阿卡邁科技 (AKAM) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the first quarter 2010 Akamai Technology's Incorporated earnings conference call.

I'll be your coordinator for today.

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

We will be conducting a question-and-answer session towards the end of this conference.

(Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Noelle Faris, Director of Investor Relations.

Good afternoon and thank you for joining Akamai's investor conference call to discuss our first quarter 2010 financial results.

Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer, and JD Sherman, Akamai's Chief Financial Officer.

Before we get started, please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance.

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 filings with the SEC, including our annual report on Form 10-K and quarterly report on Form 10-Q.

The forward-looking statements included in this call represent the Company's view on April 28, 2010.

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

As a reminder, we'll be referring to some non-GAAP financial metrics during today's call.

A detailed reconciliation of GAAP and non-GAAP can be found under the news and events 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.

Akamai performed extremely well in Q1.

Top line growth accelerated year over year as we posted record revenue of $240 million, up 14% from the same period last year.

Gross margins improved year-over-year and we achieved our highest adjusted EBITDA margins ever, while generating fully taxed normalized net income of $66 million or $0.35 per diluted share, up 14% from Q1 of last year.

These results came from strong demand for our services in all verticals.

Our cash flow generation was also strong, with $88 million of cash from operations in the quarter.

And so we're pleased to announce that our Board has authorized a $150 million extension of the share buyback program we started a year ago.

I'll be back in a few minutes to talk about some of the key trends in the market, but first let me turn the call over to JD for details on Q1.

JD?

Thanks, Paul.

As Paul just highlighted, our business performed extremely well in the first quarter and we grew revenue of $2 million sequentially and 14% year-over-year to $240 million, coming in above the upper end of our expected range for the quarter.

During the quarter we saw an acceleration in traffic growth, particularly in media and entertainment as well as continued growth in our value-added solutions.

We're particularly pleased with the sequential growth of our business coming off a very strong fourth quarter.

E-commerce continued to be our fastest growing vertical, increasing 19% over Q1 of last year but declining 5% compared to Q4 due to normal seasonality, primarily in our advertising decisions solutions.

Excluding advertising decision solutions, e-commerce actually grew modestly from Q4 with growth coming from both dynamic site and application performance solutions.

These cloud based solutions continued to gain traction in the marketplace.

Signings in the quarter, both from new customers and from existing customers who are upgrading and adding additional applications, were very strong.

In fact, the dollar value of new customer signings for our value-added solutions was up nearly 40% from Q1 of last year.

And overall, 54% of our revenue in the quarter came from value-added solutions, up from 46% in Q1 of 2009 with 77% of our total customer base using at least 1 value-added solution.

Our media and entertainment vertical grew revenue 5% sequentially and 10% year-over-year in the first quarter, driven by accelerating volumes growth and exceeding our expectations.

We're beginning to see media companies offering higher quality video online.

And as a result, performance, reliability and scale are becoming increasingly important for them, leading to key wins for Akamai.

The high-tech vertical was up 15% year-over-year and flat on a sequential basis, driven by increased software download volumes in Q1.

We also saw increased traction among software as a service, or SAS providers, with our APS solutions.

We now have over 100 SAS providers leveraging Akamai's platform to drive their businesses.

Public sector revenue was up 21% from Q1 of last year and 11% from last quarter, continuing the solid performance we've seen for the past quarters from government contracts.

During the first quarter, sales outside of North America represented 28% of total revenue, consistent with the prior quarter.

International revenue grew 1% sequentially and 16% year-over-year.

The stronger dollar had a negative sequential impact on our revenue of about $2.5 million, and on a year-over-year basis the currency impact was favorable by about $5 million.

Revenue from North America grew 13% on a year-over-year basis and was up 1% sequentially.

Resalers represented 18% of total revenue, down a point from the prior quarter.

We again performed extremely well on costs and gross margins in the quarter with cash gross margins of 83%, up slightly from Q4 and up a point from the same period last year.

GAAP gross margin, which includes both depreciation and stock-based compensation, was 72% for the quarter, consistent with Q4 and up one point for the first quarter of last year.

GAAP operating expenses were $106.5 million in the first quarter.

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

Excluding non-cash charges, our operating expenses for the quarter were $80.1 million, down about $4 million from Q4 and up 13% on a year-over-year basis.

Adjusted EBITDA for the first quarter was $118.1 million.

That's up 18% from the same period last year and up 6% from Q4 levels.

And our adjusted EBITDA margin of 49%, a record for Akamai, was up 1 point from the same period last year and up 2 points from the fourth quarter.

For the first quarter, total depreciation and amortization was $33 million.

These charges include $24.9 million of network related depreciation, $3.9 million of G&A depreciation and $4.1 million of amortization of intangible assets.

Net interest income for the first quarter was $2.7 million.

Roughly flat with fourth quarter levels and down $1.4 million from Q1 of last year despite a higher cash balance due to lower interest rates on our investments.

