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Executives

Jeffrey Lunsford - Chairman and Chief Executive Officer

Matthew Hale - Chief Financial Officer

Paul Alfieri - Senior Director of Corporate Communications

Analysts

David Hilal - Friedman, Billings, Ramsey

Derrick Bingham - Goldman Sachs

Katherine Egbert - Jefferies

Sri Anantha - Oppenheimer & Co.

Michael Turits - Raymond James

Kerry Rice - Wedbush & Morgan

Jennifer Adams - Cowen and Company

Rai Archibold - Kaufman Brothers

Chad Bartley - Pacific Crest Securities

Katherine Egbert - Jefferies

Limelight Networks Inc (LLNW) Q2 2008 Earnings Call August 12, 2008 5:00 PM ET

Operator

Welcome to Limelight Networks 2008 second quarter results conference call. (Operator Instructions) I would now like to turn the call over to Paul Alfieri, Senior Director of Corporate Communications.

Paul Alfieri

Thank you for joining the Limelight Networks second quarter 2008 financial results conference call. Speaking today will be Jeff Lunsford, Chairman and Chief Executive Officer and Matthew Hale, Chief Financial Officer. This conference call is being recorded on August 12, 2008 and will be archived on our website for approximately one week.

Some portions of this conference call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are all statements that are not strictly statements of historical facts, such as statements regarding future events or future financial performance, including but not limited to statements relating to Limelight Networks market opportunity and future business prospects, guidance on 2008 financial results and statements concerning anticipated future growth and profitability as well as management’s plans, goals, strategies, expectations, hopes and beliefs.

These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those contained, projected or implied in the forward-looking statements and reported results should not be considered an indication of future performance. Factors that could cause actual results to differ are included in the company’s periodic filings with the Securities and Exchange Commission.

I would now like to turn the call over to Jeff Lunsford, Jeff.

Jeffrey Lunsford

Limelight Networks continued to demonstrate steady progress during the second quarter of 2008. Our business grew 22% year-over-year generating revenue of $30.3 million, just above the high end of the guidance we provided on last quarters call.

We also generated adjusted EBITDA before litigation costs of stock base compensation in excess of our expectations and delivered three points of gross margin expansion over the last quarter. We experienced strong new business and relationship expansion bookings from some of the most innovative digital media businesses on the internet as well as from many of the world’s largest established entertainment and technology companies.

My comments today will cover three areas; the growth of our online customer base and network, general market trends and assured update on our ongoing litigation. First customers; during the quarter we grew our customer base to approximately 1300. Last quarter we told you that we are placing emphasis on expanding our presence in the enterprise and e-commerce market segment, an area where we believe there is an opportunity for solid growth, revenue diversification and increased margin.

We added about a dozen new customers in this segment this quarter, including traditional enterprise businesses such as Textron and Hobart Corporation. We also did well in our traditional areas of strength, both domestically and internationally, adding high profile domestic customers such as CNET networks and Check Point and noteworthy internationally customers such as GREE, a leading Japanese social networking site and another major European broadcast that we will announce later this quarter.

Additionally we renewed our expanded relationships with large strategic customers, including NetFlix Dio and the Walt Disney Internet Group and as previously announced we were selected by Microsoft as the primarily provider of content delivery services for video content on nbcolympics.com on MSN.

Limelight Networks was founded seven years ago on the belief that the internet would someday enable experiences as immersive and high quality as traditional media out-lists. The online screaming of these games is a coming of age event for this medium as a viable entertainment platform and our selection is the primary provider as further validation of the scale and reliability of the proprietary technology we have developed, which was purpose filled to deliver broadcast quality experiences to online viewers, listeners and gamers.

As further validation of our international expansion we were also selected by other rights holders in Europe and Asia to deliver the Olympic Games. Regarding network expansion, our average traffic level till now as of August climbed about the average levels that we saw in February; this is the result of both organic growth within our customer base and solid execution on the sales side.

We have booked a substantial amount of potential traffic for the second half and are embarking on an aggressive investment program for the second half of 2008 and future years, which Matt will discuss in is guidance section. As of today’s call we have surpassed two terabits per second of total egress capacity which we believe makes Limelight Networks one of the largest content delivery platforms in the world.

As large as our network is however, it is exciting to contemplate the significant growth opportunity that still lies ahead for our industry. To put how early we are into context two terabits per second is massive for CDN but it still represents only about two points of Nelson Rating and Audience Size.

