Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Noelle Faris – IR

Paul Sagan – President and CEO

J.D. Sherman – CFO

Analysts

Mark Kelleher – Canaccord Adams

Michael Turits – Raymond James

Mark Mahaney – Citigroup

Tom Watts – Cowen & Company

Rob Sanderson – American Technology Research

Tim Klasell – Thomas Weisel Partners

Colby Synesael – Merriman

Rod Ratliff – Stanford Group

Sri Anantha – Oppenheimer

Garrett Bekker – Merrill Lynch

Kirk Materne – Banc of America Securities

Derek Bingham – Goldman Sachs

Akamai Technologies, Inc. (AKAM) Q2 2008 Earnings Call Transcript July 30, 2008 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2008 Akamai Technologies earnings conference call. My name is Antoinne, and I will be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions)

I would now like to turn the call over to Ms. Noelle Faris, Senior Manager of Investor Relations. Please proceed ma'am.

Noelle Faris

Good afternoon and thank you for joining Akamai's investor conference call to discuss our second quarter 2008 financial results. Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer and J.D. Sherman, Akamai's Chief Financial Officer.

Today's presentation contains estimates and other statements that are forward-looking under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements.

Additional information concerning these factors is contained in Akamai's filing with the SEC including our annual report on Form 10-K and quarterly report on Form 10-Q. The forward-looking statements included in this call represent the company's views on July 30, 2008. Akamai's disclaims any obligation to update these statements to reflect future events or circumstances.

During this call, we will be referring to some non-GAAP financial measures that we believe are helpful to better understand our financial results and operations. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. You can find definitions of these non-GAAP terms and reconciliations of these non-GAAP metrics to the most directly comparable GAAP financial measures under the news and publication portion of the investor relations section of our website.

Now let me turn the call over to Paul.

Paul Sagan

Thank you, Noelle, and thank you all for joining us today. Q2 is a solid quarter for Akamai, with healthy earnings and revenue growth. Financial highlights for the second quarter include record revenue of $194 million, a 27% increase over the second quarter of last year, and a 4% increase over our the first quarter this year.

Normalized net income was $76.5 million, or $0.41 per diluted share. That's a 38% increase over normalized net income from Q2 of last year and consistent with our strong Q1 results. We are especially pleased to achieve these Q2 results even as we began to see the impacts of a more challenging economic environment in some customer verticals. At the same time, we continue to experience solid growth in many of our newer service areas such as application acceleration for business to business services and dynamic site solutions for ecommerce.

I'll be back in a few minutes to talk about some of the trends we're seeing in the market, but first let me turn the call over to J.D to review our second quarter results in detail. J.D?

J.D. Sherman

Thanks, Paul. As Paul just highlighted, our business performed well in the second quarter in a more challenging environment. For the second quarter, we grew revenue 27% year over year and 4% sequentially to $194 million at the low end of our expectation range coming into the quarter. Our Media & Entertainment vertical grew roughly inline with the overall business and remained an important contributor to our second quarter financial results. But as I mentioned last quarter, media growth has moderated from the pace we saw for several years during the period of rapid broadband adoption.

Growth in our commerce vertical continued to be very strong. Again it was our fastest growing vertical with more than 50% increase year over year. We also continue to make progress with our newer value-added solutions such as Application Performance Services, Dynamic Site Solutions, and Stream OS. These higher margin areas contributed to the improvement in profitability in the quarter as demonstrated in both our gross margin and EBITDA results.

During the second quarter, international sales represented 26% of total revenue, up 1 point from first quarter levels. Our international business performed very well growing 8% sequentially and 45% year over year. Revenue in North America, where we saw the largest impact both from the economic factors and media trends grew 2% sequentially and 22% year over year. Resellers represented 16% of total revenue consistent with the prior quarter. Once again, no customer accounted for 10% or more of our revenue in Q2.

Our consolidated ARPU, our average revenue per customer was up 19% year over year to $23,700 in the second quarter. This is the result of our focus on building deeper and broader relationships with our enterprise class customers by selling new more advanced solutions into our customer base. We added 53 net new customers in Q2 bringing our total customer account to 2725. Our gross adds brand new customer to Akamai increased to about 170 this quarter. Churn was again just over 4% primarily due to churn from smaller customers. The ARPU of our new customer adds continued to be well above the average revenue of our churned customer.

Our cash gross margins for the quarter were 82%, up from 81% in Q1 and down about 1 point from the same period last year. As we had expected our gross margin stabilized with the growth in sales of our Dynamic Site Solutions and Application Performance Services, which have a higher gross margin our media delivery deals.

Our GAAP gross margin, which includes both depreciation and stock-based compensation was 72% from the quarter, consistent with Q1 and down about 2 points from Q2 of last year. GAAP operating expenses were $88 million in the second quarter, these GAAP numbers include depreciation, amortization of intangible assets and stock-based compensation charges. Excluding these non-cash charges, our operating expenses for the quarter were $65.9 million, up $900,00 from the prior quarter, which is down slightly from the prior quarter. Adjusted EBITDA for the second quarter was $92.7 million, up 6% from the prior quarter and up 41% from the same period last year. And our adjusted EBITDA margin of 48% was up 5 points over the same period last year, and up 1 point from the first quarter.

