阿卡邁科技 (AKAM) 2003 Q3 法說會逐字稿

Good afternoon, my name is Jeff, and I'll be your conference facilitator.

At this time I would like to welcome everyone to the Akamai third-quarter earnings conference call.

All lines have been placed upon mute to prevent any background noise.

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

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

If you would like to withdraw your question press the pound key.

I'd like to turn the conference over to Sandy Smith, Director of Investor Relations at Akamai.

Good afternoon, everyone.

And thank you for joining Akamai's investor conference call to discuss our third-quarter 2003 results.

Speaking today will be George Conrades, Chairman and CEO; and Bob Cobuzzi, our Chief Financial Officer;

Paul Sagan, our President; and Mike Ruffolo, Executive Vice-President, Global Sales, Services & Marketing; will be available at question-and-answer portion that follows management's prepared remarks.

This conference call will discuss information about Akamai's future expectations, plans, and prospects that constitute forward-looking statements for purposes of the Safe Harbors Provision under the Private Securities Litigation Reform Act of 1995.

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

As a result of various important factors including but not limited to failure to increase our revenue, retain our significant customers or keep our expenses consistent with revenues.

General economic conditions, as well as those specific to the Internet and related industries, inability to service and repay our outstanding debt.

Unexpected network or service interruptions that cause loss of revenue, and other factors that are discussed in our annual report on form 10-K, and quarterly reports filed on form 10-Q, and other documents periodically filed with the SEC.

Any forward-looking statements represent our estimate only as of today and should not be relied upon as representing our estimates as of any subsequent day.

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.

During this call we will be referring to non-GAAP financial measures that we believe are helpful to an understanding of our financial results and operations.

These non-GAAP measures are not prepared in accordance with generally accepted accounting principles.

Under the News and Publications section of the website, we define these non-GAAP terms and reconcile on our financials with the most directly comparable GAAP financial measurements.

Now, let me turn the call over to George.

Thank you, Sandy.

And welcome to your first Akamai quarterly investor conference call, and good afternoon, everybody.

Thank you very much for joining us.

We had a great quarter.

In financial terms it was the most successful in the company's history and further improvement is in sight.

We've really turned the corner.

Growing revenue for 3/4 in a row and generating positive free cash flow a quarter ahead of schedule.

Revenue grew to $41.8 million and, increase of approximately 11% from the second quarter and 18% year-over-year.

We generated $2.6 million, of free cash flow and ended the quarter with $99 million in the bank.

Best of all, we believe positive free cash flow is sustainable because we achieved it even after making our semi annual interest payment of $8.3 million and our business fundamentals are strong.

There is market demand for our services, top-line revenue is growing, our operating expenses are under control, and the major build out of our network is behind us.

As a result, revenue growth has fallen predominantly to our bottom line demonstrating what we've always said Akamai's model is scalable and will be profitable.

Top-line revenue growth in the quarter came from a mixture of new suite customers and continued growth in content delivery by some of our largest accounts.

We launched the new Edge platform in 2001 targeting leading enterprise prospects and government agencies.

Today we offer them an entry level version as well as a full featured service, both of which contributed to the growth in our customer base.

The number of new recurring customers grew again.

This quarter by 55 net new accounts.

Our best quarterly performance in nearly three years for a total of 1,056 customers under long term services contracts including 126 net New EdgeSuite customers for a total of 560.

New EdgeSuite customers added in the quarter include Airbus, Air Tran Airways, Analog Device, BMW France, the Defense Information Systems Agency of the Department of Defense, Drugstore.com, the Food and Drug Administration, Office Depot, Reuter's.

We also recently signed a terrific new recurring revenue content delivery contract with Microsoft in which they have made a significant commitment to use Akamai's services for online software and web content distribution.

Representing what has become a very important trusted relationship with an industry leader in the use of the Internet.

We continued to improve our bottom line by growing our revenues and controlling our operating expenses.

Net loss for the quarter, in accordance with U.S.

GAAP, was $3.9 million or just 3 cents per share.

That's an improvement of 10 cents per share over the prior quarter and a 93% improvement year-over-year when our loss was $47.5 million or 42 cents per share in the third quarter of 2002.

Normalized net loss, defined as net loss before amortization, equity related compensation, restructuring charges and benefits and certain gains and losses on equity investments was 3 cents per share, substantially exceeding the first call consensus estimates of a normalized net loss of 7 cents per share.

We now believe the company will begin to generate earnings-per-share by the end of the first half of next year.

I'll be back in a few minutes to address the big issues that I know remain on your minds about Akamai including: how we view the market opportunity for our services and the progress we're making there; the significant capacity we have in the Akamai network to take on many more customers without substantial new investment to scale our services; and I'll have some thoughts about our balance sheet now that Akamai has achieved free cash flow from operations.

But first Bob Cobuzzi will take you through the important third quarter details.

Bob.

Thank you, George.

As George said in his opening remarks, Akamai generated $2.6 million in positive free cash flow from the third quarter.