Moving on to earnings, GAAP net income for the quarter was $40.9 million or $0.22 of earnings per diluted share.

As a reminder, our GAAP net income includes several primarily non-cash items including $21 million of stock-based compensation, including amortization of capitalized equity based compensation, $4.1 million of amortization of acquired intangible assets and $27.8 million of tax charges at an annual rate of approximately 40%.

As we continue to exhaust our NOLs, we expect to pay cash taxes at a rate of only about 6% for the year.

However, as we talked about last quarter, beginning this year we are including GAAP taxes when we report our normalized earnings each quarter.

Again for Q1 that tax charge was $27.8 million.

The supplemental metric sheet posted in the Investor Relations's section of our website provides a historical view of our normalized EPS on a fully taxed basis for comparison purposes.

Based on this methodology, our fully taxed normalized net income for the first quarter was $66 million, up 14% from Q1 of last year and up 5% from Q4.

In the first quarter we earned $0.35 per diluted share on a fully taxed normalized basis.

That's up $0.04 from $0.31 per diluted share in Q1 of 2009, and up $0.01 from $0.34 in Q4.

This was above our guidance range coming into its quarter as the increased revenue growth and higher margins drove an outstanding bottom line result.

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

Now let me review some balance sheet items.

Cash generation continued to be very strong.

Cash from operations for the first quarter was $87.8 million or 37% of revenue.

At the end of Q1, we had $1.1 billion in cash , cash equivalent and marketable securities on the balance sheet.

This balance included $244 million of highly rated, fairly insured student loan auction rate securities.

Capital expenditures, excluding equity compensation, were $35.2 million, a bit lower than our plans coming into the quarter due to the timing of some expenditures that pushed into Q2.

During the quarter we spent $21.9 million in share repurchases, buying back about 834,000 shares at an average price of just over $26.

Approaching the one year anniversary of the share repurchase program, we have spent a total of $88.2 million buying back 4.2 million shares at an average price of about $21.

And as Paul mentioned, our Board has authorized an extension of our share prepurchase program authorizing an additional $150 million over the next 12 months.

As with our existing program, we intend to fund it out of our strong cash generation and with a goal to offset dilution from on going equity grant.

And finally our day sales outstanding for the quarter were 58 days, down one day as compared to Q4.

With these Q1 results following a strong Q4, we're even more optimistic about the prospects for accelerated growth.

We've witnessed an acceleration in volumes in media and as a result we've seen a return to solid revenue growth in our media vertical.

We have also seen continued traction with our value-added solutions, as customers move more of their business transactions online and adopt cloud computing models.

And we executed our business model very well in Q1 with great performance on cost and expense management, on top of the record revenues.

Looking forward, we are becoming more confident in our ability to generate double digit annual top line growth throughout the year and we're committed to making the investments that we expect will drive Akamai's growth beyond 2010.

For the near term, we're expecting Q2 revenue of $236 million to $246 million.

That represents between 15% to 20% year-over-year growth accelerating from the 14% growth rate we saw in Q1.

We expect the currency headwinds will continue on a sequential basis in Q2.

Assuming current spot rates, foreign exchange will have a negative impact of approximately $1.5 million compared to Q1, but a slight positive impact of about $1.5 million compared to Q2 of last year.

We expect the cash gross margins will be approximately 82% in Q2 and GAAP gross margin, including equity compensation, will be approximately 71%.

In Q2 we plan to increase our investment levels given the positive growth outlook for the year.

On the OpEx side, we expect to grow OpEx by $7 million to $8 million on a sequential basis as we continue to invest in R&D and go to market initiatives that we believe will yield important near term and long-term benefits.

We expect adjusted EBITDA margins will be back in the planned range of 46% for the quarter, as investments catch up with our top line growth.

With the acceleration we've seen in media volumes and the increasingly large TV size events online, we're planning to ramp up our CapEx spending in Q2 to approximately $65 million.

For the full year, we expect CapEx will be at the top end of our long-term model range of 13% to 16% of revenue.

We think this is a very positive sign about our confidence in the prospects for growth across all areas of our business.

Given our revenue guidance of $236 million to $246 million in Q2, we expect fully taxed normalized earnings per share for the second quarter to be in the range of $0.32 to $0.34.

This assumes a GAAP tax rate of 39% or GAAP taxes of approximately $21 million to $24 million for Q2.

Overall we're very pleased with how the business performed in Q1.

Our value-added solutions continue to be a significant growth driver and with accelerating traffic growth, our media business returned to revenue growth as well.

Given our strong Q1 financial results and balance sheet as well as the trends we're seeing in the marketplace that continue to favor our uniquely differentiated services and delivery platform, we plan to continue making key investments in 2010 that will drive our growth for 2011 and beyond.

Now let me turn the call back over to

Thanks, JD.

As JD mentioned, we believe there are exciting trends taking shape across our business.

