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Limelight Networks, Inc (LLNW)

Q2 2007 Earnings Call

August 9, 2007 9:00 am ET

Executives

Jeff Lunsford - Chairman, President and CEO

Matt Hale - CFO and Secretary

Analysts

Sarah Friar - Goldman Sachs

Peter Cooper - Morgan Stanley

Katherine Egbert - Jefferies

Aaron Kessler - Piper Jaffray

David Hollow - Freedman Billings Ramsey

Ray Conley - PAI

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Limelight Networks, 2007 Second Quarter Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. At that time we will provide instructions for those interested in entering the queue for the Q&A. We request that individuals on the call today, limit themselves to one question and one follow-up to allow others an opportunity to participate. Please note that this conference call is being recorded today, August 9, 2007 and will be archived on the company’s website www.llwn.com.

Representing Limelight Networks today are Jeff Lunsford, the company’s Chairman and Chief Executive Officer and Matt Hale, Limelight’s Chief Financial Officer.

With that, I would like to introduce Matt Hale, Limelight’s Chief Financial Officer. Mr. Hale?

Matt Hale

Thank you, operator and good morning everyone. Some portion of today’s conference call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are all statements that are not strictly statements of historical facts such as statements regarding future events or future financial performance, including but not limited to statements relating Limelight Networks markets opportunity and future business prospects, guidance on 2007 financial results and statements concerning anticipated future growth and profitability. As well as managements plans, goals, strategies, expectations, hopes and beliefs.

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

Factors that cause actual results to differ are included in Limelight Networks registration statement on Form S-1 and in the company’s periodic filings with the Securities and Exchange Commission.

So with that opening I will turn the time over to Jeff.

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Jeff Lunsford

Thanks Matt. Good morning ladies and gentlemen, thank you for joining us. Today we are pleased to report the results of Limelight Networks second quarter of operations 2007 and to provide you with an update on how we see our strategy succeeding in the dynamic rapidly evolving and high growth marketplace of rich media content delivery.

In the second quarter we accomplished a substantial amount in moving the company forward further establishing Limelight as the service provider of content delivery services worldwide and an enablement partner of choice for businesses desiring to deliver rich media assets such as video, music, games, software and social media over the web.

The scaled performance and flexibility of Limelight's innovative and differentiating content delivery platform are becoming well understood in the buying market place. This led to our adding 149 net new customers in the quarter, achieving record booking levels in the United States, Europe and Asia.

Global new business bookings in the quarter were more than double those achieved in Q2 of 2006. This doubling represents the incremental productivity of our existing sales team and only a handful of the newly hired sales resources that started in Q1. There is a second wave of resources hired later in the quarter that we anticipate will contribute to increase booking levels in the second half of the year.

In addition to new customers, we strengthened our relationships with our current customers through modifications and extensions of their agreements with the company. As mentioned we commenced a large strategic contract with the current customer of the company, the contract, which involves custom CDN services, as well as content delivery services extends our relationship with this customer for the next five years.

The contract also involves a cross license of intellectual property and as a result requires the company to account for it's revenues including it's legacy content delivery service in accordance with SOP 97-2.

To provide transparency into the fundamentals of our business we are adopting a non-GAAP revenue measure to more accurately reflect the underlying performance of the business in Q2 and future quarters related to this change of accounting treatments, specifically for this large customer. Matt will provide more details into this agreement and its impact on GAAP revenue.

Using this non-GAAP revenue convention, the company achieved non-GAAP revenue in the quarter of $24.7 million, non-GAAP EPS on a diluted basis of zero and non-GAAP adjusted EBITDA of $4.4 million. On a GAAP bases, the company achieved revenue of $21.2 million, a GAAP EPS loss of $0.23 per share and a GAAP adjusted EBITDA loss of $5.6 million.

Turning to other operating highlights for the quarter, we achieved several notable milestones in our plan to scale the business in the key areas of customer base sales capabilities, network capacity in capital base.

In the customer area, we continue to build a diversified portfolio of customers, adding as I mentioned 149 net new customers in the quarter, and growing our base from 727 at the end of March to 876 at the end of June. Customer wins in the quarter included, Viacom, CNN, Turner, U.S. Golf Association's and Electronic Arts in United States, Sony Corporation in Asia/Pac and Nokia Corporation in EMEA.

In the sales area, we continue building a worldwide enterprise sales force growing from 44 quota-carrying reps at the end of March to 58 quota-carrying reps at the end of June. We added additional skilled resources in the areas of sales management, sales engineering and account management to support this expansion. As mentioned above, we also achieved record bookings in the quarter and looking at the solid pipeline for continued customer additions in Q3 .We anticipate that these additions will begin to show productivity in Q3 and Q4.