For the second quarter total depreciation and amortization was $23.4 million, up from $22.6 million in the first quarter. These charges include $17.7 million of network-related depreciation, $2.2 million of G&A depreciation and $3.5 million of amortization of intangible assets. Net interest income for the second quarter was $4.8 million, that's down $2.6 million from Q1 as interest rates decline despite a growing cash balance.

Moving on to earnings, GAAP net income for the quarter was $34.3 million or $0.19 of earnings per diluted share. As a reminder, our GAAP net income includes non-cash charges for stock compensation related to FAS-123R and book tax charges at an effective annual rate of approximately 40%. However, because of our significant deferred tax assets, we are paying cash taxes at an annualized rate of about 2%.

During the second quarter, our stock-based compensation expense was $18 million or $0.10 per diluted share on a pre-tax basis. A breakdown of our stock-based compensation charges by operating department is available in the supplemental metrics sheet posted in the Investor Relations section of our Web site. Additional non-cash items and GAAP net income for the quarter include $3.5 million from amortization of intangible assets and a $207 million non-cash tax charge.

Excluding these non-cash items, our normalized net income for the second quarter was $76.5 million, 38% higher than our normalized net income for the same period last year and up $900,000 from a strong Q1. In the second quarter we earned $0.41 per diluted share on a normalized basis. That's a 37% increases year over year and consistent with the prior quarter.

Our normalized weighted average diluted share count for the second quarter was 189 million shares. Now let me review some balance sheet items. Our cash generation continues to be very strong. Cash from operations for the second quarter was $70 million. Year to date, we've generated $158 million of cash from operation or 41% of revenue. That's up 78% compared to last year. At the end of Q2, we had $745 million in cash, cash equivalents and marketable securities on the balance sheet.

This balance includes $280 million of AAA-rated federally insured student loan auction rate securities, which we continue to treat as long-term investments in Q2. In the second quarter, capital expenditures, excluding equity compensation were roughly $30 million. Day sales outstanding for the quarter were 58 days, down 1 day from the prior quarter. Overall, we delivered a solid Q2. We were pleased with the continued growth in our traditional market verticals, as well as the increased traction of our new solutions across our broad customer base, which helped to improve our operating margins. With the first half of 2008 behind us, it is becoming clear the pressure is being felt by many of our customers from the economic environment that will not ease in the short term.

Further in the media space, while our clients continue to develop higher quality video initiatives, we are not expecting this trend to impact the back half of 2008 significantly enough to offset the pressure from the general economic environment. Based on the trends we are seeing, we now expect to come in for the full year at the low end of our earlier revenue guidance or slightly below. So, we are updating our guidance to revenue of between $785 million and $800 million for the full year or 23% to 26% growth.

As for our earnings expectation, we expect cash gross margins will trend down about 1 to 2 points for the full year, slightly better than our previous guidance. And our full year adjusted EBITDA margins should expand by roughly 2 points, compared to the full year 2007 as we said earlier. However, with the lower-than-anticipated interest rate impacting our interest income as well as the slower top line growth, we are also likely to be at the low end of our earnings guidance or slightly below. So, we are updating our earnings guidance to $1.63 to $1.69 of normalized earnings per share. That would translate into year over year normalized net income growth of 23% to 28%.

We continue to expect capital expenditures excluding equity compensation to be about 15% to 16% of revenue for the year. As I mentioned on our call last quarter, this capital investment level also includes leasehold improvements we have planned for our two primary offices, cost that will offset some of the efficiencies to expect to achieve from our network operations.

On our non-cash item, we now expect equity compensation to be about $0.34 to $0.35 per diluted share, compared to our previous guidance of $0.37 to $0.39 per diluted share on a pre-tax basis. .

Looking more near term, the third quarter tends to be the seasonally slowest quarter for our customers, especially those that are most sensitive to the seasonal changes in traffic levels. And for the third quarter this year, we're expecting revenue in the range of $193 million to $198 million. At the midpoint, that translates into 21% growth over Q3 of last year. But this revenue range, which is a bit wider than our typical guidance, we are expecting normalized earnings per diluted share for the third quarter in the range of $0.39 to $0.40. We expect gross margins to decline modestly by less than 1 point sequentially and EBITDA margins in the range of 46% to 47% for the quarter.

While we have seen a slowdown in growth in media, we believe that the longer-term prospects for Rich Media online remains very attractive, and we think that we are well positioned to capture that opportunity. In addition, our success in verticals beyond media as well as with our value-added solutions help to sustain growth and improve profitability in the first half of the year. And they represented significant additional growth opportunity going forward. Given the investments we've made and continue to make in these areas, we believe that Akamai is well-positioned to benefit from the long-term trends of business moving online even in a more difficult external environment.

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

Paul Sagan

Thanks JD. Clearly the economic climate has changed significantly from where we were even a couple of months ago. But as our second quarter results demonstrate, we believe we are well-positioned in the diversity of our enterprise class customer base in our broad portfolio of value-added solutions. JD mentioned that growth in our media and entertainment vertical has moderated a bit from prior years, and I would like focus a bit more in detail in what we are seeing there. It's not that this market is less promising. Explosion in traffic growth that we saw over the past couple of years has simply moderated, but we remain very excited about the future of media and entertainment online. This is particularly true because the industry is moving toward higher quality video, and that is where Akamai can deliver at a scale and quality level that we believe is unmatched.