Trends that I talked about our on last call and emphasized at our investor day in December.

We think we are still in the very early days of these positive developments and we're already starting to see their impact on our business performance.

To reiterate, we believe cloud computing is revolutionizing IT and driving more and more business processes online.

Video distribution on the internet is now fundamentally changing the media industry and online advertising is transforming marketing strategies.

Le me begin with the market opportunity for optimizing enterprise cloud computing, improving the performance of mission critical online systems and applications.

This is an area where we are differentiated and highly valued by our customers.

So we are increasing our focus here.

More and more business functions are moving online, as end users expect to access applications any time, anywhere and from any device.

However moving from a traditional enterprise IT model to the cloud introduces new performance and reliability challenges that are inherit in using the internet.

This is particularly true as computing resources are centralized and users are more and more global and mobile.

Akamai's cloud optimization services are designed to help businesses realize the full potential of their cloud strategies, without compromising on performance or security.

A great example is how Akamai's cloud optimization solution benefits AppRivers exchange service, by reducing connection times and increasing performance by 50% to end users, including mobile users.

In response to security concerns with cloud based applications we've seen strong demand for the web application firewall solution we introduced in December.

This service enables online businesses that require advanced security for their websites to access it from our distributed cloud.

One of our customers, a top luxury retailer, was looking to protect its sites and applications from information theft and down time, while also meeting strict PCI compliances.

With the Akamai Web App Firewall solution, this retailer was able to add an essential security element without additional internal IT buildout.

And so our new cloud optimization solutions are leading us into new industry verticals and enterprise customers.

Already today we count as customers six of the top ten global banks, five of the top ten online brokerages, nine of the top ten global pharmaceutical companies, 13 of the top automakers and the top accounting firms and we aren't stopping there as we continue to develop new capabilities to improve the performance of our customers cloud based initiatives.

Also getting a lot of attention these days is the online video revolution and that's having a positive impact on Akamai's business.

Successful online models such as Netflix, Hulu and iTunes are emerging for distributing recorded entertainment.

These models are pushing the Internet forward as a new medium of choice for consumers looking for premium or HD content.

Equally exciting, our live events distributed over the internet in HD, events such as the Masters and March Madness, these are demonstrating the webs ability to reach increasingly large audiences in new and in innovative ways.

During the week of the Masters for example, we set a record for peak traffic on the Akamai network, exceeding 3.4 terabits per second.

Put another way, on our busiest day, our network responded to more than half a trillion requests for content.

That's trillion with a T.

And that's a figure serving content to every person on earth every 20 minutes all day long.

That's an impressive record but one we do not expect will stand for long.

Demand like this demonstrates why it takes Akamai's distributed approach to deliver large events effectively.

On that record day we delivered TV like HD video streams from more than 500 locations in the US alone on behalf of a single major client.

We do not believe any other approach comes close to matching our scale, quality or efficiency.

And as the internet continues to transform and revolutionize business around the world, we intend to further enhance the Akamai HD network.

Our strategy is to continue investing in this platform, so we can deliver our customers premium content to their end users at scale, at the highest quality, with reduced complexity and increased accountability.

Finally, in a newer area of our business, using data to improve the performance of online advertising, we believe we are continuing to see an improving climate for advertising and increasing acceptance of leveraging shopping data to power better ad campaigns.

We had a record number of new customer signings for our advertising decision solutions in Q1.

So in summary, we are very pleased with how Akamai performed this quarter.

Five years ago when we were about a $200 million business, we set a goal for ourselves.

One that seemed audacious to many at the time.

We set out to reach $1 billion in annual revenues, something that very few independent software companies have managed to do.

Even more boldly, we declared we would get there by the end of the decade.

While it's still early in the year, I think we have a good chance at achieving that goal in 2010, just as the decade ends.

And as we drive to achieve that goal this year, we are investing in the future for the next $1 billion in revenue.

So as Akamai continues to help transform business online and the Internet itself, we are even more excited about the long term.

Now JD and I would be happy to take your questions.

Operator, the first question please.

(Operator Instructions) Your first question comes from the line of Sterling Auty from JPMorgan.

Please proceed.

This is Lauren Ye for Sterling Auty.

Hi.

How are you?

Good.

How are you?

Trying to get a sense within the media entertainment --

Lauren, you're kind of fading in and out a little bit there.

Can you hear me better now?

Yes.

Okay.

Great.

I just had a question around the media and entertainment line.

Obviously you did really well there.

Just wanted to kind of understand, how much of this upside is really HD versus what you mentioned that there might have been some events that were pretty strong, obviously they probably are HD as well, that kind of pushed it over the top?

Sure.

Well I think one of the keys is a lot of it is HD.

People are still delivering video at variable bit rates and some of them more standard like we've been seeing for a number of years.

But we're seeing increasingly HD video both for on-demand higher quality of things like movies and TV shows delivered that way and especially for a live event.

