阿卡邁科技 (AKAM) 2002 Q2 法說會逐字稿

Good afternoon.

My name is Melissa.

I would like to welcome everyone to the Akamai Technology second quarter earnings conference call.

All lines have been placed on mute to prevent background noise.

After the speakers' remarks, there will be a question-and-answer session.

If you would like to ask a question during this time, press * and the number 1 on your telephone keypad.

If you would like to withdraw, press the pound key.

Thank you.

Mr. Raby, you may begin.

Thank you for joining Akamai's second quarter investor call.

Speaking today will be George Condrades and Tim Weller, our chief financial officer.

Paul Sagan will also be available during the question-and-answer session following management's prepared remarks.

This conference call will discuss information about Akamai's future expectations, plans and prospect that is constitute forward-looking statements for purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements.

As a result, various important factors are not limited to general economic provisions and related industries, the dependent on delivery services and on outsourcing services and software.

Unexpected increases in Akamai's use of funds, failure of services to achieve acceptance and ability (inaudible) customers, failure by us to successfully enter into license, technology or technology partnership agreement within the time periods expected by us or at all.

Any failure of Akamai (inaudible) including increases in bandwidth cost, failure to achieve incremental revenue cost in a timely fashion or at all, change necessary regulations, or launch relating to privacy or other aspects of the Internet, complexity of the services and the networks services are deployed and human error.

The ability of service and outstanding debt and the (inaudible) engage a customer and other factors discussed in the annual report on form 10-k or quarterly reports on form 10-q and other documents filed with the SEC. Any forward-looking statements should not be relied upon as representing our estimates as evasive.

We may elect to update forward-looking statements at some point in the future, but specifically disclaim any obligation to do so, even if estimates change.

I would like to turn over to George.

Thanks.

Good afternoon, everybody.

And thank you very much for taking the time to join us on this conference call.

First, I will summarize our second quarter performance and follow with comments on our forward-looking outlook.

Tim will provide the financial details and finally, I will offer an update on our business. We are pleased with second quarter results.

Revenue was $36.3 middle, in the middle of guidance range. enterprise sales were (inaudible) resellers to bankruptcy xo and group telecom.

The quality of revenue and the quality of the customer base has never been stronger.

We also posted a solid EBITDA performance in the second quarter, losing only 8.3 million in EBITDA as we continued to close in on profitability profits of positive free cash flow by year-end 2003. Over the past 12 months, we have reduced cash operating expenses 37%, and capital expenditures by 80%, leading to this quarter's cash churn of just $11.5 million, the lowest quarterly level in years.

We were able to achieve this by strong collection, tight control of operating costs and minimum capital expenditures made possible by leveraging our global in-place network.

As a result, we exited the second quarter with 160.2 million dollars in cash and marketable securities, demonstrating our ability to grow our customer base, while keeping business plan fully funded. A simple comparison of $11.5 million quarterly cash burn to $160.2 million in cash and marketable securities now on hand further demonstrate our financial strength.

Revenue from EdgeSuite, grew to 36.4% of total revenue for the quarter, up from 27% in the first quarter.

Clearly, EdgeSuite is our growth engine.

Bringing our total sweep customers under long-term recurring contracts to 211, including major enterprises such as General Motors, Thomas Cooke.

Large customers we signed this quarter, but cannot disclose by name, include one of the top five sports and fitness companies in the world, a fortune 500 toy manufacturer, one of the largest telecommunication providers in the world, a fortune 500 provider of semiconductor memory solutions.

The actual number of new EdgeSuite customers were higher than 26.

I will leave it to Tim to give you dynamics of gross to net.

I think you will see the sales force is doing one heck of a job adding new permanent economy EdgeSuite customers. Also contributing to growth in EdgeSuite were renewals of key enterprise contracts with Apple, the FBI and Xerox.

EdgeSuite products are proving profitable in automotive, retail and heavy industry.

With newer verticals such as health care and financial services beginning to contribute, as well. We are pleased with the health of our overall customer base.

DSOs were 43 days.

Our accounts receivable aging is as healthy as possible.

Revenue dropped to 11% of revenue in the second quarter, from 14% in the prior quarter.

We have a great base on which to build.

It begins with our customers and our strong market position and leverages our network and world-class technology.