Many of our conversations with customers in the media go improving their performance in quality of their rich content, and extend to how we can help them with their monitorization model. We are pleased with the results from our investment in Stream OS because it helps our customers manage and monetize their assets for example. Outside of media we've seen strong growth particularly for some of our newest offerings such as Application Acceleration, and our Dynamic Site Solutions. Innovating in these categories and continually adding enhancements to these newer solutions isn't by chance, it is a deliberate strategy to diversify and extend our portfolio and invest our R&D dollars where we believe we will see the best returns, and we think that's exactly what's happened.

One example is our commitment to the application space in our recent announcement that we partnered with Citrix that compliment the net scale of product by teaming a (inaudible) based product like Netscale [ph] with our cloud-based Web Application Accelerator service, we are able to bring true end-to-end Web Application delivery performance to enterprise customers worldwide. We believe more and more of the market is coming to understand that there are inherent issues with Internet performance in the cloud, and that our capabilities provide and ideal compliment to what customers are trying to do in their data centers. We are very excited about growth in the area of Web Application Accelerator, we are currently providing these services to hundreds of customers and accelerating many critical business processes.

And these services have allowed us to penetrate new verticals such as farm and health care where we are helping to accelerate applications used in initiatives like clinical trials. You might have seen a recent study by NetForecast that highlighted how Akamai can significantly improve the performance of Internet connected SAP users around the world. The business benefit of this is that enterprisers can extend productivity towards from the consolidate data centers to a global user base, another of our value-added service is Dynamic Site Accelerator. This is especially valuable to clients with online commerce sites. In just a year, we've more than doubled the number or customers leveraging this capability from Akamai.

One customer example is JC Whitney, a large direct marketer of auto parts and accessories, they have leveraged our services to achieve significant improvement in site performance. They have seen an increase of almost 10% in online shopping conversion rate since deploying our solution. But we remain very excited about traction with our value-added offerings and their acceptance out in the market. While companies are adjusting to the current climate, most are finding they don't want to cut back significantly on their Internet investments, and our solutions remain critical to helping them grow their businesses online. Much of our continued success will come from our ability to help our diverse customer base, find ways to drive new revenue online and to help them to become more efficient by moving more and more business processes on to the Internet.

Now JD and I would be pleased to take your questions. Operator, if you could accept the queue and take the first question please.

Question-and-Answer Session

Operator

Ladies and gentlemen (Operator instructions) your first comes from the line of Mark Kelleher with Canaccord Adams. Please proceed with your question.

Mark Kelleher – Canaccord Adams

Thanks. Hi, guys.

Paul Sagan

Hi, Mark.

Mark Kelleher – Canaccord Adams

I was just wondering if you could talk a little bit about the competitive environment in the media and entertainment market, what makes you think it's a slowing in media and entertainment market and not a competitive situation there?

Paul Sagan

I think we've always said that we were in competitive markets for a decade of history. So, that's always been a fact of life, and it remains a competitive market. And I want to be careful if people understand what we are saying. We are not saying that the media and entertainment market is slowing online, what we are saying is that traffic growth on many of these sites, the rate of that growth is not the pace we saw a couple of years ago. And I think that that's not there are fewer users, but what we've seen is that we got broadband adoptions, particularly in the US and that drove not just the number of users but how much each user was consuming. What we are seeing now is that users continue to use more and more but the pace at the which they can consume is effectively thick [ph] by the amount of broadband they have. As the pipes get bigger people can consume more things like Rich Media video etcetera, and we believe we'll see adoption all the way up to HD, where Internet video effectively competitive with traditional videos that are in homes today over cable or satellite or whatever means people are using. So, we are seeing isn't a slowing in that market at all. We continue to believe that our win rates are good, that we have relationships with most of the major players not just here but internationally in the media space. And so we benefitted as they grow, but what we are seeing is that they are just not seeing the pace of growth of traffic that they had experienced say on average couple of years ago. So, the competitive environment remains and we face that all the time, that's why we focus on monitorization tools, software tools that differentiate our higher quality and scale, but we see is just derivative, which on average site is growing. In the media space it doesn't appear to be today what it was say 18 months ago.

Mark Kelleher – Canaccord Adams

Okay. And then just lastly, could you give a quick number on the bursting? Was that around 30% again?

J.D Sherman

Bursting was on the low side this quarter. We got as where we are in the low end of our guidance. The other point I would make on bursting is, it's particularly in the media space we've seen our customers rather than make their traditional period commitments in terms of our monthly commitments, they are making longer-term commitment say an annual commitment or quarterly commitment. And what that allows is for a little bit more – allows them to balance their usage patterns better with their business, but it also does put a little bit more of a sensitivity in our business in the usage. So, I think in some sense particularly in the media space, usage is growing an important – there are 70 authority guideline at least in the media space, it's becoming a little less of a guideline.

Mark Kelleher – Canaccord Adams

Okay. Thanks.

Paul Sagan

Operator?

Operator

Your next question comes from the line of Michael Turits with Raymond James. Please proceed with your question.

Michael Turits – Raymond James

First of all, you said that because of macro you are brining down the numbers and you think it's more of a traffic issue. Another question was asked about competitive, is there anything which you say I didn't change. Is there been any effect on pricing as pricing any worse than it has been? And second why you are guiding down on margins sequentially if revenues is about same? And then maybe drill into the gross adds in churn because it's kind of got in a different direction, perhaps sequentially why you are adding a lot less but still adding a lot more gross, but still churning a lot?