Not just because of the picture quality, but because of the instant replay and the effectively built in DVR, or digital video recorder, functionality we provide right in the player and I think that's very exciting.

So it doesn't account for all of the upside, we saw a strength across media, across software and high-tech, we saw it across e-commerce, but I think HD was a piece of the pleasant surprise and I think will be a big driver for us over the next several years, because what we are seeing from customers is much greater interest in adopting the Akamai HD solution faster than we had expected.

Operator?

Your next question comes from the line of Mark Mahaney from Citi.

Please proceed.

Thanks.

Two quick questions.

First can you just update us on the churn or the gross customer ads?

Second, the international growth, if you adjust for FX, was 5%, 6% year over year against comp granted, but it's not the kind of double digit growth I think you'd like to see.

Can you talk about the steps to get that growth faster in international markets?

Sure, Mark.

It's kind of hard -- last quarter we sort of disavowed talking about the broadly based churn and customer account numbers, and kind of ironic that we then had a record quarter there with -- our gross new customers were up, our churn was actually below 3%, which is very low.

But I still think the right way to look at the business is to break it down by vertical.

We talked about in the commerce vertical the signs that really do matter there, we are looking at the dollars coming in the door from brand new customers who are signing up to our value added services, particularly DSA and APS, and that was up 40% year over year.

We saw the revenue from our value added solutions go from 46% to 54% as a total of our business from Q1 of 2009 to Q1 2010, and we continue to get really good upsell of our existing customers.

We are to the point now where 77% are buying at least one solution and we continue to have really good traction there.

One value added solution.

One value added solution, correct.

So I think we are very, very pleased with the signings that we saw in the quarter, particularly around the value added solution.

Then your question on international.

You are right, last quarter -- last first quarter we had a very large quarter in international and so there are some tough compared timing type impacts.

I think also what you are seeing in international is something similar to what we saw in North America last year, particularly the economy there haven't recovered as fast, the digital media business has not turned like we've seen yet in the United States.

So the results are a little bit dragged down by that, but we continue to see really good traction of our value-added solutions over there and I do believe that in the long-term and even in the relatively near term, we'll see an acceleration there and international will continue to be our fastest growing geography.

Operator.

Your next question comes from the line of Tim Klassel from Thomas Weisel.

Please proceed.

Good afternoon.

Great quarter.

I just want to touch on the CapEx.

You're going up to the high end of your 13% to 16% range.

What is driving that?

Is it the media volumes?

Is it efforts around your cloud computing and do you think that higher end will be -- the 16% will be the go-forward for maybe a few years as growth accelerates?

No, I think it's a little hard to make the long-term call.

We've had a range, which we've been very successful at staying within as part of our model and we believe the model holds.

We just see so much growth opportunity right now by geography around the world, by vertical, whether it's performance enhancement and application acceleration or the rapid adoption of HD and the size of audiences, customers are beginning to talk to us about, delivering high quality video with interactivity.

And we just think it's prudent to be out ahead of it so we're not turning customers away or disappointing them, and we think spending a little bit more and frankly, grouping those purchases and getting even stronger possible discounts from our supplies on the hardware side is a prudent step to take.

I've gone through this before, but just for the benefit of people who may be new to the story, we're not making long-term multi billion dollar bets on some new manufacturing plant.

These are quarter by quarter decisions.

If we remain as up beat we can continue to expand capacity.

If we think there is a turn in any part of the world we can pull back a little and it's not a stranded resource.

We think we are doing the right thing to stay a little bit ahead and encourage the network group to build out faster.

But it's not a fundamental shift, it's not a fundamental shift in product type, it's just our consistent build for where we see demand, which geographies, which networks, which services around the world are making sure we stay ahead of the opportunity.

Great.

And then just a quick comment on the margins and the media business.

I know it's hard to separate them all out, but you're feeling as that business accelerates that customers are getting a little less price sensitives and margins getting a touch better there.

I think that this is a competitive field in technology.

Unit prices go down every year.

We have always worked with that.

It's been true for over a decade.

And frankly our ability to drive our own unit pricing down and share that with our customer allows them to expand their use to things like HD.

So I think that's just a given.

And since we're at the 1% line today of exploiting the market opportunity, I don't worry about it.

If you look at how much video in the home today comes over the internet, it's a little over 1%, it took 15 years to get there, I don't think it will take 15 years to double and double again.

So there is plenty of volume to go after and it's key we're going to drive price down and share some of that with customers.

One of the things I think has been terrific over the last several quarters has been our ability to drive more business for customers to do more and continue to improve the profitability of the business, whether you look at cash gross margin, GAAP gross margin, or adjusted EBITDA, they were all up and strong this quarter.

And at the same time, I think we were doing a better job delivering value for our customers.

Thanks a lot.

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

Please proceed.

Hi.

A couple of questions.

First of all, any thoughts on your strategy for pricing which you initiated about a year ago in terms of getting more aggressive on price?