From content delivery to edge computing, Akamai is leading the way offering customers the ability to outsource costly and complex infrastructure, while focusing resources on the creation of great applications that provide them competitive advantage. During the quarter, we signed three customers to commitments of more than $50,000 per month, reaffirming our vision enterprises want uniform and scalable solution to deliver content and applications across the Internet and intranet.

Our edge computing initiative gains traction with leading partners.

You will recall in April we announced relationship with Microsoft to deliver EdgeSuite for their net initiative.

Later in the quarter, we joined IBM to launch EdgeSuite for java application.

We are already working with a major customer, Sony Ericcson to meet their business needs.

Our goal is to be the computing environment of choice, independent of enterprising application, enabling customers to improve content and application delivery anywhere on the globe.

Each day I am more confident of our opportunity and success. Near term, our specific challenge continues to be accelerating top line revenue growth in spite of the difficult economic environment and the stubborn churn from weak channel partners and some remaining underfunded.

We are confident we are nearing the bottom of the barrel, but continue to be cautious about making predictions on churn.

Revenue growth comes from gaining customer revenue addition that exceed customer revenue losses.

Let me comment on that. A good indicator is EdgeSuite sales activity.

We are making more calls, more proposals and engaging in more active negotiations than any time in our history.

Furthermore, the experience level of our sales team continues to improve with their time in the field, which we believe bodes well for the future.

We continue to highly experience direct and channel sales people. We are also realizing success in driving revenue growth within existing accounts by outselling 20 distinct components of EdgeSuite.

At the same time, since the height of customer churn in the third quarter of 2001, we have substantially reduced, but haven't eliminated churn among direct customers.

We accomplished this by improving customer credit checking, better management of accounts and in some cases, securing upfront payment for services.

We experienced fall-out from financially strapped network channel partners and have taken majors to better anticipate and to respond to impending channel partner bankruptcy.

The downtake in churn from current levels will go a long way to get revenue growing again. This leads me to guidance.

Our outlook for revenue is $35 to $38 million, moderated by EdgeSuite.

For the full year, we won't give a numerical range, but expect revenue to grow in the fourth quarter, versus the third, with new gross monthly sales 10 to 15% higher due to recent additions and lower churn based on the customer base.

We believe EdgeSuite will be 35% of revenue for the full year. We intend to reach sales goals short of downturn in IT (inaudible) field resources and believe any adoption of new initiatives, such as enterprise behind a firewall, custom offerings to government accounts and Edge in support of java and Microsoft.net, could contribute to top and bottom line performance in the next 12 months.

Yesterday we received notice our GSA schedule contract was rewarded, a key milestone in government sales progress. Making predictions a quarter out remains difficult, but we have consistently demonstrated we can match expenses to revenue.

We are confident in our ability to continue to meet our bottom line EBITDA and free cash flow goal.

Our full year 2002 EBITDA forecast is now a loss of $27 to 32 million, comparing well to EBITDA loss from last year.

Savings are due in part to conservative hiring year to date, versus the budget, lower than expected network cost, better collections and the significantly improved health of the customer base that led to lower bad debt reserves. We continue to find efficiencies within our headcount and finish with 807 employees in the second quarter.

We are not replacing attrition in GNA and hiring in direct sales to maximize speed on the street.

We still expect to end 2002 with over 120 million dollars in cash and marketable securities and maintain our commitment to becoming free cash flow positive by the end of 2003.

Now, I will turn it over to Tim for details on the numbers.

Thank you.

Our (inaudible) drive toward positive EBITDA and free cash flow.

Not only did we end the second quarter with 160.2 million of cash and marketable securities after achieving lowest cash burn rate since early 2000, we secured a new headquarters building, expected to generate 9 million of annual cost savings to the company.

I will begin by walking through the results and future expectations emphasizing the numbers supporting free cash flow goals.

I will address customers, revenue, network costs, EBITDA, capital expenditures and most importantly, free cash flow.

Our revenue for second quarter was $36.3 million, in line with estimates of 35 to 38 million.

We are pleased with stabilization of top line in spite of churn and it provides further evidence of our ability to win contracts in a continued flat IT spending environment.

The revenue results reaffirm the power of our recurring business model at a time when many product businesses are seeing ongoing declines in sales.

Revenue from recurring customers was 93% of overall revenue for the quarter, versus 94% in the prior quarter.

The count was 1034 at the end of the second quarter, just below 1055 at the end of the first quarter. During second quarter, we added 162 gross new recurring customers and lost 183 recurring customers.

Reseller bankruptcies resulted in churn customers, the direct side of the business was stable on churn.

