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Akamai Technologies, Inc. (NASDAQ:AKAM)

Q2 2007 Earnings Call

July 25, 2007 4:30 pm ET

Executives

Sandy Smith - IR

Paul Sagan - President and CEO

J.D. Sherman - CFO

Analysts

Tim Klasell - Thomas Weisel Partners

Todd Raker - Deutsche Bank

Rod Ratliff - Stanford Group

Aaron Kessler - Piper Jaffray

Phil Winslow - Credit Suisse

Roberta - Lehman Brothers

John Walsh - Citigroup Research

Tom Watts - Cowen & Company

Colby Synesael - Merriman Curhan

Darren Aftahi - ThinkEquity

Jeff Van Rhee - Craig-Hallum Capital

Sameet Sinha - Kaufman Brother

Katherine Egbert - Jefferies & Co.

Michael - Friedman Billings Ramsey

Richard Keiser - Sanford Bernstein

Presentation

Operator

Good afternoon. My name is Laporsha and I will be your conference operator today. At this time, I would like to welcome everyone to the Akamai's Second Quarter 2007 Earnings Call. (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 discuss our second quarter 2007 financial results. Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer, and J.D. 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 from these forward-looking statements. 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 definitions of these non-GAAP terms and reconciliation to these non-GAAP terms to the most directly comparable GAAP financial measure under the news and publications portion of the investor relation section of our website.

Now let me turn the call over to Paul.

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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. Q2 was another quarter of double-digit sequential revenue growth for Akamai, as we delivered record revenue and normalized earnings.

Our consolidated results for the second quarter include revenue of $152.7 million, a 10% increase over the first quarter and a 52% increase over the second quarter of last year. Normalized net income of $55.4 million or $0.30 per diluted share a 9% sequential improvement and a 55% increase over normalized net income from the same period last year. Along with delivering our six straight quarter double-digit revenue growth, we continue to make good progress integrating our recent acquisitions and expanding customer relationships across the business.

In addition we are very pleased that Akamai has just added to the S&P 500. We believe that joining this index of leading global companies further validates the value of our service offerings, as well as the strength of the markets we serve.

I’ll be back in a few minutes to talk about some of the trends we’re seeing across the business. Now let me turn it over to J.D. to review our second quarter results in detail. J.D.?

J.D. Sherman

Thanks, Paul. As Paul just highlighted, we had a strong second quarter with revenue growing 10% sequentially to $152.7 million. And we again experienced healthy sequential growth in all of our core segments.

Media and entertainment continue to be our fastest growing segment with e-commerce and software distribution following close behind. During the second quarter, Akamai's international sales represented 23% of total revenue, one point higher than first quarter levels. Resellers represented 20% of total revenue consistent with the prior quarter.

As per overall customer additions in the second quarter, we added 74 net new customers, bringing our total customer count to 2,555. Our consolidated ARPU or Average Revenue Per Customer grew to $20,000 in the second quarter up 5% over our first quarter ARPU. Once again, no customer accounted for 10% or more of our revenue in the second quarter.

Our GAAP gross profit margin, which includes both depreciation and stock compensation, was 74% for the quarter or about a point lower than Q1, and cash gross margins were 83% consistent with last quarter.

GAAP operating expenses were $81.9 million in Q2 up from $77.6 million in the prior quarter. These GAAP numbers include depreciation, amortization of intangible asset, and stock-based compensation charges. Excluding these non-cash charges, our operating expenses for the quarter were $60.7 million, up from $57.1 million in the prior quarter.

Adjusted EBITDA for the second quarter was $65.6 million up 11% from the prior quarter, and our adjusted EBITDA margin was 43% up one point quarter-over-quarter, and up three point over the same period last year.

Total depreciation and amortization for the second quarter was $17.6 million up from $14.8 million in the first quarter. These charges include $12.7 million of network related depreciation, $2 million of G&A depreciation, and $2.9 million of amortization of intangible asset. Net interest income for the second quarter was $5.2 million.

Moving on to earnings, GAAP net income for the quarter was $21.6 million or $0.12 of earnings per diluted share. As a reminder, our GAAP net income includes non-cash charges for stock compensation related to FAS-123R and book tax charges at an effective annual rate of 39%. However, because of our significant deferred tax asset, we expect to pay cash taxes at an annualized rate of only about 2%.

During the second quarter, our stock-based compensation expense was $17.2 million or $0.09 per share on a pretax basis. A breakdown of our stock-based compensation charges by operating department is available on the supplemental metrics sheet posted in the investor relations section of our website.

Additional non-cash items, and GAAP net income for the quarter include $2.9 million for amortization of intangible asset, and $13.4 million non-cash tax charge. Excluding these non-cash items, our normalized net income for the second quarter was $55.4 million up 9% over last quarter, and 55% higher than our normalized net income for the same period last year.

In the second quarter, we earned $0.30 per diluted share on a normalized basis at the high end of our expectation range. Our normalized weighted average diluted share count for the second quarter was 187.4 million shares, including the first full quarter of the incremental shares from our Netli acquisition.

Now let me review some balance sheet items. Our cash generation continued to be very strong, and we reach more than $0.5 billion in cash, cash equivalents, and marketable securities. Cash from operations for the second quarter was $37.3 million and on a year-to-date basis we have generated $93.6 million. That's up 54% over the same period last year.

Capital expenditures excluding stock compensation totaled $29.7 million in the second quarter. Day sales outstanding for the quarter were 56 days, consistent with first quarter level.

Overall, we had another very strong quarter, growing revenue 10% sequentially and 52% year-over-year and delivering on our profit growth objectives, while also integrating our recent strategic acquisitions and continuing to invest for the future.

