阿卡邁科技 (AKAM) 2004 Q3 法說會逐字稿

Good afternoon.

And welcome to the Akamai third quarter 2004 earnings conference call.

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

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

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

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

Thank you.

Ms. Smith, you may begin your conference.

Great.

Thank you.

Good afternoon, and thank you, everybody, for joining Akamai's investor conference call to discuss our third quarter, 2004 financial results.

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

Paul Sagan, our President, will also be available during the 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 Harbor provisions 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 of various important factors; including but not limited to, unexpected network or service interruptions that cause loss of revenues, increased expenses or diversion of resources, failure to increase our revenue, retain our significant customers or keep our expenses consistent with revenue, general economic conditions, as well as those specific to the internet and related industries, inability to maintain the prices we charge for our service,s and other factors that are discussed in our annual report on our form 10-K, our quarterly reports on form 10-Q and other documents periodically filed with the SEC.

In addition, any forward-looking statement represents our estimate only as of today, and should not be relied upon as representing our estimates as of any subsequent date.

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

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

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

Under the news and investor relations portion of our investor website we define these non-GAAP terms and reconcile our non-GAAP financials with the most directly comparable GAAP financial measure.

Now, let me turn the call over to George.

Thanks, Sandy.

Good afternoon, everybody, thank you very much for joining us today.

Akamai had another strong quarter, the fourth quarter in a row of record in revenue and profitability.

Highlights from quarter three include revenue of $53.3 million, a 5% increase over the second quarter, and a 28% improvement over our revenue from the third quarter of last year.

This marks our 7th consecutive quarter of revenue growth.

Our GAAP net income expanded to 11.2 million in the quarter, representing 21% of revenue.

GAAP earnings were 8 cents per diluted share, a 3 cent per share improvement over the second quarter.

Our normalized earnings were 9 cents per diluted share, meeting the First Call consensus estimate for the quarter.

This past quarter, we added 44 net new customers under long-term contracts, growing our customer count by 4% quarter over quarter and 19% year over year.

Some of our new customers this quarter include Apple Vacations, California Lottery Commission, Canada.com, Cox Newspapers, Ford, Lincoln and Mercury divisions of Ford Motor Company, National Archives and Records Administration, National Oceanic and Atmospheric Administration, Visa USA, Incorporated, Vonage and MSN Music, supporting Microsoft's new online music store.

We're also pleased that last month we reached a new agreement with Microsoft, our largest customer and important technology partner, to provide a variety of Akamai service.

Overall, by helping customers to overcome internet bottlenecks and achieve their demanding online objectives, our business continued to expand with the existing accounts, as we add new customers to our platform.

And it's paying off in our financial results.

After Bob Cobuzzi takes you through our third quarter financials in detail, I will be back to talk about our outlook for the rest of the year.

Bob?

Thank you, George.

As you have just heard, the third quarter 2004 was another great quarter for Akamai.

Quarter over quarter, we grew revenue by 5%, GAAP net income by 65%, and normalized net income by 18%.

This clearly demonstrates the leverage in our financial model.

Now, I will walk you through our Q3 results in detail, covering the following areas: Revenue and customers, costs of revenues and margins, operating expenses and adjusted EBITDA; and finally, I'll review our balance sheet highlights.

Revenue for the third quarter was $53.3 million, a 28% increase over the same period last year.

As George indicated, the addition of 44 net new customers brought the total number of customers under the long-term contract to 1,258.

That's the 7th consecutive quarter of net customer growth.

While churning improved slightly over the prior quarter, we continue to focus on reducing churn long term with a target of low single-digits quarterly.

Our average monthly revenue per customer, or ARPU, as we call it, increased slightly to $14,200 over the same quarter ARPU of $,14,000 and up 7% year over year.

International sales were 18% of revenue in the third quarter, up slightly from our previous quarter and up from 15% in the third quarter of last year.

Our percentage of sales and resellers was 26% of revenue in the third quarter, consistent with the prior quarter and up from 22% in the same period last year.

Microsoft was the only 10% customer in the quarter.

Third quarter Microsoft revenue was $5.3 million, versus $5.7 million in the prior quarter, due in part to the staged rollout of certain software updates.

Our focus continues to be on growing the top line through new customer adds, upselling existing accounts and reducing our dependency on any single customer or industry segment.

Our cost of revenue on a GAAP basis was $11.7 million in the third quarter; up from $11.1 million in the second quarter, but down significantly from the $14.2 million reported in the same period last year.

Gross margins for the quarter on a GAAP basis were 78%, consistent with the second quarter and significantly higher than the 66% reported in the third quarter of last year.