As more and more audience moves online and as more and more young people weave new asynchronis entertainment modes into there lives from the start because the IT network truly does enable a superior interaction paragon which allows them to watch the movies share or spotting event they want when they want to watch.

We believe we are going to continue to see existing traffic growth. We believe that with Limelight Networks platform we are well positioned to capture more than our fair share of the large wave of new online content that will result from this long-term trend. Regarding the business environment we’ve received many questions about how the current economic environment might impact our customer base.

We are seeing tighter venture funding for some of the types of start ups the typically need CDN services. As a result we are beginning to emphasis quality of customer over quantity and are modifying compensation plans and tightening up our payment delinquency tolerances. With all that said we still believe the emerging market segment is an attractive one and that managing a diversified portfolio of customers with disciplined operations is the right strategy.

In looking at our current business mix we think we are appropriately but not over exposed to this segment. Some companies are going to do very well and we want them as customers, others will churn out. Other than this tighter funding in the emerging segment of the market we do not see any lessening in demand for our services due to the economic environment, rather we see intense competition between traditional media and a new breed of online media portal for consumer mind share and advertiser budget allocations.

We believe we are in the early years of a decade long shift of media consumption to IP based networks and have adverting dollar from offline to online and we believe that as long as we continue to scale our network and provide world class services we are well positioned to benefit irrespective of which online entities or venture eventually succeed.

Now a brief update about our ongoing litigation; first related to Akamai, I’d like to remind you that approximately half of our business was not alleged by Akamai to infringe there 703 path. These non impacted areas include software downloads, international business, live streaming and non-traffic related CDN services; all segments in which we demonstrate strength in Q2.

On July 1, the U.S. district court for the district of Massachusetts issued release denying Akamai’s motion for a permanent injunction as premature. As well as denying emotions for partial summary judgment on certain of our defenses. Additionally, the court also denied our motions for a new trial judgment as a matter of law and obviousness.

A little over two weeks ago we filed a motion for reconsideration of our motion for judgment as a matter of law based upon the new federal circuit ruling that occurred after the judge’s original decision. Our equitable defense motions are also still pending. The court has scheduled a September 24 hearing date on the remaining matters.

Last quarter we told you that we will be in a position to report to you about our ability to mitigate the financial impact of accruing for potential damages. While we cannot discuss specific technical actions we have taken due to the ongoing litigation. I would like to report that over the last quarter we decreased the amount of traffic delivered using a method alleged to infringe on the Akamai battle from over 50% to approximately 36%.

I’m pleased to report that we made further progress in the current quarter. Accordingly you will notice we are providing guidance that potential damage accruals for Q3 will be less than $1 million before accrued interest well below the levels of previous quarters. Matt will discuss this a bit further in his comments.

Second, regarding level three; a Markman hearing from which the court will construe or define certain terms used in the patents we sold in June and a ruling is expected sometime in the next 50 days. The level three trial is set to begin October 14. Third, we are still early in the Two-Way Media patent case in which Limelight is named as a co-defended among others including AT&T and Akamai.

Fourth on a very positive note with respect to the securities class action suite filed in August 2007, last week the federal court granted our motion to dismiss the law suite, dismissing certain claims with prejudice and allowing the plaintiffs lead to amend with respect to others. As we have said previously we believe the litigation that has been filed against us is without merit and we will continue to vigorously defend these matters and commit energy and resources to what we firmly believe will ultimately be successful conclusions.

Beyond this short update we will not comment on ongoing litigation during the Q-and-A portion of this call. With that I will turn the call over to Matt Hale.

Matthew Hale

During the quarter we reported revenue of $30.3 million, which is up 22% compared to non-GAAP revenue from the same period last year and a net loss per share of $0.18. We reported second quarter adjusted EBITDA for the poor stock based compensation litigation costs and damage accrual of $3.9 million; that compares to $2.1 million for Q1 and $2.9 million for the same quarter last year.

We also reported non-GAAP net loss of $1.6 million or $0.02 per basic share compared to non-GAAP net loss of $2 million and $0.02 per basic share last quarter and to a non-GAAP net loss of $0.2 million or essentially break even per share for the same period last year. Please refer to the tables in our press release for a reconciliation of GAAP measures to these non-GAAP measures.