Paul Sagan

Yes, Michael I think we got all three parts of the question you are breaking up a little. So, as I say (inaudible) will take your call offline or we'll answer that offline for you. But I think we got three points in that. I think JD can talk on that.

J.D Sherman

Yes. Let me start with the pricing. I think Michael the pricing environment has been as we've talked about pretty competitive for quite some time, and I don't see any major changes in that. We got to the point I would say particularly in the media space several quarters ago where there's not a major out there that there's not at least a competitive commodity benchmark in terms of the price. So, I think that – we expect that to continue for a long time. So, I don't really see any difference there. There was the one difference as Paul pointed out is we don't see that natural growth in traffic at the same levels we saw with the broadband explosion. I think the second question was on margins on a quarter-over-quarter basis. I think we will see a modest decline in margins even with revenue roughly flat because of depreciation is going to grow quarter over quarter as we continue to add CapEx. So, that's a major feature there, and also we continue just to grow the head counts to manage the larger and larger network. But I think overall we've seen that trend moderate, and just as we thought we would as the business starts this transition and shift towards more value-added services. And what was the third part of the question?

Michael Turits – Raymond James

Churn question.

J.D Sherman

The churn, yes. I think 117 new adds was consistent with the rate we had been at before the prior couple of quarter with maybe a little bit low in the 140 to 150. I think – so I don't think there's a major difference there. We are really pleased with the new adds, particularly given that a lot of the new adds are at larger ARPU levels and are buying our advanced our value-added services. The churn continues to be around 4%, and as I said that continues to be from smaller customers where we really have turned our focus more towards the enterprise class customers. So, I think we felt pretty good about the customer dynamics this quarter.

Michael Turits – Raymond James

While talking of follow-up on the –

J.D Sherman

The margin performance was extremely strong and I think goes to the value that we are getting in accounts particularly in enterprises. So, operator next question please. Thank you.

Michael Turits – Raymond James

Thanks.

Operator

Your next question comes from the line of Mark Mahaney with Citigroup. Please proceed with your question.

Mark Mahaney – Citigroup

Could you talk about any the quality of those customer adds you had during the quarter? Any sense of where they come from, are they Greenfield new to the CTN industry? Do they come from other companies? Could you just go over and clarify just a little bit more exactly how the economic weakening macro environment impacts your business? Do you see it more in terms of being inability to get pricing, is it really traffic from end consumers that's falling off, where – how exactly does a recession impact your business? Thanks.

Paul Sagan

The quality of the adds has been very good worldwide. And we really focus on quality enterprise customers, and that too we are targeting for our growth into the value-added services because it's the eCommerce side, it's a business to business (inaudible) the mission-critical business processes that are going online along with the media and entertainment sites that we are targeting, and we are looking for large enterprises who can grow and build the volumes in our customer base close of absorbing new products as well as traffic growth. And we are very pleased with the quality of the pipeline and the work that the sales staff did really in every region around the world, and particularly international which has been really strong. And I think that's no surprise given the general economic news of the US economy being weaker and the international and Asia being much stronger. And I had been to Asia once and Europe twice in the last few months, and that validates what we are hearing. I have seen that first hand. We shouldn't mix up the economic factors and traffic. It's not that I think consumers are hurting in the (inaudible) the more against market or something and therefore are not consuming as much. The consumption issue is really a question of how much can people consume if they are going to be online say for an hour a day, and they are going to consume video and they don't have High-def and they can only do at a cable modem speed that limits how much traffic growth. So, what you'll see is not that the same hour month over month is more data as they go from an hour to an hour in 15 minutes, but the growth is there but the amount that they can consume in an hour if you will in 10 minutes of experience can't grow if you bandwidth doesn't grow. And so what we are seeing is though we are leveling out of last mile bandwidth, and that has really nothing to do with the economic situation. I wasn't trying to imply that weren't upgrading their connectivity because the economy is not bad at all. The economic issue is really either in verticals that we sell into where people are feeling strong pressure in the economy manufacturing, automotive and then may be slowing down, purchases are being much more sensitive to how much they buy, they start a new project, how many features they add online. And I think in the media space where the economy does have some effect is in the pressure on advertising both online advertising but in particularly offline advertising and where the media companies are really feeling squeezed that gives them fewer dollar to invest in new online initiatives that might drive people to consume more right now. There's not one single event there, we just didn't take as a whole, it's created a little more headwind at the middle part of year, and it's made us feel a little more conservative about the back half of '08. But it doesn't in any way dampen our enthusiasm about the core business or that really every industry is going more and more to put their process online but in some cases they've slowed down some of the pace of that rollout.

Mark Mahaney – Citigroup

Thank you Paul, it's very helpful.

Paul Sagan

Thanks Mark. Next?

Operator

Your next question comes from the line of Tom Watts with Cowen & Company. Please proceed with your question.

Tom Watts – Cowen & Company

Thanks for the clarification between the effects of the economy and the broadband usage. If the economy were to recover, what would be the areas that you think would pick up? Is that going just attraction of new customers or trade after additional applications? And then secondly, could you just comment on the cash flow earlier, (inaudible) that was a very attractive free cash flow profile. Are there any other than trying to pay cash taxes or is there anything in the future that could interrupt those free cash flow trends such as a major CapEx investment or something else?

