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Akamai Technologies, Inc. (NASDAQ:AKAM)

Q1 2006 Earnings Conference Call

April 26, 2006, 4:30 p.m. EST

Executives

Sandy Smith - Director, IR

Paul Sagan - President & CEO

J.D. Sherman - CFO

Analysts

Michael Turits - Prudential Equity Group

Aaron Kessler - Piper Jaffray

Henry Naah - Lehman Brothers

Erik Zamkoff - Morgan Joseph

Rod Ratliff - Sanford Group

Brent Bracelin - Pacific Crest Securities

Ari Moses - Kaufman Brothers

Jeff Van Rhee - Craig Hallum

Katherine Egbert - Jefferies

Robert Stimson - WR Hambrecht

Presentation

Operator

Good afternoon. At this time I would like to welcome everyone to the Akamai Technologies first quarter 2006 earnings conference call. (Operator Instructions) Thank you. Ms. Smith, you may begin your conference.

Sandy Smith

Good afternoon and thank you, everybody for joining Akamai's investor conference call to discuss our first quarter 2006 financial results. Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer; and J.D. Sherman, Akamai's Chief Financial Officer.

Today's presentation contains estimates and other statements that are forward-looking under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and assumptions that are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our annual report on Form 10-K.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and therefore, you should not rely on these forward-looking statements as representing our estimates as of any date subsequent to today.

During this call, we will be referring to some non-GAAP financial measures that we believe are helpful to a better understanding of our financial results and operations. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. You can find definitions of these non-GAAP terms and reconciliations of these non-GAAP terms to the most directly comparable GAAP financial measures under the News and Publications portion of the Investor Relations section of our website. Now let me turn the call over to Paul.

Paul Sagan

Thank you, Sandy and thank you all for joining us today. The first quarter was an especially strong one at Akamai as we delivered record revenue and normalized earnings. Our results for the first quarter include revenue of nearly $91 million, a 10% increase over the fourth quarter and a 51% increase over the first quarter of last year, and normalized net income of $29.4 million or $0.17 per diluted share. That is more than double our normalized net income from a year ago and 12% higher than Q4.

In addition to delivering impressive financial results this past quarter, we helped our customers deliver some of the most popular events on the Internet, including the Winter Olympics and College Basketball's March Madness. Events like these help us achieve very robust sequential growth on the top and bottom lines, which is particularly gratifying coming on the heels of our strong fourth quarter results.

But even more important than the near-term growth from special events, we are experiencing a longer-term trend on the Internet. That is the wholesale adoption by many companies of the web as a new medium where users are increasingly going first for news, information, sports and entertainment.

There has been a movement in this direction for over a year as more and more people have switched to broadband connections. I believe this underlies much of the growth we have experienced over the past six months as this new online reality drives demand for our services. I will have some more thoughts about what is behind the exciting developments we are seeing in our business later in the call. For now, let me turn it over to J.D. to review our financial results in detail.

J.D. Sherman

Thanks, Paul. As Paul said, we had a great first quarter delivering 10% revenue growth and 12% normalized net income growth quarter-over-quarter. Before I jump into the details, let me note that we have posted some additional financial reconciliation metrics in the Investor Relations section of our website.

As you are probably aware, this is the first quarter we are including equity-related compensation charges in our financial statements in accordance with FAS 123R; and the first quarter we are showing a booked tax rate in our GAAP financials. Given these changes, we have posted additional information on our site that we hope will help you make better period-to-period comparisons of our core financial performance.

Now let's turn to our first quarter results. Revenue came in at $90.8 million, well above our expectations. We exceeded the high end of our revenue guidance for two reasons. First, we experienced greater than expected demand from seasonal sporting events and related marketing sites during the quarter. The Super Bowl, the Winter Olympics, the World Baseball Classic and March Madness were some of the big events during the quarter that generated higher than expected bursting revenue. These one-time events added about $2 million to the quarter, roughly matching the bursting we experienced from e-commerce traffic in the fourth quarter.

In addition, our core business was exceptionally strong. As Paul referenced, we have seen accelerating activity from our media and entertainment customers, and that has led to an increase in larger, longer-term deals which can help to increase our average revenue per customer. For the quarter, our ARPU grew to $15,400 per month. That is up another 5% on top of the 4% sequential growth we saw in the fourth quarter. During the period we added 71 net new customers, bringing our total customer count to 1,981.

International sales also delivered excellent results, growing to 23% of total revenue in the quarter. That is up from 21% in the prior quarter and 20% in the same period last year. Resellers accounted for 23% of our total revenue in the first quarter compared to 24% in the fourth quarter and 25% in the same period last year. Once again, no customer accounted for 10% or more of our revenue.

Our GAAP gross profit margin was 79% for the quarter, which includes network-related depreciation, and for the first time, FAS 123R equity-related compensation charges. Network-related depreciation grew by about $600,000 from the prior quarter but remained stable at about 6% of revenue.