Our revenue remains flat at $10,750 per month, versus $11,200 per month previous quarter.

We ended the quarter with 211 EdgeSuite customers from 185 the previous quarter. On gross basis, we added 1 new EdgeSuite customers, up from 43 last quarter.

As I mentioned, we are pleased with quality.

On net basis, however, we added 26 customers versus 33 Net customers last quarter.

The difference between the two quarters was that we lost 9 to revenue reserve for financial difficulties, which we do not include in customer count. 6 of these customers are solid, but served by bankrupt retailers.

We are confident we will migrate these to direct contracts. The rest are early adaptor non-enterprises.

Evident of this fact, average revenue per customer for new EdgeSuite customers was 50% higher than average revenue per customer for churned EdgeSuite customers.

Last quarter, we indicated it was our belief churn had bottomed out in the third quarter of 2001.

The churn we continue to experience in FreeFlow and streaming is attributable to the financial distress of retail customers and poor capital raising environment.

Similar to last quarter, the average revenue per customer of churn customers continue to be less than half that of the remaining base.

Churn is difficult to predict, but the past three quarters have been encouraging.

To the extent we experienced minor competitive churn among some product lines, we have created entry level offerings helping to preserve customers without sacrificing (inaudible) Akamai customers, remember we terminated hundreds of customers last year for nonpayment and financial difficulties and some of those certainly go to low-end competitors. It is important to remember our focus is on building long-term profitability with EdgeSuite and there is not a competitor with a comparable offering there.

Our customer base is healthy.

Today's sales outstanding for accounts receivables came in at 43 days for the second quarter. 2 days better than the 45 days achieved during the first quarter, continuing strong record of collections.

EdgeSuite revenue was 36.4% of the quarter up from 27% in the first quarter. We are obviously excited that EdgeSuite is over a third of the revenue within 5 quarters of its launch.

That is marketplace success. Overall, EdgeSuite average revenue per customer was approximately $22,250 per month, a 9.4% increase versus the prior quarter and substantially higher than per customer FreeFlow or streaming numbers.

This increase was driven by selling existing customers additional EdgeSuite services, as well as the continued conversion of FreeFlow customers under the EdgeSuite platform.

We are targeting entry level customers in 10 to 15 thousand dollar per month range.

We have large customers at $100,000 per month or more.

On customer concentration, no customer was 10% or more of revenue during the quarter.

Resellers accounted for 23% of revenue in the second quarter, down from 25% in the prior quarter. Reseller revenue contribution declined as result of bankruptcy, reducing the top line contribution while contributing to churn.

International sales are important vehicle of growth for the company with 13.4% of sales for the quarter coming from holy owned European operations and Akamai Japan. Now, look at cost in the second quarter starting with the network.

Cost of service was 10.9 million for the second quarter or down slightly from first quarter results.

Gross profit was 25.4 million or 70% of revenue.

Consistent with long-term profit margin target range of 65 to 70%.

Recall that last quarter we added network expenses to our cost of service reporting line and did not lower our long-term target.

We increased target on relative basis.

With the network many times larger than competitors we can expand server presence into key locations and move existing servers within the network.

We have a long track records of network optimization. (inaudible).

The mix shift that is occurring speaks well for margins going forward.

FreeFlow continues to see pricing pressure, but we believe we can hold margin using three strategies.

One, meeting low-end competitors with entry level offerings while holding prices for FreeFlow full value proposition.

Two, continuing to lower network costs and three, leveraging our position as a market leader and independent competitor with the strongest balance sheet.

By our performance in the past year, in spite of low end competition and FreeFlow we can deliver solid gross margin.

Streaming is providing confident contribution and is important of EdgeSuite.

We are the leader in streaming and continue to walk away from deals that don't meet margin requirements, even if we lose revenue from existing customer.

We remain committed to supporting streaming.

The functionality of underlying network are key to Akamai's value proposition.

Our global network platform is 12,976 servers and 1095 networks versus 12,674 servers and 1074 networks in the prior quarter.

Our servers are located in 66 countries.

Server count will be driven by revenue demand from network deployment, decommissioning from bankrupt ISPs and regular replacement of existing servers.

We do not believe we have reached full deployment, however, and continue to deploy aggressively into key networks in the most capital efficient way. As evidenced in the second quarter, we expanded into 50 new networks worldwide with minimal capital expenditures.