During the second quarter Limelight’s international revenue represented 16% of total GAAP revenue, an increase of 2% from last quarter. As Jeff mentioned during the quarter, our active customer account rose to approximately 1300 for a net increase of approximately 60 customers from last quarter. Our average annualized GAAP revenue per customer was approximately 93,000 in Q2 and that compared with 98,000 for the previous quarter.

Gross profit margin which includes both depreciation and stock based compensation was approximately 35% for Q2 compared with 32% last quarter. The increase in gross margin is primarily attributable to lower variable network costs as a percentage of revenue. Cash gross margin was 57% for Q2 compared to 53% last quarter. We expect to see gross margins compress in the second half of ’08 as we decelerated CapEx and recurring project expenses for the reason Jeff mentioned above.

Operating expenses were $20 million in Q2 and that’s down $3 million from the first quarter and compared to $17 million for the same period last year. If you look the provision that we made for potential additional damages in the Akamai litigation is excluded from the general and administrative costs; we’ve broken that out separately.

Cash operating expenses which are expenses before stock based compensation and potential damage accrual were $16 million in the second quarter, compared to $19 million in the first quarter and $11 for the same period last year. The $5.4 million increase in Cap Operating expenses from Q2 relates to an increase in G&A expense of $2.5 million, increased sales and marketing costs of $2.3 million and increased product development cost of $0.6 million.

The higher G&A costs relate to increased litigation expense of $1 million with the remainder associated with increased public company costs and bad debt expense. As we continue to invest in our future growth, sales and marketing and product development expenses rose from last year due to increased headcount in marketing program.

During the second quarter we recorded a provision of 6.7 for additional potential damages and accrued interest associated with alleged and printing revenue. Approximately 36% of our revenue for the quarter was generated using a delivery method that is alleged to infringe and this is down from approximately 54% last quarter.

We expect the percentage of alleged and infringing revenue to decrease substantially as we continue to take specific technical and operational steps to mitigate the financial impact going forward. As a result of these measures we expect the accrual for additional potential infringement damages to be less than $1 million in Q3 before provision for additional interests.

Total depreciation and amortization for the second quarter was $6.5 million, that’s up from $6.3 million in the first quarter and up from $5.2 million in the same period last year. Depreciation and amortization in the current quarter reflects $6.2 million related to network depreciation and $0.3 million of operating expense depreciation.

Stock based compensation expenses for the quarter were $4.3 million compared to $4 million last quarter and $6.3 million for the same period last year. During the quarter we completed a tender offer whereby employees exchange stock options for the right to purchase approximately two million shares as the company’s stock, with the right to receive approximately one million restricted stock units.

The Black-Scholes value of the forfeited options for most employees was greater than our restricted share units issued resulting in no incremental increase in stock based compensation related to this important employer retention action.

Second quarter interest earnings were $1.3 million compared to $1.9 million for Q1 and $0.6 million for the same quarter last year. The reduced interest income from Q1 is associated with reduced market interest rates and a lower cash balance.

Moving on to the balance sheet, our combined cash and investment balance on June 30 was $184.5 million down from $194.7 million in the first quarter. The reduction in cash is primarily related to payments for capital expenditures, increase in prepaid expenses and the payment of substantial legal expenses accrued during the first quarter.

Capital purchases for the second quarter were $5 million up from $3.1 million in the previous quarter and down $8.8 million in the year ago period. Day sales outstanding for the quarter were 66 days, approximately flat with the previous quarter and down from 77 days in the second quarter of last year.

Now for guidance, for Q3 we expect to achieve revenues in the range of $30 million to $32 million. Due to the variability associated with litigation costs and calculating potential damage accruals, we are not providing earnings guidance at this time, however we want analysts and investors to be aware that in the second half, based on substantially large traffic expectations for the second half we are embarking on a project to substantially expand our network capacity, so that we can continue to lead the market in supporting the industry defining large event.

This means we should model margin compression back to Q1 levels or back from the expand levels we achieved in Q2 and should model adjusted EBITDA before legal and stock-based compensation charges to be down sequentially in Q3. This investment program will primarily impact COGS and it will include run rate expenses like Rackspace power and personnel as well as capital expenditures for servers and network equipment. Please factor these comments into your models as you update with this quarters results and recap the second half of 2008.