In the network capacity and capability area we continue building, to be the worlds fastest and most scaleable content ware delivery network scaling our total network egress capacity approximately to 1.4 terabits per second today, and targeting 2 terabits per second by some point in Q1 of next year.

Lastly, we expanded our capital base in the quarter for the execution of our initial public offering, taking our net cash position, defined as total cash and investments minus debt, from a negative $12 million at the end of March to over $187 million at the end of June. This capital base provides a solid foundation for growth as we look to expansion opportunities in the future.

In our press release, we have provided guidance for the GAAP and non-GAAP revenue and GAAP and non-GAAP earnings. Our full year GAAP revenue guidance is for a range of $101 million to $103 million and our non-GAAP revenue guidance for a range of a $103 million to $105 million. Our full year GAAP EPS guidance is in range of loss of $0.54, to a loss of $0.51 and our non-GAAP EPS guidance is in range of breakeven to earnings of $0.02 per dilute share. Non-GAAP adjusted EBITDA will be in the range of $16 million to $19 million.

We began to experience some anticipated drop off in a few of our media customers in our June and July revenue. We believe this drop off is due to the seasonality that media company’s experienced after the television season ends. In addition, we began to feel some increased price pressure in certain customer segments which I will discuss in a moment. These two factors were leading us to be cautious in where we are setting revenue and earnings guidance for Q3 in the full year, in spite of the strong bookings I mentioned earlier.

Given the success we are seeing with our sales and marketing ramp however, we believe we should continue to invest as we are currently able to attract some of the most talented individuals in this sector, we are confident, it will help us capitalize the opportunities in the marketplace.

It’s important to note that we did not experience the same seasonality in 2006 as the television streaming portion of our business was just developing and business was ramping in other areas by over 200% annually. Widespread consumption of internet rich media content is still an emerging merging industry and we are learning what usage patterns will be how to factor that into our future planning.

And in Q3 we feel comfortable with the strength of our business and the prospects before us. In conversations with our customers and prospects we are hitting many major media pushes this fall, which we anticipate will have a positive impact on our traffic later this year. We are also seeing confirmation of the broadband consumers growing appetite for high quality content, whether video, music or games.

This brings us to pricing. Over the last 30 days, investors have begun focusing on a potential price war in the CDN marketplace so we thought it will be helpful to discuss what we are seeing in our sales channel with you directly today. We are beginning to experience some price pressure in the marketplace, we feel it is coming not so much from a price war, it’s directly from content providers that are seeing extremely rapid traffic growth. These are normally the forward thinking providers that are pushing the envelope on consumer experience, by investing in the higher resolution, in those high bitrate streams which consumers prefer.

In some cases the traffic growth is occurring ahead of the maturation of those customer monetization strategies, and they are asking for lower per unit rates as their volumes grow and as their business models develop. We believe this pressure actually works in Limelight’s favor as it has created opportunities for us to build inroads in some of the largest media companies in the world and into smaller, but higher potential innovators.

We believe Limelight is the most aggressive company in this space to driving down our delivery cost while maintaining world class service levels and then passing on a portion of the those savings to our customers, which enables their business models. We are seeing good progress in areas of bandwidth cost reduction, expanded viewing relationships, server throughput efficiency increases and the potential incorporation of new technologies into our delivery cost equation.

Our current potential customers recognize continually enhancing cost efficiency, one of Limelight’s core competencies. They appreciate they can count on more content delivery volume at lower per unit pricing from Limelight every year.

It is also important to note however we are tasking our expanded enterprise sales force with penetrating more traditional and higher margin content delivery areas where we see lower traffic growth rates, but also higher margin opportunities. We believe this market segment diversification, combined with the addition of expanded services in the future will help contribute to margin expansion into our targeted range.

I will now turn the call over to Matt to walk through specifics around our number.

Matt Hale

Thanks Jeff. As Jeff stated, we generate $1.2 million in GAAP revenue and $24.7 million in non-GAAP revenue during the quarter. This represented a 43% and 67% growth respectively over the same period in the last year.

We are pleased with the rapid progress we are making in diversifying our revenue and customer base. In Q2 no customer represented more than 10% of our GAAP revenues and only one customer represented more than 10%, and that customer represented 14% of our non-GAAP revenues. It's noteworthy that we are now in the first year of a five year strategic arrangement with that customer, so we are comfortable with this concentration and with our growing relationship with them.

During the second quarter Limelight's international revenue represented 15% of total GAAP revenue and 12% of total non-GAAP revenue. This compares to 7% of GAAP revenue in the prior period and is consistent with the previous quarter, and represents solid growth and penetration in the international markets.