Because of our technology and breath of our deployment inside a 1000 networks, customers receive the most reliable service, even if there is a problem at an underlying network.

Network failures have been so celebrated in the newspaper this year, have almost no impact on customers to business. ended the second quarter with 807 employees versus 822 at close of the first quarter.

As George mentioned, we continue to grow our front line direct sales effort.

We continue to attract top talent given our market leadership position, strong balance sheet and frankly the perceived upside value of our stock. Revenue per average employee, a key driver of productivity was 178,000 dollars annualized consistent with 182,000 from the first quarter and up 25% from a year ago.

Our EBITDA loss for the second quarter was 8.3 million, versus 5.8 million EBITDA loss in the first quarter. You will recall that our first quarter results included one-time cash savings not replicated in the second quarter.

Our results represent a considerable savings from the prior year period.

Cash operating expense, which is sum of research and development, sales and marketing and SG and A was 33.7 million dollars, up slightly from last quarter and down almost 40% for the prior year period.

The difference between the first and second quarter number system largely accounted for by one-time positive debt reduction in first quarter, as we explained on the last call.

Other cash operating expenses were basically flat versus last quarter. Recently we announced relocation of our headquarters to 8 Cambridge center, two blocks from the current building.

The move should cause minimal employee disruption.

We expect to realize cash operating savings of approximately $9 million per year, beginning later this year. Capital expenditures in the second quarter were 3.7 million dollars or 10% of revenue, slightly better than our guidance of 4 to 6 million.

We continue to forecast the capital expenditures will remain low, even when taking into account new initiatives and improvements at the new building.

Capex are 3.7 million for the quarter, break down as follows. 60,000 for network related purchases, versus 700,000 in 2002. 1.7 million for software development capitalized under sop 98-1, flat versus the 1.1 million in the first quarter and 1.3 million dollars for internal IT and facilities versus $400,000 for the first quarter.

You have heard me say before, our low capex is the strongest evidence of our low capital model.

We continue to believe this ratio in the long-term will be in the range of 5 to 10% of revenue, consistent with leading technology companies. We believe third quarter capex will be 6 to 8 million dollars as we move into new headquarters.

New capex for facilities improvement and network equipment is expected to be in the range of 3 and a half to 4 million dollars in the third quarter and total of 6 to 8 million.

Non-move relating capex is expected to continue at similar levels to the current quarter.

Fourth quarter capex is expected in the 3 to 5 million dollar range, consistent with the second quarter. Recurring free cash flow defined as EBITDA minus capex minus net interest expense was negative $15.7 million in the second quarter, a dramatic improvement from the $46.4 million in the year ago quarter. Overall depreciation was $20.6 million, of which $11.6 million was for network-related assets and 8.9 million related to other assets.

Net interest expense of $3.7 million is combination of interest accrued and interest earned on average cash balance.

Our second quarter normalized net loss per share was 29 cents, even with first call's net loss of 29 cents per share.

As always, normalized loss calculation excludes amoritization, noncash and one-time charges.

Our second quarter net loss per share in accordance with GAP was 38 cents.

Complete reconciliation of the loss appears in the press release. Share count was 112.3 million shares.

Our outstanding share count on June 30th was 116.4 million shares.

The fully diluted share count includes outstanding warrants and stock options was 133.4 million dollars.

At this point, let me reiterate our guidance. Third quarter revenue of $35 to 38 million dollars.

Third quarter EBITDA loss of $7 to $9 million.

Capex of 6 to 8 million dollars.

All inclusive of our move costs.

Our full year guidance without numerical range calls for revenue growth in the fourth quarter versus the third quarter.

Full year EBITDA loss of $27 to $32 million and full year capex of $16 to $20 million, both improvements over previous guidance. Full year negative free cash flow guidance remains $90 million or less.

To finish the year with at least $120 million of cash and marketability securities.

I will turn it over to George.

Thank you, Tim.

I plan to wrap up with comments about business prospects.

First a footnote on matters under litigation.

Akamai has made significant investment in developing solutions that offer significant customer value in the marketplace.

We believe that two competitors have tried to shortcut the process of developing their own offering by infringing our patent rights.

We ultimately went to court to seek redress.

Our patent sued against Digital Island we announced major step forward in litigation against the company previously known as Digital Island and now doing business under the Exodus brand for Cable and Wireless.

Earlier this month, a federal judge entered a permanent injunction against Exodus based on Exodus infringing certain patent rights.