The margin impact from the absolute dollar increase was mitigated by a higher than expected revenue growth. Our cash gross margin, which excludes depreciation and equity-related compensation charges, was 85% for the quarter, down roughly a point from the exceptionally strong margin we saw in the fourth quarter of last year.

GAAP operating expenses for the quarter were $53.9 million, up from $45.5 million in the prior quarter, primarily driven by the adoption of FAS 123R. In addition to stock compensation charges, these GAAP numbers include amortization of intangible assets related to the Speedera acquisition and depreciation. Excluding these non-cash charges, our cash operating expenses for the quarter were $43.7 million. That is up 7% from $40.7 million in the prior quarter. As a percentage of revenue, our cash operating expenses declined by 1 point from the fourth quarter.

The quarter-over-quarter increase was driven in part by the annual reset of our FICA payroll taxes, as well as sales training expenses that generally occur in the first quarter of every year. In addition, we added 50 new employees as we continue to grow our sales organizations and add key engineering skills to ensure we are well positioned to capture the new opportunities in the market.

Adjusted EBITDA for the first quarter was $33.4 million, up 9% from the prior quarter, and adjusted EBITDA margin remained consistent quarter-over-quarter at 37%. That is up 3 points over the same period last year. Total depreciation and amortization for the first quarter was $8.7 million. That is up from $8 million in the prior quarter. These charges include $5.4 million of network-related depreciation, $1 million of G&A depreciation and $2.3 million of amortization of intangible assets.

Net interest was positive in the quarter, generating $2.7 million of net interest income. For our earnings, our GAAP net income for the quarter was $11.5 million or $0.07 of diluted share. For the first time, our GAAP net income includes equity-related compensation charges related to FAS 123R and booked tax charges at an effective rate of 45%. This includes about 5 points of impact from 123R based on the timing and amount of employee option vesting and exercises.

Our booked tax rate will vary above or below 40% on a quarter-to-quarter basis based on the rate at which employees exercise options. However, as a reminder, due to our deferred tax asset, we paid cash taxes at a rate of about 2%.

In the first quarter, our equity-related compensation expense was about $7 million or $0.04 per share on a pre-tax basis. We still expect that full-year equity-related compensation charges will be about $0.20 on a pre-tax basis consistent with our comments last quarter. Expenses this quarter were a bit lower than the implied run rate due to the timing of our equity grant.

Additional non-cash items in GAAP net income include $2.3 million from the amortization of intangible assets and an $8.8 million non-cash tax charge. Excluding these non-cash items, our normalized net income for the quarter was $29.4 million, up 12% over last quarter and more than double our normalized net income from the same period last year. In the first quarter, we earned $0.17 per diluted share on a normalized basis with a normalized weighted average diluted share count of 176.6 million shares.

Now let me review some balance sheet items. We ended the quarter with $341 million of cash, cash equivalents and marketable securities, up from $314 million at the end of Q4. During the quarter we generated $33.2 million of cash from operations or 37% of revenue. That is up from $27.7 million in the prior quarter and up significantly over our cash from operations of $18.7 million from a year ago.

Capital expenditures in the first quarter were $16.2 million. As we mentioned last quarter, we frontloaded some of our network investments to take advantage of volume buying opportunities. We also invested in our network to capitalize on new opportunities we're seeing in the media and entertainment market, which is driving demand at unprecedented levels.

Capital expenditures occur in advance of revenue realization, and to date we believe we have struck the right balance between generating cash and investing for future opportunities. As we said last quarter, we still anticipate that capital expenditures for the full year will remain in a range of 13% of revenue, consistent with last year.

Day sales outstanding for the quarter were 54 days, up from 53 days last quarter. We had very strong collections this quarter, including cash collected in advance of revenue recognition, but our receivables still grew based on our very strong revenue performance.

Overall, we had a great quarter. 10% revenue growth with normalized net income growing even faster at 12%, and our outlook for the rest of the year remains very positive. As you will recall, on our last quarterly conference call, we indicated that we expected annual revenue growth of 27% to 30% and normalized earnings per diluted share of at least $0.70. Based on our strong first quarter and the momentum we're seeing in our business, we're now tracking ahead of that range.

So today, we're increasing our guidance for the remainder of the year. We now expect revenue for the year to be at least $380 million, which implies year-over-year growth on the top line of at least 34%. On the bottom line, we now expect to deliver normalized earnings per diluted share of at least $0.73 for the year or EPS growth of at least 40%. That translates into normalized net income growth of at least 60%.

As this guidance demonstrates and as we said in our previous call, we expect that our overall normalized net income as a percentage of revenue will continue to expand. We expect cash gross margins to remain roughly stable as any volume discount we offer as part of larger deals are balanced out by operating efficiencies in the network.

Additionally, we continue to expect that network or COGS depreciation will be up a couple of points over 2005 levels, but, and again as we said last quarter, we expect that productivity improvements in our other operating expense line will more than offset this increase, bringing us in the range of 40% adjusted EBITDA margin by year end.