As Jeff mentioned, we added 149 new customers in the quarter bringing our total customer count to 876. This is a record quarterly customer growth add, topping our previous high of 102 net new customers in Q3 of last year.

Our average annualized revenue per customer which we refer to our ARPC was $97,000 in Q2 on a GAAP revenue basis and $112,000 on a non-GAAP revenue basis. That compares to $94,000 for the same period last year and a $126,000 last quarter.

The sequential reduction in the ARPC is a result of a large number of customer adds in the quarter, which increases with denominator significantly. And as we mentioned during our IPO road show, while our business and the number of customers growing is rapid, as rapidly as is variations in the ARPC, either up or down, but necessarily be indicative of the positive or negative trends. We do believe that this will become a bell weather metric over time, however.

Our GAAP gross margin, which includes for depreciation and stock-based compensation, was 30% for the quarter. And our non-GAAP gross profit margin was 35%, compared to 51% for the same period last year and 36% last quarter.

Cash gross margin was 55% on a GAAP basis and 58% on a non-GAAP basis for Q2 and that compares to 65% for the same period last year. It was up 3% from the 55% in the previous quarter.

As Jeff mentioned earlier, we entered into a five-year agreement with the major customer and at this point, we are not at liberty to disclose the identity of the customer, but we expect to in the near future. This agreement is a large multi-element contract that includes a substantial traffic commitment over five years. And it also includes custom CDN services and consulting and cross-licensing, a key intellectual property from both companies, related to content delivery.

The intellectual property includes certain components of Limelight's CDN software. Because this contract involves a software component, we determine the entire contract falls under the accounting guidance of SOP 97-2 and we have very recently determined that we should defer all of revenues earned for the quarter from this customer, including the ongoing CDN traffic services into future periods.

The total revenue which we deferred for the quarter was $3.5 million, along with associated incremental costs incurred of $0.9 million. Of this $3.5 million, $2.6 million will be recognized in the third quarter of 2007. And the remaining $0.8 million will be recognized over the remaining 44 months period of agreement.

We believe the GAAP accounting for this arrangement does not reflect the economics of this contract, because substantial revenue and costs are deferred into the future quarters. And in the case of the custom CDN services, amortized over an approximate four year period, even though we will receive significant cash payments associated with this contract in the first year.

Accordingly, we adopted convention of reporting both GAAP revenue and non-GAAP revenue and earnings related to this contract to assist you in better understanding our underlying results.

Let me walk you through the accounting a little bit more in detail. With this traffic component, we earned $2.6 million of CDN traffic revenue during Q2, which is deferred under this accounting treatment, along with the incremental costs. And will be recognized in full in Q3 as acceptance of the contingent portion of the first phase of the custom CDN project occurred in July.

The deferral of CDN traffic will only happen this one time. For custom CDN and consulting revenue, we earned $0.8 million of services, during the second quarter, associated with the initial work on the first phase of the project. This earned revenue and associated incremental costs of $0.3 million was deferred and will be amortized over an approximate four year remaining life of the contract.

We expect to earn an additional $2 million of custom CDN service revenue in the second half of 2007, which will also be deferred and amortized over the remaining contract period as earned. It’s important now that there will be no additional deferral of cost under this agreement now that acceptance of the first phase has occurred.

The project calls for ongoing custom CDN services to be provided over the next several years. Amortization of this CDN revenue and associated license revenue is expected to be $0.8 million in Q3. We provided a table in our press release that reconciles our GAAP revenue and earnings to the non-GAAP presentation for the quarter. On a going forward basis we will provide this reconciliation of GAAP to non-GAAP to assist you in better understanding our results.

So to recap in using this non-GAAP revenue convention, the company achieved non-GAAP revenue in the quarter of $24.7 million, had breakeven results from a diluted EPS basis. And on a GAAP basis, reported revenue of $21.2 million of revenue and an EPS loss of $0.23.

GAAP and non-GAAP operating expenses were $17.2 million in Q2 and that’s up $4.2 million for the same quarter last year and $12.6 million in the prior quarter. Operating expenses also include depreciation of stock based compensation charges and excluding these non cash charges, our operating expenses for the quarter were $10.9 million, which is up from $4 million in the same period last year and $7.2 million in the prior quarter.

The sequentially increase in operating expenses reflect the significant investment we are making in every area of our business. From ramping SG&A costs associated with public company expenses to expanding sales in marketing, to expand platform capacity, to adding R&D capabilities and resources. And we expect to see continued investment throughout the remainder of 2007.