With our strong second quarter results, we are tracking to the high-end of our revenue guidance for the year. And we now expect revenue to be within in the range of 615 and $620 million or 43% to 46% annual growth. We also expect to deliver on our guidance for normalized EPS of $1.26 to $1.30 or 43% to 48% year-over-year growth, which translates into normalized net income growth of at least 51% for the year.

We concentrated our capital expenditures in the first half of the year investing about $60 million in the network, as our customers demand for capacity continue to grow. Excluding capitalized equity compensation, we expect our capital expenditures to be lower in the second half of the year, and in total, we now expect to spend just over a $100 million or between 16% and 17% of revenue.

On margins, we came in where we expected this quarter with cash gross margins consistence with Q1 level. However, with our increased CapEx investments, we expect to see the impact of increased depreciation cost on GAAP gross margin in the second half of the year.

For the full year, we now anticipate the GAAP gross margin will decline by about four point year-over-year, about half driven by depreciation and half by cash gross margin. But as we have said in the past, we expect to offset any gross margin declines with continued operating efficiencies and scalability. Specifically for the full year, we anticipate that adjusted EBITDA margins will improve by about four to five points.

We do expect to see some seasonality return to the business after an unusual summer last year, for content growth on the Internet overtook the normal seasonal trends we have seen in the past. As a result, we expect less revenue growth during Q3 and a stronger growth in Q4.

For the third quarter, we anticipate revenue in the range of 157 to $162 million. At the midpoint that range, that represents about 4 to 5% sequential growth and 43% year-over-year growth. We are expecting normalized earnings per diluted share for the third quarter in the range of 32 to $0.33, 2 to 3 pennies higher than the second quarter driven by normalized net income improvement of at least 8% sequentially and 44% year-over-year.

Overall, we are pleased with the progress we are making on the integration of our recent acquisition and we expect to reach the high-end of the growth expectations that we set for ourselves at the beginning of the year. We also see exciting opportunities for growth beyond 2007 and we are continuing to invest to capture those opportunity. We look forward to talking about some of these things that our analyst summit and webcast scheduled for later this quarter.

Now let me turn the call back over to Paul. Paul?

Paul Sagan

Thanks, J.D. As J.D. just detailed, Q2 was another strong for Akamai. Our content delivery and application acceleration business is performed very well for us. As we talked to our customers and learn more about their plans for their online businesses, we here request that a consistent across categories.

Copying and help us improve the performance of our business model. But customers more on our partners who help them drive revenue up and cost down. They want partners, who can provide high quality solutions that extremely reliable and flexible. And that is what we aim to deliver across market is diverse as media and entertainment, online commerce, high-tech gaming, business-to-business applications in the public sector. That’s why we believe it so important for us to continue to invest in our services.

We believe a hallmark of our success has been ongoing research and development and a commitment to innovation. This commitment allows us to keep up with our customers as their online business challenge is evolved. So we can provide them with high quality and new solutions.

Let me give you several examples. Some of our advanced services help our customer's businesses.

One of the capabilities we recently added to our suite of service is Stream OS, the rich media management solution we acquired with Nine Systems. One of our clients, a major sports league in the U.S. uses Akamai not only to deliver its web content, but also to integrate video production with Stream OS organized highlight, so they can be distributed to affiliate sites.

With Steam OS, they can do this even before the game is over. The league quickly and easily make different versions, highlight videos supplying different publishing rules for affiliate partners distribute clips to an extensive network of site in near real-time.

Another innovative service is our new live flash streaming capability. Clients are using this technology to deliver in-stream advertising and other rich media ads that achieve higher flexible rates. And to complement and enhance our new offerings, we are constantly looking to exploit one of Akamai's clear advantage are highly distributed, highly redundant global network.

We believe that the scale we provide was extremely important to our customers, as they want to serve every large online audiences worldwide. For example, we work with NASA recently to stream wide coverage of space shuttle 11 day mission to the International Space Station. And just a couple of weeks ago Akamai supported LiveEarth, the global event highlighting the critical issue of climate change.

In addition to supporting LiveEarth website, we work closely with MSN to deliver live and on-demand content events, artist interviews, and backstage footage. According to MSN, the event was the largest global entertainment event in history with more than 30 million live streams and an online audience of over 8 million [audio blip].

By leveraging our live and on-demand capabilities, producers know they will have the online capacity and quality to support a successful production that having to buildup their own cost and infrastructure and risk over for underestimating demand.

E-commerce, our ability to accelerate the performance of dynamics sites includes page download time, the speed of search queries, and the performance of shopping card applications. All of these dynamics features help increase customer conversion rates and typically grew site revenue.

One of our e-commerce customers is a top motorcycle producer that runs a leading online destination for enthusiasts experienced a 15% improvement in conversion rates after implementing our Dynamic Site Solution. This led to a 10% increase in the number of visits and a 37% increase in page views that helped to contribute to a 30% increase in revenue not to mention savings of over 60% in infrastructure cost per client.

Finally, an important and emerging area for us Application Performance Services, we are helping many companies improve their customer experience. Once again, we are pleased with another strong quarter growth in this new market. One example is GXF, a leading provider of B2B e-commerce solutions. They deployed our web application acceleration solution into their training grid, which supports 35000 customers and the world's largest online trading community.

Using Akamai, thousands of trading partners and supply chain communities experienced a 40% decrease in response time worldwide. In one country China, latency was cut in half using our services. This sort of performance again led our clients to achieve utilization and adoption of their online applications, by identified customers, partners, and affiliates no matter where they are.

