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Akamai Technologies Inc. (AKAM)

Q4 2005 Earnings Conference Call

February 8th 2006, 4:30 PM.

Executives:

Paul Sagan, President & CEO

J Donald Sherman, Chief Financial Officer

Analysts:

Katherine Egbert, Jefferies & Company

Todd Raker, Deutsche Bank

Jeff Van Rhee, Craig-Hallum Capital

Erik Zamkoff, Morgan Josefh

Jeff Liguori, Americas Growth Capital.

Henry Naah, Lehman.

Michael Turits, Prudential Equity.

Aaron Kessler, Piper Jaffray

Robert Stimson, W.R. WR Hambrecht.

Douglas Campbell, Spirit Capital.

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Operator

Good afternoon my name is Jean and I will be your conference facilitator. At this time, I would like to welcome everyone to the Akamai Fourth Quarter 2005 Earnings Conference Call. All lines are placed on mute to prevent any background noise. After these prepared remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press "*" then "1" on your telephone keypad. If you would like to withdraw your question press "*" then "2" on your telephone keypad. Thank you . Ms. Smith, you may begin your conference.

Sandy Smith, Vice President, Investor Relations

Great, thank you, good afternoon and thank you for joining Akamai Investor Conference Call to discuss our fourth quarter and year end 2005 financial results. Speaking today would be Paul Sagan, Akamai’s President and CEO and JD Sherman, Akamai’s Chief Financial Officer-Elect, Bob Cobuzzi, our retiring CFO will also be available during the question and answer portion. This call will discuss information about Akamai’s future expectations, plans and prospects that constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors including but not limited to unexpected networks and service interruptions across loss of revenues, increased expenses or diversion of recourses, selling and increase our revenue, retain our significant customer or key product expenses consistent with revenues.

Inability to realize the benefits of our net operating loss carry forward, inability to effectively integrate the Speedera Networks into our existing business or realize expected benefits for the acquisitions to lay into developing or failure to develop new service offerings and functionalities and its developed lack of marketing acceptance of such service offerings and functionality. And the other factors that are discussed in our annual report on Form 10K, our quarterly report on Form 10Q and other documents periodically filed with the SEC.

In addition, any forward looking statements represents our estimates only after today, it should no be relied on its representing our estimates as of any subsequent date. Well, we now like to update forward-looking statements at some point in the future, we specifically disclaim any obligations to do so, even if our estimates change and therefore you should not rely on any 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, as we believe, it will helpful in understanding of our financial results and operations. These non-GAAP measures are not prepared in accordance to Generally Accepted Accounting Principles under the news and publications portion of the Investor Relations section of our website, we redefine these non-GAAP terms and reconcile our non-GAAP financials with the most directly comparable GAAP financial measures. Now let me turn the call over to Paul.

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Paul Sagan, President & CEO

Thank you Sandy, and thank you all for joining us today. The fourth quarter was another record quarter for Akamai, capping of the full year terrific financial results, as we grew revenue in excess of 30% for the second year in a row. Our results for the fourth quarter include revenue of $82.7 million, a 9% increase over the third quarter and a 44% increase over the fourth quarter of 2004.

Normalize net income was $26.2 million or $0.16 per diluted share, a 19% quarter-over-quarter improvement and then 80% increase over the fourth quarter of last year. For the full year, we grew revenue fully 35% year-over-year to $283.1 million and generated normalize net income of $79.5 million or $0.52 per diluted share, at an 87% increase over our 2004 results. In the fourth quarter, we added 80 net new customers bringing our total customer account to year end, to a record 1910 revenue customers.

Now let us return to the financial review in detail. Let me welcome JD Sherman, our incoming CFO. As we announced in last call, Robert Cobuzzi is retiring from Akamai in March. JD Sherman joined us from IBM in November and is transitioning into the top financial positions at Akamai. So please welcome JD as he walks us through our fourth quarter and full year 2005 results. After that, I will be back to share some of my thoughts about the opportunities that we are excited about in the year end.

J Donald Sherman, Chief Financial Office

Thanks Paul, first let me say, I am real good to be here and I couldn’t have asked for better quarter from my first Akamai earnings call. As Paul, just highlighted, we had a great fourth quarter, ending the Company’s strongest year ever. Fourth quarter revenue came in $82.7 million significantly higher than our forecast driven primarily by two factors. First, we experienced seasonal bursting from online retailing customers above anything that we have seen before even a year ago consistent with the strong online retail season that’s been widely reported in the news. Second, the explosion of online media continues to gain momentum and provided even greater benefit than we had anticipated in the fourth quarter.

We estimate that seasonal bursting from e commerce customers added roughly $2 million to our fourth quarter top line result. Full year revenue of $283.1 million increased 35% over 2004 revenue of $210 million. During the fourth quarter, International sales represented 21% of total revenue, up from 20% in the third quarter and 20% in the same period of last year. For the full year, revenue from international account also increased to 21% of total revenue. Resellers accounted for 24% of our total revenue in the fourth quarter and for the full year. Once again, no customer accounted for 10% or more of our revenue in the fourth quarter or for the full year of 2005. As Paul mentioned, we added 80 net new customers in the quarter making it the third quarter in the row very strong net new customer addition.

The acquisition of Speedera combined with the investments we have made in sales and marketing, early in the year help us to grow our recurring customer base by 46% year-over-year. Average revenue per customer or ARPU jumped to $14600 per month during the fourth quarter, up 4% from our prior quarter. We estimate that, about half of this increase was due to the seasonally strong usage from our online

e-commerce customers and the rest came from increased usage across our entire customer base.