We are hopeful the injunction that makes use of our patent rights could be issued as early as this summer.

We also filed patent infringement, false advertising and trade secret theft lawsuits against a smaller competitor.

The trade secrets lawsuit we alleged that this competitor's chief technology officer obtained marketing trade secrets by repeatedly accessing a database managed by a third party testing service.

The reason we are concerned, by steeling sales and marketing data, they competed with us, not by making the necessary investments in their own company, but by misappropriating the hard work and significant investment we have made.

Hearings are scheduled on the suits for later this summer.

We will provide updates as events warrant. Now, final words on business and the general business climate.

It is a high level of uncertainty about when enterprise spending will accelerate.

One thing is certain, the companies that stand to benefit the most from favorable spending environment are the ones positioning themselves today with the right product, the right sales force and the right technology road map to meet tomorrow's demands.

That is exactly what we are doing at Akamai. In spite of one of the worst IT spending environments in recent memory, major enterprises continue to install EdgeSuite. 20 out of Fortune 500 enterprises have become customers over the last year, helping contribute thirty-six-36% of revenue this past quarter.

EdgeSuite's primary competitor is Customer Inertia. (inaudible).

While EdgeSuite responds to those needs by providing cap capabilities such as security against denial of service attacks and assuring integrated marketing campaigns are successful while increasing performance and dramatically reducing cost and complexity.

Best of all, our customers realize these EdgeSuite benefits immediately. Customers are buying EdgeSuite today as solution to specific problems, such as integrated marketing, personalized commerce, security and in addition, we are working with customers who are forecasting increasing demand, but are unwilling to put in fixed cost infrastructure and want to put in outsourced solution.

We expect this trend to accelerate with any upturn in the economy.

So, the sales calls we are making today are also the ones that will yield results tomorrow.

Over the last several quarters we have undertaken the difficult, but necessary steps of replacing most of our existing sales force with proven enterprise capable sales leaders.

It takes time to get up to speed, they are starting to get results. Our new business activity with high quality industry leading customers has never been more promising.

Our sales team in combination with engineering is beginning to gain traction behind the firewall.

Recently we developed our first paid beta site of enterprise content delivery solutions.

And in an important milestone of EdgeSuite service we completed our first live application trial of Edge computing with a major customer.

The company is implementing strong product roadmaps today are going to be tomorrow's success stories.

There is a significant technological shift underway in hour companies interact with company MERs, partners and employees, enabled by Edge computing.

Edge computing allow global companies to improve performance, availability and scalability of applications such as portals creating new applications.

Two of the biggest players in the industry, IBM and Microsoft, see the opportunity and are working with us to help their customers deploy and manage new web services and applications. I believe Akamai has the right solution for today's enterprise market and the right technology roadmap to increase leadership in Edge computing into the future.

Likewise I believe with 160 millions in cash on hand, a declining burn rate, and our projection of churning free cash flow positive in 2003, we have a fully business plan to get us there.

I want to thank you all for your participation on the call.

Now, Tim and I will take questions.

Paul Sagan is also available to respond this afternoon.

Operator, the first question, please.

Your first question comes from Sugi Sylva.

First on the sales force.

I am curious how many direct sales people you have at this time and how many months do you - you think Georgia will take to get productive?

Roughly 60 and we think it takes 6 to 12.

And EdgeSuite had a good quarter.

Are you seeing enough pricing strength that you think you can actually raise prices you are going through?

Or is the increase being driven by upsales? That is a question of price versus features.

We have been doing well on price to the extent somebody doesn't want to reach out there at the 50 or 100,000 dollar level.

We have scaled down offerings to go to them with.

On feature to feature basis, we feel like there aren't a lot of competitors and have a strong ROI holding price well.

Okay.

Last question on the Japanese JV you mentioned, 13%, what is margin on that, Tim, versus core business?

Want to make sure I clarify that is for Europe and Japan combined, which is 13, which is non-U.S. activity.

We haven't broken out margins by region.

I will take a pass on that.

Certainly, it is quite profitable, like other regions would be.

Thanks.

Your next question comes from Robert Fagin of Bear Stearns.

Hi, guys.

I got one general question and then a modeling question. The general question is you guys obviously have a good vantage point into what is going on.

Given the activity in the marketplace, any noticeable changes you can note in terms of Internet traffic patterns or growth?

Specific to you guys, just so I understand your free cash flow data, is it 03?

I think you were in '03 previously.