Fundamentally, we believe our customers work with us not only because of our ability to deliver the content quickly and lively across the globe, but because we can continue to develop services that go beyond basic content delivery. These advanced services help our customers make more money by limiting their online operational cost. And the continued expansion of the internet, as a vehicle for our online commerce media B2B application, software distribution, and so many other endeavors, we believe in investing and innovation is critical to serving the needs of our enterprise customers, and at the same time to growing Akamai.

We remain as excited as ever about the opportunities for our business, and we look forward to updating you on our continued progress later in the year.

Now J.D. and I would be pleased to take your questions. Operator, may we have the first question, please.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from the line of Tim Klasell with Thomas Weisel Partners.

Tim Klasell - Thomas Weisel Partners

Yes. Good afternoon, everybody.

Paul Sagan

Hi, Tim.

Tim Klasell - Thomas Weisel Partners

Hey, guys. So you're growing the top line obviously better than we had thought, but the margins aren't quite matching that. Can you talk to us a little bit about what you're doing and you're seeing in your new deals and in your customer activity. Is it the media guys, who are growing so quickly? Those contracts under those with lower margin business or it's a just deals sizes, deals get larger, which is obviously you're beating on ARPU is too. If the deals will get larger, is that going to continue to just sort of press the gross margins a bit?

Paul Sagan

I think overall, we were pretty pleased with our margin performance this quarter. We came in the high-end of our range and revenue, in the high-end of our range on EPS and we saw cash gross margins above flat quarter-to-quarter. So kind of a continuation of the trends, we talked about. Maybe even a little bit of a moderation there. I do think, as you pointed out though, what we've talked about for several quarters are the large volume deals.

We do get more aggressive on the prices and the prices are lower. And the media growth, where those deals kind of mostly M&A from driving a lot of that, but we have been able to leverage that to the bottom-line and keep improving our bottom line profitability. And I think that's the trend that we expect to continue at least to the rest of the year.

Tim Klasell - Thomas Weisel Partners

Okay. And then just a quick follow up question. On the application ‘performance services’, I know you aren't given us a lot of detail on that revenue. But can you give us an idea of what percentage your customers are currently taking the EPS and maybe give us some metrics around that?

Paul Sagan

We will report more on it in the fall, but it's still a small percentage. It's a new service and one of the things that we've been pleased with, is not only that it allow us to go visiting customers and offer them this new capability. But it also is letting us go to new customers and to new markets like manufacturing. And we've seen an increase every quarter over the last year in sales in this area, and we are really strong attraction and increasing recognition by our customers. That is not just about their webpage performance.

But the Internet layer, if you will, creates a real drag on application performance, and often the applications are where the business dollars are. And that they need to find a solution, in that our service based approach is the easiest, most effective way for them to deal with the problem of launching an application in the internet and then not having it work to the user at the other end.

Tim Klasell - Thomas Weisel Partners

Okay, good. And one real quick follow-up on the CapEx. You're spending a bit more -- and you in particularly, has there continued to be storage or is there other things that you need to invest in?

Paul Sagan

It's generally across the network. So, mostly there is servers and storage, and then, of course, you need to keep in mind that we also capitalized a lot of our developed network.

Tim Klasell - Thomas Weisel Partners

Okay, very good. Thanks alot guys.

Paul Sagan

Thanks Tim.

Operator

Your next question is from Todd Raker with Deutsche Bank

Paul Sagan

Hi, Todd.

J.D. Sherman

Hi, Todd.

Todd Raker - Deutsche Bank

Yes, how are you?

Paul Sagan

Good.

Todd Raker - Deutsche Bank

First of all, have you guys have talked apparently in the last six to 12 months? Do you think your competitive positions have changed in the industry? And what do you think is really the key differentiating features versus some emerging competitors?

Paul Sagan

Well, I don't think that the landscape has changed terribly much. As you know we've had competitors for almost all the nine years that we've been in business. We continue to see it in all of our areas that we operate around the world. It started with customers who say like, I have a website. I can do it myself. Tell me why I should outsource. I don't think our competitive position has changed. I believe we are the market leader in the area of content delivery, and really the innovator now in the emerging area of Application Performances as a service.

So, we heard the same kind of questions from prospects and customers, and I think that there are number of things that differentiate us, certainly skills and capability, reliability and security. But also the advanced features that we bring to the market that help our customer's business model.

Our goal is to help them make more money, to drive costs out of their operation faster. And so whether it's Stream OS functionality that we've added in the media category or the performance enhancements that we're adding through the Netli acquisition, or our own internal R&D in the area of supporting web 2.0 functionality like AJAX. Or the innovation that has made us a leading supporting social networking site, including many that moved to our platform in the last year because of our ability to, for example, most effectively handle the performance of user generated content and video. I think all of these things add up to really setting the pace in the market place.

Todd Raker - Deutsche Bank

Okay. And then, as you look at the growth profile. Clearly you moved the guidance towards the high end of the range here. But this is the first time we've seen, net new customer decline year-over-year. How should we be thinking from a customer growth versus ARPU growth, I think, going forward?

Paul Sagan

I think our customer growth has been pretty consistent quarter-over-quarter especially, if they normalize for the acquisitions. We don't target a specific number one of our, the things that we've done year-over-year is really raise our expectation of kind of a minimum size of a customer. We want to make sure that we're going into quality markets and quality customers, and those with the potential to grow. But as I look at the kind of net add it's roughly in the first half of this year versus last year almost the same number.