Our GAAP gross profit margin was 81% for the quarter, a slight improvement over the prior quarter. On a full year basis, our GAAP gross margin was 80% up from 78% in 2004. GAAP operating expenses for the quarter was $45.5 million, up from $41.6 million in the prior quarter. These GAAP numbers include amortization of intangible assets related to the Speedera acquisition and stock compensation charges. Excluding these non-cash charges, our cash operating expenses for the quarter were

$40.7 million, up from $37.1 million in the prior quarter. For the full year, our cash operating expenses totaled $141.5 million. Adjusted EBITDA for the quarter was

$30.6 million, up over 10% from the prior quarter. Our adjusted EBITDA margin was 37% consistent with the third quarter and up five points from the same period of last year. For the full year of 2005, our adjusted EBITDA margin was 36%, up three points from the full year of 2004.

Total depreciation and amortization for the fourth quarter was $8 million, up from

$7.5 million in the third quarter. Our total depreciation and amortization charges for the quarter include $4.8 million of network related depreciation, $900,000 of G&A depreciation and $2.3 million of amortization of intangible asserts. For the full year, depreciation and amortization was $24.2 million. Net Interest turn positive for the quarter, generating $1.3 million of net interest income as we invested the proceeds of our equity offerings.

GAAP net income for the quarter was $25.8 million or $0.15 of earnings per diluted share. Non-cash items in GAAP net income include $2.3 million from amortization of intangible assets, $1.6 million from equity related compensation and $3.5 million benefit from the fourth quarter of impact from the release of valuation allowance. Excluding these non-cash items, our normalize net income for the quarter was $22.6 million, up 19% over the last quarter and 80% over 2004. We earned $0.16 per diluted shares on a normalize basis, that’s on a fourth quarter diluted share count of 170.3 million shares which includes two months worth of the impact from our November equity offerings. For the full year, our GAAP net income was $328 million, which included $258.8 million full year benefit from the release of our evaluation reserves. Normalized net income for the year totaled $79.5 million or $0.52 of earnings per diluted share, that’s an $0.87 increase over the last year. Diluted shares for the full year was 156.9 million shares and we ended the year with $152.9 million shares up then.

Now, let me review some balance sheet items. We ended the year with $314 million of cash and cash equivalents and marketable securities, that’s up significantly from the end of Q3. Most of this increase is due to the cash from our equity offer - equity offering which close in early November. As many of you will recall, we sold 12 million shares of common stock and raised approximately $200 million. In addition, we generated $27.7 million of cash from operations during the quarter or 33% of fourth quarter revenue, that’s up from $19.5 million during the third quarter and up significantly from $15.6 million of cash from operations that we generated in the fourth quarter of last year.

For the full year, we generated $82.8 million of cash from operations, up from $51.2 million in 2004. Capital expenditure for the fourth quarter were $8.1 million, down from the third quarter. For the full year, CapEx totaled $36.2 million or 13% of annual revenue, consistent with our guidance. Days sales outstanding for the quarter were 53 days, up slightly from the prior quarter, due to the revenue related to the heavy seasonal bursting revenue that we expected to collect this quarter.

Overall, we are very pleased with the strength of our financial position, we have a strong balance sheet, a positive net cash position and we are generating positive cash flow each quarter, all the while improving our profitability. We look for to building on the success of 2005 by improving our performance in the coming year. As you recall, Paul and Bob provided you some of our early stock on 2006 during the October call. At that time, we expected revenue growth of at least 25% and normalize net income growth at least 40%.

With the fourth quarter results now behind us, and greater visibility into the year, we had increased our expectations for 2006 performance and we would now like to increase our guidance for both revenue and earnings. For revenue, we now expect to grow top line by 27% to 30%, year-over-year, which translates into an atleast $360 million in 2006.

For the full year we expect normalize earnings per diluted share to be at least $0.70, that would translate into EPS growth of least 35% year-over-year and normalize net income growth of over 50% year-over-year. Underlining this guidance, we expect that our overall normalized net income as a percentage of revenue will continue to expand.

Network or cost depreciation will be higher this year due to our increase CapEx investment in 2005. And as a result, depreciation and amortization expense, as a percentage of revenue will increase by a couple of points in 2006. But we expect the productivity improvement in our other operating expense line will more than offset that’s increased.

By the end of 2006, we expect our adjusted EBITDA margin to be in the range of 40%. Near term for the first quarter of this year, we are expecting revenue in the range of $84 million to $87 million. Adjusting for the impact of the seasonal bursting in the fourth quarter, the mid point of this range, which represents growth of about 5% quarter-over-quarter. And we are expecting normalized earnings per diluted share of $0.16 in the first quarter. Remember in Q1, we will have the impact of the full quarter of the newly exit shares from our recent equity offering and our annual resale of payroll taxes, which increases our labor cost across all operating departments.

Finally with respect to our EPS guidance, let me remind you that our normalize earnings has few adjustments from GAAP including adjustments for the amortization of intangible assets, equity compensation and the non-cash portion of our book packed charges. Also as a reminder, this is the first year that our GAAP results will include of book tax rate of approximately 40% and equity compensation charges consistent with that of FAS 123R.