Does your 3Q and 4Q guidance assume your customers come back or not?

This is George.

The best I can give on Internet traffic estimates and it comes from different things.

Analysis that other firms make.

We have a period where the Internet traffic was doubling every four months.

The best estimates I have seen is that it is doubling once a year.

It is growing.

It is being driven by permanent economy companies increasingly turning to the use of the Internet to do their fundamental work, cheaper, better and faster.

One of the big displaceables is call centers.

Anybody with call centers are moving to the Internet.

It varies by company.

If it is $6 a transaction on the call center and 60 cents a transaction on the Internet, you are going to try to get there. The good news is we make good things happen on crappy networks.

They turn from call centers to the Internet and need the reliability and security to protect their brand.

So, we see demand from companies who are doing that right now.

This is one example.

That is the kind of thing helping to drive Internet traffic.

Robert, it is Tim.

One thing I would add revenue becomes less dependant on traffic everyday as we sell EdgeSuite.

You can sell it (inaudible) in traffic.

We are really obviously selling not only the traffic component but processing capability and storage capability going forward.

That obviously is helping margins.

Important question on traffic, but definitely less important to us everyday we move the mix.

In terms of free cash flow, we still plan to go free cash flow positive in 2003.

We have had that in place for a while.

At some point next year, we believe we will become free cash flow positive. That still remains the target.

You asked about reserve.

I didn't get it, but if customers are obviously achieving a certainly level of difficult and nonpayment, we take them out of revenue and customer count.

Obviously from collections record, we continue to try to collect at all points.

Where it gets interesting if the reseller goes bankrupt, such as Quest.

We can go and attempt to attach their customers on Akamai contracts.

They know us.

We have the right to roll them over to our network.

We have been fairly successful in doing that with last year.

PSI comes to mind and a couple of others.

It takes time, but we will go hunt down the end-user customers, as good sources of new revenue.

Okay.

Thank you.

Your next question comes from San Ji Purey of Thomas Weisel Partners.

Nice job.

If I understand right, you ended 160 million this quarter.

You are looking for 120 million at the end of the year.

That is $40 million.

That is a lot.

What is happening between - I am wondering if I missed something or is something happening between the third and fourth quarter?

That is a sizable amount.

Point to two things beyond normal operation of business.

I think you can trend well off 1Q and 2Q and ongoing cost cutting.

The two things I pointed to was the move in third quarter, 3 and a half to 4 million dollars.

It was small in the second quarter and a small amount in the fourth.

The bite is in the quarter.

We have interest payments on bond of 8.2 million dollars.

The next payment is in the third quarter.

If you take the move and interest payment as the two main one timers in there, you could then get the operating numbers to connect the dots.

Then, on the - it is disheartening to see EdgeSuite is increasingly becoming a larger part of overall revenue.

But, you know, I would expect to see commensurate increases in gross profit margin given it is - my understanding is it is there and it is a less network intensive offering.

So, even though gross margins trend it down a hair, - I know you are maintaining guidance, but I think you would begin to see that moving up rather than waivering a bit around 70%?

Couple of things.

I think you are right.

We hinted on previous calls there is potential to go above 70%.

We have been unwilling to raise long-term target, but we have got for example, still churn occurring in particular on resellers.

When the customer doesn't pay us, it doesn't show in revenue that is a near-term depressor of margins.

I think we have certainly, as I said, had to rationalize streaming over the past year.

That is stabilized.

There are other effects near-term that still cause us to be cautious.

But, you make a fair point there is upside to the margin.

When the mix becomes pure, I think we will start to see that.

In terms of 35% as sort of a rough target for the year for EdgeSuite.

We did 27 in the first 36 this quarter.

We expect to drive that up.

We have growth in other areas, particularly government, as George highlighted in the custom type of things we are able to do this.

It is possible EdgeSuite could end up at higher percentage of the mix.

Just, venturing out on a limb a little bit just one more question real quick.

Venturing out on a limb, when do you expect to see your overall recurring customers begin to either stabilize?

We went from 1055 to 1034.

I know you don't have a crystal ball, but help us understand when we will begin to see that make shift in adds versus -

We will not go at that pitch. (inaudible) from the early days, some are very small.

Mike is clearly keeping score on EdgeSuite through large enperprises.

You heard him say many times the top 10,000 global enterprises are the target and a quarter of those today are near-term targets because they are mission critical on web-based technology.