Stock-based compensation expenses for Q3 are expected to be in the range of approximately $4.4 million to $4.6 million. As Jeff mentioned and I mentioned above we’re expanding the amount of our capital purchases related to anticipated traffic volume increases. As a result capital purchases are expected to be in the range of $8 million to $9 million to the third quarter.

With that I’ll turn it back to Jeff.

Jeffrey Lunsford

Looking ahead we believe that we will see continued growth in the media and entertainment segment throughout the remainder of the year and have accelerated the build out of our infrastructure to accommodate. We believe Limelight is well positioned with the right product set to compete within this rapidly growing segment and this very dynamic marketplace as well as to expand into the more mature markets of e-commerce enterprise and government.

We believe our expanding service week which attractively addresses the global scale quality and perform requirements of the top internet properties when combined with our focus on operational maturity, diversification and highly responsible customer service, positions us uniquely in the market for the long-term.

We’d like to open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Hilal of Friedman, Billings, Ramsey.

David Hilal - Friedman, Billings, Ramsey

First Matt, in your commentary about guidance, you said you guys expect large traffic increases throughout the balance of the year and I guess I wanted to just drill down on that; I know the answer is probably both, but when you think about it coming from existing customers versus when you moving your pipeline at new potential customers what really is driving other than the macro trends which we all know? Is there anything on top of that driving your expectations for our large traffic increases in the back half of the year, because it sounds like the increase is going to be bigger than maybe what we’ve seen historically?

Jeffrey Lunsford

It’s really a blend; we’ve signed up some major new, to use the words carefully potential new traffic commitments, very large customers that have existing traffic flows over their own or other CDN networks and so these are not situations where we have to bet on their growth; these are situations where we just have to execute well and get that traffic shifted from some other network on to our platform.

There are not large upfront commitments associated with most of these, but we believe that we will get a substantial portion of that traffic and in this business you need to build ahead of that traffic, so that you’ll have the capacity when it shows up. It really is a combo of new accounts, substantial accounts that have large existing traffic as well as existing customers that are working with us in a sort of a capacity planning mode and giving us visibility into their growth and traffic shifting plans.

David Hilal - Friedman, Billings, Ramsey

You guys in the past, at least in over the last 90 days have talked about diversifying your business more into new verticals outside of kind of media and entertainment and into other things like small file distribution, can you share some thoughts on how that diversification efforts are going?

Jeffrey Lunsford

Yes, with the size I mentioned we signed up by the dozen what I’d consider sort of pure enterprise customers that aren’t the traditional media entertainment types and this is for stuff like small object deliveries or for download and so we felt pretty good about the progress in the quarter and that’s an initiative we really kicked off four, five months ago and they were both platform requirements imposed upon our engineers that we’ve delivered on and go to market requirements as far as the accounts that we are calling on and in some of the implementation needs.

David Hilal - Friedman, Billings, Ramsey

You talked about changing some of the comp plans for the sales guys as your business direction changes. So, in addition to the incentive programs, is there any change in terms of the talent; in other words do you need to add bodies with different kind of DNA’s to what you currently have or do you feel what you have in house is appropriate?

Jeffrey Lunsford

Our current sales team is doing a great job and the profile hasn’t really changed and the comment on the comp plan is just you want to focus people on identifying and securing business with the high quality accounts that are growing and will fund it and not pay them for -- too many emerging guys that don’t have good funding that end up being sort of flash in the pan type customers.

Operator

Your next question comes from Derrick Bingham - Goldman Sachs.

Derrick Bingham - Goldman Sachs

On the gross margin commentary Matt, specific to cash gross margins, I just want to make sure they were clear; you expect the cash gross margins to comeback down to kind of more like Q1 levels?

Matthew Hale

Yes, as we deploy that level of CapEx which really started at the end of Q2 and then you’ll see from the guidance we’re pushing out a lot of servers we increased the fixed charges associated with the color space that we parked that CapEx.

Derrick Bingham - Goldman Sachs

And do you currently expect to exit the year at a cash gross margin also below second quarter levels?

Matthew Hale

We’re not giving that guidance yet, so I’m not going to comment further. We’ll update the margin discussion on next quarter’s call.

Derrick Bingham - Goldman Sachs

Okay, and on some of the kind of the new architecture that you’re moving some customers to that is not alleged to be infringing; can you give us some color, maybe one on what the capital requirements are to do that and maybe number two, what the performance difference is if anything and how that’s being received by customers who are being switched to the new architecture?