We expect equity compensation charges would be around $0.20 on a full year pre tax basis. This compares to that of $0.17 in 2005 have we reported on the same basis. For the full year, we expect capital expenditure to remain roughly consistent with 2005 level, as a percentage of annual revenue. Similar to last year, we expect the larger portion of our networks investment to occur early in the year as we planned to take advantage of volume purchase opportunities and continued to optimize our networks. As I mentioned earlier, it was an exciting quarter to join Akamai, we are extremely pleased with our fourth quarter and full year 2005 results in virtually every areas of business. These results have given us the confidence and momentum to raise revenue in earnings guidance for 2006, which we expect to be another record year for Akamai. Now, let me turn the call back over to Paul.

Paul Sagan, Chief Executive Officer & President

Thanks, as you just heard, 2005 was a great year, as we look back, there is a lot to celebrate. We achieved the number of significant accomplishments that improved the financial strength of the company and positioned us well for future growth. Among the highlights, we launched our Web-Application Acceleration service at mid year, opening an important new market opportunities. We closed the accretive acquisition of Speedera in June, adding over 300 customers. We bought back the remainder of our 5.5% debt in September producing our overall long term debt, to only $200 million of 1% convertible notes. And then we raised approximately $200 million in equity in early November, bringing our balance sheet to a net-cash position for the first time since early 2001.

And last but not least, we grew revenue, customer count and normalized net incomes sequentially each quarter, making 2005 the most successful year in Akamai history. This success was a result of very hard work. Many long days and sometimes nights by the folks who work around the world for Akamai, and I want to thank them. Their efforts have benefited you, our shareholders immensely.

Now, as you look forward to 2006, we are excited about the momentum we see across the number of our verticals especially the media and entertainment, online commerce and technology fronts. And we expected to continue traction from our application acceleration service offerings, which is still in the early stages of the market development. We are particularly excited about the rising demand for online distribution of digital media. We have all witnessed the success of online music sales to consumers and now we are beginning to see content providers migrate their video offerings online as well.

Akamai benefits from this growth of online media distribution because content providers value the higher quality consumer experience over the Internet that we enable. As our enterprise customers recognize the success of the Internet as a distribution channel with media depends on the consumers experience. As we have more and more content providers to deliver rich media online, we will continue to target the premium content that drives profitable business models for our enterprise customers. Often, advertising support us for subscription based content. We believe our network architecture uniquely qualifies us to most defectively enable the high quality of distribution of media over the Internet. And several recent customers wins that help to validate our strategy.

In the fourth quarter, we started to working with Clear Channel, to deliver more than 400 radio stations to 8 million unique online listeners. Overtime, we planned to help Clear Channel bring all their 1200 radio stations online. We are also helping Stars with their new movie download service called Bango. With Bango subscribes had access to over 1000 featured films. STARS chose Akamai because they need a solution that will help them deliver high quality to large volumes of subscribers. If ever you have been asking about one of our multi-profiled customers in this category, Apple Computers, were we provide worldwide support for iTunes. Did you know, Apple is one of our longest standing relationships, I am pleased to tell you that we recently signed a new multiyear contract extension with Apple. And look forward to continuing to support ground breaking online efforts.

Now as, JD mentioned, part of fourth quarter success was due the higher than expected bursting activity from our online commerce customers. With an estimated

$2 million seasonal revenue boost from online shopping activity, e-commerce clearly remains the big driver of our business. But, we don’t expect, as much revenue in the first quarter from commerce customers in the long term outlook in this category, which appears very strong. According a to recent Forester report, e-commerce will take a 13% share of total retail sales by 2010, up from single digit today. We expect to continue to benefit from this trend because online merchants recognize that better performance translates into higher sales.

As we move into 2006, we believe further expansion of our content delivery business would drive the majority of our growth. At the same time, early response to our new web application acceleration offering is very encouraging. It indicates that, the customers understand the need for improved web based application performance, a deed that we believe will grow as more companies migrate even more business applications online.

Since we began offering the new performance service, we have closed business with several dozen customers. Importantly about two-thirds of the contracts are with new accounts. And we are really pleased that the application performance services are bringing us into a new market that is manufacturer. And we won’t be providing that in each quarter on the number of application acceleration service offerings we sell, who wanted to give you a six month update on our progress. We believe strongly over the next several years, more and more applications will move to the internet, in our expertise in using network latency would be more critical than ever as business look to improve the performance of their apps. In addition, we believe Akamai is uniquely positioned to offer a best of breed solution. Our service runs on our vast global network of servers at the edge of the Internet, away from the enterprises and enterprises origin infrastructure. And that offers not a point solution, it’s a global services scales that users needed around world providing better performance, greater reliability and higher security all at a lower total cost and without upfront capital expenditures.

Finally, before we wrap up, let me take a moment to thank our retiring CFO Robert Cobuzzi, for all of his efforts to help us build Akamai into the successful company it is today. From the time Bob joined Akamai, over three years ago, we have more than doubled our revenue, turned cash flow positive, become profitable and just capacity of our normalized net income by over 85%. We have been very fortunate to have Robert and JD over the lap with the company for the past few months to ensure a smooth transition for employees and investors. So, thank you Bob, you have helped Akamai achieve phenomenal results and positioned us well to exceed those results as we move into 2006. Now, JD Sherman, Robert Cobuzzi and I will be happy to take your questions.

Questions-and-Answer Session

Operator

Operator Instructions And your first question comes from the line of Aaron Kessler with Piper Jaffray.

Q - Aaron Kessler

Hi, thanks guys.

A – Donald Sherman

Hi Aaron.