Now, to review our operating expenses and adjusted EBITDA: This past quarter, our operating expenses were $27.7 million, as compared to $26.7 million in the second quarter of this year.

The $1 million quarterly increase in operating expenses was due in part to payroll costs from head count additions, a mid-year merit wage increase and employee performance bonuses, and costs associated with Sarbanes-Oxley compliance.

We estimate the full-year out of pocket cost of Sarbanes-Oxley compliance will be approximately $1.3 million.

On an absolute basis, adjusted EBITDA increased to $17.9 million, up from $17.7 million in the second quarter of 2004, and 53% higher than our adjusted EBITDA in Q3 of 2003.

Adjusted EBITDA margin for the third quarter was 34%, slightly lower than the previous quarter, but in line with our guidance, and a strong improvement over our 28% from the third quarter of 2003.

As we indicated last quarter, we are making increased investments in research and development and sales and marketing, with expected further head count additions planned for Q4 and the first half of 2005.

Although the anticipated investment is likely to have a continuing impact on cost, we expect that adjusted EBITDA margins will remain at or near their current levels.

Our total depreciation and amortization expense declined in the third quarter to $4.1 million, down from $4.8 million in the second quarter, and down significantly from $10.8 million in the third quarter of last year.

Total network depreciation costs were $3.2 million, including $1.6 million for amortization of internally- developed software.

G&A depreciation declined slightly from Q2 levels to $900,000.

Depreciation expense should not begin to track Cap Ex spending and remain at approximately $4 million per quarter for the next few quarters.

Net interest expense dropped from $2 million last quarter to $1.5 million in the third quarter of this year.

This reflects the impact of our buyback of $13.1 million of principal amount of 5.5% notes of repurchase that we announced during our July earnings call.

Our third quarter net interest expense of $1.5 million is significantly lower than our net interest expense of $4.3 million from the third quarter of 2003, due to the cumulative benefit from the debt repurchases.

And now turning to profitability.

On a GAAP basis, we generated $11.2 million of net income during our third quarter of '04.

That's a 65% increase over second quarter income of $6.8 million and a $15.2 million improvement over our $3.9 million loss during the third quarter of 2003.

On a diluted share count basis, we generated 8 cents of GAAP earnings per share in Q3.

That's a 3 cent improvement over our diluted EPS of 5 cents in Q2, and an 11 cent improvement over our loss of 3 cents a share for the third quarter of 2003.

Overall, we look at GAAP net income as a percentage of revenue -- we brought 21% of revenue to the bottom line.

That is great performance, and clearly demonstrates the power of our business model.

On a normalized basis, we generated net income of $12.2 million during the third quarter.

That's an increase of 18% quarter over quarter and an improvement of over $15 million, marked $3.5 million normalized loss during the third quarter of last year.

Normalized earnings per share -- diluted share -- was 9 cents in the third quarter, up from 8 cents a share in the prior quarter, and up significantly from a normalized loss of 3 cents a share in the third quarter of last year.

Our shares outstanding as of September 30, 2004, were 125.9 million shares.

Our weighted average shares outstanding were 125.6 million in the third quarter of 2004, up from 123.6 million in the second quarter.

Our diluted share count, which includes [INAUDIBLE] stock options invested restricted stock and deferred stock units, was 134.3 million shares for the third quarter.

Our diluted share count does not include the shares underlying our 1% contingent convertible bonds.

Until FAS-B buy formally ratifies FAS 128, our diluted share count will not include shares underlying our 1% contingent convertible bonds.

In the event the proposal does pass, we expect it to be retroactive.

And that would bring our diluted share count to Q3 to 147.3 million shares.

A reconciliation of both adjusted EBITDA and normalized net income to our GAAP net income can be found on our website.

Now to review our balance sheet highlights.

We ended the third quarter of 2004 with approximately $120 million in cash, cash equivalents and marketable securities.

We generated $14.5 million of cash from operations, a 17% increase from $12.5 million of cash from operations in the second quarter of this year, and a significant increase of $1.1 million of cash from operations generated in the third quarter of 2003.

We ended the quarter with total long-term debt of $281 million. $81 million in the 5.5% note due in 2007, and $200 million of 1% notes due in 2033.

During the third quarter, we spent $5.3 million on capital expenditures.

We still expect, however, to remain within our annual guidance of spending 10% or less of revenue on Cap Ex per year.

Day sales outstanding, or DSOs, for the third quarter of 2004 were 47 days as compared to 46 days in the prior quarter, but much improved over 52 days in the third quarter of last year.

Overall, it was a great quarter with solid financial performance.

And now, I'll turn the third quarter results -- I'll turn the call back over to George, so he can fill you in on our expectations for the remainder of 2004.