Jeffrey Lunsford

So Derrick, we do not believe there is any dramatic shift in capital requirements. We’ve run multiple platforms and what we’re doing is were constantly driving for efficiencies at the hardware level, at the bandwidth procurement, at the Rackspace procurement level as we scale and it’s a blend of all of that that will continue to drive down unit cost and this is a business that’s characterized by decreasing unit revenue and decreasing unit cost, so you surf the margin down, but the number of units, its growing at a pretty dramatic pace.

Derrick Bingham - Goldman Sachs

Okay and like on a performance basis, does it have any impact? I mean is it the same, is it a little worse, is it better for customers when they move to this new architecture?

Jeffrey Lunsford

We anything that we put into production is an advancement, we wouldn’t be doing anything to take our customers backwards and I think if we did do that you’d end up seeing that in the form of sort of slower growth trajectory and this is a briefly transparent industry and there is a lot of talk out there. I think you would have heard if there had been any such issues.

Operator

Your next question comes from Katherine Egbert - Jefferies.

Katherine Egbert - Jefferies

So the new capacity that you’re adding is this for committed contracts or is this mainly for potentially new contracts?

Jeffrey Lunsford

Katherine it’s primarily for signed contracts, but not ones that have massive upfront commitments. We execute and we’ll get to business.

Katherine Egbert - Jefferies

Okay, fair enough and then your guidance for September looks like you’re calling for about 10% revenue growth year-on-year at the mid-point which is a deceleration between 22%, why is that?

Jeffrey Lunsford

Are you talking about Q3 ’08 over Q3 ’07?

Katherine Egbert - Jefferies

That’s right.

Jeffrey Lunsford

I don’t know, I’d have to look back in what was in Q3 ’07. We’re looking at it sequentially and if we believe we will be up sequentially from Q2, Q3, remember we had a couple of these large guys that ended up leaving and shutting down website and stuff in Q1 and they were reasonably large last year towards the second half of the year, so that that maybe something that’s cause in it, but from this point we’re running the business and growing it forward, we’re looking at sequential growth from Q2, Q3.

Katherine Egbert - Jefferies

Okay and then just a couple more; you won the contract for the NBC, the Olympics and you won some other contracts around the Olympics; is that fully contemplated would you say in guidance and changes given an example of how your calculating it if it is?

Jeffrey Lunsford

We strive through it in our guidance and so we contemplate all the different commitments we had predictability of revenue when we set guidance. Does that answer your question?

Katherine Egbert - Jefferies

I guess so, that’s probably all I’m going to get. Just one quick one, did you have any 10% customers in the quarter?

Matthew Hale

Yes, Microsoft continues to be at 10% customers, there is no other customer.

Katherine Egbert - Jefferies

And how big were they Matt?

Matthew Hale

We won’t disclose that. Last quarter they were 14%, I don’t have the percent right now. It will be in the Q that we’ll file probably on Thursday.

Operator

And your next question comes from the line of Sri Anantha of Oppenheimer.

Sri Anantha - Oppenheimer & Co.

Jeff, just from a top down level, one of the biggest concerns or investors seem to be the slow down in IP traffic growth. Could you guys about what kind of a growth rate are you guys seeing on your network and if that’s the case do you think it’s just being driven by the overall growth in the market of CDN or by market share gains?

Jeffrey Lunsford

So, what we said in the prepared remarks was that we had traffic decline at the end of February and we had a couple of large customers go off the network and we have since seen very solid growth and as of August had exceeded those average levels from February. So, on our network from sort of March forward we’ve seen very solid growth in traffic levels.

Now there is a lot of talk out there about price competitiveness in the market, so that’s what’s held down top line growth a little bit. As we said we think that long term works in our favor because we have scale and we have efficiency and so it will force a bit of Darwinian process in the sector over the next year or two and we think we’re in a solid position to gain market share as that works it’s way through the industry, but we are not seeing a slow down in traffic.

We did see one very large, maybe the largest video site on the web at the time just shut down; the company just pulled the plug on it and that happened back in Q1, but we are not seeing an overall slow down in IP traffic internet wide.

Sri Anantha - Oppenheimer & Co.

And just on the second one I know you guys previously talked about some of your online video business customers restructuring; is there anyway to quantify what kind of an exposure do you still have if at all any to some of those doubtful customers today or are they out of the system totally?

Jeffrey Lunsford

No, we view that emerging segment as a portfolio and we think we’re as I said appropriately exposed to the segment, but not over exposed. In the past we might have had too much exposure and we’ve gotten much more aggressive about communicating with our customers on their own funding; the customers within this segment, but when you look at our overall customer blend, the gaming companies, the game console manufactures, the technology companies, the software companies, the traditional media companies, are far and away the majority of our revenue base and then we have this one slice of our revenue that is focused on emerging businesses, but we are now being careful not to make sure that segment grows too rapidly.

Sri Anantha - Oppenheimer & Co.

And last question, I know you guys seem to be making pretty good progress on diversifying your revenue base; could you talk about what percentage of revenue is now coming from other than media and entertainment and what do you expect that to be at the end of this year, if you’re looking at your pipeline?

Jeffrey Lunsford

Sri, I don’t have those numbers to quantify at my figure tip, so I don’t want to do that, but in our updated investor presentation we do have a slide that breaks it out by market segment and so as of our next investor presentation, which I’m not sure when it is, we’ll have that update and that will be on our website.

Operator

Your next question comes from the line of Michael Turits of Raymond James.

Michael Turits - Raymond James

On the traffic question again, I want to be in specific in asking going about changes. What we are concerned about is not whether the traffic is growing or not, we assume it is, but what's happening with growth rate and maybe if you can just be more specific instead; I think something with the same store sales in terms of growth rate. Now, if you were to look it at the growth rate of the traffic with existing customers, has that moderated at all, that growth rate or do you see the growth rate of traffic with the existing customer is about the same?

Jeffrey Lunsford

Michael I think, you’ve got a couple of factors to play here; first of all the law small numbers. What people were comparing, their ’06 to ’07 growth rates versus their ’07 to ’08; I have said in the past, we were seeing 5x increases in event sizes and that was driven probably by a 2.5x increase in average encode rate and combined with probably a doubling of audience size.

It’s kind of event-by-event and there are some events like the Olympics where there isn’t a last year comparison, but we are still seeing encode rates increase and we’re seeing audience sizes grow and as you get more and more broadband penetration, consumers are filling up those prices with comp and so it’s a little bit difficult to commit because as an example you might take a large global media company, where they’re working with us and one or two other CDNs and our traffic from them may have double, but some of that may have been because they shifted it to us from another CND.

So, most of the largest publishers work with multiple CDN, so we don’t have a comprehensive view, we just see what’s happening on our own network, but we believe audience sizes are growing, encode rates are increasing and that we’re not actually seeing a dramatic deceleration for our bid volume.

Michael Turits - Raymond James

And on the pricing question what you mentioned you said that you’ll be seeing more up side, but pricing is putting Cap on that; what are the trends in pricing? You think that you’re seeing about the same rate of price decline or price pressures in the last couple of quarters?

Jeffrey Lunsford

To give you some very ballpark numbers, we I think historically we’re modeling about a 2% per month price decline. I think that’s what we’re modeling in sort of the ’06, ’07 timeframe and it’s probably increased from there but to specifically quantify for you is difficult. You are looking at both new deals that are being signed, but they’re all being signed at much higher volumes, so they get a lower unit price and you’re looking at just sort of blended rates as we renew customers also usually at higher volumes for lower price.

Michael Turits - Raymond James

And then last question is around the customer adds. The was about what I was modeling; can you give us some sense, what your gross adds and churns are like?

Jeffrey Lunsford

So, I think we added about a net 60 this quarter, I think last quarter we’d added a net 70 something like that. The churn as we are sort of increasing our tolerance with some of the slower payer or the guys where we see funding risk churn might go up a little bit; it’s more of a customer account issue and a revenue issue. If you look at the revenue growth rates, I’d say that’s 90% driven by price factors not by churn.

Operator

Your next question comes from the line of Kerry Rice of Wedbush & Morgan.

Kerry Rice - Wedbush & Morgan

Just a couple of housekeeping questions; in previous quarters you used to give out what the percentage of revenue that was from your top 20 customers?

Matthew Hale

Yes, Kerry that was approximately 53%, which I think is about flat with last quarter.

Kerry Rice - Wedbush & Morgan

And can you talk a little bit about seasonality; do you see anything in Q3 that would indicate -- is there a little bit of bump up just as kids go back to school or do you expect any kind of seasonality in Q3?