Q - Aaron Kessler

Hi, how is it going.

A – Donald Sherman

Good, thank you.

Q - Aaron Kessler

Couple of things on the ARPU average revenue per user seems to have volunteered, should we expect at that pipe are now on Q1 given the e-commerce drops off a little. But you feel that Q4 or I guess, Q3 with the bottom for that, kind of addition to it also seems like you continue to grow at a nice rate of 80 plus. It is definitely the right level to think of going forward here and generally speaking, a lot of talks from web companies that they are increasing their investments in a more interactive sites, can you give us a sense what you are hearing from customers in terms of increased balance retirements, that they, when they redesign these sites. Thank you.

A – Paul Sagan

Sure, nobody want the first two together, because we don’t provide guidance on ARPU or customer additions, we’ve often said that ARPU could move sideways to down quarter-over-quarter depending on customers adds and seasonal traffic. We are certainly pleased with the results in Q4, we are pleased with another strong quarter of customers add. But increasingly, we are going to focus on the quality of customers and up selling within those corporate opportunity , so we don’t try to manage that or focus on it in too much detail, or try to provide guidance for you on it. And in terms of, what we are seeing from new customers, clearly people are trying to richen up their site, they understand that we remain competitive whether they are media sites or commerce site, or what have you. They have to compete to get audience and get business, have a rich site and often includes rich media interactivity audio and video and all that can drive usage of our services, I think, that is the activity that we saw on lot of ’05 and certainly expect that trend will continue in ’06. And It’s really being enabled by what I call “the virtue in the past�?, it is primetime in broadband, really the proliferation in broadband connectivity to the home, in enough homes that at any one time, a that site can find it’s niche audience to build the business on and that certainly is driving some of the expansion that we seen in our business.

Q - Aaron Kessler

Great, following a quick on model clarification, if pro forma net income of about 26.15, so that by share count $0.15 or $15.4, am I missing something?

A – Paul Sagan

You are missing adding back the interest for 1% offering, when you did a diluted share count for the 1% convertibles.

Q - Aaron Kessler

Okay, great.

Operator

The next question comes from Michael Turits with Prudential Equity.

Q - Michael Turits

Hi guys, good evening.

A – Donald Sherman

Hi Michael, how are you?

Q - Michael Turits

Good, thanks. First question, you mentioned, media in general, I think you mentioned video in particular, is this video now becoming a material portion of the revenue and how much of that contributes, you expect that today?

A – Paul Sagan

Well, we don’t break out segments that way. We certainly seeing more and more video, we have certainly always done video, we have been in streaming business for a long time. But I think that, the fundamental scenes that we are seeing is pay modules that allow people to monetize video, we have talked about will some of these examples before, usually baseball is a great example with a pay model certainly, now iTunes is a great example with the pay model for video. And I think, that is encouraging content providers and produces as if you will to put up video offerings, because they now believe that they can make money on it, it is not just a little bit of marketing on which they make an investment and hope it somehow gets returned in another way.

Q - Michael Turits

Thanks, could you guys comment on sharing it all, and obviously good net ad numbers, what supposed to be the direction on churn?

A - Paul Sagan

We didn’t comment in the text that churn still under 5% in the quarter and it was up a little bit quarter-over-quarter, lot of it was driven by some of the Speedera customers who are coming to the end of their contract and for you know, either they are small customers that we don’t want to renew or with acceptable, the policies we have, we have not renew those. So, churn picked up a bit for that but it is still under 5%.

Q - Michael Turits

Is there, are we getting through those Speedera customers or we should we start to see that go down and another of saying that is also, the express Speedera customers, do you think, they are still in the 3% of less range?

A - Paul Sagan

I think so, our goal is to migrate all of the customers within a year, that will take us into Q2, of ’06 and so there is some more of that to go through again, very small customers so we don’t think make them keep long term or people whose businesses let us say don’t need our acceptable use policy for doing business with Akamai that ph to be a little bit but I think, the, if you will sort of the core term is pretty close to our target and staying, they are all under control.

Q - Michael Turits

Last question if could, you are above, I think, little bit above 10% CapEx in terms of 8% of revenues in '05 and what you kind of thought it guides us 10% long term it sounds like a bit above again for next year. What are your thoughts on that long term and where is the CapEx going last year?

A - Paul Sagan

I think, it will stay probably close to where it was as a percentage of revenue in ’06, as compared to '05, we are just seeing such explosion of usage on the internet, the growth of video, to growth of traffic in a lot of interesting geographies outside the US. So, we are going to continue to make the appropriate investments in news service and in our network, ofcourse, some portion of our software development and capitalize as well as not just for hardware and the network. And we think that’s prudent right now and even that 12%, it’s a very small percentage of revenue compared to the typical service provider model.

Q - Michael Turits

Thanks guys.

A - Paul Sagan

Thank you.

Operator

Your next question comes from Katherine Egbert with Jefferies.

Q - Katherine Egbert

Hi Good Afternoon and a very good quarter, I have to ask Paul, is for you, about the impact Speedera pricing, something that, you have talked about in the guidance right now. Can you comment on, what that might do to, if it passes through the annual prices and therefore increase cost of goods?