Thank you, Bob.

A year ago, we told you that we were targeting revenue growth as 15 to 20% for 2004.

And, now, a year later, we are very pleased with our progress.

We now anticipate an overall revenue improvement of at least 28% year over year, combining the terrific start we had in the first quarter and the sustained growth of 5% we've experienced for each of the past two quarters. 2004 performance has been fueled in part by greater than expected growth in software downloads, online media and entertainment content and also some major events, such as the Olympics, on top of expected growth in other parts of our business.

We are in the process of detailed planning for next year, and we remain very confident about our business model and ability to continue to generate profitable revenue growth.

For the fourth quarter of this year, we expect revenue at 54 to 56 million.

We expect GAAP gross margin of at least 78%, which includes network depreciation and amortization charges.

And GAAP earnings of 10 cents a share on a basic share county basis and 9 cents a share on a diluted basis.

As you will recall, we started the year by providing you with a GAAP earnings target for 2004 of at least 25 cents per share based on a basic share count.

We now expect that for the full year, GAAP earnings will be at least 27 cents a share on a basic share count basis, and that includes charges of 5 cents a share from restructuring our debt.

On a diluted share count basis, we expect full-year GAAP earnings of at least 25 cents a share.

Now a few comments about the trends we're seeing in the market for Akamai services.

As you might expect, our 7x24 always on service to leading enterprise customers and private government agencies gives us a unique view into their changing needs.

This helps us to develop solutions that remove many of the roadblocks that customers face as they remove business processes to the internet.

We are particularly excited about the growth opportunities in several of our key verticals, including media and entertainment, software distribution, online commerce and the public sector.

In media and entertainment, we are witnessing the continued growth of online music sales, internet radio and other fee and entertainment content distributed over the internet.

Of course, here in Boston, we're living with the success of MLB.com and the Red Sox.

Today, Akamai delivers five of the top six online music stores, including Apple's I-2 Music Store and now Microsoft MSN Music.

As higher bandwidth offers, such as movies and television on demand -- find their place on the internet, we believe Akamai is ideally positioned to leverage our unique capabilities, infrastructure and experience to build new revenue streams.

In the public sector, the government is focused on using the internet to better serve citizens, such as the way we helped the Transportation Security Administration provide information on airport security checkpoint wait times.

The Department of Homeland Security required that TSA have the application up and running in a matter of weeks.

Akamai has helped make that deadline, using Edge Computing powered by Web Sphere, with no infrastructure build out required by TSA.

Certainly, we expect to see increased use of the web by software distributors, particularly the antivirus companies, who will continue to leverage the internet as a delivery vehicle.

And online commerce is expanding, which drives the need for our Edge Suite business by numerous retailers and wholesalers moving more and more of their business online.

In fact, Internet Retailer Magazine just compiled its list of the top 50 retailing websites, and over half are Akamai customers.

Increasingly, we are incorporating Edge Computing functionality into our Flagship Edge Suite service to develop solutions targeted at real word business problems, such as increasing adoption of corporate extra nets by enterprises, insuring online business continuity and enhancing the security of websites.

And we just announced a new set of packaged applications on our platform targeted at solving common web-based problems that many of our customers face daily, and changing the way web-based applications are deployed and managed.

These offerings are on-demand applications, such as site search, user prioritization, user registration and online content.

All of these help customers generate more sales per second and accelerate their time to market with new functionality at lower cost by off loading more business processes from their origin infrastructure to Akamai's global platform.

The bottom line for Akamai is that customers increasingly turn to the internet to do their work better, faster and cheaper; and in turn, they turn to Akamai to improve performance, availability, scalability, security and time to market for new applications, all for less cost.

That's what will continue to drive our growth and profitability into 2005.

Thanks for taking your time to participate in today's call, and now, Paul Sagan, our President;

Bob Cobuzzi, our CFO and I will be happy to take your questions.

Operator, the first question, please.

Your first question comes from Michael Turits.

Hi, guys, can you hear me on this line?

Yes.

Okay, great.

Couple of questions, first as a clarification, on the 5-cent [INAUDIBLE].

So does that -- that's including a 5-cent charge or extra charge that would [INAUDIBLE] on a diluted basis for the full year?

Is that correct?

Repeat your question again?

I think, Mike -- there's a lot of static, Bob, but I think Michael was asking the charge for the restructuring of the debt would be 5 cents -- you would add that in to yield the number?

Yes, that's right.

Okay, so if I add -- extra charge is 30 cents diluted at least is the guidance for a full year, right?

Adding back that 5 cents for the buy back of the bonds, yes.

Okay.

And then the next question, also on the EPS, 9 cents is the guidance for the next quarter.