Non-GAAP adjusted EBITDA was $4.4 million and that compared to $5.6 million for the same period last year and $6.6 million for the last quarter. Similar to the gross margin changes above the reduction in non-GAAP adjusted EBITDA reflects the impact of cash investments for making this quarter grow.

Total depreciation and amortization for the second quarter was $5.2 million, and that's up from $2.1 million for the same period last year and $4.8 million last quarter. These charges include $5.1 million for network-related depreciation and $0.1 million for operating expenses.

Net interest expense in Q2, up 0.2 million, included interest on bank debt of a $0.5 million, and a non-cash charge of $4 million associated with a debt discount that was written off in conjunction with the retirement of that debt during the quarter. This was offset by $0.6 million of interest income during the quarter.

GAAP net loss for the quarter was $10.5 million or a loss of $0.23 per share. Non-GAAP diluted EPS was a profit at $0.4 million and breakeven per diluted share. Our diluted weighted average share count for the quarter was 79.4 million shares.

During the same quarter our stock based compensation expense was $6.6 million, up from $5.5 million in the prior quarter, and I will ask you to please see the table included in our press release for a break up of these expenses by area of our business.

Moving on to the balance sheet our cash balance at June 30, was a $187.9 million and that's up $12.5 million from the previous quarter. The increase in cash represents the net proceeds from the public offering, offset by the payoff of the $25 million bank debt. We also used $3.9 million of cash in operations during the quarter.

Capital expenditures for the quarter were $8.5 million and that's up from $5.6 million in the previous quarter. GAAP day sales outstanding for the quarter were 83 days and that's up from 53 days in the previous quarter. When you calculate the DSO using non-GAAP revenue that number drops to 72.

Included in that 72 is another 10 days associated with end of quarter billings for pass-through hardware, that was purchase for this large CDN project customer. The additional increase in DSO was primarily associated with new monthly minimum startup billings associated with a large number of new customers activated during the quarter. We generally expect DSO to range in the 60 days to 70 days area.

For Q3, we expect to achieve GAAP revenues in the range of $27 million to $28 million and non-GAAP revenue in the range of $25.5 million to $26.5 million. And I remind you that the Q3 GAAP revenue will include the reversal of the $2.6 million of CDN traffic revenue differed in Q2.

We expect to record a GAAP EPS loss to range from $0.10 to $0.08 and a non-GAAP EPS loss of $0.06 to $0.04. Stock based compensation expense for Q3 is expected to be approximately $5 million to $5.5 million. Details of stock based compensation expense by categories I mentioned is provided in the press release.

Jeff had already described our full year guidance, so I will not repeat that here. And I'll just remind you that there is a complete reconciliation of GAAP to non-GAAP measures for each of those GAAP to non-GAAP metrics that we’ve provided. Capital expenditures for the first year were $14.1 million and we expect expenditures for the full year to be in the range of $30 million to $35 million.

Investments in sales and marketing, which we kicked off at the end of last year, began to bear fruit, as evidenced by the 149 new customers. And our capital expenditures have continued to expand our network capacity to position us for substantial reserved capacity to meet the coming market demand.

So with that I will turn it back to you Jeff.

Jeff Lunsford

Thanks Matt. Summing up, we feel good about the quality and strength of our platform and the sales momentum with which we enter Q3. And we’ve taken a cautious view regarding seasonality and price pressure in our forward-looking guidance. We don’t believe the latter effects the long-term prospects for the business, because we feel Limelight is the best positioned content delivery provider to execute within this rapidly changing competitive marketplace.

We believe our service suite, which attractively combines quality, operational utility performance, flexibility and operating efficiency, positions us to continue on a path of expanding market share. We are building this company to win and our two most important forward-looking metrics, customer additions and bookings were both nicely turning in the right direction in Q2 and illustrate that our plan is succeeding. Based on the trends in these metrics, we feel great about the market and we are continuing to invest in the opportunity.

We will now open the line for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Sarah Friar of Goldman Sachs.

Sarah Friar - Goldman Sachs

Good morning, guys. Jeff.

Jeff Lunsford

Yes Sarah.

Sarah Friar - Goldman Sachs

Talking about the conservativeness on guidance, so if I think of the three levers, there is demand, there is pricing and then there is competition. Seems like you are saying demand is still very good, you talked a little bit about price. Can you give us more color on a competitive insight, so in particular your big competitor being Akamai? Are you seeing changes in their strategies vis-à-vis pricing? And then we have seen a lot of announcement -- sort of smaller small CDNs, are they starting to nibble away or how do you think their momentum is growing in the market?