In the near term, we expect second quarter revenue to be between $93 million and $96 million and normalized earnings per diluted share of $0.18. Excluding the unique events in the first quarter, the midpoint of our second-quarter guidance would represent 6% quarter-over-quarter growth on the top line. We're very pleased with our progress in accelerating revenue growth as reflected in our increased guidance. At the same time, we continue to take a consistent approach to estimating future performance.

We should note for those of you who may be new to the story that we often see a slight slowdown in Internet growth during the summer months, making the exceptional level of bursting we have seen recently less likely. We're also focused on making the right investments in both capital and human resources in an environment where we see enormous potential.

We're off to a great start in 2006, and we're expecting to deliver another record year, and I look forward to updating you on our progress next quarter. Now let me turn the call back over to Paul.

Paul Sagan

Thanks, J.D. As you just heard, we had a terrific first quarter getting off to a great start for the year. It is always tempting when things are going well on a recurring revenue model to maximize short-term returns and overlook making strategic investments that would benefit the long-term health of the business. I believe it is our responsibility as management to balance near-term results with long-term success, and we are focused on ensuring that Akamai will remain in the best position to capitalize on new opportunities for a long time to come.

I would like to share with you some of the trends that enabled us not only to exceed expectations in Q1 but also to raise our outlook for the year on both the top and the bottom lines. I believe we're witnessing an explosion in the use of the Internet, enabled by pervasive broadband connections at home and at work and by a surge in compelling digital content that is now being made available under a number of different business models.

Whether it is watching a sporting event online or downloading your favorite music or turning to the web for news, search results or other forms of information, we're beginning to see clear signs that the Internet is displacing other forms of media for many users as their medium of choice.

We benefit from this trend because Akamai has become one of the preferred ways for content providers to ensure fast, safe, reliable and scalable delivery of these digital offerings to users worldwide. Online distribution choices for media producers will continue to expand, whether it's for downloading or streaming and for revenue models that are subscription-based or ad supported.

At the same time, Akamai is uniquely positioned to help make these distribution models viable over the Internet because we help deliver a high quality experienced reliably at enormous scale, guaranteeing that content owners can meet the expectations of their audiences.

Now before we let Digital Media grab all of the headlines, we should note that overall we are seeing very strong demand in our core content delivery service business as more and more enterprises continue to move critical processes online.

Here is a terrific example: the way we are assisting Friendster, the popular social networking site. When Friendster turned on our EdgeSuite service, the rate of daily page views nearly tripled. As an advertising supported site, Friendster correlates increased page views to an increase in revenues. Friendster did not have to make any additional investment in infrastructure to take advantage of what Akamai has to offer.

Another example is our connection to Super Bowl advertisers. This year we helped to deliver online marketing campaigns for more than half of the game's national sponsors. Online tie-ins to the TV ads demonstrates how significant multi-channel marketing has become and how the Internet is playing a key part in helping marketers reach their customers.

Finally, in addition to growth and demand for our core content delivery offers, we continue to develop demand for our new Web Application Acceleration Service. For example, this past quarter Inspireworks selected Akamai's Application Acceleration Solution to help bring more reliability, scalability and security to their online education portal. As Inspireworks prepared to scale its web-based learning service to hundreds of thousands of users by year-end, it has relied on Akamai to help ensure a high-quality experience.

So based on results like these and others we are seeing with early adopters, we remain very excited about our application acceleration offer. We're still in the beginning stages of this opportunity. We believe this market has tremendous future potential and that we are well positioned to capture it as enterprises increasingly migrate their business processes online.

So in summary we're very pleased with our first quarter results, and we believe we have a lot of growth still ahead of us this year. We look forward to updating you on our progress later in the year. So now, J.D. and I will be happy to take your questions. Operator, can we have the first question, please?

Question-and-Answer Session

Operator

Our first question is from Michael Turits, Prudential Equity Group.

Michael Turits - Prudential Equity Group

Hi guys, how are you today? First of all, can you tell us what happened on the churn front, where you are with getting through the Speedera customers as a percentage of churn? Also, anymore color you can give us on the Web Application Acceleration deals? You mentioned last quarter that you could get several dozen half of which are new; where are you at this point?

Paul Sagan

This is Paul. I will take both of them. Churn actually was down. It was 5% if you remember. In Q4 it was actually down to 4% in Q1. Actually it was a pleasant surprise for us -- we had not expected to see that improve because of the completion of the Speedera migration, so that is continuing to go exceptionally well. In managing churn, I think the folks have done a spectacular job at that, so that was a nice surprise as well.

In terms of Web Application Acceleration, when we gave the six-month update last quarter, we said we would not provide extensive updates every quarter as we build that business. I actually don't have the statistics on how much was new accounts and how much was upsell right in front of me, but we continue to find new users, both new customers and upsell in the existing base. We are going to continue to look down both of those channels to build that business over time.