If you're going to get a couple million in revenue growth, why we are not seeing, you know, a penny of growth in EPS?

I think what we indicated that we are continuing to add head counts in both research and development and sales and marketing, so that our EBITDA margins will remain near where they are today, so we're reinvesting in the short term here.

There could be some upside but, you know, basically, we are looking at 9 cents as our guidance for the quarter.

Which is a penny improvement.

I'm sorry, the penny improvement was what?

It is -- I thought you had said that there was no improvement and that would represent guidance of a 1 cent improvement quarter over quarter.

Upside, you mean?

No, no, the guidance is 1 cent higher than the past quarter.

Okay.

And then, I don't know if you commented or not.

I'm sorry, I joined the call late, but anything you can tell us relative to whether or not the renegotiating Microsoft deal will have any material effect on your margins around your revenue?

We don't give specific customer revenue guidance.

As you know, they're our largest customer.

We were very pleased to sign a new agreement going forward having a variety of services -- also to tell you today that we're supporting the MSN music store.

But we don't give specific margin guidance.

Okay.

All right, guys, thank you.

Your next question comes from Maria Cusemal.

All right.

Thanks, very much.

Congratulations on a good quarter.

Thank you.

Bob, I was hoping you could give us a little color on the mix of bursting versus fixed revenues in the quarter.

And, also, to discuss pricing trends, both as they pertain to the bandwidth that you acquire and the pass through of those savings that your customers may expect.

Maria, it's Paul, I'll take that.

The mix of bursting and committed revenue has been consistent for a couple of years.

We generally see on average, 70% of the revenue comes from committed contracts and 30% on average comes from bursting across the entire customer base, quarter in quarter out.

It varies who's bursting by season or event across verticals, but generally that 70-30 split is just held for several years and continues to.

On the network side, we continue to see some declines in bandwidth that we acquired; and we of course try to use our buying leverage to maximize that.

We continue to see some pressure on the other side from customers who know that trend and expect our concessions back from us but we've done a good job of maintaining our margins in the marketplace.

Okay, and then with the -- you did mention the Olympics -- or perhaps George did in his commentary -- as sort of a source of growth.

You also had the conventions in this quarter.

But not enough to spike that bursting, it sounds like?

Well, we see bursting from different places every quarter.

Sometimes it comes from commerce, sometimes it comes from software updates, sometimes it comes from sporting events.

And so generally, what we see is every quarter, the mix moves by vertical but the split of 70/30 doesn't change much.

So some of the revenue from the one-time events that you mentioned in the quarter -- the Olympics, the convention, etc -- is covered by committed contracts or it may be covered by bursting.

Okay.

Terrific.

Thanks very much.

Your first question comes from Henry Nau.

Hi, Henry.

Hey, guys.

A couple of questions here for you.

I'm wondering -- I know Michael kind of touched on this -- but I was wondering if you could discuss Microsoft a little bit here?

Take the midpoint of your guidance next quarter, which would be -- call it $55 million.

Do you expect Microsoft to remain a 10% customer?

You know, they are a great customer and a valued customer and we're pleased that they are under a long-term contract.

But we've never provided a forecast on Microsoft revenue.

Obviously, our revenue is growing as we add more customers and expand business through current customers, and it's conceivable that at some point that they wouldn't represent 10% of our revenue, and they still could be growing or consistent.

But we're not going to provide, you know, a quarter by quarter estimate on where they're going to be.

And some of them, we don't know because they burst sometimes.

Okay.

That's one of the difficulties in estimating our revenue, is not knowing exactly who's going to burst where.

Right.

Okay, a question for Bob here then.

Could you talk a little bit about the change in the deferred revenue?

Not on the balance sheet but it looks like deferred revenue is going down about 2 million on the cash flow statement?

Right.

What happens, normally -- deferred revenue is made up of a couple of things.

One, it's made up of prepaid items in some cases, it's made up of some of the public sector transactions, where we do a percentage of completion contracts.

On prepaid, which have sometimes the customer is going into a special event, will pay before that event occurs.

In this particular case, we had someone who paid in a previous quarter, and the event actually happened in the third quarter.

So when that happens, you know, we bring it the revenue when the event actually occurred, which means the third quarter at this point.

So we actually had received cash earlier in the year, which is in the second quarter in this particular case.

That was in two different activities, not really what drove it, this particular quarter down below than normal.

Again, it's not a major piece of our business, but it does fluctuate from quarter to quarter based upon the public sector and how certain pre-paid activities take place.

Great.

And one last question if I may.

This one's for George.

I was wondering if you could talk a little bit about some of the different verticals.

You highlighted, you know, software, media, the public sector.

