阿卡邁科技 (AKAM) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2008 Akamai Technologies earnings conference call.

My name is Antoine and I will be your operator for today.

At this time, all participants are in listen-only mode.

We will conduct a question-and-answer session towards the end of this conference at which time you may press star followed by 1 to participate.

(OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Ms.

Noelle Faris, Senior Manager of Investor Relations.

Please proceed, ma'am.

Good afternoon, and thank you for joining Akamai's investor conference call to discuss our second quarter 2008 financial results.

Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer; and J.D.

Sherman, Akamai's Chief Financial Officer.

Today's presentation contains estimates and other statements that are forward-looking under the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements.

Additional information concerning these factors is contained in Akamai's filing with the SEC, including our Annual Report on Form 10-K and quarterly reports on Form 10-Q.

The forward-looking statements included in this call represent the Company's views on July 30, 2008.

Akamai disclaims any obligation to update these statements to reflect future events or circumstances.

During this call, we will be referring to some non-GAAP financial measures that we believe are helpful to better understand our financial results and operations.

These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles.

You can find definitions of these non-GAAP terms and reconciliations of these non-GAAP metrics to the most directly comparable GAAP financial measures under the News and Publications portion of the Investor Relations section of our website.

Now let me turn the call over to Paul.

Thank you, Noelle, and thank you all for joining us today.

Q2 was a solid quarter for Akamai with healthy earnings and revenue growth.

Financial highlights for the second quarter include record revenue of $194 million, a 27% increase over the second quarter of last year and a 4% increase over the first quarter this year, a normalized net income of $76.5 million, or $0.41 per diluted share.

That's a 38% increase over normalized net income from Q2 of last year and consistent with our strong Q1 results.

We're especially pleased to achieve these Q2 results even as we began to see the impact of a more challenging economic environment in some customer verticals.

At the same time, we continue to experience growth in many of our newer service areas such as application acceleration for business-to-business services and Dynamic Site solutions for e-commerce .

I will be back to talk about some of the trends we're seeing in the market, but first let me turn the call over to J.D.

to review our second quarter results in

Thanks, Paul.

As Paul just highlighted, our business performed well in the second quarter in a more challenging environment.

For the second quarter, we grew revenue 27% year-over-year and 4% sequentially to $194 million, at the low end of our expectation range coming into the quarter.

Our median entertainment vertical grew roughly in line with the overall business and it remained an important contributor to our second quarter financial results.

But, as I mentioned last quarter, media growth has moderated from the pace we saw for several years during the period of rapid broadband adoption.

Growth in our commerce vertical continued to be very strong.

Again, it was our fastest growing vertical with more than a 50% increase year-over-year.

We also continued to make progress with our newer value-added solutions such as application performance services, Dynamic Site solutions and Stream OS.

These higher margin areas contributed to the improvement in probability in the quarter as demonstrated in both our gross margin and EBITDA results.

During the second quarter, international sales represented 26% of total revenue, up 1 point from first quarter levels.

Our international business performed very well growing 8% sequentially and 45% year-over-year.

Revenue in North America, where we saw the largest impact both from the economic factors and media trends grew 2% sequentially and 22% year-over-year.

Resellers represented 16% of total revenue, consistent with the prior quarter.

Once again, no customer accounted for 10% or more of our revenue in Q2.

Our consolidated ARPU, or average revenue per customer, was up 19% year-over-year to $23,700 in the second quarter.

This is the result of our focus on building deeper and broader relationships with our enterprise-class customers by selling new, more advanced solutions into our customer base.

We added 53 net new customers in Q2 bringing our total customer count to 2,725.

Our gross adds, brand new customers to Akamai, increased to about 170 this quarter.

Churn was, again, just over 4%, primarily due to churn from smaller customers.

T he ARPU of our new customer adds continued to be well above the average revenue of our churn customers.

Our cash gross margins for the quarter were 82%, up from 81% in Q1 and down about a point from the same period last year.

As we had expected, our gross margins stabilized with the growth in sales of our Dynamic Site solutions and application performance services which have a higher gross margin than our media delivery deals.

Our GAAP gross margin, which includes both depreciation and stock-based compensation, was 72% for the quarter, consistent with Q1 and down about 2 points from Q2 of last year.

GAAP operating expenses were $88 million in the second quarter.

These GAAP numbers include depreciation, amortization of intangible assets and stock-based compensation charges.

Excluding these non-cash charges, our operating expenses for the quarter were $65.9 million, up $900,000 from the prior quarter.

Adjusted EBITDA for the second quarter was $92.7 million, up 6% from the prior quarter and up 41% from the same period last year.

And our adjusted EBITDA margin of 48% was up 5 points over the same period last year and up 1 point from the first quarter.

For the second quarter, total depreciation and amortization was $23.4 million, up from $22.6 million in the first quarter.

These charges include $17.7 million of network-related depreciation, $2.2 million of G&A depreciation, and $3.5 million of amortization of intangible assets.

Net interest income for the second quarter was $4.8 million.

That's down $2.6 million from Q1 as interest rates declined despite a growing cash balance.

Moving on to earnings, GAAP net income for the quarter for $34.3 million, or $0.19 of earning per diluted share.

As a reminder, our GAAP net income includes non-cash charges for stock compensation related to FAS 123R and book tax charges at an effective annual rate of approximately 40%.

However, because of our significant deferred tax assets we are paying cash taxes at an annualized rate of about 2%.

During the second quarter, our stock-based compensation expense was $18 million, or $0.10 per diluted share on a pre-tax basis.

A break down of our stock-based compensation charges by operating department is available in the supplemental metrics sheet posted in the Investor Relations section of our website.

Additional non-cash items in GAAP net income for the quarter include $3.5 million from amortization of intangible assets and a $20.7 million non-cash tax charge.

Excluding these non-cash items our normalized net income for the second quarter was $76.5 million, 38% higher than our normalized net income for the same period last year and up $900,000 from a strong Q1.

In the second quarter we earned $0.41 per diluted share on a normalized basis.

That is a 37% increase year-over-year and consistent with the prior year quarter.

Our normalized weighted average diluted share count for the second quarter was 189 million shares.

Now let me review some balance sheet items.

Our cash generation continued to be very strong.

Cash from operations for the second quarter was $70 million.

Year-to-date we've generated $158 million of cash from operations or 41% of revenue.

That is up 78% compared to last year.

At the end of Q2, we had $745 million in cash, cash equivalents and marketable securities on the balance sheet.

This balance includes $280 million of AAA-rated, federally insured student loan auction rate securities which we continued to treat as long-term investments in Q2.

In the second quarter, capital expenditures, excluding equity compensation, were roughly $30 million.

Days sales outstanding for the quarter were 58 days, down one day from the prior quarter.

Overall, we delivered a solid Q2.

We were pleased with the continued growth in our traditional market verticals as well as the increased traction of our new solutions across our broad customer base which helped to improve our operating margins.

With the first half of 2008 behind us, it is becoming clear that the pressures being felt by many of our customers from the economic environment will not ease in the short term.

Further, in the media space, while our clients continue to develop higher quality video initiatives, we are not expecting this trend to impact the back half of 2008 significantly enough to offset the pressure from the general economic environment.

Based on the trends we are seeing, we now expect to come in for the full year at the low end of our earlier revenue guidance or slightly below.

So we are updating the guidance of revenue to $785 million and $800 million for the full year, or 23% to 26% growth.

As for our earnings expectations, we expect cash gross margins will trend downward by 1 to 2 points for the full year, slightly better than our previous guidance.

And our full year adjusted EBITDA margins should expand by roughly 2 points compared to the full year 2007 as we said earlier.

However, with the lower than anticipated interest rates impacting our interest income as well as the slower top line growth we are also likely to be at the low end of our earnings guidance or slightly below.

So we are updating our earnings guidance to $1.63 to $1.69 of normalized earnings per share.

That would translate into year-over-year normalized net income growth of 23% to 28%.

We continue to expect capital expenditures, excluding equity compensation, to be about 15% to 16% of revenue for the year.

As I mentioned on our call last quarter, this capital investment level also includes leasehold improvements we have planned for our two primary offices, costs that will offset some of the efficiencies we expect to achieve from our network operations.

On a non-cash item, we now expect equity compensation to be about $0.34 to $0.35 per diluted share compared to our previous guidance of $0.37 to $0.39 per diluted share on a pre-tax basis.

Looking more near term, the third quarter tends to be the seasonally slowest quarter for our customers especially to those that are most sensitive to the seasonal changes in traffic levels.

For the third quarter this year we are expecting revenue in the range of $193 million to $198 million.

At the midpoint that translates into 21% growth over Q3 of last year.

But this revenue range, which is a bit wider than our typical guidance, we are expecting normalized earnings per diluted share for the third quarter in the range of $0.39 to $0.40.

We expect gross margins to decline modestly, by less than a point sequentially and EBITDA margins in the range of 46% to 47% for the quarter.

While we have seen a slowdown in growth in media, we believe that the longer term prospects for rich media online remains very attractive and we think we are well positioned to capture that opportunity.

In addition, our success in verticals beyond media, as well as with our value-added solutions, help to sustain growth and improve profitability in the first half of the year.

And we believe they represent a significant additional growth opportunity going forward.

Given the investments we've made and continue to make in these areas we believe that Akamai is well-positioned to benefit from the long-term trends of business moving online even in a more difficult external environment.

Now let me turn the call back over to Paul.

Paul?

Thanks, J.D.

Clearly the economic climate has changed significantly from where we were even a couple of months ago.

But as our second quarter results demonstrate, we believe we are well positioned (inaudible) and the diversity of our enterprise-class customer base and our broad portfolio of value-added solutions.

J.D.

mentioned that growth in our media and entertainment vertical has moderated a bit from prior years and I would like to focus a bit more detail on what we're seeing there.

It's not that this market is less promising.

The explosion in traffic growth that we saw over the past couple of years has simply moderated, but we remain very excited about the future of media and entertainment online.

This is particularly true because the industry is moving toward higher quality video and that is where Akamai can deliver at a scale and quality level that we believe is unmatched.

Many of our conversations with customers in the media go beyond improving the performance and quality of the rich content and extend to how we can help them with their monetization models.

We are pleased with the results from our investment in Stream OS because it helps our customers manage and monetize their assets, for example.

Outside of media, we have seen strong growth particularly for some of our newest offerings, such as application acceleration and our Dynamic Site solutions.

Innovating in these categories and continually adding enhancements to these newer solutions is not by chance, it's a deliberate strategy to diversify and extend our portfolio and invest our R&D dollars where we believe we will see the best returns and we think that's exactly what's happened.

One example is our commitment to the application space and our recent announcement that we partnered with Citrix to complement the NetScaler product.

By teaming a premise-based product like NetScaler with our cloud-based Web Application Accelerator service we are able to bring true end-to-end web application delivery performance to enterprise customers worldwide.

We believe more and more of the market is coming to understand there are inherent issues with Internet performance in the clouds and that our capabilities provide an ideal complement to what customers are trying to do in their own data centers.

We're very excited about growth in the area of Web Application Accelerator.

We're currently providing these services to hundreds of customers and accelerating many critical business processes.

And these newer services have allowed us to penetrate new verticals such as farm and healthcare where we're helping to accelerate applications used in initiatives like clinical trials.

You might have seen a recent study by Net Forecast that highlighted how Akamai can significantly improve the performance of Internet-connected SAP users around the world.

The business benefit of this is that enterprisers can extend productivity tools from the consolidated data centers to a global user base.

Another of our value-added services is Dynamic Site Accelerator.

This is especially valuable to clients with online commerce sites.

In just a year we've more than doubled the number of customers leveraging this capability from Akamai.

One customer example is JC Whitney, a large direct marketer of auto parts and accessories.

They have leveraged our services to achieve significant improvement in site performance.

They have seen an increase of almost 10% in online shopping conversion rates since deploying our solution.

So we remain very excited about traction with our value-added offerings and their acceptance out in the market.

While companies are adjusting to the current climate, most are finding they don't want to cut back significantly on their Internet investments and our solutions remain critical to helping them grow their businesses online.

Much of our continued success will come from our ability to help our diverse customer base find ways to drive new revenue online and to help them become more efficient by moving more and more business processes onto the Internet.

Now J.D.

and I would be pleased to take your questions.

Operator, if you could set the queue and take the first question, please?

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Mark Kelleher with Canaccord Adams.

Please proceed with your question.

Thanks, hi, guys.

I was just wondering if you could talk about the competitive environment in the media and entertainment market?

What makes you think it's a slowing media and entertainment market and not a competitive situation there?

Well, I think we have always said we are in competitive markets for a decade of history.

That has always been a fact of life and it remains a competitive market.

I want to be careful that people understand what we're saying, we are not saying that the media and entertainment market is slowing online.

What we're saying is that traffic growth on many of these sites, the rate of the growth is not the pace we saw a couple of years ago.

And I think that there's not there are fewer users.

But we've seen is we got to broadband adoption particularly in the U.S.

and that drove, not just the number of users, but how much each user was consuming.

What we're seeing now is that users continue to do more and more, but the pace at which they can consume it is effectively fixed by the amount of broadband they have.

As the pipes get bigger, people can consume more things like rich media, video, et cetera, and we believe we will see adoption all the way up to HD where Internet video is effectively competitive with traditional video to the home today over cable or satellite or whatever means people are using.

So what we are seeing isn't a slowing in that market at all.

We continue to believe that our win rates are good, that we have great relationships with most of the major players not just here but internationally in the media space.

We benefit as they grow, but what we're seeing is that they are just not seeing the pace of growth of traffic that they had experienced, say on average, a couple of years ago.

The competitive environment remains and we face that all the time.

It's why we focus on monetization tools, software tools that differentiate us, higher quality and scale.

But what we are seeing is the rate at which an average site is growing in the media space doesn't appear to be today what it was, say, 18 months ago.

Okay, and just lastly could you give a quick number on the bursting?

Was that around 30% again?

Bursting was on the low side this quarter.

You know, we are sort of got us to where we are on the low end of our guidance.

The other point I'd make on bursting, particularly in the media space, we've seen our customers rather than make the traditional period commitments in terms of a monthly commitment they are making longer term commitments, say an an annual commitment or a quarterly commitment.

It allows them to balance their usage patterns better with their business, but it also does put a little bit more sensitivity in our business into usage.

In some sense, particularly in the media space, usage is growing in importance.

And the 70/30 guideline, at least in the media space, is becoming a little less of a guideline.

Okay.

Thanks.

Operator?

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

Please proceed with your question.

Hi, Michael.

Let me ask a couple questions.

First of all, you said that because of macro you are bringing down the numbers and you think it's more of a traffic issue.

Another questioner asked about competitive.

But you said, I think, didn't change.

Has there been any effect on pricing?

Is pricing any worse than it has been?

And, second, why are you guiding down on margins sequentially if revenue is about the same?

And if you can drill into the gross adds and churn which have kind of gone in a different direction than they have sequentially.

Why are you adding a lot less -- excuse me adding a lot more gross but still churning a lot?

Okay, Michael, I think we got all three parts of the question.

You're breaking up a little.

As they say on drive time radio we will answer that offline for you.

But I think we got all three points and I think J.D.

can take them.

Yes, okay.

Let me start with the pricing.

I think, Michael, the pricing, environment has been, as we've talked about, pretty competitive for quite some time.

And I don't see any major changes in that.

We got to the point, particularly in the media space, several quarters ago where there is not a major deal out there where there is not a competitive commodity benchmark in terms of this price.

I think we expect that to continue for a long time.

I don't see any difference there.

The one difference, as Paul pointed out, we don't see that natural growth in traffic at the same level as we saw with the broadband explosion.

I think the second question was on margins on a quarter-over-quarter basis.

We will see a modest decline in margins even with revenue roughly flat because depreciation is going to grow quarter-over-quarter as we continue to add CapEx.

That is a major feature of that.

And also we continue to grow just the head count to manage a larger and larger network.

But I think overall we have seen the trend moderate just as we thought we would as the business started to transition and shift towards more value-added services.

And what was the third part of the question?

The churn question.

Yes, the churn.

I think 170 new adds was sort of consistent with the rate we had been at before the prior couple of quarters which maybe were a little bit lower in the 140 to 150.

So I don't think there is a major difference there.

We were really pleased with the new adds, particularly given that a lot of the new adds are at larger ARPU levels and are buying our advanced, our value-added services.

The churn continues to be around 4% and as I said that continues to be from smaller customers where we really have turned our focus more towards the enterprise-class customers.

So I think we felt pretty good about the customer dynamic this quarter.

(multiple speakers)

The margin performance was extremely strong and I think goes to the value that we are getting in accounts, particularly in enterprises.

Operator, next question, please, thank you.

Thanks.

Your next question comes from the line of Mark Mahaney with Citigroup.

Please proceed with your question.

Thank you.

Can you talk about the quality of those customer adds you had in the quarter?

Any since of where they come from?

Were they greenfield new to the CDN industry, did they come from other companies?

And could you just go over and clarify exactly how the economic weakening macroenvironment impacts your business?

Do you see it more in terms of an inability to get pricing?

Is it really traffic from end consumers that is falling off?

How exactly does a recession impact your business?

Thank you.

The quality of the adds has been very good worldwide.

And we are really focused on quality enterprise customers and that is who we are targeting for our growth and for the value-added services because it's e-commerce sites, it's the business-to-business portals, it's the mission critical business processes that are going online along with the media and entertainment sites that we are targeting.

And we are looking for large enterprises who can grow and build the volumes in our customer base both of absorbing new product as well as traffic growth.

We are very pleased with the quality of the pipeline and the work that the sales staff did, really in every region around the world, particularly in international which has been really strong and that is no surprise given the general economic news of the U.S.

economy being weaker and the international and Asia being much stronger.

I have been to Asia once and Europe twice in the last few months and it validates what we are hearing.

And I have seen that first hand and heard that.

We shouldn't mix up the economic factors and traffic.

I don't think that consumers are hurting in the pocketbook or in the mortgage market or something and, therefore, are not consuming as much.

The consumption issue is really a question of how much can people consume.

If they are going to be online for an hour a day and they are going to consume video and they don't have high def and they can only do it at cable modem speed that limits how much traffic growth.

So what you'll see is not that the same hour month-over-month is more data, it's if they go from an hour to an hour and 15 minutes that the growth is there.

But the amount they can consume in an hour, or if you will, 10 minutes of experience can't grow if the band width doesn't grow.

So what we're seeing is really a leveling out of the last mile bandwidth.

But that has nothing really to do with the economic situation.

I wasn't trying to imply that people were not upgrading their connectivity because of the economy.

It's not that at all.

The economic issue is really either verticals that we sell into where people are feeling strong pressure in the economy, manufacturing, automotive and they may be slowing down purchases or being much more sensitive to how much they buy or if they start a new project how many features they add online.

In the media space where the economy does have some effect is in the pressure on advertising, both online advertising, but in particularly, offline advertising and where the media companies are really feeling squeezed they have fewer dollars to invest in new online initiatives that might drive people to drive people to consume more right now and there is not one single event there.

We think taken as a whole it is creating a little more headwind at the middle part of the year and it has made us be a little more conservative about the back half of '08.

But it doesn't in any way dampen our enthusiasm about the core business or that really every industry is going more and more to put their process online, but in some cases they have slowed down some of the pace of that rollout.

Thank you, Paul.

That is very helpful.

Thanks, Mark.

Next?

Your next question comes from the line of Tom Watts with Cowen & Company.

Please proceed with your question.

Thanks for the clarification between the effects of the economy and the broadband usage.

If the economy were to recover, what would be the areas you think would pick up?

Is that going to be attraction of new customers or a trade up to additional applications?

And then, secondly, if you could comment on the cash flow.

Clearly, you are starting to establish a very attractive free cash flow profile.

Are there any, other than starting to pay cash taxes, is there anything in the future that could interrupt those free cash flow trends such as a major CapEx investment or something else?

I'm I'll take the first part.

The general economic issue really is vertical specific for us.

Commerce, how much people are driving more efforts online.

Particularly B to B , not B to C, there's a lot of growth there, but more B to B initiatives, automotive is really a hammered sector which was trying to make a lot of changes to the digital world.

Those are the kinds of things where anecdotally some of the regions are starting to see longer sales cycles and people being a little more conservative about rolling out projects.

We don't see them being canceled wholesale.

To us this is not a stoppage in growth, but we are being a little more conservative about the pace at which these things are coming online and we wanting to make sure we have our expectations set correctly.

If there was a shorter impact on the economy overall we would see the pickup in those sectors.

One would presume it would impact the broader add market, and that would drive more spending by the media companies.

And a lot of that could be spending in their traditional non-online initiatives, revenue in them allowing them to invest more online.

They are doing more online.

The question is the pace at which they feel they can afford to go there.

And I will let J.D.

talk about the cash flow.

But I will make the comment there is no -- and Tom, you have known us for 10 years nearly.

We don't have a single upgrade event in our CapEx or network model that would necessitate some major change in

Right.

That is pretty much what I was going to say, Paul.

We talked about our long-term model at our last analyst day.

And as Paul said we don't have a step function or need a step function the way we build out our network.

We think it's a nice incremental investment.

We think we spend CapEx in the range of 13% to 16% of our revenue.

And you can see as our performance over the last few years the model really scales nicely when you look at it on a cash flow basis.

And I don't see any major, significant event changing that in the near term.

Okay.

Thanks.

Your next question comes from the line of Rob Sanderson with American Technology Research.

Please proceed with your question.

Thank you.

Good afternoon, gentleman.

Hi, Rob.

Hi.

I had a couple of questions.

First, on the media and entertainment vertical do you think there is a rationalization of that monetization model going on there?

We have heard about the video portals missing their expected add revenues and social networks coming in a little bit light as well.

Do you think there is some sort of a bigger trend there with bit more of a rationalization of the business model and a little bit of slowdown on that?

And then I have a follow-up.

We are seeing one of the areas where traffic is growing strongly is in some of the social networking categories.

So it's always dangerous to over generalize.

You have heard me say, I think, quarter-over-quarter for a year now that I thought there were some of those models that were more suspect than others and that there would be a rationalization of that market.

So that may be a piece of what's going on.

I'm not sure it ties directly to what we have seen affecting the traffic growth.

In fact, I'm not sure that it does.

Some of those sites report crazy levels of traffic with no means of supporting it.

And their business models, particularly if tougher times come economically will get rationalized, it probably means that there seed funding would dry up or some such thing.

But I think that may be going on, but I don't think that is what we are seeing in terms of general traffic.

Most of it is across the board of, I think, just the limitation on broadband consumption has just, again, dampened the pace of growth.

I think it's very important here that all we're talking about here is the slope of the curve up.

We're not talking about less time online or less consumption, but it's just the rate of that growth, we think, has moderated a bit more than we expected or modeled.

And I would just add to Paul's point earlier there is definitely an imperative from these businesses and sites to improve their monetization which is why some of the discussions we have with our customers around how to better and more effectively monetize their websites, that is really something we are seeing heating up.

That makes sense.

Do you have a follow-up, Rob?

Yes, I did.

Just more of a macro level.

You guys are in a unique position seeing so much of the world's Internet traffic.

And I know you spend a lot of time looking at traffic trends, any notable clues there that could help us figure out the macroeconomic climate, if it's strength or weakness in certain industry verticals or anything notable that jumps out from the global traffic trends you monitor?

Yes, traffic trends in commerce are very, very strong.

And that continues.

And I think that is a number of things.

One, there was a trend of people doing more and more shopping online and they're doing more media online just not at the same pace.

And some of macro things may be influencing it.

We've all read high gas prices.

People are not going to the mall as much so they still need to do some of their shopping, they're doing it online.

So we're seeing strong trends there in traffic.

So that is one of the things we could peek out, one of the things that gives us confidence about the e-commerce sector for the rest of the year, one of the verticals that is very important to the services that we provide or we think those services are important to that vertical.

And we continue to see very strong or stronger growth internationally which is not a new trend.

We've talked about that.

But we don't see any impairment there.

Also we should be cautious about trying to read too much into traffic trends and correlate it.

People are using the Internet more and more even if they are in more uncertain economic terms.

I don't think anyone has talked about people disconnecting their Internet connection because they cannot pay their bill.

People will be using the Internet more.

Maybe we'll even see them use more if they default away from taking vacations or things like that.

But really difficult to draw any kind of specific conclusion like that or to look into the data and understand it.

At the more macro level, I think, it's strong e-commerce , continuing growth in business-to-business usage of online applications.

People maybe being a little more cautious about how fast they are investing in new online B to B initiatives.

Again, all of these things are growing, it's just a question of

Thank you very much much.

Thanks, Rob.

Your next question comes from the line of Tim Klasell with Thomas Weisel Partners.

Please proceed with your question.

Good afternoon, everybody.

You mentioned the commerce site is growing at 50% year-over-year.

I know you only do this once a year, but could you give us some color around the media and entertainment space?

What is the growth profile there?

That is about 40% to 45% of our business.

And as I said on the call, it grew roughly in line, Tim, with our overall growth rate of 27%.

Slightly below that, but roughly in line.

Okay.

And your guidance going forward what do you assume for bursting around the media and entertainment?

Again, as I said to an earlier question, a lot of what is happening in media and entertainment we are seeing longer term volume commitments rather than a standard monthly deal.

What that means is for our customers they realize their usage is more seasonal, particularly in the volume driven parts of the business.

And so what this allows them to do is balance their commitment over a longer period.

What it means for us is we are a bit more susceptible to seasonality.

We saw it last year in our Q3 and Q4 dynamics.

We had a very strong Q4 last year.

Just natural seasonality, particularly in the media and entertainment space as people go outside for the summer.

And the new programs come online and the holiday season drives online advertising, et cetera.

We see more of that.

I would say outside of that area, the bursting relationship stays the same.

But that dynamic is changing a bit, the dynamic of our overall seasonality.

Okay, great, thank you very much.

Thanks, Tim.

Your next question comes from line of Colby Synesael with Merriman.

Please proceed with your question.

Great.

Thanks for taking my question.

Just looking at your international revenues it looks like you have 26% of revenues which is up nicely from last year.

Is there an opportunity for you guys to accelerate your growth in the international space?

Obviously, you mentioned the U.S.

as being one of the areas of weakness.

Maybe international could balance that out a little bit.

And if you could talk about the competitive dynamics internationally verse domestic if there's any nuances there that changes how you guys compete?

Thanks.

We have been really pleased with international performance over the last year, not just this year.

And you have seen that in the steady increase.

And given that the domestic business has grown very strongly means international has really been executing well to not just stay current but to catch up.

Obviously, for 26% of the business to counter balance 74% they have to be really outstanding.

We are seeing some of that.

And we are making investment in the international, we're opening new offices and expanding the staff in most of the regions.

We continue to see new opportunities.

As you may be aware, our habit is to move into a region first, if you will, by parachuting in, meaning we fly people in and out of one of the other capitals where we operate offices and if we get enough traction we will open offices in new cities or new countries.

We are opening several, or already have this year in Europe and Asia and are very pleased with that performance.

And I think that is an area where we will buy some incremental investment.

The opportunity is strong and you're seeing the payoff.

Frankly, there are just more Internet users outside the U.S.

than there are inside.

And in many countries they have broadband already that exceeds ours.

If you look at Korea, just came back from Europe.

France now has 20 megabit a second service available to homes at very competitive rates and they are seeing uptake there that I think exceeds what we are seeing, way exceeds what we're seeing in the U.S.

Some of those markets have for all verticals, including media and entertainment, more growth opportunity than they have, than we are seeing here even so far.

And in no way are we discouraged about the U.S.

market, but there are just really interesting Internet things going on internationally.

And you're right to ask the question about competition.

We see some of the names you would recognize as U.S.

competitors in some of the international markets.

We deal with that kind of competition in some areas and in some countries there are domestic, local competitors.

Some are -- try to sell a content delivery service similar to ours, others might try to mix in production or some kind of professional services as a local differentiator.

I think we compete effectively.

One of the things that we have that really differentiates us is global scale, and we are generally targeting enterprises with global operations or global suppliers.

And in this world economy, almost any decent-sized company today is dealing with suppliers, partners, marketers in distributed geographies and they are looking for WAN-like performance for global Web operations and we can offer that and we think that most of the competition internationally can't do that at all.

It really helps us there.

In other ways it is kind of similar.

We look at channel partners, developing local extensions of sales operations as well.

Some of those are a bit more regionalized as we go.

The other thing I would add to that.

The investment that we need to make and we are making to grow internationally is a go-to-market investment.

It doesn't require a new level of buildout on our network.

We already have the massively distributed global footprint and that is a significant advantage.

Great, thank you.

Operator?

Your next question comes from the line of Rod Ratliff with the Stanford Group.

Please proceed with your question.

Hi, Rod.

Hey, guys.

Obviously, nice expansion in the gross margin there.

Is that just the greater presence in the mix of higher margin verticals?

I think that is certainly the major driver of that.

It's something that we talked about for a while that as we get more and more penetration of our value-added services we start to see that benefit.

We also even in a -- forgive my term -- in a more basic delivery deal we still command a significant premium just based on our fundamental performance advantage and reliability.

But I would say it has been our strategy to upsell our customers with value-added services and build out on our differentiation and we're starting to see some of the benefit of that.