Michael Turits - Prudential Equity Group

If I can get one further question, you still have the cash that you got from the offering. Maybe you can tell us about some of your strategic priorities that might go to use for?

Paul Sagan

We continue to try to be opportunistic to look for places to invest it. We certainly haven't found anything to buy or we would have told you about it. There are not a lot of deals that look as good as Speedera does. That was a very successful acquisition for us. We continue to look for accretive propositions or important technology that we find that might be better to add quickly rather than to build ourselves. But today, the cash is in the bank and earning interest.

Michael Turits - Prudential Equity Group

Thanks, Paul. Strong quarter.

Operator

Our next question comes from Aaron Kessler, Piper Jaffray.

Aaron Kessler - Piper Jaffray

Hi, good quarter. A couple of questions for you. In the digital media side, is it just streaming media that you are posting a strong acceleration from, or is it other areas there as well?

Also, the gross margins seem a little out of my estimates in the quarter as you are frontloading the expenses a little this year. What areas do you think you're seeing acceleration, actually in the business? Is it just the media sector, or is it really across the different verticals?

Paul Sagan

Let me ask J.D. to take margins first, and then I will talk about the growth sectors.

J.D. Sherman

Sure. So, first of all, Q4 was a great quarter for us on margins, and we are down a little bit from the level. There are some things that naturally happen in Q1. The FICA tax impact does impact our margins as well as some of the buying ahead of network capacity. But if you look over the last couple of years, our cash gross margins are consistently in the 84% to 86% range, and it has bounced around up-and-down, and I think we will kind of continue at that level. I don't see a tremendous upside or down side to the cash gross margins going forward. I think we're in a healthy range in the 85% range.

Paul Sagan

So you said digital media and streaming and asked me to differentiate. Did you mean streaming versus download, or were you asking about something else and I missed it?

Aaron Kessler - Piper Jaffray

Yes, basically digital media, the growth -- is that coming from the streaming side, or are other areas within digital media as well?

Paul Sagan

We continue to see lots of interest across digital media, meaning sports, information, news, other forms of entertainment such as music, and we see customers growing with different business models. Those who are doing live events and selling, if you will, a live stream or monetizing it with advertising; and those who are selling a subscription to either a sporting event or the ability to buy things like song downloads. So I don't think it is any way restricted to one or the other, I think which is why it has been so positive.

But we continue to see growth in a lot of areas. Some of the upside with sports a little bit ahead of projections, but we were clearly way ahead of even our own estimates, and sports does not explain that fully. We continue to see it across a wide spectrum of portal traffic, of M&E traffic. But also e-commerce; those customers continue to be very strong, and the government business is strong as well.

Aaron Kessler - Piper Jaffray

Great. It also sounds like bandwidth costs, from what we are hearing, are starting to stabilize a little. Are you seeing a similar trend? What do you see in the market right now?

Paul Sagan

I always say -- I have said this call after call -- that at the wishful thinking of the network providers, if it bears out, that is probably a net positive for our business, but there's still a very competitive market. As you know, we sourced connectivity from 1,000 different networks.

Operator

Our next question comes from Henry Naah, Lehman Brothers.

Henry Naah - Lehman Brothers

Great quarter. Two questions if I may. Paul, can you talk a little bit about how the sales funnel looks exiting the March quarter? It seems like your gross adds, gross customer adds have been pretty strong, north of 125 customers for the last year or so. Could you give a sense; how is the sales funnel looking compared to how it has been over the last couple of quarters? It sounds like it may be expanding a little bit?

Paul Sagan

You know, it is still strong. I don't know that I would say it is expanding a little bit, but both gross adds and net adds continue to be very strong, and we continue to see demand in a lot of categories. I have been very pleased to see adds are not just in the large media companies. Obviously there are not that many large media companies to be adding at the rate we have been adding customers.

Henry Naah - Lehman Brothers

Right. Okay. This is a broader question, but given your broad network delivery in terms of Internet traffic, can you give us any sense of how quickly is the traffic growing on a year-over-year basis?

Paul Sagan

That is a very tough one to estimate. I don't know how to do that because you have got different kinds of traffic. You have got certainly streaming and media is of a different scale, clearly, than a Web-based but certainly then, e-mail traffic. It is growing across I think all of those. I don't see an area where traffic is shrinking, but I don't know what the kind of blended average is.

Henry Naah - Lehman Brothers

Well, maybe in terms of your network traffic, would you say it's growing maybe 75% a year, 100% a year?

Paul Sagan

We have never really given that out, and I just don't have that in front of me. Because again, we look at it across lots of different services, and there is really not one number that I think would be very helpful for people.

Henry Naah - Lehman Brothers

Great.

Paul Sagan

Sorry not to be so helpful on that one.

Henry Naah - Lehman Brothers

No worries. Thank you.