J.D. Sherman

It's actually a little bit higher if you look at the first half because we signed up 89 net new customers in the first quarter, which was down a bit higher than the range. I'll think, if you're going back to last second quarter, we stand at about 79 net new customer. So, yeah bit lower than last first quarter. But I think, if you look at it first half it's going to balance around a little bit. We're still really pleased with the new customer signing.

Todd Raker - Deutsche Bank

And last question just following up on Tim's question on CapEx, this 16 to 17% of revenue level picking up, if you have adjusted a steady phase model, is that the pretty good benchmark or do you thinking of more efficient in that overtime?

J.D. Sherman

I think, we continue to get more efficient and the user technology, and our software. We've had explosive traffic growth in the last year, and always felt that we stay ahead of that. We never wanted some customers to go away. It has been higher than we had targeted two years ago, and our expectation is overtime it will come down a little bit. But given the explosive nature of the market, we're not going to cut short on ability to handle customers.

Todd Raker - Deutsche Bank

Okay. Thanks guys.

Paul Sagan

Yes. Thanks Todd.

Operator

Your next question is from Rod Ratliff with Stanford Group.

Paul Sagan

Hi, Rod.

Rod Ratliff - Stanford Group

How are you?

Paul Sagan

Good.

Rod Ratliff - Stanford Group

Paul, can you speak anecdotally at least about where you might be seeing strength in the software download market? Any particular sort of vertical within software that you guys were seeing any extraordinary strength?

Paul Sagan

Well, we continue to see the whole industry has shifted from shipping just get to downloading software online. So, we're seeing really across the board in enterprise software and desktop software both to the business and the consumer space. And another area that's really emerging is, in the gaming space, so that is essentially software being downloaded either to PCs or to consoles. So, we are seeing that elusion of business just continue across the Board.

Rod Ratliff - Stanford Group

Then you have got the V-Business with Nintendo, correct?

Paul Sagan

No, we have talked about that a while ago.

Rod Ratliff - Stanford Group

Right. On the apex sales front, it seems that the press release has really picked up in the past calendar quarter, so announcing a lot of quarter. So, you indicated earlier on the call that you're going to be, probably giving a little bit more granularity around that particular product line in the second half, was that correct, when I heard that?

Paul Sagan

Yeah, I think we give an update in the fall. We've been very pleased, obviously we make announcements when we would have think it. It contributes to the dialogue or sometime our customers want to make announcement for themselves, we've been very excited about the growth and acceptance of distance and we'll take a lot about it in our analyst day.

Rod Ratliff - Stanford Group

Okay. One last one, if you can or will, Paul, any particularly strong vertical investing in the second quarter, just off the top of my head. It would seen that media and entertainment what was the sports networks that you are broadcasting for over the web, that would tend to support investing in the second quarter. Can you give any color there?

Paul Sagan

We work with so many intermittent leagues that, I think we are in every season. So I really don't think that there with anything unusual in the second quarter. It was very much businesses as usual I think across from all of verticals.

Rod Ratliff - Stanford Group

Okay, great. Thanks.

Paul Sagan

Thanks Rod.

Operator

Your next question is from Aaron Kessler with Piper Jaffray.

Aaron Kessler - Piper Jaffray

Hey, guys. Couple of questions, first on the CapEx, can you with little more detail into what you are investing is just more storage on specifically in the rich media side. And any more details on what percentage roughly may be of your servers today can be used for cover large digital media files, first maybe more traditional content of the brain and one follow-up question.

Paul Sagan

Well. First of all, just to reiterate what I said before most of the spending on CapEx is hardware, which is servers, or dedicated storage. The entire network can be used very flexibly for any kind of content may be, that you have a misconception that there is kind of an old technology and a new technology. But one of our hallmark has been if you had claimed vanilla commodity hardware infrastructure, it's enhanced through software. So our ability to handle large file, live events, user generated content, is really done through the magic of the software that create not essentially the hardware itself.

And so we've take the CapEx and can spread it across commodity relatively low price devices and then effectively enabled into the software in the functionality. So, whether we are handling small object kind of on an average webpage or enormous file high def type movies or very, very like software patches or even full game or operating system install the network is very flexible and capable of handling that and allowed us to do. I think the largest distribution ever software over the net.

Aaron Kessler - Piper Jaffray

Great, and one follow up. There has been a lot of success like, couple of your competitors in web application area are kind of keeping it behind the fall. Any indications, companies I guess becoming increasing well into that data go across the Internet, which could accelerate your application acceleration offering. Thank you.

Paul Sagan

That's exactly what we are seeing, because, as you know we are not going to operate behind the firewall today or in the data center, in the traditional device or a client space. So that's what we are seeing is that more and more customers are saying “I am going to the web or the Internet", the public Internet with my application and all of a sudden I'm not getting the performance I need. And so, we are finding them increasingly open to the discussion and recognizing that they have got a real problem to address.

Aaron Kessler - Piper Jaffray

Great, thank you.

Paul Sagan

Thanks, Aaron.

Operator

The next question comes from Phil Winslow with Credit Suisse

Phil Winslow - Credit Suisse

Hi guys. I was wondering if you could talk about contract length that you saw this quarter you discussed how late in the, and sort of the second half of last year you saw lengthening contracts.

I wondered, if I get a sense for what you saw this quarter, but also some of those contracts that you were signing, let's say in the second half of the last year. When do you think those will start to come up for the renewal, again you talked about some of the contracts might going to 18 months. Does it last to full 18 or do you think it renew sometime before that?

J.D. Sherman

Well most go to full length.