A - Paul Sagan

Well you are referring to that the debate that something of the ISPs are having about trying to charge premium pricings for the delivery certain kinds of content. I don’t think, that will impact us directly, I frankly think that it is pretty bad idea because I think, it can overtime slow down overall broadband adoption by customers, which wouldn’t be good for the Internet. In general, as you may have noticed, there were hearings literally today on Capitol Hill about it, this is got the attention of both congress and the regulators, I think, they used it these efforts by some of the ISPs as very impact anti-consumer, so there is some possible that they will weigh and block it’s development and certainly being opposed by many content sites because they are concerned it could advantage one over another and clearly change the landscape of choice for the consumer. But I don’t expect that it will have really any impact in our business or effect our cost of goods sold because of the hesitative way that we work with about 1000 networks today that deliver content, brings them incremental benefit.

Q - Katherine Egbert

Okay, can you talk a little more broadly about online media, can you give us any senses of what you think the market is there for you, any sites or a kind of penetration rate. Just give us some qualitative information about, what iTunes and some of the other video and audio services are doing for you?

A - Paul Sagan

Well, you know I don’t break out specific customers and won’t give you , can’t really give you specifics on any account, that’s their propriety information and as a provider to so many of these sites, we really respect obviously their business confidentiality. But I can tell you that, we are getting seeing more discussions of delivering rich media content, some times that is video and some times that is music and some time that’s just as much richer website than ever before in the years that we have been working and we work with virtually every premier website certainly in this country and many other internationally as well. And they are all moving towards figuring out how to do richer media, which we think as an opportunity because there is the need for performance and quality goes up because if you got a live stream you can’t have latency in the middle and we will really excel to solving that problem for our customers. In terms of giving you a total market size I think the industry analyst Foresters and Gartners and others firms like that are probably much better placed to with their estimates, our view though is that as more people do it, it opens up more opportunity for us and allows us to grow our business. We think that some of the growth we saw in ‘05 and one of the reasons that today’s we are so bullish about our opportunities in ‘06.

Q - Katherine Egbert

Okay and then last question specifically on Apple you mentioned that you just renegotiated a multiyear contract can you tell us how long that is and then we all have been napping, you know we come up something that is very small permissible price for Apple and even that it seems like there should be a 10% customer because they release periodically how many videos or how many songs are downloaded so, can you just tell whatever you are able to about your relationship with Apple.

A - Paul Sagan

Well I’m afraid I’ll disappoint you. We have a great relationship there we are doing more today than we have ever done with them and we are really proud to support their efforts, they have succeeded and executed magnificently over the last few years we been honored to be part of that to be serve iTunes as well as their websites and their software delivery but I am going to respect the confidentiality of our relationship with them and any day that they want a release it is up to them. The relationship is as solid as ever and we are very pleased with all of the terms and we think that we deliver a lot of value and get paid for our service for it. I think that any 10% customer, it is our policy to release the names and so if we did we let you know who that was.

Q - Katherine Egbert

Did they burst in Q4 and will they burst in Q1?

A - Paul Sagan

I am not going to comment on that.

Q - Katherine Egbert

Okay thanks.

A - Paul Sagan

Thank you.

Operator

Your next question comes from Henry Naah with Lehman.

A - Paul Sagan

Hi Henry.

Q – Henry Naah

Hi guys. Congrats for a good quarter.

A - Paul Sagan

Thank you.

Q – Henry Naah

Welcome JD.

A – Donald Sherman

Thank you very much.

Q – Henry Naah

One question for Paul and one question for JD if I may. Paul I think a couple of pupils kind of touched on this a little bit earlier but customer ads 80 this quarter 94 last quarter obviously a marked increase of where it had been in 2004, 2005 what do you think is surprising the new customer ads. Is this web application acceleration service, or is it like just the more rich media, can you kind of point to what key average that are or is it increased productivity of sales force? And then one for JD if I can.

A - Paul Sagan

Yeah. I’ll answer the first and you can ask JD the second question. I think it’s the combination of the investments we made in our market facing organizations as well as such general acceleration of demand in the market across a number of verticals where we are well established and well know and I think we really worked to establish ourselves, content delivery networking, application performance are really well recognized. So I think that as besides think about, expanding the use of internet, going to business critical functions, using Akamai I think is an accepted part of the way they work, I think we have had great execution but the sales organization led by Bob Hughes to really train people well, go after great prospects and demonstrate the value to our customers. If you think I’m going to caution you and not have people focus on the net customer ads every quarter we try to sell the new business but we also try to find great customers reciprocate up selling and I think we have a long way to forth penetrate accounts. This one is a trade off of resources every quarter I’m going differ over time to Bob and his staff to think about where should we focus every quarter and sometimes it’s going for more new logos and sometimes it’s going to be for mining the accounts that we are in because we are in, 1900 premier places today. Well I think in most of them the opportunity to sell more so that it will drive same store sales up and we are just trying to balance that over the long term to grow the business. So far you know everything has been working really well for us and I’m optimistic that it’s going to continue and we’ll be able to balance doing both increasing in current accounts as well selling new but quarter-to-quarter it’s not a number that we sort of focus on too much and try to target a specific result.

Q – Henry Naah

Are there new verticals that you can penetrating better and you are getting little hangs kind of broad based.