Matt Hale

Good morning Sarah. So, first of all yes, we see demand with the bookings numbers, the customer adds, demand is very healthy and the sales folks we are hiring are coming online so we feel good about demand. On the competitive front we have been, this company has been and I guess better competition with Akamai for almost six years, its entire existence. And I think the dynamic there is the same as it’s been since we started talking, which is on very strategic deals we will see those guys, they didn’t get very aggressive on price.

And then the smaller guys -- or I would say you are always in hot market like this, going to have established providers and then folks you see how well those establishment providers are doing and then so they are coming into the market. And there are three or four smaller players that we see from time to time in the sales channel, but none of them you know steps out glaringly, I mean really for large opportunities we believe that we and Akamai are the kind of head and shoulders from a scale and quality standpoint above the rest and so our competition in those, in the large opportunities, usually ends up being head to head with them.

Sarah Friar - Goldman Sachs

Alright, so you haven’t seen a marked change, kind of if you think about going into your IPO road show kind of in the June timeframe to now, it’s still similar competitive environment?

Jeff Lunsford

Yeah. I think that since I've been here, I have heard that their management team has told them "not to loose a deal to Limelight on price". So that's, I believe has been their mandate and I think that what happens is we basically each evaluate opportunities looking at our own cost structure and our own P&L; and as we discussed before, profitability in this business is all about filling the valleys. And different customer opportunities have different cost profiles for both us and them, and I think we just look at each opportunity on a case-by-case basis.

Sarah Friar - Goldman Sachs

Okay, one quick follow-up on that. Are you still comfortable with the view that gross margin can continue to rise, despite the fact you had this down sequentially, and what continues to drive that rise in gross margin?

Jeff Lunsford

A couple of things, we are as I mentioned seeing good progress and as our traffic scales getting increased leverage on our core bandwidth buying for transit, we are still seeing some success in [colo]. We have some very good server efficiency projects underway. In the lab we are seeing very promising results and those are the sort of initiatives that we discussed with you a few months ago.

So then the second thing is, as we expand the solution set, and as we pass our enterprise sales force to go, penetrate sort of the more, let’s call them classical content delivery market segments, that aren't these new rich media super high buying, super high growth. As I said earlier, they are lower growth, but higher margin opportunities. We believe that we can expand into those markets and execute higher margin customer relationships.

And then the third element is, we have discussed in the past, that today we have a great core CDN service and it is our plan to add complimentary solutions to that in the future. We don't have anything that we're ready to talk about immediately, but that is absolutely long-term. We spoke in the past about a gross margin target in excess of 50%, and we still feel comfortable based on what we saw in that -- the latest months of June and July from a gross margin standpoint, that we can march towards that. And as I have said in the past, probably a point a quarter or something like that, but it's not going to be a straight line.

Sarah Friar - Goldman Sachs

Okay, great. Let me leave it there. There are no other follow-up questions. Thanks.

Jeff Lunsford

Thank you.

Operator

Our next question comes from Peter Cooper of Morgan Stanley.

Peter Cooper - Morgan Stanley

Great, thanks very much. Hey Jeff, let’s talk about this deal for a second, the license deal which is certainly a nice chunk of revenues. As I am looking at it, the rose colored glasses here, is this kind of way where somebody will think, am I doing some in-house, you've guys are still making out of it?

Jeff Lunsford

That is correct, Peter.

Peter Cooper - Morgan Stanley

Could we expect, like this in the future, do you think?

Jeff Lunsford

It is not a core part of our strategy to become a software company. But, when a very large and very strategic customer approached us about this opportunity, we sat down with them and crafted a large five-year strategic relationship where we believe it made a lot of sense for Limelight. As we mentioned there is cross-license of intellectual property involved here and ongoing CDN services that we are providing for five years, with commitments there in.

So, if something makes good business sense for us, we will look at it and now that we’ve done that once, we certainly wouldn’t rule out doing it again. But we are not on a dramatic path of becoming a software company. We do not have any active discussions with other folks along those lines today.

Peter Cooper - Morgan Stanley

Okay, that’s very helpful, thank you. And I am not sure if you can comment on -- we saw it recently in the ongoing court saga, you guys have won a motion recently, the Markman hearing seems to be leaning in your favor. Any updates that you can discuss about the lawsuit at this point?

Jeff Lunsford

The only factual update is, yesterday the judge set a trial date of February 1st.

Peter Cooper - Morgan Stanley

Okay.

Jeff Lunsford

And beyond that we have been advised that we should not discuss litigation matters.

Peter Cooper - Morgan Stanley

Understood, okay, I'll leave it there, thanks very much.

Jeff Lunsford

Thank you.

Operator

Our next questions come from Katherine Egbert of Jefferies.