Paul Sagan

I'll take the first part. I think the general economic issue really is vertical specific for us. So, commerce how much people are driving more efforts online particularly b to b not b to c, there's a lot of growth there. But more b to b initiative, automotive as you know is really a hammered sector which was trying to make a lot of changes to the digital world. Those are the kinds of the things where anecdotally some of the regions are starting to see longer sales cycle and people being a little more conservative about ruling a project. Now we don't see them being wholesale because this isn't a stoppage in growth, we are just seeing a little more conservative about the pace at which we think these things are coming online and wanted to make sure that we have our own expectations, is that correctly. So, if there was a shorter impact on the economy, overall we see the pickup in those sectors. One would presume that would offset an impact the broader ad market and that would drive more spending by media companies. And again a lot of that could be spending in their traditional non-online initiatives or revenue in them allowing them to invest more online. So, again they are doing more online, the question is the pace at which they feel they can afford to go there. And then I'll let you JD talk about cash flow, but I will comment that there's no – and Tom you've known us for 10 years nearly, we don't have a single upgrade event in our CapEx or network model that would necessitate some major change in cash flow.

J.D Sherman

Right. That's pretty much what I was going to say Tom. And we talked about our long-term model at our last Analyst Day, and as Paul said, we don't think we have step function or a need to step function the way we build out our network. We think it's nice incremental investment we think that we spent CapEx in the range of 13% to 16% of our revenue. And you can see as our performance over the last few years, the model really scales nicely when you look at it on a cash flow basis, and I don't see any major significant event changing that in the near term.

Tom Watts – Cowen & Company

Okay. Thanks.

Operator

Your next question comes from the line of Rob Sanderson with American Technology Research. Please proceed with your question.

Rob Sanderson – American Technology Research

Okay. Thank you, good afternoon gentlemen. I have a couple of questions, first on the media and entertainment vertical, do you think there's really a rationalization of the amortization model going there. We've heard about tune the big video portals started missing their expected ad revenues, social networks coming in a little bit late as well. Do you think there's some sort of bigger trend there, where there is bit more of a rationalization of the business model and a little bit of slow down on that? And I have a follow-up.

Paul Sagan

We are certainly seeing one of the areas where traffic is going strongly is in some of the social networking category. So, it's always dangerous to over-generalize. But you have heard me say, I think quarter over quarter for a year now that I thought there was some of those models that were more suspect [ph] than others, and if there would a rationalization of that market. So, that may be a piece of what's going on. I'm not sure that that ties directly to what we've seen effecting traffic growth. In fact I'm not sure that it does. Some of the side report crazy levels of traffic with no means of supporting it. And so their business model I think particularly if tougher times come economically, we'll get rationalized probably means that there'll be funding would dry out from such thing. But I think that that maybe going on but I don't think that's what we are seeing in terms of general traffic. Most of it is really across the board of I think just the limitation on broadband consumption hasn't again dampened the pace of growth. I think it's very important that all we are talking about here is the slope of the (inaudible). Last time online or last consumption, it's just a rate of that growth we think has moderated a bit more than we expected to moderate.

J.D Sherman

Yes. I would just add to Paul's point earlier. There's definitely an imperative from these businesses and sites to improve their modernization which is why some of the discussions we have with our customers around how to better and more effective monetize their websites are – that's really something that we are seeing heating up.

Paul Sagan

Do you have a follow-up, Rob?

Rob Sanderson – American Technology Research

Yes, I do. Just more of a macro level. You guys are in a unique position seeing so much of the world's Internet traffic. And I know you spend a lot of time looking at traffic trends. Any notable clues there that should help us may be figure out the macro economic climate if it's strength or weakness in certain industry verticals or anything notable that jumps out just from the global traffic trends that you monitor?

Paul Sagan

Yes. The traffic trends in commerce are very, very strong. And that continues and I think there's a number of things. I think one there's just was a trend that people doing more and more shopping online like they are doing more media online. It's not quite at the same pace. And some of the macro things maybe influencing it. We've all read high gas prices, people aren't going to the malls (inaudible) still need to do some of their shopping, they are doing it online. So, we are seeing strong trends there in traffic, so that might be other things that we could seek out one other things that gives us some confidence about the eCommerce sector for the rest of the year, one of the verticals that's very important to the services that we provide. We think that services are important to that vertical. Also we continue to see very strong or stronger growth internationally, which is not a new trend, we've talked about that but we don't see any impairment there. I do think that it's also – we should be cautious about trying to read too much into traffic trends and correlate it because people are using the Internet more and more even if there are on more uncertain economic terms. I don't think anyone start to disconnecting their Internet connection because they can't pay their bills. So, I think people are using the Internet more may be will even use more if they default away from taking vacations or things like that. But really difficult to try any specific conclusion like that or look into the data and understand it. At the more macro level I think it's strong eCommerce, continuing growth in business to business usage online of applications just may be people being a little more cautious about how they are investing in new online BtoB initiatives. But again all of these things are growing, but it's jus a question of the pace.

Rob Sanderson – American Technology Research

Thank you very much.

Paul Sagan

Thanks Rob.

Operator

Your next question comes from the line of Tim Klasell with Thomas Weisel Partners. Please proceed with your question.

Tim Klasell – Thomas Weisel Partners

Good afternoon everybody. You mentioned that eCommerce sites growing at that 50% year over year. But and I know you do this once a year, but could you give us some color on the media and entertainment space? What's the growth profile there?