A - Paul Sagan

Well, technology sales in the last two years I don’t think you can describe anything as well hanging through after Y2k and the web bubble people a little bit skeptical about spending technology money in other ways. We think it is pretty skeptical and that’s what we face when we go into new accounts because it is a great testament to our organization and our product offers that we have been so successful in the last two years. But we are seeing that more and more companies are understanding the use of the web and more and more business who maybe didn’t of the web as critical from a public facing marketing or media point of view are adopting it for the way people deal with their business as an extra net quarter for example. They maybe dealing with a small number of users but it’s always a login secure site if business processes and that’s where web application acceleration has gotten us into those accounts where we hadn’t been in. And into categories like manufacturing, chemical manufactures for example. One example of a company that signed up never probably would have bothered with our CDM server not because it didn’t work well but it just wasn’t a priority for them to have their dot com site work better, they didn’t really care that much about users and had a lot of other priorities for their IT efforts. But they are very concerned about their extra net quarter working over the web and we solved their problems for themselves. Certainly the innovation we worked on, the investments we made in R&D over the last two years, they have started to pay off by opening up some new avenues and I think that’s helped accelerate our growth and hopefully we’ll do the same over the next several years.

Q – Henry Naah

Great then for JD, in terms of operating expenses they have been ramping pretty, you know $4 million a quarter and last quarter before this year. Just wondering where you think that’s going to go and what’s pace of hiring on this chopped out.

A – Donald Sherman

Yes. I think we, if you look at last year we continued to expand our overall margins and that’s really where we going to focus this story and I believe we can continue to expand through productivity our operating margins at the bottom line. It’s not unusual if you look at 4th quarters in past we see a bit of spike up in the sales and marketing expense. We had a very good quarter in terms of revenue, in addition to that we had a good quarter in terms of new logos and signings that you saw and that drives a lot of commissions expenses. So we did see a bit of a spike up there, but as I said before I think in 2006 we continue to see our operating margins improve as revenues grows faster than we make investments in sales and marketing and R & D.

Q – Henry Naah

Great thanks guys.

A - Paul Sagan

You asked about headcount and here we’ll give you a little bit of our thoughts about that as well as we built into the model for this year. We ended 2005 with close to 800 employees and probably by the time we end 2006 will be a 10% to 15% higher.

Q – Henry Naah

All right. Thanks guys.

A - Paul Sagan

Thanks Henry.

Operator

Your next question comes from Jeff Liguori with Americas Growth Capital.

A - Paul Sagan

Hi Jeff.

Q - Jeff Liguori

Hi how are you, good afternoon. Let me follow up Henry’s question a little bit in the sales and marketing line, is there anything else in there maybe other than commissions and accelerators that’s driving that slightly greater rate that maybe we expected.

A - Paul Sagan

No we had we great quarter drove some additional commissions and accelerators but there is nothing that beyond that was unexpected in anyway.

Q - Jeff Liguori

Okay great. And Paul can you talk for a minute about the contrast between your opening remarks and the need for sites to drive more interactive content more heavy pages if you will. And some of the speculation that’s been out there about Google and moving into your space and effectively commoditising your business and those two don’t necessarily agree and wanted to get your thoughts.

A - Paul Sagan

Sure I will. I certainly stand by what I said before and believe that we are going to see increasing demands for our services and high value placed on it by our customers. We don’t view Google as a competitive in the market place, they are great company we are very focused on the consumer and the advertising business. They have a lot of technology demand on their side to keep their business going and I don’t think they are interested in competing in our space at all.

Q - Jeff Liguori

Great and with that the last question is can you talk about in the acceleration space who if anybody you are running into?

A - Paul Sagan

No we are not well, what we see mostly in this market which is already taken some form in the last couple of years and some estimates that $1 billion is already spent broadly on application performance. What we see mostly is that people have tried to solve this with a hardware solution. With a point solution that’s deploying a client as in a data center and it certainly provides some benefits, it provides some benefit in the data center but it does not solve the fundamental problems that the network layer provides or creates. And our services is a comprehensive global service provides benefits that no other solutions really solves and that differentiates our service model from the hardware. Of course think it’s why even as a new entrant in the market about the last six months we met with I think considerable success and that’s because the customers already identified if there is a problem and they figure out what they might do about it we have a credibility as an expert in internet performance and when we show them how apply some of old technology and some new engineering to solve this problem they are having, they are willing to sign up.

Q - Jeff Liguori

Great thank you very much.

A - Paul Sagan

Thanks Jeff.

Operator

Your next question comes from Todd Raker with Deutsche Bank

A - Paul Sagan

Hi Todd.

Q - Todd Raker

Hi guys nice quarter.

A – Donald Sherman

Thank you.

Q - Todd Raker

Just a quick financial house keeping. Could you guys actually give us the actually interest add back against your 16 digit number. And while you are scrambling around for that from a higher level perspective, comment a lot on my distribution and media and the driver. Can you give us a feel in terms of your core business how much revenue momentum is coming from mature customers just growing in their business organically ie the Apples of the world versus you guys signing new initiatives in the space. If you have to kind of quantify what percentage of the growth in that space is coming from, established players, will be curious just trying to feel what the market is growing organically at.

A – Donald Sherman

Okay just as quickly I’ll turning over to Paul to answer your broader question but it’s $700 and $10000 thousand a quarter or $2.8 million a year of interest income of the 1% convertibles.

Q - Todd Raker

Great thank.

A - Paul Sagan

And then I think I just back at the enveloping but I think probably about 50-50 new customer business driving growth and if you will same store sale.

Q - Todd Raker

Okay.

A - Paul Sagan

So it’s probably half driven by it’s existing customers continuing to grow their businesses online and half overtime are bringing on new customers, intuitively my guess is that will switch because new customers represent a smaller and smaller portion of whole customer base grown large. And there will probably more of that overtime will be if you will think for sales growth but we really haven’t modeled that too precisely.