I'm wondering if you could talk a little bit about the strength you're seeing in different verticals -- are some of them growing faster than others?

And I was just wondering if you could touch a little bit upon the government, which ended the fiscal year in the September quarter, and whether there's an impact there.

Well, yeah, I highlighted those four verticals, in particular, because they are fast growing for us, and we don't break that out as to their relative rate.

But, as you know, we continued to do well in media and entertainment with music and sports, and other forms of entertainment that we see moving to the internet, driven by, in this case now, profitable business models.

They haven't had that, you know, in the last five-year, but for a variety of reasons, the acceptance of pay per view subscription and the fact that advertising is moving to the net helps them on the revenue side.

But on the cost side, costs are really down.

It isn't, you know -- it isn't just the bandwidth, but it's also the hardware and the software at the origin, plus the value of a CDN carrying it for them at less cost and high quality, and digital rights management has taken hold to give them greater confidence to put intellectual property out over the internet.

So all I see is growth prospects ahead.

I was with a person the other night who commented that while we've seen tremendous success with legal music downloads, that only about 5% of the world's music content has been digitized.

And I don't know if that is an accurate percentage or not.

It came from an industry-knowledgeable person, but I think it's fair to say there's a lot more music and a lot more other forms of content to be digitized and conserved.

So we like that space a lot, because if you're going to pay for it, they want high quality and reliability, availability under scaling, and we provide that.

On the software side, that's an increasing market, because not only are the software providers moving off of the hard CDs, if you will, but they are linking with customers in an on-demand way, and you can especially see that with the virus companies that have live updates, and and when a live update or an on-demand update is available, especially in today's internet environment, everybody around the globe seems to hit it at once and the spikes are incredible.

We've seen s out of just handling for one customer of ours to over 30 gigabytes per second in an afternoon.

So, I really think that that industry, software industry, just isn't the more static shipment of CDs, but a much more dynamic environment of software updates.

And in online commerce, that's continuing to grow, although some estimates are that only about 10% of the retailers and hotels and travel sites that are also implementing the internet, you know, in an integrated way -- only about 10% of their revenues are on over the web, although it's fast growing, and so we see plenty of opportunity there.

And in the government, that's a combination of our government agencies that continue to utilize the internet plus the custom work that we do for the government.

So, I didn't really respond.

I haven't really responded to your growth rate question, but I'm trying to give you the sense that these are important segments for us.

We've got great customers in each one, and I think we're fundamentally over at the beginning, although robust as it is, of their use of the internet.

Okay.

Okay, great, thanks guys, good luck tonight, get your brooms out.

Your next comes from --

Just to clarify, that was a comment about St. Louis, not about Akamai, right, Henry?

We're very sensitive, those Red Sox fans -- we count nothing too early.

Go ahead, operator.

Your next question comes from [INAUDIBLE] Grover.

You might need those brooms for our Yankees down here.

Our condolences to your customers.

That said, could you talk about what you're seeing from your existing customer base?

For example, yesterday, when Equinox reported, they're saying about half of their existing customers expanding usage of their new services and a third of orders roughly coming from customers that have never outsourced before.

And so I was curious if you could give us your views on any kind of similar trends or different trends you're seeing in your customer base.

It's good to talk about those 44 net adds, but what about the other 1200 customers?

Couple of followups, on the Microsoft negotiation, you mentioned long term.

And I don't know if -- I didn't see it in the 8-K, but when does it reprice again?

And then last question I had was you had mentioned in the last call that you may at some point in the future reverse some of your NOLs into deferred tax assets.

Have you made any progress on looking at that?

Thanks.

This is Paul, I'll take the first two.

I would say we've seen consistent feedback from the field.

You've seen our RPU go up, so you're seeing consistent growth in same customers buying more features and making more use of features of the internet.

Some of the growth also comes from the increased customer adds, and we're seeing growth from customers who've never utilized services like ours before.

And so those are both positive trends.

Microsoft, the terms are filed.

The pricing is not in there, but that was, if you recall, really an amendment to a two-year contract.

So there's another year remaining on that portion of our Microsoft relationship, and then I'll let Bob handle handle the question about NOLs.

As you recall, in the last quarter we talk about the fact that at some stage, at some point going forward that the valuation reserve, which is currently on the books, will come back into income.

We will continue to monitor that.

It will not be until later in the year, but we'll try to keep you apprised.

But it will not be certainly until '05 -- sometime late '05 when we'll see it.

And one last question,n if I may.

You mentioned Vonage as a new customer.

It hadn't dawned on me until you mentioned that.

Are you in the sessions with numerous other carriers who are delivering [INAUDIBLE] to customers' PCs or digi-type devices over the world to use Voice over IP?