J.D Sherman

That’s about 40% to 45% of our business. As I said on the call it grew roughly in line, Tim with our overall growth rate of 27%, slightly below that but roughly in line.

Tim Klasell – Thomas Weisel Partners

Okay. Some of your guidance going forward, why do sort of assuming for bursting around the media and entertainment?

J.D Sherman

Again as I've said to an earlier question, a lot to what's happening in media and entertainment is we are seeing longer-term volume commitments rather than a monthly standard deal. So, what that means is for our customers they realize that their usage is more seasonal particularly the volume-driven parts of their business, and what this allows them to do is balance their commitment over a longer period. What it means for us is we are a bit more susceptible to seasonality. We saw it last year in our 3Q and 4Q dynamics. We had a very strong Q4 last year just natural seasonality particularly in the media and entertainment space as people go outside for the summer and then the new programs come online, and the holiday season drives a lot of online advertising etcetera. So, I think we would see more of that. I would say outside of that area the bursting relationships stays the same but that dynamic is changing a bit to the dynamic of our overall seasonality.

Tim Klasell – Thomas Weisel Partners

Okay. Great. Thank you very much.

Paul Sagan

Thanks Tm.

Operator

Your next question comes from the line of Colby Synesael with Merriman. Please proceed with your question.

Colby Synesael – Merriman

Great. Thanks for taking my question. Just looking at your international revenues, it looks like you had about – as you mentioned I think 26% of revenues which is up nicely from last year. Is there an opportunity for you guys to accelerate your growth in the international space, obviously you mentioned US is being one of the areas of weakness may be international could balance that out a little bit. And also could you just talk about the competitive dynamics internationally versus domestic if there's new answers there, which changes how do you guys compete? Thanks.

Paul Sagan

Yes. We've really been very pleased with international performance over the last year not just this year, and you are seeing that in the steady increase. And even that the domestic business has grown very strongly that means international has really been executing well if you will not just stay current but to catch up. Obviously for 26% of the business to counterbalance 74% that got to be really outstanding, and so we are some of that. And we are making an investment in international, we are opening new offices, we are expanding the staff in most of the regions. We continue to see new opportunities as you may be aware our habit is to move into a region first if you will by parachuting in, meaning we would fly people in and out of one of the capitals where we operate offices. And then if we get enough traction we'll open offices in new cities and new countries we are opening several or already have this year Europe and Asia and we are very pleased with that performance. And I think that is an area where we will buy some of incremental investment because the opportunity is strong and you are seeing the path. Frankly there are just more Internet users outside of US than there inside of many countries, they have broadband already that exceeds ours. If you look at Korea, just came back from Europe. France now has 20 megabit a second service available to home at very competitive rates and they are seeing uptick there, that I think exceeds what we are seeing way exceeds what we are seeing in the US. So, some of those markets have really all verticals including media and entertainment more growth opportunities than they have than we are seeing here even so far. In no way we are discourage about the US market, it's just really interesting Internet things going on internationally. And you are right, to ask the question about competition, we see some of the name you would recognize is US competitors in some of the international market and so we deal with that kind of competition in some areas, and then some countries there are domestic local competitors. Some try to sell counter-deliver service similar to ours, others might try to mix in production or some kind of professional services, it's a local differentiator. I think we compete effectively. One other thing that we have that really differentiates us is global scale. And we are generally targeting enterprises with global operations or global suppliers in this world economy, almost any decent sized company today is dealing with suppliers, partners, marketers in distributed geographies and they are looking for WAN-like performance for a global web operations, and we can offer that and we think most of the competition internationally can't do that at all. And so it really helps us there. In other ways it's similar, we look at channel partners developing local extension of sales operations as well. Some of those are bit regionalized as we go.

J.D Sherman

The other thing I would just add to that is the investment that we need to make and we are making to grow internationally is really go to market investment, if not it doesn't require a new level of build out in our network because we already have the massively distributed global footprint, and that's a significant advantage.

Colby Synesael – Merriman

And great. Thank you.

Paul Sagan

Operator?

Operator

Your next question comes from the line of Rod Ratliff with Stanford Group. Please proceed with your question.

Rod Ratliff – Stanford Group

Thank you.

Paul Sagan

Hi, Rod.

Rod Ratliff – Stanford Group

Hi, you guys. Obviously, nice expansion in gross margin there. Is that just the greater presence in the mix of higher margin verticals?

J.D Sherman

I think that's certainly the major driver of that. It's something that we talked about it for a while, but as we get more and more penetration of our value-added services, we'd start to see that benefit. We also even in a – forgive my term, a more basic delivery deal, we still command a significant premium just based on our fundamental performance advantage and reliability. But I would say it’s been our strategy to really up sell our customers value-added services and build out on our differentiation and we are starting to see some of the benefits of that.

Rod Ratliff – Stanford Group

Two very quick ones, what do you seeing in online casual gaming, video gaming?

Paul Sagan

Large growth in the gaming space, that’s been very strong area for us for probably about 18 months and I think we see more connected devices that will grow.

Rod Ratliff – Stanford Group

And as a press release out, I believe yesterday that listed NBC’s partners re-streaming the Olympics. Do you think you guys will see any notable benefit from that at all?