Q - Todd Raker

And if you look at the same store sales portion of that can you give us some commentary in terms of as contracts are renewing what you seeing in terms of pricing.

A - Paul Sagan

What we really seen for the last several years, there is always price pressure in technology. But we do two things, one we drive growth in those accounts so they just using most of those volumes often makes up it and we sell them our more advanced services that’s has always been our effort for the last 7 years, is to add value in the platform and sell people increased functionality, web application acceleration is just one example but we really have portfolio of things that we offer our customers and in their online efforts to become more and more mission critical, they are more concerned with reliability, security, protection from denial service attacks, global load balancing, reporting and real time message of what’s going with their traffic and those are all things that we offer to add value that go beyond the traditional bandwidth pricing. So it continues to be something we focus on because it’s the nature of building a technology product or solution but I think our on going efforts in innovation and engineering keep us ahead of that.

Q - Todd Raker

Okay and then switching gears on three more questions for you. Can you just comment on the profitability both in revenue verses and the core revenue.

A - Paul Sagan

No we really don’t break that kind of metric out.

Q - Todd Raker

Okay. Is it generally more profitable, less profitable than core?

A - Paul Sagan

In general it’s probably more because we often get a premium and we can try to manage it very efficiently.

Q - Todd Raker

Okay, second question can you just give us a feel for where web application acceleration ARPU coming in is it below kind of the average, above. I assume it’s a little bit smaller deal size initially.

A - Paul Sagan

You know I’m not going to give you specific number but we are very encouraged by the value that our customer is seeing and therefore their willingness to pay for it.

Q - Todd Raker

Okay.

A - Paul Sagan

It’s really sold a day solution, it’s not sold as a data delivery model. So it’s really a solution sold as value based on what the customer’s business problem is and the scale of that so we’ve been able to really tradition that very successfully in the market if the customers are both seeing value for it and comparing it to much more expensive potential solutions such as building up a network of global data centers.

Q - Todd Raker

Then last question for you. Can you just update us in terms of the on going relationship with Microsoft and where that stands?

A - Paul Sagan

They are also one of our longest standing customers we have a very strong relationships with Microsoft. They haven’t been a 10% customer in while so we don’t breakout their number but we continue to have a very good relationship with them on a number of fronts.

Q - Todd Raker

Is it still basically a month-to-month relationship or is there chance that they will resign an annual contract for sometime.

A - Paul Sagan

I don’t comment on that contract. But we have a very good relationship with them I’m not concerned about.

Q - Todd Raker

Okay, thank guys.

A - Paul Sagan

Thanks.

Operator

Your next question comes from Jeff Van Rhee with Craig-Hallum Capital.

A - Paul Sagan

Hi Jeff.

Q - Jeff Van Rhee

Hi guys. A couple of questions like everything has been answered so I’ll be very pleased on the web app accelerator can you give us any context in terms of a broad goal a year or two out in terms where you would like to see it as percentage of revenues in general and then secondly in correlation with the CapEx questions Speedera brought you some infrastructure, services and number of other things the CapEx does that assume the ability to use this Speedera servers particularly once people are mapped over. Thanks.

A - Paul Sagan

Sure, the Speedera migration plan is moving along the path that we have outlined before so we certainly expect after we finished the migration we recovered some infrastructure and to be able to reuse some of that investment it’s not massive but we certainly will reuse some everything we can that’s worth salvaging there. And in terms of web applications acceleration, I certainly have put down some markers if you went for the sales in the marketing although this is internal goals but as long as the all aspects of the business grow I am not concerned about what percentage web application acceleration grows to as a piece of the overall.

Q - Jeff Van Rhee

Okay thank.

A - Paul Sagan

Thanks Jeff.

Operator

Your next question comes from Erik Zamkoff with Morgan Josefh

Q - Erik Zamkoff

Hi guys this is Erik Zamkoff with Morgan Joseph, congrats on a great quarter.

A - Paul Sagan

Thanks Erik.

Q - Erik Zamkoff

I was wondering if you can focus on a couple of big picture topics. We hear a lot of talk and there has been some questions about Google and possibility of commoditisation of the business etc. Can you talk to how Moore Law impacts you on the far side ie your CapEx what you spend in 2006. You should be getting more storage, better memory, better performance in the server than what you bought previously and how does that figure into the whole equation in terms of maintaining gross margin and then number two given Speedera at the time of acquisition was the price aggressor and one can argue with the largest direct competitor, who would you take right now as your competitor that you see the most in the market place in the course see the embers?

A - Paul Sagan

Well let me answer those in reverse order. We actually covered the Speedera competition at some length in the past but I have to review it again so if you look at the customers and revenue they brought over I think what people were clearly described about was that their ARPU was very healthy and then by and large they got a very strong enterprise customer base as well and so the pricing difference was not what people had necessarily thought they would see at the time which was one of the reasons when we did our dudiligence we were so pleased with the acquisition and that turned out to be really one of the highlights of last year leading into this year. What we see in terms of competition is really what we seen consistently the main competitor remains do-it-yourself so they think why should I outsource this problem, I’ve got a big infrastructure, big budget and an army of people why can’t I just keep figuring out how to run my network problems for my network my staff has been solving the problems on my own. So Our biggest challenge is to showing people how we can make their online efforts more reliable, more scalable and more secure, and then I think you really help me answer the first question, Morse law certainly helped us, the server we buy today is far more powerful, and far less expensive, for that power than the one we bought six or seven years ago when we started to build out the network, some of those 300 servers are still out there, running just fine, and many of the new servers that we have deployed, you know really put the, the performance of the old ones to shame and so that benefits us, it allows us to manage our physical footprint, very efficiently and frankly the need to demand of increasing traffic we’ve seen grow over the last two years in many way is driven the broadband content of our customers.