We are still focused on 250 top web companies.

That is where he is keeping score.

We have many other customers in other areas we serve.

If they pay, we are happy to keep them on.

It is not a big number to watch.

I will not make a forecast there.

It certainly isn't dropping very fast.

We have been adding at a rate consistent with churn.

Finally, can you give us headings for the third quarter?

All the uncertainty out there and given the international is 13% of revenue, can you give us a sense of - we are in July, what expectation s in Europe are and the international front?

There seem to be divided opinions out there.

I don't think we will do that.

The important thing for us, we are still small enough in the markets that we in general control our own success there.

We are focused on large enterprises and in spite of having down spending, have more than enough money to pay.

It is a question of sales cycle and when can we get them to commit to the vision.

You heard a few names today that are big enterprises on EdgeSuite.

We certainly not a nice pipeline.

So, I don't want to get more specific than that.

It is not dramatically different than in the U.S.

Great.

Thank you.

Your next question comes from Vance Edleston of Morgan Stanley.

Thanks.

Congratulations on the quarter.

Sounds like you are doing all the right things.

After the first quarter reduction in general and administrative expenses, is there quarter's increase in GNA line, despite the reduction in headcount, how much is related to legal hassles you had to deal with or is it a matter of growing the company's capabilities and therefore, how do you see that growing going forward?

I mentioned the bulk of that was a swing in bad debt.

Remember back in the first quarter call, we had a positive bad debt expense, in other words, income, because we had such a strong clean-up of the balance of aging in the first quarter.

That is a pretty unique thing.

We expect to have a small bad debt expense going forward like we did this quarter.

The swing there was bad debt expense.

Look at line by line in salaries, real estate, you will not find a story between one and two q in terms of the change.

Legal is the same.

It is expensive to maintain it, but we are going forward with the same strategy as George described.

If we normalize for the bad debt it is more evident the success in reducing expenses?

Yes.

Great.

Your next question is Harry Blount of Lehman Brothers.

Couple of quick questions on the quarter.

First, as it relates to government contracts.

George had mentioned something about where you are at in the GSA cycle and getting approve wills.

Can you give us a better sense of where you are at on that?

I know you guys had a lot of activity with the government after September 11th, of the portion of the market you consider highly likely, where are you at in actually recognizing the revenues?

That is question one.

Then, I have a couple others follow-ups?

Overall, we are pleased with the federal government results so far.

It is true that after September 11th, we - it was a kick-start in an unfortunate way.

But, we had two customers really at about September 11th.

We have 15 or 16 customers now.

These are the major agencies.

We have very interesting custom work underway that I cannot and will not get into.

It is important for us to achieve that GSA scheduled contract.

So, overall, I would say our government business is going great.

We did almost as much revenue in the first six months as 2002 as we did for all of 2001. I introduced over the phone last time, Keith Johnson, who is a veteran in the federal marketplace.

His team now is flushing out.

They are doing terrific job at getting coverage there.

I am pleased with the results to date and I am also pleased with the pipeline he is developing.

Where do you think government work settles out as percent of revenue is this you know 12 to 24 months from now is this

We don't want to take that bait.

It will certainly be a major region for the company and you know, it is double digit percentages when you look at forecasts and the kind of potential.

You are well aware of the budget and numbers down there as they focus on Homeland Security and other initiatives.

Another question relates to the reseller.

On absolute dollar basis, actually percentage basis has been flat.

If you were to remove the revenue you received from resellers one or two quarters ago that are no longer resellers how would the revenue look?

I don't understand the question.

I am trying to get a sense of how you are doing with the existing resellers versus the contribution from resellers no longer around?

There is 80 20 rule to it.

We have 43 resellers right now and certainly the top 10 carry most of the load.

You are well aware of the names like IBM and Telephonica.

We have had good growth in our stable reseller partners and particularly with EdgeSuite.

They introduced us to major enterprises.

That trend is great.

As it relates to EdgeSuite, I think it was 25 customers churn.

I guess I was surprised by that number given the fact EdgeSuite is still newer type service and generally higher-end customers given the entry price point.

Can you address why we are seeing that number pick up?

Nine were revenue reserve.

It is our hope to go get at least 2-thirds or so of those back because they were behind resellers.

The reseller went out.

The rest, as I said in my remarks are largely early adopter non-enterprise.

EdgeSuite had been out for a month or two.

A number of technology-type companies embraced the technology and thought it was cool and didn't make it or don't have a value need.