Are you pretty much through that?

Do you feel now that has played out?

And has that worked in the sense of both driving more demand out of your customers and also maybe winning share?

And I have a couple of follow-ups.

I think that one we dealt with before, Michael.

I think people A, made more than there was of it over a year ago.

We were more aggressive in some cases.

It was the right time, because it unlocked demand, we found some elasticity that we either missed, or frankly wasn't there before and think it's regular course of business.

Our customers want to do more, their businesses are improving, their monetization options are increasing and their turning to us for quality, scale, reliability and security and we're pricing it fairly and I think that's working for both parties, us and them.

And so there is really, I think much less to be made of what people thought was some declared radical new strategy.

Second question is this quarter you expected cash gross margins to be flat, which they were.

They were up a little.

But you expected GAAP gross margins to be down a point.

And it seems like you had less of an uptick in depreciation than you thought you would.

Now you're increasing CapEx and so although it seems like you're in a good direction as far as the EBITDA margin, should I be concerned that we're going to see, one, two, three points more of increased depreciation per year and that will drag down my net income margin?

Michael, I think the reason that we saw an uptick there was really on the top line, the accelerated revenue growth.

It helps the numerator there and I think if we continue to see very solid growth on the top line, then basically our investments in the CapEx have paid off and that's not a big worry.

If we see the top line start to level off, then we'll have to pull back on our CapEx.

As Paul said before, we're making sort of 90-day decisions here and we're not making one year or two-year out type decisions.

But the way I look at, or the way I would recommend that you think about it is, this is an investment because we see things starting to look very positive for us in the near term and that bodes well for top line as well as the model.

Okay.

Thank you.

Thank you, Michael.

Your next question comes from Mark Kelleher from Brigantine Advisors.

Please proceed.

Great.

Thanks.

I was just wondering if you could address the possibility as HD ramps and the bit rates increase, are there any bottlenecks in the network that are beyond your control.

I know that was an issue for some of the initial HD deployments, but particularly in the last mile, are there any things that can catch you that are sort of beyond your control?

Well I think one of the things that unlocked the potential for HD was the massive expansion of last mile broadband and end users capable of getting several megabits a second and we see that increasing and creating more bottlenecks on the other side of the internet across peering points and in the first model.

And so as you know, the Akamai distributed mile solves that problem as we did with some events recently delivering HD video from literally over 500 locations in the US alone for our customers.

So actually we think we are in exactly the right spot.

There are certainly networks that get under provisioned.

We've seen that to some extent in some wireless networks and the end users wind up with a disappointing experience.

I think the challenge there is those providers either have to expand their capacity or they will lose subscribers somewhere else.

So you're right, we can't do better than the last mile in the ISP networks.

We partner with them to help them expand their capabilities and be more efficient.

We do a last for ISPs there.

But ultimately the last mile is only as good as the last mile that you are in, and I think we'll see consumers going more and more to the best network providers who can give them a great first mile connection to the Internet and our goal is to be in those networks and deliver to scale.

So there is no technical limitation, there certainly will be places with poorer performance and countries with slower networks, but buy and large we've seen a dramatic improvement there over the last five years and we'll continue to see it, I believe, going forward.

Okay.

Great.

Thanks.

Thank you.

Your next question comes from the line of Todd Raker from Deutsche Bank.

Please proceed.

Hi, Todd.

Hi, it's Brian Thackray pinch hitting for Todd here.

Hi.

First question, just to drill down a little bit more on the media side.

Can you give us maybe -- help us quantify what percent of video delivery today is higher resolution.

And around that, can you maybe compare this adoption cycle on higher resolution compared to the previous cycle in 2006 and 2007.

Are you tracking faster or slower than that?

How should we think about that as we think about the adoption.

I don't have a scientific way to measure that.

I can give it to you sort of anecdotally as we see it.

I certainly think we're seeing more interest in HD faster from a broader set of customers than we saw before and expected.

I think there was a long period where people were in the 300 kilobit, 500 kilobit, 700 kilobit and once in a while experimenting with something more.

And it's pretty typical now, if it's a professional sports league or a studio or somebody with premium content talking about much higher bit rate files making one and two meg and up streams or formats available, and one of the interesting things is we're seeing that when it's available, often more than half of the users are going to the highest available and we're seeing that the engagement levels are much higher.

So the live sporting events are very interesting because you can get a true AB comparison real time.

How long people stay at different bit rates -- we've done some events recently and the engagement time or the amount of time people stay watching is often double or more the standard bit rate.

And so that just raises huge new monetization opportunities for the distributors and the content producers and I think that's why they're so excited about it and we've been able to show them examples of that, and I think that's a very powerful message in driving, at least anecdotally, faster interest and faster adoption.

At the same time, there is certainly plenty of standard bit rate video and I've sure you've been to many websites where that's all you get.

So I think there is a long way to go, which is great opportunity for us.

I would just add, Brian, that -- while we're seeing that happen and the interest is moving a lot faster than when he thought, we still haven't seen that inflection point that broadband adoption drove back in late 2006 and early 2007.

A huge ramp up.

I still think we're in the early -- maybe not the 1% point anymore, but it's specially the 5% or less point.

Agreed.

And the incremental expenses you talked about, JD, for next quarter, you can give a little bit more color in terms of where they are going to be, maybe what products they are attached to?

Sure.

This quarter we added about 90 people.

Largely our expenses are associated with people.

And 90% of those adds were in two places, go-to market, meaning sales, services and support and R&D.

And we're going to continue to invest in that.

I think we scale pretty nicely in terms of network support and G&A, et cetera.

Obviously we'll have to continue to grow in scale to handle more customers and more network traffic, et cetera.

But our primary focus is building out our services and support and sales, particularly around value-added solutions and building out our capabilities in R&D to add additional functionality.

Again particularly around our value-added solutions.

But also the HD network, we're investing heavily there.

Thanks.

Operator.

Your next question comes from the line of Kerry Rice from Wedbush.

Please proceed.

Thanks a lot.

Great quarter.

Maybe another way to ask about gross margins, and you may have already kind of implicitly implied the sustainability of those or kind of what is driving the growth or the positive upside in that number.

Was it primarily -- I don't know if you can break it down.

Was it primarily revenue?

Was it the reduction in unit cost?

Or is there something else kind of as we should think about that and maybe relate that to pricing in the industry.

Because I assume that's still coming down, and with media and entertainment being a lower margin business, we see some pressure there.

So it seems like you're able to offset that pretty easily.

And then the last question, advertising solutions, can you -- not necessarily to break it out or get into much detail, but did that grow year-over-year or can you give any kind of insight into that business?

Yes, sure so let me answer that question first.

It obviously is going to go down sequentially, and it did.

About a $6 million sequential decline, but it grew very nicely sequentially.

It's our fastest growing product area, not surprising because it's also one of our newest and still smallest in terms of dollars --

On a year-over-year basis.

On a year-over-year basis.

So we're really pleased with the continued traction we're getting with that solution.

And back to your question about gross margins.

I think there is two things going on fundamentally.

One is we're doing a great job taking cost and expense out of the network and matching that with the price benefits, or the cost benefits for passing on to our end customers and that particularly plays out in the volume driven areas of media, software, downloads, et cetera.

At the same time, our mix is changing very dramatically toward the value-added solutions and we talked about how the value-added solutions, particularly DSA and APS, are much software like and have much higher gross margins on average.

So the results of those two things has been a -- actually a gross profit margin on the cash line that has actually crept up a little bit recently and I think as we've looked forward for the year, we've talked, not specifically about guidance, but we think we can sustain in that same kind of range based on those trends.

Great.

When think about value-added solution, have you started thinking about breaking out the mix of those value-added solutions?

I'm assuming DSA still primarily the biggest components on that.

But any thoughts about that?

What we have started to is talk about, on a percentage basis, where we are.

It's something we'll dive into on a -- at least on an annual basis when we get to our investor day, just as we did last year and give a little more granularity there.

Thank you very much.

Thank you.

Your next question comes from the line of Katherine Egbert of Jefferies.

Please proceed.

Hi.

Good afternoon.

Very nice quarter.

How much of your revenue now is non-variable, ie the platform fees?

It's not always platform fees.

It depends on the structure of the deal.

But we're still in the ballpark of -- and of course there is a time element to this as well.

We are still in the ballpark of 70% coming into a quarter being non-variable.

70% non-variable.

Okay.

Great.

And on the CapEx, what exactly are you spending that additional money on this quarter?

Some of it is servers in the network and some of it is drives and storage for cloud storage for our media customers.

And then as you know, we capitalize a certain amount of our R&D as well.

But the ramp up is really capacity in terms of servers and storage in the network, not on the R&D side so much.

Capacity in what areas?

What specific -- because usually your services are dedicated to a certain function, at lease when they are initially rolled out.

It is actually quite flexible in terms of we deploy the servers out there and we provision them real time automatically software based to respond to the requirements and needs of our customers.

So literally the same server that is delivering traffic for the HD network one day, may be serving edge computing content in the next 15 or 20 minutes.

And one of the keys in moving to the HD network on the HDP standard is it makes more of the network available to be flexible and do more things.

Sure.

I guess my question was what initially are these new servers targeted at?

The driver for the capacity is clearly media volumes and HD video.

There is no question about that.

And the point there is it's not -- we do not have to make a bet about this capacity here and then if something else takes off we have to respond differently.

That's the beauty of our network.

In some sense that media -- that big footprint that we build out for the massive volumes in media, we can leverage to deliver our value-added solutions on top of that footprint.

And so in fact as we grow the capacity, they can also do software delivery and those volumes are growing.

And as we expand the footprint there are more nodes getting more data of realtime Internet congestion or conditions.

So on that day I talked about serving over half a trillion requests, the more locations we're in and the more data points we get every second, the smarter our routing is not just for delivering jitter free video, but for accelerating a SAS function for some B to B Corporation function as well.

So the deployment gives us benefit across the board.

The big catalyst is the growth of the volume business around media and software.

And then just quickly, last one.

Paul you said a billion dollars in revenue this year.

Should we take that as guidance?

You should take it as me pointing for the fences and trying to get the team motivated to make the be heg by the end of the decade.

I think we'll give you formal guidance on Q2, which we did and then you can do your own calculations for the rest of the year.

I see a way we could get there.

We can do better, we can do worse, but it's certainly within our grasp to meet the goal we set out.

And the other point is we're now looking for the second billion in revenue as well and that's why we're making investments in all of these areas.

Sure.

Congratulations.

Thank you.

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

Please proceed.

Yes, good evening and thank you.

JD, in your prepared comments you sounded absolutely confident about double-digit growth and how much of that is predicated just on higher media entertainment as opposed to the opportunities that you're seeing in cloud computing services?

The way I look at it is what we're seeing with our value-added solutions, which are a lot around the cloud optimization services, those have been growing 20% plus for quite some time and we see that continuing.

In fact, as I talked a little bit about the demand, particularly with our new customer signings, it is actually increasing -- it grew almost 40%, which is faster than even our revenue growth in that area.

What is different and what we're seeing change and drive the acceleration is the media business primarily, which was -- had slowed down in terms of growth and even showed a couple of quarters of decline last year, we're seeing solid growth there driven by the return to very positive volumes growth.

And just one quick question.

Paul, is it possible in any way to maybe give us a little more color.

How did the nature of the conversations are going with media and entrainment.

I know people are focused on pricing and volumes, but as more content (Inaudible) is getting monetized here, are media entertainment customers more increasingly focused on a better value-added services which gives them better ways to monetize their content, or is there something else they are looking for from you rather than just the pricing?

The discussion we've had with them for over a decade is about scale and quality and how do they find the audience and how do they get them to stay longer and how do they monetize their content.

And whether that's the HD network and the built in functionality like DVR, the ability to put multiple video streams and camera angles in a live event and keep people there longer so they see more advertising or interact with advertising, our media analytics that helps them to figure out how to monetize better, both historically and in real time, our advertising decision solutions that raises the value of advertising for a certain set of our customers.

Or our digital media acceleration capabilities that takes the dynamic aspect of a media site and makes it more reliable and engaging are all the kinds of things that these customers talk to us about.

And increasingly I think they are the value-added pieces on top of video, because that's how they are going to make money and I think we have a great portfolio and a growing portfolio of services that meet their expectations for how do they build profitable businesses.

Great.

Thanks so much.

Thank you.

Your next question from the line of Sameet Sinha from JMP Securities.

Please proceed.

If we keep the questions tight we will be able to fit them all in in our hour, folks.

Go ahead.

Okay, thank you.

You spoke about the cloud and cloud optimization.

Is there a way to quantify how big that market is because if you look at the all of the projections for cloud computing, the broadly defined term goes into tens of billions of dollars, but optimization fees, which you specialize in, how big would that be?

And secondly, just on expenses.

Sequentially we saw G&A come down a little bit, sales and marketing come down quite a bit.

Should we use that as the baseline and then track it throughout the year?

So let me answer the second question.

I would expect that we're going to have sequential growth probably in -- across the board and in all of our areas, but it will be highly focused in R&D and sales and marketing.

So I do not have specific guidance for you by line item underneath the totals, but we'll have some natural growth as the business grows in the G&A area, et cetera.

But the primary growth is going to be in engineering and in sales services and support.

And then to your first question, I'll take a shot at it.

The cloud -- there are a lot of people defining cloud computing very broadly and give it very big numbers.

The way we think about cloud optimization is how we're helping our customers deploy cloud solutions or deploy into a cloud based model the applications they're running today in a more centralized data center model, and customers today spend a lot of money optimizing the way their applications work in that model and there is a lot of cost savings to be had there.

So we focus on the parts of the market that -- where customers are spending money to optimize solutions today.

And that's probably a $2 billion to $3 billion defined narrowly and obviously you can have even broader discussions as you go farther out into the cloud optimization world and get into the billions of dollars.

Okay.

Thank you.

Your next question comes from the line of Mike Olson from Piper Jaffray.

Please proceed.

Thanks very much.

Talking about the second billion of revenue.

You've said in the past that you have 95 of the top 100 e-commerce sites using VAS.

Is there any change in how you'll go about tackling the next 100 e-commerce sites?

Is that size of that opportunity for next 100 drop off significantly or is the opportunity for [acrimide] really similar to what it has been with the top 100.

Then secondly, as part of that, VAS was 54%, where does that top out as a percent of the mix?

Thanks.