Katherine Egbert - Jefferies

Hi, good morning. I also have a question on some CDN customers. Can you tell us what exactly kind of content have been delivering and also does this business have any offline component or are they purely an online business?

Jeff Lunsford

This customer is a very large company that has all types of internet media and also has what you probably characterize as offline business as well.

Katherine Egbert - Jefferies

And what are you doing for them Jeff? Is it within their own network? Is it something customer facing, can you tell us the kind of content it is?

Jeff Lunsford

Katherine, we’ve been asked by this customer not to discuss either their identity or their specifics around the contract. This contract will become, I believe attached to our 10Q for the third quarter and I think at that time there will be -- prior to that there will be a good more color. But we are trying to honor the customer's request for confidentiality in our contractual commitment for confidentiality.

Katherine Egbert - Jefferies

Okay, I understand well then just really quickly, Jeff, you said that there was traffic growth ahead of monetization strategies that was creating some pricing pressure. Can you talk about where it is, like a social networking site, is it rich media, where are you seeing that?

Jeff Lunsford

Where we are seeing, it is most prevalent in sites that are investing in high quality video, and we are seeing that consumers are flocking to those sites. Consumers don’t like the jerky low bitrates stuff, they definitely migrate to the areas where they can get a quality viewing experience, and there’s a direct correlation between that and bitrate streams.

And so some of these customers are experimenting with those, and what’s happening is, they put the high bitrates streams up there. Their traffic goes through the roof and they realize they have a success on their hands from a consumer-viewership standpoint and based on that now it’s time to get the whole add raping the system in sales force or partnership in place and sometimes that monetization project lags the traffic growth.

Katherine Egbert - Jefferies

Okay. That helps, thank you.

Operator

Our next question comes from Aaron Kessler of Piper Jaffray.

Aaron Kessler - Piper Jaffray

Hi guys, few questions. First on the large customer deal can you give us a sense if that was a competitive win or if you already had the customer? Maybe you gain some additional share from the customer? Also was this kind of originally in your thinking, this sized customer for the year? Then a couple of follow up questions.

Jeff Lunsford

Yes, Aaron. So, this was an existing customer and that's what primarily led to this adoption of the non-GAAP revenue. Because, all of the revenue from this existing customer, which has been a substantial part of our revenue in the past essentially goes to zero on a GAAP basis in Q2, even though we've done 90 days of traffic for them, it gets rolled into the 97 two bucket.

So, that's why we believe it was appropriate to adopt this non-GAAP convention, to show to you both ways -- how does it look GAAP and how does it look non-GAAP. But, it was an existing customer and yes the existing part of this customer relationship, as well as the revenue contemplated from this long term strategic partnership, was factored into our thinking since the days that we began talking with you.

Aaron Kessler - Piper Jaffray

And is this an exclusive deal or they are still using other vendors out there?

Jeff Lunsford

Not exclusive.

Aaron Kessler - Piper Jaffray

Got it, okay and then just any visibility you can provide us with at this point, what you have in to Q4 revenues? The Q4 revenue guidance does look somewhat conservative given that you have relatively solid Q3 guidance. How should we think about the Q4 ramp and just a follow-up question for Matt, can you give us some sense of the share count for Q3?

Jeff Lunsford

Right, so, well the Q4 I guess you are just backing out the Q3 guidance from the full year, and again we believe the right thing to do here when we are seeing a little bit of seasonality that we haven't seen in the past, is to just step back and monitor that.

All of our customers are forecasting good, big projects for the fall, but we believe it would be aggressive to just assume that all that's going to happen, and the way our forecasting works is that we take current month's revenue and flow it through and add new booking to that. And when you have a dip from seasonality in the month like July, then that falls through into Q3 and Q4.

And so we just think, while bookings are ahead of plan and doing great and adding to the revenue, we want to make sure that we don't over estimate the return of that seasonal traffic in the fall.

Aaron Kessler - Piper Jaffray

Great and Matt, can you give us the sense of the share count for Q3?

Matt Hale

Yeah, I meant to pop that in before; the basic shares you should use is 82 million and diluted shares 86 million.

Aaron Kessler - Piper Jaffray

Great, thank you.

Operator

The next question comes from David Hollow of Freedman Billings Ramsey.

David Hollow - Freedman Billings Ramsey

Thank you. A few questions, a follow-up to the seasonality question there Jeff. I understand there is softness potentially in Q3 for seasonality, but certainly we think Q4 would bounce back and be quite strong, and as you pointed out it can back into the Q4 numbers. So, I guess, I don't understand why Q4 guidance is so low, because seasonality theoretically should actually play to your advantage in Q4 and not to your disadvantage?

Jeff Lunsford

You are right, David. We believe it will, we just think again to be as a newly public company, we want to be very forthright and transparent with you guys and in the way this industry is developing and at this growth rate we want to give you all the benefits of what we're looking at, and show you how we're thinking about it.

And the way we are thinking about it right now is, we believe that traffic's coming back, you believe a lot of big fall initiatives will flow over our networks, customers are telling us that, but until we see it we think it's prudent not to go ahead and count on it.

David Hollow - Freedman Billings Ramsey

So, when you think about what's changed between when you were on that IPO roadshow and now, obviously seasonality seems to be something new, more severe pricing pressure you mentioned as well. If you had the kind of, the one of those, is one of those having a bigger impact on your guidance versus the other is fairly equal? I am just trying to understand.

Jeff Lunsford

I would probably say it’s about equal, because we have some reasonably large customers that are in this category of high traffic working on monetization. And so, we just again believe it’s prudent to assume that, while they are working on that we just can’t, though we have always viewed ourselves as partners to our customers and not as an arms length benefit vendors that’s going to gauge every penny item, we want these guys to be successful. So, I say it’s about half that and it’s about half the seasonality. It’s kind of hard to quantify it on the fly, but those are really the two factors.

David Hollow - Freedman Billings Ramsey

And on the pricing pressure, were there deals in the quarter that it got so bad that you walked away, because it didn’t make economic sense and may be philosophically you can talk about how you view that?

Jeff Lunsford

Yes, there were deals like that and our sales operations process and pricing approval process has gotten much more rigorous, just over the last six months as we put in more measures. And I’m personally approving anything that is over 20% of a list and our pricing practice is just like most technology companies where you see things on average between 20% and 30% off a list price.

So there are definitely deals where we say no, we are not going to do that at that rate; I would say that those were -- that’s not at all the norm, there is probably, that might be 1 in 10 deals that we look at where we say their expectations or their request is unrealistic and we are going to move on to work with customers that value what we do for a living.

David Hollow - Freedman Billings Ramsey

Alright. Then let me ask you, the next software update I think you guys -- Calle Divino Pastor, is that still on target for I think Q1 of '08?

Jeff Lunsford

Well Pastor is a multi-element or multi-component release. There are, in our architectures there are many components in the software layer and there will be some components of Pastor that we put in production in Q1, is that I think mentioned to you in the past that you will not see a step function where, you know we propagated through the network and all of a sudden our efficiency doubles. It’s a major performance enhancement release and it will go out in components and we should see, we think over the next, over probably all of next year as it phases in what we hope to be something around at doubling of server throughput efficiency.

David Hollow - Freedman Billings Ramsey

Okay, alright. And then my last question, if you could bifurcate your sales and I would be curious to look at it on a bookings base, as well as 149 net new customers. But, if you think about your old sales model, which was the indirect, basically your retailer sales offer versus now your direct model, how much of the business was driven via the direct sales that you have been adding versus traditional indirect go-to-market strategy?

Jeff Lunsford

That’s a good question. So as an example, our New York field office in the quarter delivered I'd say probably 10% of our bookings, and these are all folks who are new to Limelight within the last roughly six months. And so the New York sales office is coming online. We've added substantial resources in our London office and those guys are knocking the cover off the ball. Europe is a very fertile market for us right now.

We think that we are taking about four months for these field reps to come online and it's more like two to three months for a telesales rep to come online. The bulk of the year performance and the bookings as I mentioned, was however delivered by the existing Tempe telesales force team. And that's what's actually very encouraging, as these guys are performing at efficiency rates, sales productivity rates higher than they have. So their productivity is improving and we have the field coming online.

But the record bookings in Q2 were really mostly by the old team and it's just one, it’s one team but the field is just beginning to come online. So we think that we'll see strong bookings in Q3 and Q4, given the pipeline that we are looking at today, and the productivity ramp of those field resources.

David Hollow - Freedman Billings Ramsey

Okay, and I have - I got one more question for Matt. I don't understand the guidance, the delta the between GAAP and non-GAAP revenue in Q3 is $1.5 million. I would have thought it would have been the $2.6 million that got the differed out that you are going to recognize in Q3. So help me understand that, what's the $1.5 million delta?

Matt Hale

Yeah. In Q3 we flip the $2.6 million into revenue and then we also take about $1.1 million of additional from a pro forma or a non-GAAP measure. We recognized about $1.1 million of additional services on the custom CDN. So the net, the two offset each other.

David Hollow - Freedman Billings Ramsey

Okay, got it. Alright guys. Thank you.

Jeff Lunsford

Thank you, Dave.

Operator

Your next question is a follow up from Katherine Egbert of Jeffries.

Katherine Egbert - Jefferies

Hi, thanks. A couple of quick ones, Jeff you said that bookings in the quarter were pretty good. Can you give us any color on that?

Jeff Lunsford

Well, it was -- bookings, there is not a GAAP definition of bookings, so as we've said in the past, we'll give you color on bookings, but a number is not really something that is easy to quantify. As we defined our booking, we doubled bookings, more than doubled bookings over the last year. It was record bookings in all three theatres, which is the Americas, Asia/Pac, and Europe.

The average term of our contracts is still around one year, but we have also implemented incentive plans where our sales force gets compensated more for multi-year deals. So, we are working to drive up the longer-term commitments. We also have incentivized our sales folks to get higher, committed revenue and that is working. We picked up about 4 percentage points of our total revenue in the quarter that is 4 percentage points higher in Q2, with these committed revenue as a percentage of revenue than we were in Q1.

So in all these things give you a sense of that, and with the customer adds at 149 the performance was, it was, it was basically record all around. And we feel like Q3 will be from an overall bookings standpoint, even higher.

Katherine Egbert - Jefferies

Okay, that’s what I was looking for, that’s helpful. And then really quickly Matt, can you tell us about bandwidth pricing, what you see both for longer term contract and spot pricing?

Matt Hales

We continue to see our ability to achieve decreases there, when in bandwidth was $100 we achieved big dollar savings, as a percentage though we continue to see that come down. We also see the amount of peering going up.

We’ve added a significant number of peers, since we last reported and our peering is the amount of traffic that we are spending over settlement peering, which has the same effective of reducing bandwidth, that’s drawing up.

So we are tackling it on both fronts. And at this point, looking at it from a percentage reduction, we’ve been able to achieve pretty well along the historical averages.

Katherine Egbert - Jefferies

Okay, that’s all. Thank you.

Operator

Your next question is a follow-up question from Aaron Kessler of Piper Jeffery.

Aaron Kessler - Piper Jaffray

Just a follow up on the EBITDA guidance, it was also a little lower than we were expecting. Could you give us some color on what just little lower revenue expectation or is that more increased sales and marketing with the pricing pressure that you noted? Thank you.

Jeff Lunsford

So, it’s a combination Aaron, you know, I think the guidance of $103 million to $105 million in pro forma revenue is a little lower than we’ve been modeling as I mentioned for the two reasons of seasonality, just being cautious about price pressure.

And then that combined effect that we -- the company has enjoyed kind of, a good bit of prominence recently and we have been able to attract -- we have been approached by many of the most talented sales folks in the industry and we believe the right thing to do is to go and get those folks on the team while they are interested in Limelight. They are going to help us execute on this plan and move further up the enterprise value chain and deepen our relationship with enterprise account.

So we believe the right long-term thing to do here is to proceed with that sales and marketing build and build for ‘08 and ‘09 where we see a great opportunity and not to just, because we feel a little cautious about revenue to also and dramatically change that growth profile.

Aaron Kessler - Piper Jaffray

Great thank you.

Matt Hale

Sure.

Operator

Your next question comes from Ray Conley of PAI.

Ray Conley - PAI.

How are doing Jeff?

Jeff Lunsford

Fine, Ray. Good morning.

Ray Conley - PAI

Good morning. Could you talk a little bit about how you are thinking about CapEx in your forecasting going forward?

Jeff Lunsford

Sure, Matt?

Matt Hale

Yeah Ray, we had the first half -- we spent a little over $14 million and as I said in the prepared remarks, we expect that to be probably top $30 million and come in between there in $35 million for the year. And then we have previously said we think that, that somewhere between $35 million and $40 million would be a sustainable amount of CapEx for the next couple of years. So as a percentage of revenue, CapEx should continue to drive down.

Ray Conley - PAI

Okay. And can you tell us what percent of your traffic was created in the quarter?

Matt Hale.

Yeah, it was 56%.

Ray Conley - PAI

Okay, thank you.

Jeff Lunsford

Thank you, Ray

Operator

And we have reached the allotted time for our Q&A session. I would now turn the call over to Mr. Lunsford for closing remarks.

Jeff Lunsford

I would just like to thank you for joining us today. As mentioned, we feel like the bookings trajectory and the customers adds here paint a bright picture and we are going to continue investing. We look forward to seeing you out there and talking to you on any follow-up calls that you'd like to have. Thank you.

Operator

This concludes our conference call for today. Thank you for your participation. You may now disconnect.

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Source: Limelight Networks Q2 2007 Earnings Call Transcript
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