Paul Sagan

We’re really looking forward to the summer games and the roles we’re playing there across the globe, I can touch on a number of them. We’re working for the first time with partners inside China to support their efforts to distribute the games on the web which is quite interesting. We work with the EBU to deliver the Olympics across the European continent. We’ll also be delivering the summer games towards the UK with the partnership there and domestically, we’re really excited to be working once again with our partners at the NBC Universal to deliver the nbcolympics.com site. So, we think it should be a very sizeable Olympics. As we’ve said, there’s no one single event or customer who at our scale is that significant to the quarter. At the same time we’re happy to have all that business to do work on a global event which we think will be interesting. You never know how exciting it’s going to be until we see how good the individual games are and whether people capture someone’s attention. And the time zone differences, also, we’re going to see how that place and it’s going to regionally different where the games are live or not, how significant the Internet is. But we’ve been doing the summer games every four years. We obviously get some version every two years because of the winner games as well. It’s always been interesting traffic driver on our network and we’re looking forward to it. But again at our scale, we don’t think that anyone thing is so significant but we will be involved in the Olympics really in almost every geography in the world including out here with NBC.

Rod Ratliff – Stanford Group

Can I throw out a follow up, Paul?

Paul Sagan

Yes, sure.

Rod Ratliff – Stanford Group

How do you feel about gaining a foothold in China?

Paul Sagan

It’s a – as everybody says particularly in fact – actually in any industry, it’s usually exciting and intriguing market because of its scale. In many ways, they are very different place to operate because of state of development, regulation etcetera. We have worked there with partners successfully, and we’re very pleased about it to deliver content into China on behalf of some of our customers and we look forward to working with our partners there to expand our ability to really make the Internet in China achieve all of its potential. And we think that that presents a growth opportunity for us as well over the next couple of years because we think our technology and services can help benefit Internet performance there as they do everywhere else in the world.

Rod Ratliff – Stanford Group

Thanks a lot.

Operator

Your next question comes from the line of Sri Anantha with Oppenheimer. Please proceed with your question.

Sri Anantha – Oppenheimer

Yes, thank you. Couple of questions, I know one of things you guys you highlight is than your value-added solutions such as killer App services and Dynamic Site Solutions that helps differentiate in the marketplace. Could you guys quantify what percentage of revenue comes from these services and how much they’ve been growing year over year?

J.D Sherman

Yes, we talked about that at our Annual Day. Last year we said at that point, it was about 30% of our revenue came from customers using our Dynamic Solutions including those and that continues to grow. We haven’t quantified that number externally since then. Probably we’ll give an update at later on the year as we have Annual Day this year, but that number continues to grow as a portion of our business and as a major strategic driver for us.

Sri Anantha – Oppenheimer

And Paul, you talked about the overall slow down in traffic. Do you see any clearer application whether on the enterprise side or the consumer side that you think is going to reaccelerate the growth and IP traffic?

Paul Sagan

I just wanted to make sure there’s no slow down in traffic, what I said was and just want to be very clear that everybody gets this. A slower rate of growth in some of the media sites. So there’s no slow down in traffic. It is really a growth rate question in some vertical. There is a slow down in internet traffic or internet usage. So I don’t think it’s a question of killer app. I really think particularly from media it’s a question of last mile bandwidth accessibility. And the ability to consume data or the rate at which people can consume it. And the reality is that in the US, you are lucky if you can get a television quality video picture over IP and all your neighbors better not be trying to share the same link to do that. We are looking forward to the day when you can do true HD to any home over IP. And in fact as you looked at our HD web demonstration site and you have the right and left mile connectivity, probably more likely at work than at home today, you can watch a live stream of a fully competitive if you will HD picture. It would be as good on your big screen TV as your HD standard TV signal. So, if you will, I think that’s the killer App, but it’s not what the content needs to be existent in HD, it exist, the last mile and then the monetization models that go with it or what we’re needing to re-accelerate the growth rate there. And on the business side, we’re seeing those Apps and we’re seeing the adoption. That’s why you see the strong uptick of those services and the reason I think the gross margin was so strong and there some of the applications are B2B portal. Many of the buying provisioning and database apps that people tend to do behind the firewall and let someone access over a phone or a call center that are now being opened up on the secure portal. Those apps exist and the question there is the pace at which enterprises are putting a web front end on a legacy system and saying that people sell, effectively self service. So, I think the apps exist there. It’s really the question of the shift in the way businesses are operating and that reengineering that we’ve been seeing over the last couple of years and really have driven the strong growth in our B2B services.

Sri Anantha – Oppenheimer

Thanks for the clarification. And J.D one quick clarification on the expenses. I think you mentioned gross margin is going to decline by a percentage or so. Are you talking about cash gross margins or GAAP gross margin? And the second one is the G&A declined like a quite a bit at least relative to their expectations in this quarter sequentially, would any onetime events help that? Thanks a lot.

J.D Sherman

So our G&A was actually up about $1 million, quarter over quarter. And maybe that’s a bit lower than we expect it to stand but I think you just have the timing and managing how we have in our expenses come in. In general though, our expenses are largely resource delay and we did continue to add resources. On GAAP gross margin, I should mention that our litigation cost went down slightly quarter over quarter from Q1 to Q2, offsetting some of the increases that we had. On gross margin, I think both cash and GAAP gross margin will decline somewhere and less than a point range.

Sri Anantha – Oppenheimer

Yes. Thanks a lot.

Paul Sagan

Operator. I think we’ve got time for couple more questions, if people would keep them short.

Operator

Your next question comes from the line of Garrett Bekker with Merrill Lynch. Please proceed with your question.