Jeffrey Lunsford

I guess the answer is no. There is always, each year a little bit lower internet usage globally during the summer, at least in the Northern, where the bulk of internet consumption occurs, but with the traffic growth that we’re seeing, it’s a little difficult; there are big events happening this summer, the Olympics is one examples, so it’s a little bit difficult to quantify.

Kerry Rice - Wedbush & Morgan

Okay and then, sorry to be the dead horse, but kind of going back to the traffic volume and it just kind of what you had just said, at least what I thought you said was you didn’t see a dramatic decline of traffic volume and I think that was really the existing customer. So, just to clarify you are seeing some amount of decline in the rate of traffic volume growth?

Jeffrey Lunsford

What I said was, it’s really hard to quantify and what we’re seeing is overall growth, but the actual rate of growth is difficult to quantify because we don’t have a comprehensive view across most of our larger customers complete traffic base.

Kerry Rice - Wedbush & Morgan

But what about for your existing customers?

Jeffrey Lunsford

That’s what I mean; our existing customers the biggest ones where most of the traffic is are using multiple CDMs.

Operator

Your next question comes from the line of Jennifer Adams with Cowen and Company.

Jennifer Adams - Cowen and Company

In the second quarter sales and marketing expense kicked up a little from the first quarter levels; do you see a similar pattern throughout the year especially as you fill the new expanded capacity on your network?

Jeffrey Lunsford

What we’ve said Jennifer is you should expect sales and marketing grow generally inline with revenue growth from here forward.

Jennifer Adams - Cowen and Company

Okay, so it’s staying at about Q2 level on a percentage basis moving forward?

Jeffrey Lunsford

Roughly, that’s an approximation. With the revenue volatility here you put a hiring plan in place and a sales plan in place and the percentages may vary a couple of points here and there, but our general direction is to keep the same mix.

Jennifer Adams - Cowen and Company

Okay, great. Then looking at other tentative landscape, earlier this year levels three launched lot of new CDN products, streaming products and AT&T has announce plans to news into CDN; are you starting to see these companies has competitor or is it still really traditional CDN like Akamai that Limelight is competing with.

Jeffrey Lunsford

So, this market segment has been characterized with intensive competition at least for the two years I’ve been involved in it and it seems like it’s Akamai and Limelight competing for the larger accounts given the fact that we have the scale that is needed to deliver our broadcast quality experience to the growing audiences and there are always many other players that see this market opportunity that are building to try to capitalize on it, but when you get into the big deals, its not a 100% the case but its primarily the case that we’re competing at Akamai.

Operator

Your next question comes from the line of Rai Archibold - Kaufman Brothers.

Rai Archibold - Kaufman Brothers

I just want to go back on the sort of the capital spending. I guess you said it was going to be about $8 million or $9 million in 3Q with the idea that you’ve had some large customer bookings, but you haven’t had commitments to traffic. So one, I’m just trying to get a sense; what’s your confidence level that this capital is going to generate an appropriate return in terms of your ability to capture sufficient traffic to justify it or is this more an expectation of just building out in anticipation of scaling demand over a longer period of time?

Jeffrey Lunsford

So, the investment decision is made, both looking at the second half of 2008 as well as what we believe is going happen in the out years. As you scale CDN there are certain things that happened at a pretty steady pace and an example of that would be adding servers and adding pops. Then there are other things that happen where there is a reasonably large step function up in cost that you make a commitment that then you’re able to monetize over a three year period before you have to take the next big step function up and we are in the second half of this year embarking one of those step functions up with certain components of our COGS that we do not want to go into detail exactly what that is for competitive reasons.

Operator

Your next question comes from the line of Chad Bartley - Pacific Crest.

Chad Bartley - Pacific Crest Securities

Just going back to your Q3 guidance that implies the deceleration growth to I think about 7% to 14%. So, I just want to clear, it’s not a traffic issues so it’s predominantly just a tough comp in the lost customers or did pricing get that much worse I guess in the last 90 days and then my second question, in terms about the potential traffic that you’re building out for could that impact Q3 revenue or is that surely going to be a Q4 and 2009 event if you will.

Jeffrey Lunsford

Well, non-committed traffic, an over performance in that could always impact a quarter, so that’s potential. Can you ask the other part of your question?