Or is that a more advertising driven relationship?

We tend not to discuss the specifics about individual customers, so I can't talk specifically about what we're doing with them without their permission.

All right.

Thanks a lot, guys.

Yep, thank you.

Operator?

Your next question comes from Jean Orr.

Thank you.

I wanted to go back to the net customer increases in the quarter.

I wonder if you could give us some detail on the trends that are occurring in terms of the churn and the net new customers.

What goals do you have, and are those goals changing?

Well, we have been looking at 40 to 50 new net customers a quarter, and that's where we've been -- continually been very pleased with the results given by -- Bob Hughes and his team have done a great job in the last two years turning around our [INAUDIBLE] in the field, and they deserve a lot of congratulations.

We're seeing, you know, similar kinds of enterprise customers and government agencies coming on quarter after quarter.

And we've been very pleased with that result.

On the churn side, as you know, churn, you know, was really was a crisis over two-years ago.

That came down very rapidly through last year.

We've continued to work on improving it this year.

And as Bob said, we saw a little improvement in the prior quarter, but we still think we can do better as we chart towards or try to achieve single-digit churn on an annualized basis.

Can you give us some idea where you stand on that metric now?

We've been in the mid single-digits this year, on a quarterly basis.

Lower on Edge Suite and a little higher on traditional services, so that we think we can get pretty close to our goal this year.

Operator?

Your next question comes from Doug Campbell.

Thank you very much.

It seems like a natural extension of your business to introduce your own applications.

I was just wondering a couple of things about that.

One, is that likely to require a dedicated sales effort?

Will your customer base be ready to adopt that generally, or is it kind of a one on one, one at a time type of thing?

And then I have some additional questions.

Well, I think the addition of the applications is, they are a natural extension of our sales process.

You take search, for example, customers do searches at our origin site.

They can now do search distributed, which means that they avoid the capacity planning for seasonal growth, such as the holiday season.

Where people are increasingly searching product files, so they've always had the search function, but now we enable them to distribute that search capability, which gives them greater scalability, and they don't have to worry about the capacity planning associated with it, because the Akamai network absorbs it for them.

So these application -- contests are a similar story.

What we're doing is taking these -- our registrations.

We are taking -- sometimes our code and sometimes code from others, and deploying it on the platform, so that we can handle the request and the scalability associated with them without the customer having to worry about adding origin infrastructure and/or deploying and managing the applications themselves.

Could that be a pretty good part of your business in two or three years?

Well, we certainly always are trying to improve our functionality to our customers where it makes sense for them, and we would hope that it would be.

The other question relates to the scope of services being adopted by brand new customers versus the full Akamai function -- I mean, [INAUDIBLE] limited function versus new function for customers.

Has that been pretty stable lately or do you see a higher proportion of customers coming in for a fuller service up front?

No, I think the trend there is pretty stable.

We try to get no logos, if you will, with basic services and move them up.

It depends on what business problem they have that we can help them solve.

Increasingly, we try to bring ideas like these packaged applications to bring a solution to them to have a faster adoption, but our expectation is that the new customer will use fewer features, and over time will increase the usage in their contract.

I meant to ask -- I meant something that Bob said, I couldn't -- I didn't get it -- whether over the coming quarter you're going tol be increasing or decreasing head count?

We expect to add people throughout the remainder of the year, both in sales and engineering.

Thank you.

Thanks, Doug.

Your next question comes from Erol Rudman.

Hi, Erol.

Hi.

I just going over some arithmetic to make sure I'm understanding this correctly.

On the first page where you've adjusted EBITDA, it was up by 200,000.

And part of that as I understand it is due to the depreciation decline.

So if I take the depreciation out, EBIT was up roughly 7% in the quarter, and I just wanted to make sure that I'm doing that correctly.

And a question relating to that is that your general administrative expenses took a big jump over the second quarter, and also your sales and marketing were down.

So could you explain that inner relationship and comment, whether my arithmetic and the maintenance of the gross margins is correct?

Well, one second, Erol, let us just check them out.

Hello?

Are you there?

Yeah, I'm here.

Okay, in the operating expenses is 900,000 of G&A expense, which is down to 100,000 from the second quarter -- went from $1 million in Q2 to 900,000 in Q3, all right?

So -- but getting a look at EBITDA, EBITDA is up itself $200,000 quarter over quarter.

And, again, as we indicated, we've made investments in people, all right, over the previous quarter.

I had EBITDA, 700,000, approximately, from 1287 EBIT after deducting the two categories of depreciation.

And it rose to 1376, if I did it correctly.

We'll have to -- we'll look at that, Erol, all right?