Paul Sagan

Yeah, most do. And we've seen that trend towards lengthening in the 18 to 19 month range. We saw a continuation of that in the first quarter and the second quarter. I haven't call through precisely all of our contracts in the second quarter. But we're definitely seeing lengthening of those contracts. We still have a pretty even distribution of our contracts over our customer base. So, and almost any quarter, we've some portion of our customer base up for renewal, and I think that will just continue to be relatively and even split over the quarters.

Phil Winslow - Credit Suisse

Great. Thanks guys.

Paul Sagan

Sure.

Operator

The next question comes from Harry Blount with Lehman Brothers.

Roberta - Lehman Brothers

Hi, guys. This is Roberta in for Harry. Just wanted to ask can you talk a little bit about how you see your growth opportunities going forward in terms of how many large customers are out there or if you think you will be able to relying more on existing customers? And also, if you could give us your comments on how you see ARPU returning for the rest of the year that would be great? Thanks.

Paul Sagan

Sure. So, one of the exciting things about doing business on the internet is that there are some many opportunities, and so many emerging areas, and even enter traditional internet spaces. The majority of business is in online today. So, as you look at the amount of video that's consumed most of it's going on television in the living room not attached to the internet. If you look at most advertising dollars the vast majority is offline, not online.

As you look at applications most are not available across the internet or outside the firewall. And so we think, we're excited that probably got at least a 10 year trajectory now of steady migration from the old method to an internet method that's give us a lot of opportunity to go after customers, and find growth. We've always looked at both increased volume from existing customers by selling the new services or penetrating them more deeply with new offers or frankly just their own organic growth in traffic and we still see no reason that those trends won't occur.

At the same time there are hundreds of new possibilities worldwide to find customers and we see very strong demand, and very long list of qualified leads in our system that we want to go after and talk. But certainly all of them don't turn out to be customers once you get in and find out all the details. But certainly a lot do and so we're very encouraged about this. So, I think we'll continue to look for both new and managing the accounts and probably fairly equally split between the two, as we go forward.

And one of the things we look at, when we take on a customer because they tend to start smaller than ARPU is that they have the potential to grow without a stable business model that they understand the internet. We try to go after those, and have the highest likelihood. And then around ARPU, we don't give specific guidance on ARPU. We say it can go up, down or side ways. It's not like how we try to manage the business.

We've been extremely pleased with the steady important in ARPU over the last several years. We have to think that's mitigated it has been, when we've down acquisition several times, and we've done that with the history of bringing in often small customers, who had access to fewer services. And then over their first year or two was up having an opportunity to sell them more services, and therefore seeing that the total ARPU grow again as soon as we've done an acquisition and integrated customers and there's no reason to believe that trend won't continue overtime as well.

Roberta - Lehman Brothers

Thank you.

Paul Sagan

Thanks Roberta.

Operator

Your next question comes from John Walsh with Citi.

John Walsh - Citigroup Research

Good afternoon. Could you talk about the international side you saw an uptick as for as the percentage of revenue, but what you're doing, what kind of efforts are made there, and may be is there any color you can give on the type of customer that are starting to use at overseas?

Paul Sagan

Yes. So we've been seen an uptick pretty much every quarter, as you know we think the international opportunity is actually growing faster than the North American opportunity. In last quarter because we've integrated a couple of the acquisition particularly nice distance ever primarily North American base.

We didn't see that uptick, but it's been a really positive trends. I think the interesting thing we are seeing is that particularly with some of the thing that occurred in the North American market around media and entertainment, last year and even the year before.

We are really starting to see those types of initiates gain tractions in the international marketplace and we feel like where, really well positioned to help customers in that environment. We have the advantage of very broad global footprint already in place and we are investing internationally in our sales force and go to market capabilities to be able to handle those customers. So we are very positive about the potential for growth internationally.

John Walsh - Citigroup Research

Okay. And then the application acceleration in these, you gave more color in the fall, but could you tell us what was the drag on ARPU for this quarter?

Paul Sagan

I think probably the average application acceleration deal is a bit smaller than our average ARPU, but the interesting thing is, the first deal that we tend to sign there are bigger than the first deals we tend to sign on, in our traditional kind of CDN business.

So I think overtime its going to be a very health business for us and not necessarily drag an ARPU, but we'll keep for our growth. And then of course, piece to that business comes from signing up new customers. So they tend to be a bit small and then a piece is adding advanced services on top of an existing customer. So obviously that helps to boost your ARPU if you take a customer, who is already using here for a media delivery or software downloads and then you extend into application acceleration that the boost for your ARPU.

John Walsh - Citigroup Research

And the terms of those deals are they same type of deal, certain amount committed for a month, for example in the trading exchange is that a commitment for a month?

Paul Sagan

Right, we don't price those deals on a kind of bandwidth or megabits per second type basis. Its much more like an enterprise software sale or re-price on a per application basis or occasionally with the customer has a unique application will come up with another pricing out whether embedded is not a volume base thing. It's more like an application sale, like an enterprise software sale.

John Walsh - Citigroup Research

Okay, great. Just one final one, mix between committed and gross revenue is it above in that 70, 30 or is change there?

J.D. Sherman

Yeah. It stays roughly in that range this quarter. That's an unusual.

John Walsh - Citigroup Research

Okay great. Thanks.

Operator

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

Paul Sagan

Hi, Tom

Tom Watts - Cowen & Company

Hi, good afternoon. Two quick questions, first on the gross margin guidance you increased your guidance for GAAP gross margins to 400 basis point decline from the 300 basis point. Can you just explain a little bit further what changes you've seen to drive that as a primarily in the medium emerging area, is it specific products. And do you expect the, could we see -- what's your expectation for the change in that during the course of the year.

J.D. Sherman

Yeah, I think the 4.0 year-over-year, we've talked about 3.0 year-over-year, that the main fundamental thing is that we did accelerate our CapEx spend into the first half of the year. So, we do expect a little bit more depreciation in the back half of the year, and that leads us to see that.

We do see the trends that we've been talking about, which is the very large deals in the media space and in other spaces like in high-tech as well, where we get lower price points, and therefore lower gross margins. Still had a premium to kind of commodity in our hosted solution, but lower on the gross margin. But we're able to leverage those very positively to the bottom line, and so as a result, we expect that our operating margins are going to still continue to be above where we expected.

Tom Watts - Cowen & Company

Okay. And just second question in terms of long form video 30 minutes are longer, are you seeing a much demand for that, and also some of your competitors are focusing specifically on that. How do you think you are positioned to capture that sort of traffic? Do you see it as a big market?

J.D. Sherman

I think it's going to be a big market. I think, if you look at the average viewing time on websites with video it's still very short, it still will be short of attention span data of a minute or two or three. Now, there are exceptions there are cases where people are watching movies and full TV shows, but I think the bulk of we experienced they are still very short. The exceptions being some movie sites, some television sites, and sporting events clearly where people will be watching a live game as oppose to clips.

What we found is that we're really well suited for it because performance really matters in the user generated category the ability to handle high upload rates, and fast turnaround of massive amounts of files from many, many different contributors if you will are all things that are flexible network and the software that we developed have really helped us.

We've been allowed to win some key business in that space, and our ability to handle large files very, very efficiently both to store them and deliver them, but whether it's core content meaning the long tail something that not too many people want or hard content something that in demand and suddenly you've a huge run on a set of request for. We're very well positioned there and we see that with our relationship with many of the studios, the major network, the leagues, and other producers.

So, I think there is a lot of growth opportunity. I think we're very well positioned at the same time I think the part of usage still remains short clips.

Tom Watts - Cowen & Company

Great. Thanks a lot.

J.D. Sherman

Thanks

Operator

The next question is from Colby Synesael with Merriman.

Paul Sagan

Hi Colby

J.D. Sherman

Hi, Colby.

Colby Synesael - Merriman Curhan

Hi guys. In terms of customer churn have you guys seen an increase in customers coming from other CDN providers? Have you guys continuing to see most of your customers coming from do-it-yourself towards you guys? And then wise versa have you seen any of your customers leaving off late really to go more towards the different type of provider?

And then my second question is more or a little bit on just the macro basis, how are you guys positioned in terms of wireless opportunity. It seems like we're going to continue to see a lot more demand coming from the wireless space I haven't really heard you guys talk much about how you are positioned for that?

Paul Sagan

Well in the case of churn, no real change this quarter nothing significant there in the pattern. I think we've done a very good job managing churn. We don't loose a lot of customers certainly not competitively. What we see is often their business model changes; often they end a project or something like that. In terms of we're getting customers from a certainly win from our competitors. But I also think that a lot of it is, new opportunity, as we just talk to people, who are moving their businesses online increasingly.

Again churn was under 4% kind of close to the target range, we've had. And that while customers not revenue the customer we tend to turn tend to be very small relative to average ARPU. So they represent and even small fraction of revenue than customer account. In the area of wireless we have talk about wireless on a number of call, we were excited about it because if you are accessing a website, we deliver whether its on a wireless device or a broadband big screen device in your home. It's probably being accelerated by Akamai, we deliver a great deal of the video to wireless devices in the states.

For example, that's often done under the covers it's not brand Akamai, of course and we are seeing more and more going on there. Again really, we are fighting back on the comments for my answered to Tom's prior question. Most of the video there, and audio is definitely short intention to ban on theater. People are not watching entire movies over a live cellular connection today.

And so again, its short growth, what we are seeing some growth there significant growth, but again on a small number. And I think that we are very well positioned because in wireless, because if you were the last mile, it's so small, so narrow there can't be any latency or performance problems upstream and we can help both the content provider and the wireless network mixture, that there is no upstream problem. And in fact we are doing that today for several of the largest carriers.

Colby Synesael - Merriman Curhan

Okay. I guess just one more question and in terms of Nine Systems and Netli, those acquisitions tracking to what your expectations where, when your first announcement?

Paul Sagan

Yeah, we are very pleased with the integration efforts. We are functionally oriented company, so we don't leave, tend to leave to an acquisition sort of hanging up. There is separate operating group, we just cooperate all of the functions that we find is much more efficient and trying to talk in the customers transfer them our network. And we are pleased with how those it gone so far and our ability to take some of the technology are offers such rolled in to the broader set to Akamai customers. Operator?

Operator

Your next question is from Darren Aftahi with ThinkEquity

Paul Sagan

Hi, Darren.

Darren Aftahi - ThinkEquity

Hi, two quick questions. Can I get an update on Red Swoosh relations, your comments about long form content. And then my second question was Google acquiring DoubleClick as your relationship with DoubleClick changed downturn to customer?

Paul Sagan

We don't tend to comment on individual customers. I'm sorry, no change there to tell you about. In the case of Red Swoosh, we really haven't made any public products announcement, so I'm sorry at this place announcement is well. I don't think even to announce today, we think it was a terrific acquisition for us. We think integrating that technology into Akamai's content delivery capabilities and backend control system to protect the rights and business rules of our customers.

We meet some really interesting new capabilities, but at the time we did that acquisition earlier in the year in Q1 we said. We didn't have a product announcement then, we are going to integrate the technology and added to our offers overtime and that's exactly the path that we are on.