Q - Erik Zamkoff

One last follow up, I mean you raised the good point, if your competition today, I agree with you, is in-house do-yourself-guys, are you having an easy, would you characterize it as easier self today, than it was a year ago or two years ago when you walk into a potential new customer and present your value propositions?

A – Paul Sagan

I think there is greater understanding today of our value propositions, but as I said earlier nobody throws money around, today in technology purchases, you have to prove the return on investment, it is your offer, you have prove the performance and fortunately we have I think a great reputation, in the market, a great brand so people understand that we are reliable and that we have a reputation for doing what we say we will do and trying not to throw our promise, but I think it is wishful thinking for anyone, to believe that we are going to get to a stage, you know people just call you up and throw money at you, for technology purchase, customers believe that choice, they want to make sure, they are not completely lost in any one solution, that is in there, and it wasn’t lot of fun, but we have been very successful at partnering well, showing the value and obviously winning the confident of many many leading brands, and our goal is to continue to do that. Operator I think we gave time for two more quick questions, before we wrap up.

Operator

Your next question comes from Robert Stimson with W.R. WR Hambrecht.

Q – Robert Stimson

Hi Paul, Hi Judy, just a couple of quick ones, one is, is the Microsoft One Care, is going to be part of the Microsoft project, can you comment on that or not?

A – Paul Sagan

No sorry, I can’t really give you any specifics by customer, that, it is our policy not to do that.

Q – Robert Stimson

Okay, and then can I ask you just, another question is, was the Superbowl traffic this year, a lot bigger than what you saw last year this time?

A - Donald Sherman

You know, We didn’t, I didn’t do that kind of comparison, we obviously carried the majority of the Superbowl advertisers, you may have seen our online index, that tracks usage and those are some interesting stuff and other odds, including some great PR for Akamai in a number of newspaper and online reports, but we didn’t do a aggregate comparison year over year. My guess is, in the entirety it got more broadband use, but we haven’t looked at that.

Q – Robert Stimson

Okay. Thanks, JD, real quick, Op margins, you know, you are getting, where do you think if you had a much higher revenue run rate, what are peak Op margins, what can they get to, or we talking 40% plus or where do you think those numbers could go, if we are running at $400 million in revenue etc.,

A - Donald Sherman

We haven’t talked about, kind of peek out, very far in the future but as I said in my comments, we do see the margins getting in the 40% range, by the end, the EBITDA margins by the end of 2006. So I think this business, has shown that it has a scalability in terms of improving margins over the last couple of years, I think we still have the capability to continue to expand those margins, I am not going to project beyond that, in terms of where we will end up. But we clearly are going to, the other two will drive some productivity.

Q –Robert Stimson

And real quick on the CapEx number that you gave, how much would you say is kind of CapEx percentage storage build out, I know you got, spending a lot of money incrementally to deal with something in the digital media versus traditional servers, are bigger mix going on there on the same side versus the traditional servers side?

A - Donald Sherman

We haven’t really broken out, I am sure where you have drawn that conclusion about how we spend the CapEx by title of hardware, and we are not going to break out, those numbers to do, I think frankly that is proprietary information and doesn’t help us to put that into the market place.

Q –Robert Stimson

Okay. Great, thanks everybody.

A – Paul Sagan

Thank you, operator why don’t we take one last question?

Operator

And your final question comes from Douglas Campbell with Spirit Capital.

Q – Douglas Campbell

Hi. I am guessing that the companies that have a lot of content delivery business to do, know about you and me, you know about them, and many of them already are our customers, on the other hand, you mentioned that in the half accelerated business, 2/3rds of the signups were customers new to AKAMAI, my guess would be that there are lot more in this, it is more of a Greenfield opportunity for you, and there are probably a lot of extra nets out there, who may be spruced up a little bit, just of sort of broad framework, is there an opportunity that could equal your current business, a few years down the road, or have you, how do you look upon them?

A – Paul Sagan

Well, I look on it, as a great opportunity, we think It could develop into a large market for service provider like AKAMAI, our guess is that, because it is such a large opportunity you will see lots of different solutions in the market, you will see other service providers trying to put solutions into the market that certainly have the appliance players who can consolidate a month under the big hardware companies pushing very hard into the market, that is going to great for us, because it is going to really raise awareness and then we really believe that we are going to be unique, because we are one of the few companies able to offer a service and then on top of it, we really are the only one who can give you a whole portfolio that shows the content deliveries and does app acceleration and finally can actually be distributed completely vitalizing you data center, so we think we are very well positioned, I don’t want to speculate on whether it is you know, as big or bigger than our current business, the business continues to grow then, I will be happy, from just to both chase each other in growth and we’ll continue to have more happy results. At this point we are just focused and will have our head down on the business in trying to meet our objectives for this year and continue to innovate and have things that our customer want to add to the order form if you will in years to come.

So why don’t we stop there, thank you all for joining us. Look forward to reporting back in another quarter. We are all thankful for your support in ’05 and look forward to reporting back to you again in ’06. Bye Bye.

Operator

And that concludes today’s conference call. You may disconnect at this time.

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Source: Akamai Technologies Inc. Q4 2005 Earnings Conference Call Transcript (AKAM)
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