All right.

Two very quick ones.

What are you seeing in online casual gaming?

Video gaming?

A large growth in the gaming space.

That has been a very strong area for us for probably about 18 months.

And as we see more connected devices that will grow.

And I was -- there was a press release out, I believe, yesterday that listed NBC's partners for streaming the Olympics.

Do you think you guys will you see any notable benefit from that at all?

We are looking forward to the summer games and the role we are playing there across the globe.

I can touch on a number of them.

We are working for the first time with partners inside China to support their efforts to distribute the games on the Web which is quite interesting.

We are working with the EBU to deliver the Olympics across the European continent.

We'll also going to be delivering the summer games throughout the U.K with a partnership there.

And domestically we are really excited to be working once again with our partners at NBC-Universal to deliver the NBCOlympics.com site.

We think it should be a very sizable Olympics.

As we've said, there is no one single event or customer who at our scale is that significant to the quarter.

At the same time, we are happy to have all that business and to work on a global event, which we think will be interesting.

You never know how exciting it will be until we see how good the individual games are and whether people capture someone's attention.

And the time zone differences.

Also we're going to have to see how that plays and it will be regionally different where the games are live or not how significant the Internet is.

We've been doing the summer games every four years and we get some version every two years because of the winter games as well.

It always has been an interesting traffic driver on our network and we're looking forward to it, but, again, on our scale we don't think any one thing is so significant.

But we'll be involved in the Olympics in almost every geography in the world including here with NBC.

Can I throw out a follow-up, Paul?

Sure.

How do you feel about gaining a foothold in China?

As everybody says, particularly in tech, actually in any industry.

It's a hugely exciting and intriguing market because of its scale.

In many ways it's a very different place to operate because of the state of development, regulation, et cetera.

We have worked there with partners successfully and we are very pleased about it to deliver content into China on behalf of some of our customers.

And we look forward to working with our partners there to expand our ability to really make the Internet in China achieve all of its potential.

And we think that that presents a growth opportunity for us, as well, over the next couple of years.

We think our technology and services can help benefit Internet performance there as they do everywhere else in the world.

Thanks a lot.

Your next question comes from the line of Srinivas Anantha with Oppenheimer.

Please proceed with your question.

Yes, thank you.

Couple of questions.

One of the things you guys highlight is the newer value-added solutions such as app services and Dynamic Site solutions that helps differentiate in the marketplace.

Could you guys quantify what percentage of revenue comes from these services and how much they have been growing year-over-year?

We talked about that at our analyst day last year.

We said at that point it was about 30% of our revenue came from customers using our Dynamic Solutions including those and that continues to grow.

We haven't quantified that number externally since then.

Probably will give an update later in the year as we have an analyst day this year.

But that number continues to grow as a portion of our business.

And that's a major strategic thrust for us.

And, Paul, you talked about the overall slowdown in traffic.

Do you see any killer applications whether on the enterprise side, on the consumer side you think will reaccelerate the growth in IP traffic?

There is no slowdown in traffic.

What I said was and I just want to be very clear everybody gets this, a slower rate of growth in some of the media sites.

There is no slowdown in traffic, it's really a growth rate question in some verticals.

There is no slowdown in Internet traffic or Internet usage.

I don't think it's a question of killer apps.

I think for media it's a question of last mile bandwidth accessibility and the ability to consume data or the rate at which people can consume it.

And in the reality in the U.S.

you are lucky to get a television quality video picture over IP and all your neighbors better not be trying to share that same link to do that.

We are looking forward to the day when you can do true HD to any home over IP.

And if you looked at our HD Web demonstration site and you have the right last mile connectivity, probably more likely at work than at home today, you can watch a live stream of a fully competitive, if you will, HD picture.

It will be as good on your big screen TV as your HD standard TV signal.

If you will, I think that is the killer app.

It's not that the content needs to be existent in HD, it exists.

The last mile and then the monetization models that go with it are what we're needing to reaccelerate the growth rate there.

And on the business side, we are seeing those apps and we're seeing the adoption.

That's why you see the strong uptake of those services and the reason, I think, the gross margin was so strong.

And there some of the applications are B to B portals.

Many of the buying, provisioning and data-based apps that people tend to do behind the firewall and let someone access over a phone or a call center that are now being opened up on a secure portal.

Those apps exist and the question there is the pace at which enterprises are putting a Web front end on a legacy system and saying to people, effectively, self-service.

I think the apps exist there, but it's the question of the shift in the way the businesses are operating and that reengineering that we have been seeing over the last couple years and have driven the strong growth in our B to B services.

Thanks for the clarification.

And, J.D., one quick clarification on the expenses.

I know you mentioned that gross margins are going to decline by a percentage or so.

Are you talking about cash gross margins or GAAP gross margins?

And the second one is the G&A declined quite a bit at least relative to your expectations in this quarter sequentially.

Were there any one-time events that helped that?

Thanks a lot.

Our G&A was actually up about $1 million quarter-over-quarter.

And maybe that was a bit lower than we expected to spend.