Operator

Your next question is from Jeff Van Rhee with Craig-Hallum

Jeff Van Rhee - Craig-Hallum Capital

Yes, two quick questions. First of all the commentary about the seasonality for Q3, can you just talk to, it's sounds like its come into more clarity for you or with more convection that you will see seasonality in that quarter. Can you just talk to what's giving you have increased convection of seasonality and then the second quarter go to the net customer adds, understanding those lumpiness there, you don't want to put down on any given quarter.

Can you talk to us on a two or three quarter rolling average, where you think we might be six, nine months out in terms of net adds, in other words are we generally in this category, as you see it or is there a longer-term trend one direction or the other? Thanks.

Paul Sagan

Yeah. I mean, just go back on the customer adds, if you go back literally over the last eight or nine quarters we've been between 70 and 90 net new customers, every quarter that's kind of a consistent add rate that we've seen. And we're very comfortable with that rate and while we won't project it going forward looking at the traction we've gotten there that we're pleased to see that kind of customer adds every quarter. So, I think that's positive, and your first question was on the seasonality.

Jeff Van Rhee - Craig-Hallum Capital

While you commented the Q3 seasonality seemingly with a little more conviction or clarity that we're going to see it. I was just curious what is giving you a little more conviction or clarity on that?

Paul Sagan

I will let J.D. answer more fully. But one thing is that it is actually July, so we're in the season and felt we have real data.

J.D. Sherman

Yeah. And the first thing, I had planned the third quarter will beat the first quarter in the last couple we haven't had an acquisition to add to our growth. So, obviously that's contributes a little bit. Last year was a year which was exceptionally strong growth and kind of major macro trends going on in the media space.

We also had the tailwinds of the vested download in the third quarter that kind of bolstered the whole software growth industry. And we've always prior to last year seasonality it's kind of way of life in terms of Internet usage, and so we're just expecting to see a return to that, and what that means for us generally is a little bit slower growth in Q3, but much stronger growth in Q4. So, that's kind of what we're expecting for the back of the year.

Jeff Van Rhee - Craig-Hallum Capital

That's right. Okay, thanks.

Operator

The next question is from Sameet Sinha with Kaufman Brother.

Sameet Sinha - Kaufman Brother

Yes thank you. In terms of speaking about Red Swoosh, can you give us elaborate on your strategy there what are you expecting to do with that acquisition is it totally going to be focused on media and entertainment vertical or other applications? Secondly, in terms of international opportunity, can you talk about how you are targeting your customers there, is that direct sales force or mostly resellers?

Paul Sagan

Sure. This is Paul, I'll take that. Again I'm not going to add too much color to the Red Swoosh acquisition we talked about it in some detail, when we close the deal and first announced it, and we're really ready to make product announcement. We'll clearly it can apply to large file delivery especially non live events.

So that lend itself to large media files that I will substantially lend itself to software and gaming and any kind of a large payload that where you need lots of capacity, and it can be done potentially a non real-time, where we can use some edge resources combined with our much additional content delivery resources. And as we grow this capability, this will make product announcements going to ready, I'm sorry to disappoint you on this call, but this is not the full and approximate product announcement.

Our international strategy is the mix of direct and channel very much mirrors what we've done here looking at the same market, as they emerge. What we've seen is outsource internet services like we provide tent to takeoff first in the US and then little more slowly or lack behind a little bit internationally. We've used resellers very effectively in some markets, and other direct has been more successful for us. And I think we'll continue to look at it as the case-by-case basis across Asia and Europe primarily of whether we'll go direct or channels, and is our markets as we do in the states very similar pattern.

Sameet Sinha - Kaufman Brother

Okay. Thank you very much.

Paul Sagan

Thank you.

Operator

Your next question is from Katherine Egbert with Jefferies.

Katherine Egbert - Jefferies & Co.

Hi, good afternoon. I have a question regarding on the price increases that you talk about a bit on the call, whether is coming from, are there your own doing or is that something you're getting for competitive reasons or customers pushing back?

Paul Sagan

Well. As you know with the history of our business, one other thing that we've done very effectively is drive cost out of doing business on the internet. And we've been able to reduce unit cost every year for the last nine years and frankly it enables people business model. So the prices that we're charged, not just by us, but even more traditional for bears the in that capacity, just peer transit for example we are much higher a decade ago. And kinds of business model that are gaining traction, they particularly in the media and entertainment space, we are not at work ten years ago.

And that’s what we saw in many ways with the first bubble, when it pop because there was no support for business model and the cost structure. So we work really hard to drive unit cost down share that with our customers and led to really the dramatic growth of business you've seen, every year over the last several years. And we see continuing the offset for us, as we are very effective and driving our own cost out.

And as customer volume has increase that it has for the last several years, frankly consistently as we've been in business. It allowed us to grow accounts and grow profitability, while driving cost down and that pattern continued, our customers understand, what goes on with the cost that run really if you will bandwidth, servers, et cetera. And they compare what we do to lot of competitive offerings including the cost of doing it themselves.

So that dynamic has remained very consistent and really that the deal, that we've made very successfully with the marketplace is, if you grow your business we will help you do it more efficiently and you will help us to grow for us. And that continues really across every single vertical, is not just relegated to media vertical at all. It's really in every categories people tried to leverage the internet more, they need to find ways to get efficiency and scaling. We’ve been very effective and helping them to do that.

Katherine Egbert - Jefferies & Co.

Okay. There is leverage and in the EBITDA margin come mostly at in sales and marketing?

Paul Sagan

I am sorry. I couldn’t understand, what you said, Katherine.

J.D. Sherman

The leverage on EBITDA margin?

Katherine Egbert - Jefferies & Co.