Because I believe, you know, when you look it, I believe it's 17.9 versus 17.7 the previous quarter.

Oh, and it was 17.7, but I'm taking out the depreciation to get EBIT for the two quarters.

Okay, if you want to take 1 million out of the previous quarter, that would be G&A expense.

I'm taking -- I just took the combination of -- I took the --

The 4.8 million?

I took that network depreciation and other depreciation.

So the network and other, I just added those together from the second quarter and compared it to the third quarter.

Right, so you'd have, I think, $12.9 million in Q2 would be -- if you back out depreciation, is that what you're doing?

I'm sorry, you got to add it in.

So 22.5, right?

No, I'm backing it out.

I'm backing it out to get to the EBIT before DA.

Yeah, you're working on the EBIT.

Okay, so I think --

So I'm taking 17.7 minus 4.8, giving me 1287, and then I'm comparing that to 1376 in this quarter, so that was about a 7% increase and the gross margins are good.

And the change in expense categories, does this have some implication for us in the future?

That is, will G&A be up at that rate, or is it just sort of a quarterly fluctuation.

And I know you don't normally comment about pricing, but we've heard rumors that pricing and costs are starting to firm to some degree, and maybe in view of the changing environment, you might consider making a comment or two?

Okay.

So, Erol, I think I understand the question -- your math is correct.

We continue to see favorable pricing for our variable costs on the network side.

Some of the G&A costs we talked about in the past were additional head count for mid-year raises and large accrual around Sarbanes-Oxley expense, over $1 million for the year.

And I think that that explains the increase on the G&A side --i t's really representative to those operational issues, not to costs on the outside.

Okay.

Well, that's very clear, and I appreciate it, and I thank you for your success.

Thanks.

Thank you, Erol.

Thank you.

Operator?

Your next question comes from Andy Shoepfer. [PHONETIC] Hi, it's from Q1 research.

Curious, is Microsoft your only 10% customer?

Can you make any comments about -- I assume you have a lot of customers that have grown disproportionally more.

Can you talk anything about concentration in terms of top 10 customers, or top 25?

Well, we're very fortunate we have diversified [INAUDIBLE] days across, you know, over 1200 customers.

We've only had 10% customer for the last -- more than a year, and their portion of revenue has declined over the last year, even though they remained a very strong customer with us.

Our goal is to have diversification across individual customers and vertical, so that we're not too vulnerable to sways in any one area.

If you look at the top 25 now versus a year ago, is the top 25 a larger percentage of revenue or smaller?

We don't break that out, but we're pleased with trends that we've seen in diversifying the revenue overall.

All right.

On the new [INAUDIBLE] business, since you had so many of the key ones, is the price point that you're getting for each download changing, or has pricing stabilized across each of the five that you had?

It varies.

We do different things for different services, so it's a little hard to compare apples to apples, if you will.

But we're very with the way that business has grown and we've emerged as really the defacto platform for the distribution of this kind of digital content on a global basis.

And we think that sets us up well as other kinds of rich media, even richer media such as video, can actually find its way online.

So that's the reason for my question, trying to understand it.

Were they using music originally as a way to test the way they want to pay the different suppliers to that value chain?

No, I think that gives too much credit to the idea of testing, one vertical for the other.

I think what you saw was the music industry in disarray because of the internet.

Finally, some models that emerged, led by several companies, particularly Apple's success in A, proving that customers would pay a reasonable amount and a structure that allowed various components of the value change from the creators and owners of the copyrights to the distributors to make money.

And that pushes it.

It wasn't that they said, you know, we really wanted to move you so we're going to just see if it works with music.

Okay, what you're seeing is that music was first in the barrel, because what happened in that industry, and, if you will, necessity was the mother invention of finding a solution on the music side, and it's taking off and growing rapidly.

And, then, final question on lawsuit with Madera, I think that goes to trial early next year.

Any -- is that a significant legal event for you in terms of the potential financial outcome, or is that more of a technical issue, good or bad?

Yeah.

Bearing the cost of expense is just the cost of doing business in today's society.

We certainly believe that they have done some really egregious things, and you know, it's not our desire to settle business disputes in court, but once in a while, it is required to defend, frankly, the shareholders' interest.

We believe that they have transgressed both our IP and conducted themselves in inappropriate and maybe severely illegal ways, and damaged our company, and if it requires going to court and spending some money to defend ourselves and the shareholder value, we're going to do it.

We have great counsel, it's handled on the outside, so it minimizes the distraction to management as possible.

So we run the business and they'll fight that battle, frankly, on your behalf as well.

Its outcome we don't know until we get there, but we're very optimistic about our chances and if it's required to go to court, that's where we will see them.

Thanks for the answers.