So, the real key point is the churn customers are less than half on our crew of the new customers.

It is evidenced if I showed you the two lists, it would be readily apparent the enterprises are coming in and the others that are not renewing are nonenterprise.

Okay.

Thanks.

Your next question comes from Chris Cooke of Zozo Associates.

Hi.

I wanted to know - I have a couple of questions.

The average term of the EdgeSuite contracts you are signing?

Well, it has got to be 12 months or greater because that is our - unless it was some kind of trial period for which we got paid.

But, as they are largely 12 month or greater contracts.

211 customers are 12 months or greater.

The long-term contracts is all we ever count in the customer count.

We have the number of large 24 month deals.

In fact, a 36-month deal, and I think one five-year deal in there.

We are starting to see enterprises making the platform bet ask for longer term relationships.

The vast majority between 12 and 24 months?

I want to clarify what I said.

I was wondering if there were a lot?

We wouldn't have given you a two-month trial, even though they pay us for that, we would not have counted that in that customer number.

Great.

Then, cap-lease obligation s.

What are those yearly now and what the present value of those?

I don't have that in front of me.

You are basically talking about our move into the new headquarter building as major lease.

And, very small amount of vendor financing on servers, less than a few million dollars.

I will point you back to the 10-k for the whole breakdown on real estate.

No real change.

The move to the new headquarters building does not change?

You can work it out.

It will save us $9 million per year off that and with this 10-q, will provide a summary of that.

You will have in all the public filings that data in terms of the leasing and such.

That gets you out of the old lease?

Absolutely.

The term on the new lease?

How long is it?

Well, looking at each other right now, it is between 5 and 7 years.

We have five floors in the building. 7 years.

One last.

The revenue to get cash flow break even you guys are targeting, the revenue level?

We haven't made that forecast.

Okay.

How do you get to cash flow break even if you haven't made a -

Take current cash burn and adjust for a couple of the nonrecurring items I described earlier.

That gap clearly would define a revenue level.

If revenue was at that level, we would be free cash flow break even.

We work cost down network and otherwise. (inaudible) smaller than that gap.

We will grow from here.

Okay.

Thanks very much.

Good luck, guys.

Your next question comes from Andy Shroeder of Pier One Research.

Four questions.

How much revenue was for software licensing in the quarter?

Looks like $1.3 million in the first quarter.

Yeah, we don't usually break that out to the queue.

Recurring was 93%.

You have that as a bound.

The other 7% is licensing and streaming events and other small and material one-time revenue.

That has been stable the last couple of quarters.

Nothing unusual on the licensing side.

Okay.

What was deferred revenue for the quarter?

I don't have that in front of me.

It is in the 10-q, not a major change there.

No significant items.

Okay.

Third one, on the custom government contracts you are talking about having the opportunity with.

Do you expect to price those with 70% margin?

Overall, I would say margins are commensurate with our total business to the extent they improve professional services.

It may be - if it is large enough contract, we would be willing to do it at lower gross margin.

We would be looking for something in line with overall operating margin.

But, as a general rule, the government deals are certainly as profitable as the rest of the business.

Got you.

How many customers are in recurring customer count from resellers?

How many are there now?

43 resellers now.

I don't know if we have ever given a percentage of customers.

We report the percent of revenue of resellers.

I don't think the revenues are reasonably any dramatic difference.

In other words, we are channel neutral on what they are selling for on the street and that is what we are selling for on the street.

Take typical reseller discounts described as being 30 to 50% from wholesale perspective and back into a customer number.

We never reported that.

Thanks.

Your next question is a follow-up from San Je Purey of Thomas Weisel Partners.

Can you hear me?

Thanks.

It is Thomas Weisel Partners.

Two quick follow-ups.

One is housekeeping.

Number, what was the average revenue per overall customer in the quarter?

Was that 10 thousand -

10,750.

The (inaudible) product.

When do you expect that to show up in the model?

I got to imagine that will have a favorable impact on profitability going forward?

I think for modeling purposes, it is q1, 2003, as we said.

We did have a customer come onboard now and we certainly have others in the pipeline.

Is that a paying customer?

Yes, to move the needle, you are looking at 2003 impact on the model perspective.

Great.

Thank you.

I think we have time for one more question.

There are no further questions.

Thank you all very much.

Appreciate you being on the call with us.

Bye-bye.

Thank you for participating in today's Akamai second quarter earnings call.

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