Right.

J.D. Sherman

Yeah. The biggest, it comes mostly out of the rapid growth on the revenue line and we continue to invest in sales and marketing and in engineering. But not nearly at the pace of our revenue growth, and we don’t feel the need in at that pace. We will continue to invest very rapidly, but really scalability comes from how rapidly top line is growing.

Katherine Egbert - Jefferies & Co.

Okay, thanks J.D. And last one, can you comment on the court order that was filed post Markman hearing?

J.D. Sherman

There was no court order post the Markman hearing. The Markman hearing was one more step and a very long legal process. We don't comment on active litigation. We understand that's a very long process to demonstrate what we think the facts are and we will see how that plays out over the long term.

Katherine Egbert - Jefferies & Co.

Okay, thanks.

Paul Sagan

Operator?

Operator

Your next question is from David Hilal with Friedman, Billings, Ramsey.

Michael - Friedman Billings Ramsey

This is actually Michael for David.

Paul Sagan

Hi, Mike.

J.D. Sherman

Hi, Michael.

Michael - Friedman Billings Ramsey

How have you been?

Paul Sagan

Great.

Michael - Friedman Billings Ramsey

I am just curious, what is the average change of price you're seeing for customers whose contractors are up for renewal?

Paul Sagan

Well, we don’t give detailed pricing information, but we do talk about a little bit what we seen in the changes in the raw material costs, which has been pretty consistent year-over-year in the change in bandwidth pricing and pretty similar changes. Process remains pretty consistent over the last year, pretty much inline with our expectations.

Michael - Friedman Billings Ramsey

Okay. So, is it fair to say then our dollar per bits basis that’s been reduced?

Paul Sagan

Yes, we continue to drive down the price per bid that it caused us to move data and the price per bid that we charge our customer.

Michael - Friedman Billings Ramsey

Okay. Thank you.

Paul Sagan

Okay.

Operator

The next question is from Richard Keiser with Sanford Bernstein

Richard Keiser - Sanford Bernstein

Hi I just wanted to clarify, the guidance you gave for, the midpoint of the guidance you gave for next quarter was 159 is that right?

J.D. Sherman

Well 147, I am sorry, 157 to 162, so I guess that would officially be 159.5.

Richard Keiser - Sanford Bernstein

Okay. And then the guidance for the end of the year you said was again just clarifying 615 to 625. Did I hear that correctly?

J.D. Sherman

That’s correct.

Richard Keiser - Sanford Bernstein

Okay. So that implies a number of like 170 for Q4, which is about 33% below the street and maybe 35% year-over-year growth, is that correct as well?

J.D. Sherman

I'm not sure about; it would be just below the street, number you are looking at. I think this guidance is roughly consistent with what the model that we saw it on the street.

Richard Keiser - Sanford Bernstein

Right. Now consensus is 170 that's immaterial 174 right now, but the rate year-over-year compare is going to be sorry just for doing it live will be 126 is that right in Q4 of '06?

J.D. Sherman

That we didn't….

Richard Keiser - Sanford Bernstein

So, that will be 35% growth versus like 53% growth or 51% growth this quarter right? And I know there is some acquisition in there. But can you talk about just what's driving this kind of deceleration it seems pretty appropriate?

Paul Sagan

Well, you have two acquisitions in Q1 and Q2, and you don’t in last year, you don’t have that. Here, I think the numbers have been very consistent. We talk very consistently about the quarterly numbers and in fact what we've done here is gone to the higher end of our range for the rest of the year. So, we've been very pleased with the year and it's really unfolded as we thought going all the way back to late last summer when we started to talk about it.

Richard Keiser - Sanford Bernstein

Right. Does that imply that those acquisitions are growing slower than you core organic growth rate right?

Paul Sagan

I'm sorry. I don’t think we should do this math light because --

Richard Keiser - Sanford Bernstein

Well, you understand where I'm going with the question, right? Okay, fine. In terms of the announcement with respect to the Board, can you talk about, there has been some other chatter and other avenues like in Juniper, for example, announced that it was doing some trials with advertising, you've recently brought on, and Mr. Kenny was at Digitas. Can you talk about the opportunity you see in potentially using your knowledge of content streams and who is watching what compare that with an advertising offering?

Paul Sagan

Well, the delivery of web based advertising is very important component of our business. We work with 19 of the 20 largest ad servers. Many of our customers in the media vertical, their entire business model is predicated on online advertising. So, understanding that understanding, what's important to them? How they do it more effectively, I think are all things that we really try to do well and need to continue to do well.

And bring in David Kenny on with his understanding not just of the advertising market, but the Internet business models, I think would be a good contribution to our Board. We already have I believe a very strong infinite Board and David will just enhance that particularly with his expertise in the Internet marketing and Internet advertising.

Richard Keiser - Sanford Bernstein

Just one thing incremental on that, don’t you have very good information about who is receiving which streams? And if so, are you monetizing that with advertising to any extent at present?

Paul Sagan

Let me be very, very clear, we do not collect any personal data on anyone on the Internet we deliver content on behalf of our customer, but we have no personal identifiable information. We do not collect data on what an individual does on the Internet or share that in any way would be all.

Richard Keiser - Sanford Bernstein

All right. Thank you very much.

Paul Sagan

Thank you. I think operator, we have time for one more question.

Operator

Your final question is from the line of David Hilal with FBR.

Michael - Friedman Billings Ramsey

Thank you. My question has been answered.

Paul Sagan

Okay. Thank you, David and thank you all for calling in and we look forward to talking to you next quarter. Bye.

Operator

This concludes today’s conference call. You may now disconnect.

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