Garrett Bekker – Merrill Lynch

I was just wondering if you could talk about some of the new customers you added this quarter. Were any of those international?

Paul Sagan

Yes. All across the board in every region with very strong performance with enterprise new customers in Europe where I just came back from recently, Asia as well and the US with strong ad and that J.D. mentioned that once returned tended to be much smaller than the customers we bring on which really is that process of getting better and better advancing the pipeline of bringing in good customers and rolling off those at for whatever reason don’t really make sense and tend to be small.

J.D Sherman

I’m not sure if I can mention any of the names but one of the things that was very encouraging to me was to see that good portion of the larger deals that came in were APS and DSA deals. Really, some really high value ad service and relatively large deals coming in the door for a first time customer on the B2B side.

Garrett Bekker – Merrill Lynch

Okay. And then I heard maybe on the start of previous question there with respect to Dynamic Site Solutions but any chance you could give us any color on the Application Performance Solutions. I know obviously it ticked up and helped your margins but I think the last time you saw it was about a $40 million run rate the last time that you give us any number. So any other color will be –

Paul Sagan

We’ll update that one once a year. At this point, we’re not doing segment reporting quarter by quarter. But again, we were very pleased with what we’re seeing in not just Dynamic Sites but Application Performance as well and some of those deals that J.D. was referencing. Domestic and international, those enterprise deals where Application Acceleration and in summer for Dynamic Site acceleration.

Garrett Becker – Merrill Lynch

Okay. And then maybe if I could sneak on one other – given some of the–

Paul Sagan

Yes, but just keep it short.

Garrett Becker – Merrill Lynch

Any buybacks, any thoughts about buybacks?

Paul Sagan

No. We’re not going to speculate on things in the future. Obviously, we meet with our Board on a regular basis, look at our balance sheets, think about all the opportunities for investment and tend to be opportunistic and we’ll make the right moves at the right time when we see them but we certainly won’t speculate on we might do this, we might do that.

Garrett Becker – Merrill Lynch

Great. Okay, thanks.

Paul Sagan

Thanks.

Operator

Your next question comes from the line of Kirk Materne with Banc of America. Please proceed with your question.

Kirk Materne – Banc of America Securities

Yes, thanks very much. Just a little bit more color on the APS side. Can you guys talk a little bit about where most of the customers that were added this quarter, I guess historical customers every year, did you go out – were they new brand, new customers? I’m just trying to get a sense on where some of the demands coming from on that side?

Paul Sagan

Yes, the customer – well– I think you mean how many –what percent – how many?

Kirk Materne – Banc of America Securities

I guess what percentage were existing Akamai customers versus your brand Greenfield opportunity trio?

J.D. Sherman

Honestly, I don’t know that answer off the top of my head. What we’ve been seeing is a roughly half and half type ratio. One of the things about APS is it’s really been an entrée for us into markets where we didn’t have a presence like pharma and manufacturing and some of the places where web content delivery is less important. So, we’ve had a great penetration in there but we also had APS – even our biggest media customers have online applications. So, we are getting some penetration in there. So, I apologize I don’t have the stat for the number of things this quarter off the top of my head but the rough ratio has been 50/50.

Kirk Materne – Banc of America Securities

Just a follow up on that point, J.D., when you were talking about your big media customers taking on some of the APS services, clearly it’s a different part of their business but so did you have money to spend obviously on an IT but it’s just on the Internet or in the pushing more content out? They’re taking a pause on that side? Is it just so as to become more of a modernization issue for them on that side because it’s –

J.D. Sherman

Yes, I think –

Kirk Materne – Banc of America Securities

Yes, if they had money to spend on APS, they have money but I guess it’s just a matter of where they’re focusing their spend right now?

J.D. Sherman

The great thing about APS and obviously, it’s something that we sell into these guys is this is – not only does it boost productivity but it also drives cost savings. So, obviously in an environment like this as you would expect and as you’ve seen probably anecdotally, IT budgets get scrutinized a little bit more closely. So, there’s a sales challenge there but fundamentally what our application performance relations do also saves company’s money in their data centers as well. So, that’s the real powerful story particularly in this type of environment. And then when you talk about DSA, particularly in the commerce area, the great thing about that is the benefits aren’t in terms of an investment to make your site nice or something like that. It is very easily translatable to top line improvement. In an environment like this, that’s something that people find very valuable.

Paul Sagan

Operator, why don’t we take one more question and we’ll make sure we’re off in the hour. We promised everybody.

Operator

Your final question comes from the line of Derek Bingham with Goldman Sachs. Please proceed with your question.

Derek Bingham – Goldman Sachs

Hi, thanks. I wanted to ask what your sense is for your outlook for net customer ad as you continue to churn off more smaller customers? Is that 25 to 50 pace? Is it the right way to think about it going forward on a net basis?

J.D. Sherman

Derek, we don’t really forecast that on a going forward basis. What we do is focus on making sure that the signings that we’re delivering and the new customers we’re bringing on are high quality customers and then taking care of the customers that we have and making sure that the ones that are growing with Akamai and we have an opportunity to up sell and improve, deliver value for them that we keep. But we don’t have a forecast going forward on that.

Derek Bingham – Goldman Sachs

All right. Thank you.

Paul Sagan

Operator, thank you. Thank you all for tuning in. We’ll be back in three months as usual to update you on the summer and the rest of the year. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Akamai Technologies, Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts