk about how we see the application acceleration business working as a service from our end. And that would be our expectation is who would be taking the best of both, but sticking to our model.

It's primarily selling on an application bases for enterprise. It gives us the opportunity to sell more applications into a given customer. But not so much based on number of users. It's not sold on a desktop basis or a per seat basis as enterprise software would be. It's more sold of on an application basis and a usage model.

So again it's a service component very similar to our content delivery business with a guaranteed commitment from our customer. We generally see them signing longer deals then in the content space. Often 2 or more year deals are typical in the application space.

Steven Freitas - BMO Capital Markets

I'm just wondering if there's any technology elements from Netli that can be applied to your traditional CDN offering.

Paul Sagan

Well in the dynamic site area as opposed to just static content delivery. We use a lot of the same technology that we develop for our web application offer to do dynamic routing in the area of TCP optimization, persisting connections, pre-fetching, etc.

So the enhancements that we'll integrate from Netli into the application acceleration space will also be looking there to improve even further our dynamic content delivery capabilities at all. So you get kind of a two for one win there.

Steven Freitas - BMO Capital Markets

I guess, you know, given that you're not going to utilize their network to a large degree and they had a fairly small revenue base. Is the price paid for the acquisition is that really an acknowledgement of how useful or powerful their protocol optimization is that really where the source of value is you think in that acquisition?

Paul Sagan

I think the nice thing about the acquisition is it's a combination. We get great technology, rightly, we get great people and recruiting a team is very expensive and it speeds that up because they have added a lot of people and they have a great core team and it speeds up the R&D, and we've done it. It's something that we've said inside of this year. We'll be breakeven and will be accretive next year.

So I think it was a very fair price and very good for us and for the selling shareholders and I think the fact that they were interested in taking our equity speaks to the bullish outlook that both sides have about the future of this businesses, especially on a combined basis, so operator -- thank you. Operator, why don't we take one last question?

Operator

We have time for one final question. Your final question comes from Darren Aftahi with ThinkEquity Partners.

Darren Aftahi - ThinkEquity Partners

Hi, guys. Just couple of quick questions. First on the take down in gross margins for '07, does any of that have to do with the acceleration in Flash streaming that you guys were seeing?

Paul Sagan

No. I wouldn't associate any of it directly with that.

Darren Aftahi - ThinkEquity Partners

Okay. And then can you, kind of, talk to that point, what you're seeing as far as the streaming market in terms of format, Flash relative to other formats and then the second question would be 25 to 30 million of Netli and Nine systems, does that contemplate any sort of revenue synergy or is that clearly just, kind of, an organic projection.

Paul Sagan

So I think, streaming is a market that's really been taking off over the last couple of years. There's really two ways of delivering video there's pure streaming and then there's the download or progressive download. You know, I don't want to get too much into the geeky nuts and bolts of it. But there are two ways of delivering video or audio content. We've seen strong growth in both.

Customers pick one or the other depending on what their business model is. We see growth across format depending on an end-customer's needs they'll pick one format over another. We're pleased to be able to support really all of the best formats out there to work very closely with engineers that the company's developing this technology.

Because, frankly, I think we stress this as much or more than anyone else because of our scale and we're very encouraged about the growth that we expect because of broadband in the video and audio space.

Darren Aftahi - ThinkEquity Partners

Okay. And then on the revenue synergies from the two acquisitions, is the projection of 25 to 30, is that organic or is there any contemplation that could be the upside to that?

Paul Sagan

Well, I think that the run rate of those businesses coming in. We hope that when we add those customers and add the technology we'll both be able to up sell their customers and take some of their technologies and sell it into our customer base and fuel our organic growth going forward.

So I think, you know, our objective is to have those things be completely blended in as we integrate these two businesses. So what we have coming in is a solid run rate from these business that's, we think, in combination with Akamai can generate and help us generate our growth.

Sandy Smith

All right. Thank you everybody for calling. We appreciate it. We look forward to talking to you at another quarter about our next set of results. Bye-bye.

Operator

That concludes today Akamai's fourth quarter and full year 2006 earnings call. You may now disconnect.

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