We're confident we can sustain positive free cash flow going to forward.

We define free cash flow in the most basic terms as the net changing cash in cash equivalents restricted cash in marketable securities quarter-over-quarter.

I would like to walk you through our Q3 operating results and metrics addressing the areas of revenue and customers, network costs, operating expenses, adjusted EBITDA, interest expense, and capital expenditures, as well as per share results in our share count.

We also want to acknowledge your request during prior calls for additional guidance.

I'll be providing more detail for Q4 in our preliminary thoughts about next year.

The third quarter revenue of $41.8 million reflects the affects of five consecutive quarters of positive net monthly recurring revenue bookings.

It increased in the number of recurring customers plus an increase in basic content delivery traffic delivered over our network.

We define net monthly recurring revenue bookings as the committed monthly contract value for new customers entering into our existing customers upgrading or committing to new services under contracts at 12 months or greater, less turned customers and downgrades.

EdgeSuite accounted for 61% of total third quarter revenue.

We ended the quarter with a total of 568 Suite customers, a net increase of 126 in the Q2 EdgeSuite customer account of 434.

On a percentage basis that's a 29% increase in last quarter and 130% increase year-over-year.

Now that we have successfully migrated the majority of our business to the more than 500 customers and the majority of our revenue comes from the EdgeSuite platform, we believe that continuing to distinguish between EdgeSuite customers and revenue and revenue from all other customers and services is no longer meaningful.

So going forward, we will know longer break out EdgeSuite customer data from our other service business.

In the third quarter, overall [INAUDIBLE] costs across all customers increased to approximately 13,300 a month up from 12,300 in the second quarter.

Microsoft accounted for 20% of our revenue in third quarter, up from 12% in Q2 resulting from our growing business relationship and significant increase in traffic related to the blaster worm which accounted for $2 million of third-quarter revenue.

We can't predict when large spikes might happen again.

We're not counting on Microsoft to generate as much as revenue in the fourth quarter as they did in the third.

But we do forecast, that they'll represent over 10% of our revenue.

We have built a trusted relationship with this very important customer.

Further, we are pleased to be able to tell you today we have signed a new recurring revenue content delivery contract with Microsoft.

Under which Microsoft has made a significant commitment to use Akamai services for online software and web content distribution.

No other customer accounted for 10% or more of revenue in the third quarter.

Many of you have asked us to quantify what some call same-store sales, or more appropriately for us would be same customer sales year-over-year, because of the ongoing nature and the way our customers use our services, their usage fluctuates in terms of traffic delivered and services utilized.

For that same reason, same customer sales provided period to period are not a good way to forecast future business.

However, when we look at our business as a whole, we have seen two positive trends: first, business is growing overall and, second, customers who have been with us for at least a year are using, on average, more of our services and paying us more today than they did a year ago.

As we go forward we will provide data on total customers, the net change in customers, and average revenue per customer.

Now a few comments on churns.

Historically, we have look at customers churn in two categories.

Basic content delivery customers where churn has been historically high because the concentration of early dot com customers, EdgeSuite customers where we expect lower churn from our enterprise base who use more advanced features.

In the third quarter, churn was the best it's been in years and our [INAUDIBLE] churn was significantly below our average.

We are pleased with the improvement we've made to replace the existing customer base from two years ago adding more high quality customers than ever before.

We know there's room for improvement, and we are working to get churn to low single digits.

Our sales team continues to focus special efforts on industry verticals including automotive, financial services, government agencies, media and entertainment, online commerce, high-technology, and travel and hospitality.

International sales accounted for approximately 15% of sales in the quarter, consistent with the previous quarter, and up slightly from 14% in the third quarter of 2002.

Resellers accounted for 22% of revenue in Q3 versus 27% in the prior quarter.

While in absolute dollar the resale of revenue was down slightly our expectation remains that longer term the reseller percentage will grow.

Our day sales outstanding were flat at 52 days, however, we expect to show improvement in our DSOs in the fourth quarter.

Now let's review our network costs.

Network costs excluding depreciation and equity related compensation were essentially unchanged at $6.7 million for Q3.

The same as the prior quarter.

Even though we carried more traffic this quarter than the previous quarter.

Cash gross profit was $35 million or 84% of revenue up from $31.2 million or 83% last quarter.

And up from $25.89 million or 73% in the third quarter of last year.

We expect to see gross margin percentages continue to be in the low 80s in Q4 and we believe they'll remain around 80% in our 2004 plan.

We are focused on sustaining our cash gross margin percentages through continued effective bandwidth procurement and network management, as well as an improvement in our product mix with higher sales of higher margin features.

Our global network at the end of Q3 consisted of 14,488 servers and 1108 networks in 71 countries versus 14,372 servers and 1134 networks in 74 countries last quarter.

We continue to have unprecedented reach with our distributed network and excess capacity remains even when our largest customers experience traffic spikes.

While network capacity is not a major concern for us, we will continue to expand our global footprint in servers and networks as we move into the fourth quarter and next year.

To ensure that we're optimally located to reach all an end users especially as the Internet itself continues to grow.

We believe the breadth of our network continues to be a significant competitive advantage.

Now some comments in operating expenses, net interest expense, and adjusted EBITDA.

Cash operating expenses were $23.3 million, essentially flat with the $23.5 million we spent last quarter.

And an improvement of 28% from the prior year level of $32.5 million.

Adjusted EBITDA, defined as net loss before interest, taxes, depreciation and amortization, equity-related compensation, restructuring charges and benefits and certain gains and losses on equity investments was $11.7 million or 52% increase over the previous quarter of $7.7 million, and an improvement over the adjusted EBITDA losses $6.7 million in Q3 of '02, that's a 18.4 million quarterly improvement in adjusted EBITDA year-over-year.

We're very pleased in the growth in adjusted EBITDA, which represented a margin of 28% of quarterly revenue.

While we do not expect to see such significant gains quarter-over-quarter going forward, our target business model calls for achieving adjusted EBITDA margins in excess of 30% of revenue and we believe we'll do that in '04.

This, of course, has positive implications for our ability to manage our balance sheet obligations.

Net interest expense of third quarter was $4.3 million consistent with last quarter.

Overall depreciation for the quarter was $10.8 million of which $6.3 million was for depreciation network related assets. $1.2 million of amortization of internally developed software costs, and $3.3 million for other G&A depreciation such as leasehold improvements.

Depreciation declined from $13.4 million in the first quarter and $20.7 million in Q3, 2002.

We expect to see a continued downward trend in depreciation through the second half of 04 as we continue to depreciate the network built out over the past five years.

For those of you wondering whether there's a big spike in spending coming to maintain our network, I want to reiterate what we've said before.

Our plans call for spending less than 10% of annual revenue on cap ex, including capitalization of internally developed software.

As a result, we expect to see depreciation level off in late 2004 at around 3 to $4 million per quarter.

It's important to understand this trend in our business model as the company approaches positive earnings-per-share.

Capital expenditures for the third quarter which include capitalization of internally developed software cost with $2.1 million.

That's in line with $1.9 million spent in the second quarter and in line with our targets.

Our third quarter net loss in accordance with U.S.

GAAP, was 3.9 million or 3 cents per share, compared to a net loss last quarter of $14.6 million or 13 cents per share and a net loss of $47.5 million or 42 cents per share in the comparable period of 02.

Weighted average shares outstanding using basic and diluted per share calculation for Q3 were $118.6 million compared to 117.1 million in Q2.

And 114.3 million in Q3 of the previous year.

Our share count September 30 was 119.4 million shares, while the fully diluted share count, which includes outstanding warrants and stock options, was 137.1 million.

Finally, to recap highlights for the third quarter, we generated $2.6 million in positive free cash flow, one quarter ahead of schedule even after making our semi annual interest payment and we expect to sustain positive free cash flow on an ongoing basis.

In addition to free cash flow positive, we achieved revenue increase of 11% quarter-over-quarter, strong growth margins of 84%.

Adjusted EBITDA margin of 28% of total revenue.

And closing position of $99 million in cash, cash equivalents, restricted cash and marketable securities.

We believe this positions us well for Q4 and beyond.

As you'll recall we've begun given only limited guidance this year around our goal of achieving positive free cash flow for fourth quarter as part of a longer term plan to reach profitability.

Now that we've reached this critical milestone and reached it ahead of plan it's time to focus on growth and earnings-per-share.

In the fourth quarter we expect revenue of 42 to $44 million.

That assumes approximately 5% growth in our core business, but anticipates that bursting usage will be lower than we experienced in Q3.

On a full year basis in 2003, we're expecting to end with revenue in the range of 158 to $160 million or increase of nearly 10% from the prior year.

That's a tremendous turnaround.

So as we look towards 2004, we expect continued top line growth of 4% per quarter on a yearly growth rate of 15 to 20%.

While holding our operating expenses to a significantly lower rate of growth.

That should provide a clear path to positive earnings-per-share by the end of the first half of 2004.

I will talk more about '04 projections in our year-end conference call.

Now let me turn the call back to George.

George.

Thank you, Bob.

Now I want to talk about three things I know are on your mind.

First, the market opportunity for our services, second, the ample capacity we have in the Akamai network, and third, some thoughts about our balance sheet now that Akamai has started generating free cash flow from operations.

First the market opportunity.

We focus our sales efforts on the global 2000 enterprise accounts the Web 250 and the public sector, and we're off to a strong start.

For example, over half of the companies on the Dow Jones industrial average are customers, six of the top 10 and 36 of the top 100 firms on the Fortune 500 list buy from us, and we serve seven of the top 10 agencies on the most recent keynote systems government top 40 index.

And we think we've only begun to tap the potential for our services.

A 2003 study by IDC estimates that the U.S. market for basic content delivery services will grow to nearly half $1 billion a year by 2007 a compound annual growth rate of 14%.

We're already running well ahead of that if you look just at our first three quarters of revenue growth this year because of our ability to win new accounts and to increase usage by current customers.

The vast majority of our 1,000 plus recurring revenue customers use our basic content delivery capabilities for objects and streams that's Free Flow and EdgeSuite deliveries.

On top of that, most of our customers buy at least one of our 15 advanced services which range from improving security to content targeting, personalization, all the way to Edge computing.

And, of course, the growing number of them buy multiple features.

One example is Apple computer.

One of our earliest customers starting with Free Flow for object delivery and streaming for quick time over the Internet.

They then added advanced services such as global load balancing to optimize multiple data centers and web intelligence reporting with the launch of I-Tune Apple added even more Akamai services including EdgeSuite features such as replicated storage for the online music library and our edge escape Geolocation technology.

So we're investing in these enhanced features, building on our content delivery platform because that'll enable us to tap into even larger IT market opportunities with package solutions such as business continuity services, which Gartner estimates to be a $5.4 billion market by 2004, and network security, which Forester estimates to be a $20 billion market in the U.S. alone by 2006, and web services, estimated by IDC to be a $21 billion market by 2007 which is what our work with IBM WebSphere and Microsoft.net is all about.

Our strategy is to penetrate and grow with our customers as they increase their use of the Internet for business and as their need for advanced capability grows.

Effectively, that means building on our content delivery relationships with additional services that will capture adjacent market opportunities, while leveraging the intellectual property on our platform allowing us to quickly develop new offers that meet customers needs while having the capacity to meet their on demand requirements.

The Akamai network has plenty of capacity.

Our globally deployed servers running our proprietary technology can serve massive loads, providing on demand capacity for any customer while still serving all other customers as they expect, and for certain EdgeSuite customers, absorbing denial of service attacks which are becoming a more frequent occurrence on the Internet.

Now Bob commented earlier on our low Cap Ex model.

It's important to understand that our existing infrastructure can accommodate hundreds of additional EdgeSuite customers as well as additional usage by our existing customers without varying significantly new cost.

At the same time, if for any reason we decided to add or replace significant number of servers, we are confident we can do so and keep capital expenditures within our guidance at less than 10% of revenue including capitalization of software necessary to support our network.

Due to our technology and buying power we can purchase servers economically.

The result is that if you amortize the server's cost over three years that cost is left in 10% of the revenue we can generate from that server.

This is why we believe our cap ex cost will remain low well into the future.

But it's not just the number of servers that give us our effective capacity.

Our servers are located very close to end users in thousands of locations in more than 1100 leading networks around the world.

This enables Akamai to bypass the many bottlenecks in the Internet and to provide as much as bandwidth as end users can handle on their last mile connection.

That's what gives us our enormous performance edge in comparison to the Internet itself and with competing offerings, because we are in so many locations, most users are in the same ISP and city as an Akamai server and they get Akamai's content far more quickly and reliably than if they had to traverse the Internet to get it.

For example, take a city in Europe, say London, we have servers in 18 different ISPs in London alone.

Take another city such as Washington, D.C. where we are in 25 unique ISPs, or Tokyo where we have of servers in over 17 different ISPs.

This means that we are able to serve content to end users by just using the last mob connection as opposed to going across the country or the world to retrieve the requested information if you are not on that particular network.

Does this breadth of deployment matter?

You bet it does.

It certainly matters for E-Bag which sells premium brand luggage over the Internet.

After improving the performance of their site with Akamai's services E-Bags increased their visitor-to-buyer conversion rate by 15%, that's more revenue for E-Bags because of the improved performance that Akamai brought to a greater number of visitors to their site.

Our massive server deployment also provides Akamai with a significant advantage over competition.

While it is always possible for a would-be competitor to buy 15,000 servers if they spend enough money, it's far more difficult to replicate our relationships with 1100 leading networks around the world.

We have those relationships because we have so much popular web content on our platform and because we are such a trusted partner to those networks.

One final point on capacity, the really hard part of what we do is making all those servers located all over the world operate as a cohesive distributed computing platform on behalf of over a thousand heavily traffic customer websites.

That's a problem that took hundreds of man years of effort by some of the industry's best and brightest to figure out, and we continue to build on that significant technological lead.

So capacity is more than servers.

It's our presence in and our relationships with over 1100 end user subscriber networks worldwide running the more than 6 million lines of code on our servers that makes it all happen on demand anywhere.

We built the scale from the beginning and increasingly it's a critical competitive advantage in an environment where we are only at the start of even bigger things to come and where we intend to remain the market leader.

Now the significant investments we've made to realize the power of our business model are just beginning to bear fruit in terms of realizing profitability and ultimately our ability to improve our balance sheet.

Many of you have asked in previous calls about our debt. $300 million in convertible bonds.

First, I should remind you that they aren't due until the middle of 2007.

Also we're paying an interest rate of just 5.5% or roughly $16.5 million per year.