But I think you just have timing and managing how we have our expenses come in.

In general, though, our expenses are largely resource-related and we did continue to add resources.

On GAAP gross margins -- I should mention that our litigation costs went down slightly quarter-over-quarter from 1Q to 2Q offsetting some of the increases that we had.

On gross margin, I think both cash and GAAP gross margins will decline somewhere in less than a point range.

Yes, thanks a lot.

Operator?

I think we have time for a couple more questions if people keep them short.

Your next question comes from the line of Garrett Becker with Merrill Lynch.

Please proceed with your question.

I was wondering if you could talk about some of the new customers you added this quarter?

Were any of those international?

Yes, all across the board in every region.

We had very strong performance with enterprise new customers in Europe, where I just came back from recently, Asia as well.

And the U.S.

We had strong adds and, as J.D.

mentioned, the ones we churned tended to be much smaller than the customers we bring on, which really is that process of getting better and better at managing the pipeline, of bringing in good customers and rolling off those that, for whatever reason, don't really make sense and tend to be small.

I don't know if I can mention any of the names, but one things that was very encouraging to me was to see that a good portion of the larger deals that came in were APS and DSA deals, some really high value-add service and relatively large deals coming in the door for a first time customer.

On the B to B side.

Right.

Okay.

And then, maybe I misheard the previous question with respect to Dynamic Site Solutions.

Can you give us any color on the Application Performance solutions?

Obviously, it ticked up and it helped your margins.

I think the last time you said it was about a $40 million run rate the last time you gave us any numbers.

So any other color would be helpful.

We update that once a year.

At this point we're not doing segment reporting quarter-by quarter.

But we were very pleased with what we're seeing in not just Dynamic Sites, but Application Performance as well.

And some of the deals that J.D.

was referencing, domestic and international, those enterprise deals were for Application Acceleration and some were for for Dynamic Site Acceleration.

And if I can sneak on one other.

Keep it short, now.

Short?

Any thoughts about buybacks?

No, we're not going to speculate on things in the future.

Obviously, we meet with our board on a regular basis, look at our balance sheet and think about all the opportunities for investment and tend to be opportunistic and we'll make the right moves at the right time we when we see them.

But we won't speculate on might do this or might do that.

Great, okay, thanks.

Thanks.

Your next question comes from the line of Kirk Materne with Banc of America.

Please proceed with your question.

Yes, thanks very much.

Just a little bit more color on the APS side.

Can you guys talk a little bit about were most of the customers that were added this quarter, I guess, historical customers of yours, were they brand new customers?

I'm just trying to get a sense on where some of the demand is coming from on that side?

I think you mean --

I guess what percentage were existing Akamai customers versus brand or greenfield opportunities for you?

Honestly, I don't know the answer off the top of my head.

What we have been seeing is roughly a half and half type ratio.

One of the things about APS is that it has been an entree for us into markets where we didn't have a presence like pharma and manufacturing and some of the places where Web content delivery is less important.

So we've added great penetration in there.

But also we, even our biggest media customers have online applications so we are getting some penetration in there.

So I apologize I don't have the stat for the number of things this quarter off the top of my head, but the rough ratio has been 50/50.

Just a follow-up on that point, J.D.

When you are talking about some of your big media customers taking on the APS services it's a different part of their business.

Do they have money to spend on IT or is it pushing more content out, they are taking a pause on that side?

Is it just -- is it more of a monetization issue for them on that side, I mean if they have money to spend on APS they have money, but is it a matter of where they are focusing their spend right now?

The great thing about APS, and, obviously, it's something we sell into these guys, not only does it boost productivity but it also drives cost savings.

In an environment like this and as you would expect and as you've seen probably, anecdotally, IT budgets get scrutinized a little bit more closely.

So there is a sales challenge there.

But fundamentally what our Application Performance Solutions do, also saves companies money in their data centers, as well.

So that's a real powerful story, particularly in this type of environment.

And then -- when you talk about DSA, particularly in the commerce area, the great thing about that is the benefits aren't in terms of an investment to make your site nicer or something like that, it's very easily translatable to the top line improvement.

And in an environment like this that's something that people find very valuable.

Operator, why don't we take one more question and we'll make sure we're off in the hour we promised everybody.

Your final question comes from the line of Derek Bingham with Goldman Sachs.

Please proceed with your question.

Hi, thanks.

I wanted to ask kind of what your sense is for your outlook for new customer adds as you continue to churn off more smaller customers?

Is that kind of 25 to 50 pace kind of the right way to think about it going forward on a net basis?

Derek, we don't really forecast that on a going forward basis.

What we do is focus on making sure that the signings that we're delivering and the new customers we're bringing on are high quality customers, and then taking care of the customers that we have and making sure that the ones that are growing with Akamai and we have an opportunity to upsell and improve and deliver value for them that we keep.

But we don't have a forecast going forward on that.

All right.

Thank you.

Operator, thank you, thank you all for tuning in.

We'll be back in three months as usual to update you on the summer and the rest of the year.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.