Your next question comes from Phil Zucchi.

Hi, thanks.

Competition, I think in the past, you guys mentioned that there wasn't really any except you guys penetrating the market.

Anything looming out there?

This is George.

That's not so.

There's plenty of competition out there.

I think what we've said is that the largest competitor that we have, really, is our -- the lethargy, if you will, of the -- get the origin infrastructure site to change, and we're making steady progress on that as we reduce our sales cycles and we get additional customers, and they reference the benefits of using Akamai.

But, in addition to that, there are a number of point services, the competitors in the marketplace, and we take them all very seriously.

Anyone sort of coming on stronger than might have been over the past quarters?

We're the competitor that's coming on strong.

Okay, and, a couple of other questions.

I believe that four years ago, during the election, you guys had a 1 or $2 million jump in revenues because of what happened during the elections, which may well happen again next week.

Are you guys -- do you have any customers that are -- like CNN, I believe it was last election.

Anybody else out there that you have under contract that could be hit hard as far as websites are concerned from the election?

Well, we continue to support, you know, I believe -- most of the major news sites in this country and many worldwide, they spike on major events.

Elections are clearly one, although it tends to be a one-day event.

I don't recall the revenue spike being as significant from several years ago.

Fourth quarter, often -- actually, eCommerce is more important to us from a bursting point of view, because it's sustained over several weeks as opposed to one night.

But the thing to remember is that what I said earlier, is that on average, every month, or every quarter, we've seen about 70% of our revenue comes from committed rates under contract and 30% comes from bursting; but that bursting moves from vertical to vertical and customer segment to segment.

So there's some expectation around maybe news in the fourth quarter and maybe eCommerce, but other things such as software, viruses or the Olympics, or certain sporting events that are winding up won't be there at the end of the year.

So kind of hold as we try to protect our quarters to that 70/30 and try to figure out which of those verticals might be busy or not in a given quarter, but I don't think you should look to election night as a signal that would skew our results.

Okay, and just one quickly.

I may have missed it on the news day.

But I thought there was a string -- an issue still open with the cable and wireless litigation concerning damages.

Has that been completely wrapped up?

Well, the filings we have are the most up to date.

So you can just go back and look through them, if you had a specific question on where we stand with them.

Okay.

Thank you very much.

Operator, one more question?

Your last question comes from Jay Aspen.

Under the wire.

Quick question is the follow-up to the Voice over IP question -- and not specifically to Vonage, which is speaking more broadly.

Is Voice over IP an application for which the Akamai solution provides value add, and are there situations in which the conversations you all having with Voice over IP providers about how you can add value to what they do?

Well, I'd repeat what we've said in the past, which is that we believe that some of our routing solutions might add value in the voice space, but that we were not pursuing it specifically, because we didn't think that there was a large enough opportunity for us given that maturity in that industry.

As it matures, there may be an opportunity.

The thing to remember, though, is that we're talking about point to point, noncashable conversation, if you will, in Voice over IP, and that doesn't lead itself to the strength of our traditional Edge suite offered.

Our routing technology, however, might, but we have not seen in enough upside to pursue the development work there, but we'll keep our eye on it going forward.

I appreciate that.

And just as a follow-on to that, with all of the barrels rolling out tons and tons of fiber, and intending to have a video offering at some point down the road, would you just spend a moment, if you would, speaking about the types of video on demand applications for which you all are providing service today, and also whether or not, again, that sort of -- that sort of business development presents an opportunity in the future?

Well, we're very excited by the various flavors that VOD may take, as we see entertainment content and richer entertainment content getting business models that work.

You see some today -- certainly our favorite right now is our relationship with Major League Baseball and the Red Sox -- they still -- they create business -- streaming video.

You see other other cases of music where it's audio.

Other things in video would be movie trailers, for example.

I think what we'll see is -- and music bandwidth increases and people actually can get enough bandwidth to watch video, that there will be opportunities for us to take our technology to both the networks and the content providers and license holders and say, we have a platform on which your rich media can be delivered, and users, because the more users interacting with the more data, across more networks, getting more chaos on the general structure of the internet, the more opportunity there is for our unique technology to sort that out, if you will, and bring real time value to content that people want to pay for and others want to sell.

So we're very excited about that and, you know, it's taken years to get music to the point.

My guess is it will take more years to get video to the level that we take for granted today on DVDs or video rentals or television or going to the theater, but I think we're going to get to that day somewhere down the road, and Akamai will play a role.

Great, thank you very much.

Thank you, Jay.

Thank you very much for joining our call.

We look forward to seeing you at the end of the fourth quarter.

Bye bye.

This concludes today's Akamai third quarter 2004 earnings conference call.

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