We've always believed we could service the debt from operations and now that we're adding to our cash in the bank I'm confident that we will have a variety of options for handling the principal as well.

So we'll take steps in this area only when they're in the best interest of our shareholders and the long-term interest of the company.

In closing, I'm very pleased with our solid financial performance this quarter, reaching sustainable free cash flow is a major milestone for any company and it certainly is for us.

We are now focused on sustaining top-line growth and achieving bottom-line profitability through positive earnings-per-share by the end of first half 2004.

So thanks for your continued support and for your participation on our call today.

Now Bob and I will be happy to take your questions, Paul Sagan, our President;

Mike Ruffolo, our EVP, Global Sales, Service & Marketing, are with us this afternoon to take questions.

So operator the first question please.

At this time I would like to remind everyone in order to ask a question, please press the star and then the number one on your touchtone telephone.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Michael Turrits of Prudential Securities Equity Group.

Hi guys, how are you doing.

Good, how are you?

Good, Microsoft is 20% of revenue this quarter, sounds like you said it was $2 million this quarter, that was from bursting related to blaster, sounds like about 15% x that, right?

Yes.

So now you've good an expanded considerate with Microsoft.

What does that mean relative to that run rate that you've established on the core Microsoft business, does that go up?

What's the financial meaning of that increase and expanded contract?

What I think I said is that we don't expect to run the same rate we have in the past, however, we have an extending relationship with Microsoft and we expect them to be well over 10% of our business going forward.

Again, don't mean to push, Bob.

You're at 15% x that bursting amount of $2 million.

Is there any reason to think that it should be less than level?

Well, again we continue to get rest of the business so I think that's the important thing to focus on.

We believe that will continue to grow x any virus type of activities which this past quarter we identified is about $2 million probably of additional revenue.

Taking that out we expect to see continued growth in that account, but we also expect to see growth in our core business.

Maybe you can give me an idea how should we interpret the impact of the expanded contract relative to the core business of Microsoft.

I think it's the most important part, Michael is that we have a long-term recurring relationship contract with Microsoft.

Okay.

So, in other words, this is formalized the relationship and created some minimums or created a framework relationship?

That's correct.

Okay.

You gave the two million that was from Microsoft for virus related activity.

How much was it overall, in other words, how much should we think, we follow the security companies so a lot of them are quantifying how much of their revenues came from total came from this quarter's virus reactions.

In addition to Microsoft what would you say the total is from this kind of one time event.

We don't track that activity.

That's not one of the metrics we're forecasting on certainly we deal with Microsoft because it's a large customer but beyond that we don't track that as a metric.

Recurring revenue was how much was that as a percentage of total.

Recurring.

Yes.

99% of our revenue.

Go ahead.

I was going to say substantially all our revenue is a recurring nature.

And you said that revenues will grow.

The guidance right, 15 to 20% for '04 on top line. 4% quarter-over-quarter, 158 to 160 this year, 40 to $42 million for fourth quarter which is 5% growth in the core business.

Right.

Also, you said revenue grows faster than Op Ex.

That makes sense.

You could do EBITDA margins of 30% at '04 does that mean for the year of '04 or some point in '04?

At some point in '04.

We're at 28% this past quarter, we expect to continue to expand, but I'm not going to commit to exactly when that will take place.

Should we be seeing a significant growth in op ex, you've pretty much flattened it out, do you start to grow op ex at this point?

We've said in the past op ex will basically as a top line growth, commissions will grow, they'll be inflation, and we'll make selected investments as the opportunity a arises and deem it appropriate.

It's Paul.

I just want to make clear on one point. 98% of our revenue comes from customers under long term recurring contracts. 98% of the revenue is not under contract.

They have a minimum and when they go above them, we call that bursting such as the Microsoft revenue that we broke out.

I understand that you break out --

I wanted to make sure, I know you're aware if there are any newcomers on the call that they understood the distinction.

Thanks very much, Paul.

Your next question comes from Doug Campbell of Spear Capital.

Thanks very much.

I think it was long about a quarter or so ago that you disclosed the entry level EdgeSuite product and marketing effort.

Evidently quite successful, but I wonder if you could talk around that one a little bit in terms of new customer accounts whether they're taking primarily the entry level and those customers who have already purchased entry-level going back over the last several months, as to whether they are stepping up to additional features as time goes by.

Okay.

This is Mike Ruffolo responding to the question.

Thanks for the question.

The platform of services that we call EdgeSuite, clearly we have a large increase as you saw from the notes that Bob offered.

Large increase in the number of customers that we picked up in the last quarter and many of them were purchasing what you were describing, and we described last quarter as our entry level, or entry delivery service.

Our strategy this year has been to continue to penetrate as many as accounts as possible and to increase their penetration for usage and additional features and that strategy is continuing to play out and it's one where we anticipate more customers entering our platform and becoming long-term recurring customers of ours.

Thank you.

Your next question comes from Errol Redmond of Redmond Capital Management.

Hi, it's Shawn Lee.

Great quarter. [INAUDIBLE] an idea of how your sales cycle is moving with EdgeSuite.

Granted, you're doing the early stage as that product is helping out, but how quickly are you managing to now get customers to sign up?

I think you've seen, this is Mike again.

I think you've seen over the last few quarters our velocity or volume of customers increasing consistently and the reality is as our brand and as our services become well-known in the industry, there are more and more reference customers that make it easier for us to go to similar customers and describe the business benefits of using the Akamai suite of services.

So, you know, it's a tough economy out there, and certainly buyers are looking at all of their purchases, but we're finding more and more often that the familiarity and the reliability of what we're seeing in our existing customer base is causing it to be a more familiar brand to customers and there for many cases shortening the sell cycle.

Under no circumstances would you want to assume that this is a service that is just in a position where many, many customers are migrating to it quicker than a demonstrative way than we've done in past, you should assume, once people become aware of our services, that their interest level continues to grow.

The sell cycles are coming down and our ability to retain those customers is going up.

Are you noticing any competition as you go to the customers, any new competition.

Our key competitor is Inertia, so there's a traditional approach to centralized web infrastructure.

So all of our enterprise customers and government customers can attempt to improve the performance of their websites with internal resources, but the reality is that our challenge has always been to make them aware of it, then essentially work with them and their internal IT organization to understand the advantages, and then accelerate that migration and, as I mentioned, in my earlier response the more customers that we have, you know well over 500 customers, we have a very large proof case of customers that understand and accept the business benefits of a distributed web architecture and the unique services we provide.

There are certainly small players at the low end of the market that provide basic content delivery services.

We compete aggressively with them but, by and large, we're mostly selling against the customers awareness of our service and the ROI of our value add.

This is Errol Redmond.

One additional question.

Analysts, some analysts focus heavily on your outstanding converts and I want to make it clear that we don't think that this is an issue but others do.

Could you share whatever thoughts have developed as a result of achieving earlier than expected positive cash flow with respect to funding or handling that debt obligation?

Well, this is George.

Again, we've always believed as I said we could service the debt, and now I'm more confident than ever that we'll have a increasing variety of options ahead of us for handling the principal as well.

We've routinely reviewed this.

I think we're of greater interest to more companies who would like to help us with this issue, and -- but we're sensitive to our -- the, you know, the long-term interest of the company and of our shareholders.

So we're going to do the right thing at the right time.

Thank you, George.

Yep.

Your next question comes from Henry Naah of Lehman Brothers.

Hi, Henry.

Congratulations on a great quarter.

Thanks, Henry.

I wanted to ask you where if you guys can talk about, a little bit about the growth in EdgeSuite customer additions, what do you think drove the nice growth in the customer adds there, if you could break it out sort of how many were new customers, how many were existing Free Flow customers that you added on, and also if you could talk a little bit about the churn you saw in the Free Flow product on that customer side.

Thanks.

This is Mike Ruffolo.

We had I think you heard earlier that we had 126 net new EdgeSuite customers, and for your purposes and for the rest of the audience, about half of them were upgrades and other half were new logos meaning customers we didn't do business with in the past so about half and half of upgrades from other services like Free Flow and other half new logos.

In terms of the churn, we're very pleased with the trend line in the churn.

This was the lowest that it's been in years in terms of the last quarter, and we're targeting quarterly churn in the low single digits, and we're making good progress towards that goal.

Churn will be a part of a business like this, but we're making great progress in driving it down to low single digits long term.

Following up on that question, do you think in terms of Free Flow customer accounts do you think you've seen that somewhat stabilized or a little more churn going forward?

Well, certainly it's not, the Free Flow customer base not much has been converted to EdgeSuite.

Much of it is business that continues to remain with us going forward.

We'll have some churn but I would say it's consistent with my comment about moving toward a low single digits long term.

Great.

One last question if I may.

On the EdgeSuite product sounds like you guys have had great success with EdgeSuite light.

Could you talk about some of the upscale services that customers are frequently requesting?

Sure.

This is Mike again.

Certainly the objective this year was to get as many as customers leveraging the EdgeSuite platform and so many of them did purchase what you would EdgeSuite light which we call EdgeSuite Delivery and it allows the customer then to purchase the myriad of value added services that we have in addition to the basic platform.

So, for example, if it's an e-commerce retailer, they may want to purchase our secure content delivery service so that they're able to have good secure e-retailing and e-commerce capabilities.

They may want to purchase some of our accelerated performance in connection capital that we have.

We have a product called SureRoute that enables customers to take advantage of non-cashable content being able to be accessed in a much more accelerated performance over the Akamai Internet, and then other services that we have including web analytics, log analysis, there's a number of different things that we provide that customers are able to ultimately sell or we're able to sell the customers and enrich the use of our services.

Clearly, the idea of moving more and more of their business critical content on to the Internet is what we're all about, and as George mentioned earlier, edge computing initiative as additional way to push more functionality around the application to the edge so we happen to think that the up sell opportunities with a customer once they're on the platform are tremendous and it includes both content delivery as well as application processing.

Great, thanks, guys.

Yes.

Your next question comes from Doug Campbell of Spear Capital.

Thank you.

George mentioned some studies by Gartner, IDC and others in which forecasts for business continuity services, web services and so on can become quite large over time.

I sort of doubt whether there are corporate internal budgets that have line items that say business continuity services or web services.

But I wonder if you could talk about that a little bit in terms of specifically what functionality you have addresses whatever Gartner, IDC and so on seem to define as these activities and whether this is sort of insipient or whether this is day-to-day stuff in terms of your marketing activity?

Well, I think the first thing you have to envision is the increasing use of the Internet for mission critical applications, not just objects and streams, because when you begin to think about that and the dependency that your business has on the successful operation of internet transactions, then business continue yet, for example, continuity, for example, becomes a greater concern.

And if you can store in the network, if you can compute in the network, you can effectively back up a website.

And that's an example of business continuity services where the -- it's out in the network.

And protected by Akamai.

Web services, we've demonstrated that already with WebSphere in the network, we are working on Dot.net and as that comes into play, and your comment, you probably can't find that in people's budgets, it's already in the budgets because they're transforming to these new programming models as we speak.

And we'll support that in the development of new applications.

So we feel we're in the center of each one of those three market opportunities that I talked about as more and more people move their critical applications on to the network.

And in this case on to the Akamai business Internet.

And so that's -- I think that's the best answer I can give right now.

Thanks very much.

Just one little tweaking of that.

If one reads sort of the general press, the phrase utility computing is popping up all over the place from IBM.

Is this something where you are specifically engaged or does your network and various services simply play into that in a general manner?

No, absolutely are we engaged.

We are the largest commercial example on the Internet of utility computing.

If you define it as paying for can computing similar to paying for a public utility, utility owns the resource the hardware and software and the company is built only for the capacity, the processing power and storage and bandwidth they use, that's us.

We enable on demand utility computing.

I like that, thanks.

Yep.

We do too.

Your next question comes from Jack Ritstein of [INAUDIBLE] Capital Research.

Could you talk about your target margins what you guys see as sort of the goal in terms of net margins?

You're talking about gross margins or--

No, net income margins.

Well, we really haven't given that, I think we've given it.

Certainly looking at the gross margin percentage and we expect that to be in the low 80s.

And we've also talked about EBITDA margins which this past quarter was 28 and looking for 30% next year.

You know, we really haven't given out any further guidance around that but I think it's probably fairly easy for someone to compute actually.

So somewhere in the 30% on EBITDA.

Yeah.

Great.

Thank you.

Your next question comes from Charles Greej of Atlas Capital.

Just had a couple quick questions for you.

Your cash gross-profit margin was 82.7 in the second quarter. 83.9 in the third quarter and you had given some guidance that the third quarter expectation would be a little bit below the second quarter because of some cash rebate from network renegotiation.

Right.

The 83.9, is that a sustainable number or is 04 more in the 80% range, and we'll see more benefit in the fourth quarter?

You know, as a business we continue to renegotiate contracts with our network providers as we take into consideration additional commitments we're place placing with them along it's way; this past quarter we had $600,000 worth of benefits which, accrued, is 1 1/2% on the margin so if you strip that out you're around 82 1/2, again we've indicated we expect to be in the low 80s.

Right.

Pretty much puts us in that ball park.

Okay.

The network renegotiation benefit, do you think that's going to be an ongoing thing?

As the business continues grow it gives the opportunity to go back and renegotiate things as the opportunity arises.

Just a couple other questions.

Your sales are growing, sales and marketing expenses are still going down.

How should we think about that?

This past quarter?

Yes.

We're down, I mean, we spent less in sales and marketing this quarter.

Commissions even though revenue was up, commissions don't necessarily track directly to revenue on a quarter-to-quarter basis.

I think as we look forward I think generally what you'd expect to see is that sales and marketing expenses will turn up in line for what we've given for overall guidance, which will basically be in-line with top-line growth, commissions will grow.

We expect inflation and as the opportunity arises we will make investments which will be to long term benefit of the company and long-term growth of the company.

So is it fair to say that G&A is probably more leverageable than sales and marketing as you continue to grow?

Across our board all our operating expenses are quite leverageable, or scalable, as we try to refer to it, so if you look at in it's totality you'll see some upward but basic basically driven by top-line growth, inflation and more driven around investments we're trying to make it to basically grow the company and look out for long term prospects.

Are you still growing the sales and marketing team?

I think you had added a few key personnel in the second quarter with expectations to continue?

This is Mike again.

Let me just support Bob's comment with one addition is that certainly sales and marketing when you lump it together, there's different elements of those lines be that obviously vary.

The commission or the variable end of sales, of course, will change based on the revenue growth.

But the marketing side of it is very leverageable because we're obviously essentially leveraging the marketing spends over a larger base of revenue but not growing the leverageable spending so it moves as a fixed investment versus a variable.

In terms of the sales force, we've got essentially 64 reps in the company across the world.

And we're adding modestly to that.

But it's not in the tens, it's more in the single digits and, frankly, from our standpoint we're getting our sales force is getting more time in the saddle, if you will, time in the territory and that's helping with productivity, as well as our reseller partners really helping us grow our business in areas where they have strong account presence and you're familiar with that our largest resellers tend to be well-known companies like IBM, and EDS, and Telephonic and others.

Right.

Thanks a lot.

I really appreciate it.

We got time for just a couple more.

Your next question comes from Krishna Rangarajan of CRT Capital.

My first question has to do with customer concentration.

Besides Microsoft, if you look at the next tier of companies, can you talk a little bit about how you see the concentration pattern developing there?

We really don't, you know, we give out the Microsoft because they're a customer in excess of 10% but beyond that we really don't give out specifics around customers.

I'm not looking to a number.

I'm not looking for a number of customers that constitute 50% of you are your revenue or metrics but just in terms of a general flavor is there anything you can comment on that?

Let's let Mike make a few comments about the vertical markets we find particularly attractive.

Yes.

What we've experienced is that the vertical markets, I said this in earlier calls as well that we're continuing to expand our customer base across-the-board and you saw this quarter we had the best customer growth that we've had over the past three years.

But the verticals that were very strong, and not surprisingly, are verticals that are adopting the use of the Internet in ways that are important in the way they run the business in addition to the success we've had in our private sector, our government business so the vertical market of automotive, high-tech, financial services, media and entertainment, the retailers, the online commerce providers as well as the travel and hospitality industries, those verticals we're getting more and more traction in each of them each quarter.

And, as I mentioned before, kind of the virtues of our business is that we start to get some traction with a few of the leaders in those industries and then many of the other industry competitors become aware of that and become interested in our services.

And we believe all those verticals will continue to expand their use of the Internet for even more missing critical portions of their business model.

So it's not about customer names, but it is around key vertical markets.

Thank you.

My second question has to do with your experiences and your selling cycles.

What is different from, what was different in the September quarter compared with your experiences in the recent past, particularly from a standpoint of objections you used to come across previously that maybe mitigated or maybe even have disappeared?

Okay.

This is Mike.

Let me at least start to try to give you a answer.

I said earlier about the fact that, you know, when you have a market share penetration and a customer penetration of over 560 or so EdgeSuite customers we're becoming a lot more well-known as being a trusted vendor for many of these large enterprises in web companies and government agencies.

And the reality is that our brand is becoming more synonymous, if you will, with the de facto choice for people that are serious about doing business on the Internet and fortunately, in our particular case, as we continue to invest in Research & Development well in excess of our competitors we're coming out with new and innovative services that endear those customers to us even more, so the stickiness factor seems to be improving quite nicely and our brand itself becoming more accepted in the marketplace and each quarter we expect that to continue to improve incrementally.

But besides the improvement or reference-ability of your services, what are you seeing in terms of the adoption of the category itself, you know, be it edge computing or distributed delivery.

What are you seeing vis-…-vis adoption of the category of services that you offer?

Well, this is George.

I think we're only at the beginning.

I think it's directly related to customers increasing little using the Internet for mission critical work.

That's adoption rate outside of us and when they get serious about it and begin to think about extending quality metrics to how they want their operations to perform on the Internet as they extend their brand over the Internet, we believe (a), we're only at the beginning, and (b), the adoption rate is reflected in our revenue growth quarter-to-quarter.

One more question.

Your last question comes from Jay Albany of Crystal Capital.

Great quarter.

A couple quick questions.

First, your network depreciation unwinds towards the end of last year.

I assume you keep cap ex at less than 10% or 10% of your revenues.

Shouldn't we see nice earnings growth towards the back half of the year?

I think what we said we're looking at depreciation of 3 to $4 million a quarter which this quarter was, you know, $11 million so down substantially.

Great.

And be the other question is streaming, is that a big part of the business, is that growing at all or something that could just stop really paying attention to.

This is Paul Sagan, I'll take that question.

Our streaming business is doing very well.

It's a core offering, we see customers using streaming in more inventive ways today.

Short form films, fully produced videos not just pop-up ads or short commercials to build their brands online.

I'll give you two examples.

Apples I-Tunes, for example, using streaming song preview to drive the purchase of the actual music downloads.

That's great customer using streaming as part of their business.

Another would be BMW films which produces full miniature movies that they stream online to build their brands and to accelerate sales of their real business, selling cars.

So streaming as important piece of our business.

It's something that's now integrated and used by more customers serious about their online business.

Great, thanks very much.

You bet.

Thank you all very much for your support again, and for your participation in our call.

And we'll see you at the end of the next quarter.

Bye-bye.

This concludes today's conference call.

You may now disconnect.