Operator

Our next question comes from Erik Zamkoff, Morgan Joseph.

Erik Zamkoff - Morgan Joseph

Good afternoon, great quarter. Could you talk a little bit about the breakdown between new media and rich media or more of the Legacy business in terms of static web pages? If you can talk about potentially how streaming advertising plays into it and whether you are seeing it as a driver going forward?

Paul Sagan

I'm sorry. I don't quite understand the streaming ad question?

Erik Zamkoff - Morgan Joseph

Just in general whether you're seeing -- there was a Journal article a couple of weeks ago about how traditional product advertisers are starting to build video into their web advertising budget?

Paul Sagan

Okay. Well, so I think taking them in reverse order, the order book a couple of weeks ago was really about how brand marketers are going online, and certainly a component of what they are doing is video. We're seeing our customers doing more and more of that, but we are also seeing them just do richer media and even animated banners and things. So I think people are progressively moving up the step to do more interesting advertising that looks more and more like television with higher value everyday.

In terms of the new business versus static, we moved a whole site to dynamic content years ago. So we are just seeing a steady trend for the last several years of people doing more and more dynamic application-driven content both in the media sector but across the board in e-commerce and everywhere else. So I think that has just been a steady march on the web for several years.

Erik Zamkoff - Morgan Joseph

Got you. And then one last follow-on, can you give us an update as to when you expect to start paying cash tax?

J.D. Sherman

We have not been real specific on that, but the size of our deferred tax asset is in the $330 million range, and it will be well into the next decade before we are in a taxpaying situation.

Erik Zamkoff - Morgan Joseph

Got you. Thanks.

Paul Sagan

That would certainly be our expectation now. I guess it could change if we grow a whole lot faster.

Erik Zamkoff - Morgan Joseph

Excellent. Thanks. Congrats on a great quarter.

Paul Sagan

Hi Rod.

Operator

Our next question comes from Rod Ratliff, Sanford Group.

Rod Ratliff - Sanford Group

I think you misfired there, Paul?

Paul Sagan

They told me you were waiting. It is nice to hear from you.

Rod Ratliff - Sanford Group

It is nice to be heard from. Most everything I had has been asked and answered, but because we have somebody here at my firm that follows the e-learning space, if there is any detail you can give us with regard to how robust of an opportunity that might be given that you are only really a publicly announced customer for Application Acceleration, do you think that there might be more of an opportunity there? Now I realize in terms of revenue contribution it is probably pretty small right now. But is there a viable market there?

Paul Sagan

Well, yes, absolutely. We certainly talked about University customers in the past, other e-learning customers. The new WAA-specific customer or Web Application Acceleration customer, was kind of an e-learning customer if that is what you are referring to.

But we have been working with e-learning sites for a long time, and some of that is a subset of what people do. It can be, for example, an internal and external portal that a corporate customer would make available to employees on the inside or partners or prospects or customers on the outside. So I think there is a broad definition to e-learning, and we certainly see lots of people doing many flavors and forms. In terms of the viability of the business model, if you mean sort of stand-alone e-learning companies, I think that is probably not an area where I'm an expert.

Rod Ratliff - Sanford Group

Good enough. Congratulations.

Operator

Our next question comes from Brent Bracelin, Pacific Crest Securities.

Brent Bracelin - Pacific Crest Securities

I just actually wanted to circle back on the growth drivers. Obviously looking at the growth rate here, even ex-ing out the bursting traffic and ex-ing out an estimate for Speedera, it looks like your reported the best organic growth rate since 2001. Obviously you touched on live events, subscriptions, but could you go into a little more depth on what is really kind of driving that? Obviously international was also strong. Could you touch on the drivers of international growth and highlight some other areas of your business where you're seeing kind of robust growth take place here?

Paul Sagan

Well, first, thank you for looking back so long and making the calculation because I had not actually done that, but that sounds about right. I think the biggest growth driver is the widespread access to broadband connections in the U.S. and elsewhere. Frankly, as we all know, the broadband connections are better in Asia and lots of places than they are available to those of us at home in the U.S.

I think the growth in the business is being pushed by this broadband availability. I think there is something to being able to get broadband at home, and I think there's something very significant to having broadband at home and work. Meaning you can develop an online habit that is reinforced by the two and is sort of one and one is more than two then.

If you are limited to broadband at work but narrowband at home, maybe you don't shop as much or consume as much or buy the subscriptions to an online service as you do when you can stumble into something of value to you in one place and know you can access it somewhere else. So I think we're seeing really fuel in online content and usage coming from this prevalence of broadband.

In terms of us, we're seeing it in the media and entertainment sector, but we are seeing it continue in online commerce, not just from, if you will, the people who are Internet only, but the bricks and mortar companies who are doing more and more retail selling online to complement their traditional businesses.