Chad Bartley - Pacific Crest Securities

Okay, so I guess that the first part is again going back to the Q3 guidance that implies a pretty material deceleration in growth about 7% to 14% if I’m doing my math correctly. Is this basically a tough comp and then the fact that you lost customers or is it pricing and things got that much more aggressive in the quarter, because if I’m understanding it, it’s not a traffic issue.

Jeffrey Lunsford

Correct, I think the overall factor impacting top line growth for the last three quarters has been price competition.

Operator

Your next question comes from line of Katherine Egbert, of Jefferies.

Katherine Egbert - Jefferies

Jeff you referred to a couple of times to incurred rates, can you talk about how those have being going up and then also talk about what Akamai referred to in their call with last mile issues around HD streaming thanks?

Jeffrey Lunsford

Okay, so an encode rate is how many bits you’re using to deliver a video file and a year ago you might have seen an average encode rate of 400 kilobits per second and this year you are seeing higher encode rates, exactly what the averages are we don’t know, but it’s 50% or higher and 50% or more higher and that’s because content publishers are realizing that end consumers watch more of higher quality contents than they do of lower, jerky, rainy content. So, quality definitely brings dealership and this is in primarily an advertiser funded medium and advertisers want to advertise along side high quality content. So, that’s the first piece of your question.

The second is the last mile question and we call this is a condo cul-de-sac problem. So, if you have too many people in one large condominium or in one cul-de-sac that are trying to you use the same last mile connection to watch whether it’s SD or HD content, you do run the risk of congesting on that last mile and there is really nothing that the CDNs can do to work around that.

As you know we partner with around 800 last mile providers around the globe and we were consistently with them, to hopefully give them traffic and give them scale which drives the compelling end consumer experience, which gives them good subscription revenues, with which they can build out of their networks. Some are being more aggressive than others, but we don’t view it as a major holdback. We see it as something that’s going to continually evolve, we do think the U.S. is behind other markets, we see as said I believe on the last quarters call much more content being consumed for end customer in a place like Korea where people have 40 and 100 megabit per second connections to the home; they are consuming much more content there preview than we are here in the U.S.

So, we do think the U.S, is behind a little bit, but we see aggressive investment from some last mile providers and that’s going to drive from a competitive standpoint the need that the others will have to invest as well. So, it will work itself out overtime, the technology providers always find a way and it’s a consumer pool phenomenon. If consumers can’t get the kind of broadband connectivity, they want from one last mile provider they will move their dollars to others that have made those investments.

Operator

Your final question comes from the line of Michael Turits of Raymond James.

Michael Turits - Raymond James

This obviously it’s a follow up. I have a couple of questions in deceleration of revenue going into the next quarter. I’m not sure you can do this off the top of your head, but to pull out MySpace, YouTube and StageSix, which were the biggest customers, you had still I think last year and it was completely off in the third quarter and it seems (inaudible) that organic growth might not have decelerated that much 2Q to 3Q this quarter, this year.

Jeffrey Lunsford

Well, I think the YouTube and the MySpace had already work their way down to non-material levels, but we talked on the first quarter call about two large customers that we are not at liberty to name that were a substantial portion of traffic and revenue and if you back those guys out then of course yes you’ll get much higher year-over-year comparison. We’re not in the business of trying to go off things over though. We are going to go out and sign up good high quality customers and drive growth and as I said earlier we sort of look at it on a sequential basis. “Here’s where we are this quarter, let’s go out and get more business and grow it from here;” having learned what we’ve learned over the last couple of years in the dynamic marketplace that this is.

Michael Turits - Raymond James

Let me just check one other thing then; at least in terms of the last quarter. I assume you still had a little bit of StageSix on your last quarter; some of that deceleration is affected by that?

Jeffrey Lunsford

Again, we’re not at liberty to comment on particular customers.

Matthew Hale

When you say last quarter, you’re talking about Q2, the one we’re reporting?

Michael Turits - Raymond James

Yes Q2, exactly Q2, you’re right. So on 2Q you still have some of that large customer on.

Jeffrey Lunsford

No, at the end of Q1 we said those customers had gone away.

Michael Turits - Raymond James

Alright, thanks.

Jeffrey Lunsford

At this time operator, no further questions. Thank you for joining us today.

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Source: Limelight Networks Inc Q2 2008 Earnings Call Transcript
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