We saw strong growth, as you noted, internationally where we are seeing demand for a number of our services from large multinational companies who are expanding their online business; and in some large markets from people who are really just worried about their performance in country as well. That was spread across Europe and Asia. So again, I think that universal broadband phenomenon is driving this growth in our business.

Brent Bracelin - Pacific Crest Securities

Great. Just one quick follow-up if I may. Looking at the pretty substantial growth in CapEx in the quarter, how should we interpret that? As you guys deploy your network, is this deploying infrastructure ahead of business that you actually have in hand or see or anticipate? And then, could you also tell us how we should interpret the CapEx build relative to the competition?

Paul Sagan

I will give that to J.D I don't understand the CapEx question, but we will certainly speak to our own planning.

J.D. Sherman

So obviously the CapEx comes ahead of the revenue, so we're investing as we see the opportunity materialize going forward. We are clearly really pleased by the fact that that opportunity seems to be growing faster than we had anticipated earlier in the year. So we have taken up our CapEx bit since the last quarter.

One thing, the $16 million, as we said last quarter, we front-end loaded a lot of that because we like to buy in big chunks to get better volume discounts. So that accounts for a big part of the spike in the quarter.

I think maybe on the competition -- I'm kind of guessing where you're going, but -- the point I would make there is our network remains very scalable. So we don't see a need for a big step function increase in investment. So we think we can of continue to balance the investment with the opportunity as we see it and as we see it expand.

Brent Bracelin - Pacific Crest Securities

Yes, I guess on the competition side I would assume the larger network footprint that you have, the more difficult it would be from a barrier to entry to replicate this similar type of network. Is that the case, and if you could just address generally what you're seeing on the competitive side, that would be great.

Paul Sagan

Well, we continue to see home grown and do-it-yourself as a primary competitor. We have always had competition, though, from the managed service providers, as well as specialists who try to go after niche or focused markets or just the CDN market in general. It remains a competitive world out there. We have to differentiate ourselves by superior service, superior product, and superior care for our customers.

We think that our technology, our network deployment, our scale gives us some significant advantage in the offers that we can make to our customers. But at the end of the day, prospects make their own determination. I think certainly being in 71 countries with nearly 20,000 servers is a significant advantage in our ability to offer customers a better alternative.

Operator

Our next question comes from Ari Moses, Kaufman Brothers.

Ari Moses - Kaufman Brothers

How are you, good afternoon. I just wanted to touch on the revenue per customer you talked about in the $15,400 range. Just as far as thinking about that, obviously part of the quarter's surprise was due to the diversity you talked about, the $2 million from the sporting events and some others.

Going forward I think CBS, for example, was surprised by the demand for the tournament, and therefore, they had bursting, rather than revenues that they had kind of planned on or traffic they planned on. As you see some of that happening where customers start realizing that the demands are higher, start booking it higher, are we going to see those type of levels of bursting obviously taking out the summer months, a fact that you referred to?

Do you think we will still see that type of bursting, or is it going to be more factored into just the typical contracts as this becomes the norm, and how is that going to impact this margin level per customer? Will that be up in the $15,400 range? Will it trend back down because that was kind of just the one quarter effect?

Paul Sagan

Well, whether the people pay us upfront, meaning they come in or they pay us in bursting, we get it in the ARPU either way. So if the business continued on these trends, the ARPU would keep going up regardless whether someone pre-bought or paid it as bursting. I guess in bursting they might pay a higher rate depending on how the specific deal was structured, of course. But I don't think the bursting mix effect is affected. There was so much extra traffic and extra revenue to help bring the ARPU up very, very nicely two quarters in a row, which I think is a very good sign for the business.

J.D. Sherman

I think just to add to that, in general I think we have seen and we're going to see the same kind of trend, which is traffic grows in our customer bases, and as those customers come up for renewal or as we continue to work with them, they will end up committing more of that traffic in larger, longer-term deals. We saw a lot of that start to happen recently. So that helps to drive ARPU as well, and I think that is a healthy trend that will continue.

Paul Sagan

I think that if you do the math, certainly sports from all of those events, not just the one you referenced, doesn't explain nearly all of the upside that we found. It is because there was strength really across the core. So I think that is very positive.

Ari Moses - Kaufman Brothers

So it sounds like this new range that was set, the $15,400 range, it could be sustained going forward?

Paul Sagan

We don't give specific ARPU guidance. We have said over and over again that one quarter over another it could go up, down, sideways depending on the mix of new customer adds, etc. That said, it did go down last year as we did tell people it would because of the Speedera acquisition, not as much as I think people had anticipated. Then it has been on a nice uptick since. So we are very pleased about that, but we don't provide guidance on where we think that goes quarter to quarter.

Clearly on the long-term our goal is to keep raising same-store sales through increased usage of services and selling additional services, but quarter-over-quarter we don't try to predict that.

Ari Moses - Kaufman Brothers

Okay, no problem. And if I can, just one quick follow-up. I don't know if you have hit upon this one, in terms of growth from new customers versus upselling, you have obviously added another strong quarter of customer adds. Have you broken down how much of your growth came from those new adds versus?

Paul Sagan

We did not break that out in the quarter.

Ari Moses - Kaufman Brothers

Okay. All right. Thanks, guys.

Operator

Our next question comes from Jeff Van Rhee, Craig Hallum.

Jeff Van Rhee - Craig Hallum

A couple of quick questions. Most of what I need has been answered. You mentioned the contract length has notably expanded here. Can you talk about where we are now and how much it has expanded since three or six months ago?

And then on the Web App Acceleration deals, I know early on you were feeling your way through the model and trying to get a sense of where you would end up in pricing. Can you just talk about revenue potential per customer on those deals? Lastly, a pretty brief one, sales capacity. Where are you in heads and where you think you will be in six or 12 months?

Paul Sagan

We did not speak specifically today about contract lengths. So what were you referencing?

Jeff Van Rhee - Craig Hallum

I thought you noted that as contracts are coming in now, you're seeing customers taking a step towards the longer-term contract length in contract terms?

Paul Sagan

We said that in the past, and that continues to be true. I think maybe the last time it was around 15 or 16 months on average. You know, we don't really sign 15-month contracts, so that's a mix of one, two and three-year deals. It is probably up now to about 18 months. I don't have the exact number, but we continue to see a nice trend there, particularly among corporate buyers, which is pushing out the average expectancy of deals, and that's a nice positive.

In terms of sales heads, we are always looking for good ones. We are always moving on people if they don't perform. We have done some alignment in some areas to go after these verticals with more specialization with an eye towards boosting productivity of the sales team, which is both the direct heads and the people who support them, account management, etc., and trying to do that very efficiently.

Jeff Van Rhee - Craig Hallum

Where did you end the quarter in direct heads?

Paul Sagan

About 90.

Jeff Van Rhee - Craig Hallum

Then the other question was Web Application Accelerator, as you work your way through the pricing model, can you give us a sense of the size of these deals, potential of these deals relative to your core business? Whatever you can do to color in the potential and what you have seen so for?

Paul Sagan

Yes, we have not broken that out. We continue to see what I think are successful new pricing models out there in the corporate market with various strong initial size for us and good margins. It has allowed us to move into some new verticals that did not necessarily see as much value in traditional content delivery such as manufacturing. But that's really all the comment we're going to make on it at this point.

Operator

Our next question comes from Katherine Egbert, Jefferies.

Katherine Egbert - Jefferies

I'm glad I was able to get questions in. I will start with a few of them. So the net new customer adds were 71. Can you tell us qualitatively on a go-forward basis, how should we expect net new customer adds to balance against ARPU? Typically more new customers means less ARPU, but can you just kind of walk us through does that kind of equation still hold?

J.D. Sherman

Well, more net new customers does mean it can weigh down the ARPU. Obviously as the base gets bigger and bigger, if the adds stay at about this number, they will have a smaller impact per quarter on ARPU. I guess that would be perceived as a positive.

On the other hand, anytime we can find a good future customer, I want to bring them on board as long as we think it is a profitable deal and we think that they will grow. I have not done the math to calculate it -- has the customer basis grown? At this level of customers we have been adding, exactly how much that is not bringing down the margin on a net basis. But the math comes out in the end very strong both in terms of growing the customer base now to practically 2,000 the highest we have ever had, and very, very strong same-store sales.

Katherine Egbert - Jefferies

Right. It seems harder and harder to move the needle. That is what I'm trying to get at. Would you say the main driver of ARPU, is it the longer-term contracts? Is it heavier comps or is it you upselling additional services?

Paul Sagan

You know, I think it is all those things. Their volume continues to grow, we have been successful at selling additional services, and we are often I think finding some initial customers who may be bigger than we would have seen before, just because as people launch new online initiatives, they just know more is going to come. So they don't necessarily put a toe in, they will put a whole foot in to start because they just have a reasonable expectation of higher volumes, day one.

Katherine Egbert - Jefferies

Okay, that is fair. What was the bursting percentage of revenue this quarter?

J.D. Sherman

It is roughly in the same percentage of 30%, roughly speaking, plus or minus.

Katherine Egbert - Jefferies

Okay. Can you help us out? Your receivables were up pretty markedly quarter on quarter. What about cash flow guidance for Q2? Is it fair to say it will be up just on better collections, higher receivable base?

J.D. Sherman

So we have not actually given any cash flow guidance. A couple of things I would say about this quarter's cash flow. First of all, collections, we actually collected more in terms of receivables than we had in revenue. But we had some growth in our deferred revenue, which is, of course, revenue we will recognize over time.

Secondly, this quarter we had some natural things like with our payroll accruals that we recognized a lot of payroll expense in the quarter that we will hit next quarter. So there are some things going on within the cash flow. But it was a very strong cash flow quarter. This model is a very strong cash generating model.

Over a longer period of time, the cash flow tracks very closely to the EBITDA, and we are projecting obviously EBITDA to grow with revenue and, in fact, expand on a marginal basis.

Paul Sagan

I generally say we watch DSOs very carefully, but when you're growing at this pace, even with strong collections, they can go up, and it is not an alarming thing.

J.D. Sherman

We actually used a methodology to calculate our DSOs, which uses the ending revenue point rather than the average. So it makes it very difficult.

Katherine Egbert - Jefferies

Okay. Got it. Last question. Can you tell us what percentage of revenue, roughly, are media companies?

Paul Sagan

No, we don't break out the verticals. There has certainly always been a strong one in probably our strongest category. But we really look across about seven different categories to contribute to the business.

Katherine Egbert - Jefferies

Okay, good job. Thanks Paul.

Paul Sagan

Thanks, Katherine, and why don't we take one more question, operator.

Operator

Our final question comes from Robert Stimson, WR Hambrecht.

Robert Stimson - WR Hambrecht

Just a quick question. Hi, how are you? Just let me ask a dumb question maybe if I may. You guys did $91 million in revenue, and I think Consensus estimates were about $85 million for the quarter, and roughly $2 million came from bursting. You made a comment that the remainder came from some pretty big contract wins going forward. You had commented a little bit about as you do bigger volume, there is some pricing there. Can you comment a little bit on what you meant by that?

Paul Sagan

So just to be clear, because maybe we were not clear enough; the upside came from bursting. Some of it came from sports as we identified. New big deals don't contribute revenue quickly. You know, we are in the recurring revenue business, and we have to sign them, integrate them, bring them on and then see them grow. So it was really new business that came in in Q4 that started and then grows broadly across the customer base.

So I hope that clarifies it a little bit. I will let J.D. talk about the margins, but I want to make it really clear. There were not just a couple of big sudden deals that spiked the quarter. Our business does not work that way. It is very much steady as she goes, find a customer, do the technical assessment, close the deal, integrate them, put them on the network, add the features.

J.D. Sherman

Right. So the signings and the bigger longer-term deals are what give us the comfort to take up our guidance for the year. It had some impact in the quarter, but more a smaller impact because of the recurring revenue nature, as Paul said.

On the pricing point, basically the point there is the same trend we have seen for years in this business, maybe a little bit more pronounced than some of these bigger deals. But as we increase the size of deals and increase the volume on our network, we tend to give volume discounts, and we tend to use those larger commitments to do a better job of managing our network costs, buying bandwidth efficiently, buying co-location efficiently, and we will manage that kind of balance point going forward in our model.

Robert Stimson - WR Hambrecht

J.D., has the average length of contract elongated a little bit versus what you saw last quarter, maybe the quarter before? Can you give a sense of the average length of contracts this quarter versus last?

J.D. Sherman

Sure. As Paul said to an earlier question, that contract length has drifted up from the 15 or 16 months. On average we're seeing probably closer to 18 months. So obviously we don't sign 16-month deals very often. So what that really means is we're seeing more two and three-year deals than we have in the past, which is really good for us because we like to have those kind of commitments.

Robert Stimson - WR Hambrecht

Okay and then just a last quick one. You know, your stock at the end of the quarter , great numbers, but your stock really traded up nicely and then you guys gave guidance. I thought the top line guidance was extremely bullish, and I think maybe the stock is sort of trading down a little bit when you gave your EPS guidance. Is there a certain level where you think margins could go from a net operating standpoint versus what you guided to?

Paul Sagan

Bob, if you can figure out how after-hours trading and second by second correlates to words coming out of my mouth, you are smarter than I am. We're in this for the long-term. We drive the business. I think we have very, very strong growth in earnings, and people out there will draw their own conclusions about the value. I have no doubt about the strength of where we are as a Company.

Robert Stimson - WR Hambrecht

I guess I was asking where you think, if margins go further as you get more volume, can net margins -- is there a range where they could go to -- not saying that you are guiding to that?

J.D. Sherman

Yes, we have had discussions on our long-term model in the past. I think those hold very bullish on the financial model that we have. In the short-term, people have to draw any valuation conclusions they want to, on their own. I think the financial model of the business is very, very sound, both on the top line and how it drops all the way to the bottom line, and we expect to do better on both fronts today than we did 90 days ago. We're feeling very positive about it.

Paul Sagan

Underlying our guidance, 34% revenue growth on the top line is driving 60% net normalized net income growth. So that is good scalability. We have demonstrated that over really the last couple of years. So I don't see anything in either our guidance or in the business that says that is going to stop.

Paul Sagan

Thank you, everybody, for tuning in, and we look forward to talking to you in another three months. Bye.

Operator

This concludes today's Akamai Technologies first quarter 2006 earnings conference call. You may now disconnect.

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Source: Akamai Technologies, Inc. Q1 2006 Earnings Conference Call Transcript (AKAM)
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