I think you mean DSA, dynamic site acceleration -- value added solution.

That's a little over 50% overall with commerce being the biggest piece of that.

I think there are two great parts to e-commerce.

First, as e-commerce has grown overall the second 100 and the third 100 sites are becoming big enough, big enough online businesses that we think they can benefit and pay for our services.

So we're going after the next 100 and 100 after that with the original suite of services because we think we can help them sell more and improve the ROI.

But we're not done with the first 100 either where we have over 90 of them.

We're adding functionality, we're adding features like Web Application Firewall where we can go sell and raise the wallet share that we get and we have a road map of additional features.

Some will just be enhancements that they will get with their current service, but many will be new services that we believe will help them sell more and have more successful online businesses.

So we're going to focus on continuing to add value and hopefully getting paid more from our existing great customer set and going to the next 100 and next 100 after that with the current offers in e-commerce to help them grow and be more successful online.

And we think that's a great category from us that's just starting to benefit, for example from our advertising decision solutions and our ability to help online retailers find for in market customers and drive sales they weren't going to get otherwise for example.

And so we're very optimistic about that portion of the business.

And as far as the sort of the share of our business that will become, it's hard to say long term because it depends also on how volumes grow in our media business.

The nice way to grow the share would be to have both parts of our business growing very rapidly.

We're at 54% now and that's up seven or eight points from where we were this time last year.

I wouldn't be surprised if we are talking about 60% type of number by year end, but we'll have to see how all of the pieces play out.

Thanks.

Your next question comes from the line of Donna Jaegers from DA Davidson.

Please proceed.

Hi.

Great quarter.

Just to try to drill down a little bit more.

You have had a number of press releases recently about these software as a service contracts that you have been getting for web -- for optimization.

Can you give us sort of -- what is the average size of one of those contracts?

We have done some customer relations, we've also done some partner ones where we're being embedded or providing a solution as they grow.

So to some extent, as they sign up more customers their business grows and they are effectively sort of a channel.

So I do not think there is one answer of what is the size of those customers, it really depends on the use case and whether they are a single customer or they really our way to get to many others.

It's hard to say -- it's hard to give an average and have that be meaningful because we have some very large deals with very large SAS guys and small deals with SAS guys who are not as big and their user base is not as big.

Can I try to pin you down on one other thing.

On HD, obviously I had people calling me about the Master's and look at the Dogwood tree, you can see every blossom on it.

How much did that -- as far as revenues, did that add $3 million, $4 million?

You can give us a little more specifics on how much that might have added to the quarter?

So, sorry, we won't comment on a specific customer.

The one thing we've said for awhile and I think this is important, in our size no single event is that important to the results.

We certainly care about every customer and we want everyone to go well, but no single event is a large piece of our quarterly revenue.

But I won't give you obviously the specific revenue for a customer on an event.

Good question.

But cannot go there.

I'm not sure how you would model it in any way because there is no way to calculate how many events per quarter per year.

There are always a few per quarter, they are always pretty interesting, but they are sort of regular course and speed of our business by now.

Thanks.

Thanks, Donna.

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

Please proceed.

Hi, gentlemen.

Congratulations.

Two just quick financial related ones.

JD, first on the headcount, as you said you added 90 people in the quarter.

Is that the pace you expect in Q2 and as we go through the year?

And also you mentioned what you think the cash tax is going to be this year.

Any view right now on how that's going to flow into calendar 2011 in terms of cash tax?

So I'll answer that one first.

So I do think there is always timing impacts in a year on the tax rate and obviously we have to deal with that.

I do believe that we'll be sort of 39% or lower this year on tax rate and I think over time, as our business shifts into more international, that tax rate will come down, sort of gradually over time.

There won't be a step function, but we'll have a gradual decline in our tax rate over time.

We'll never be the kind of company that has 10% or 12% tax rate because we do not make anything that we ship offshore, but what we will be able to do is just manage that better as our business shifts internationally.

But does it bleed into next year at all or is it just as soon as the year begins, suddenly you are paying full cash taxes?

Oh, I see on cash taxes.

You make an estimate, you start paying based on where you think you are going to come out and the way we see this year playing out, we'll be through our NOLs this year and be a full cash taxpayer in 2011.

All right.

And then headcount --

I'm sorry, headcount.

We added about 90 people this time.

I actually think that if anything, we'll ramp that up a bit in the second quarter.

We tend to have significant hiring towards the end of the school years and second quarter is a little bit slower.

In the third quarter, during the summer months.

But I do think we'll ramp that up a little bit.

Probably up in Q2, down in the summer and we'll see about Q4 when we get there.

Yes.

Your next question comes from the line Jeff Van Rhee from Craig-Hallum.

Please proceed.

Hi.

One remaining question.

As you look back to the February call you were pleased with Q4 and yet very hesitant about Q1, obviously it's turned out to be much, much better, can you talk to the progression through those months when you started so see that visible improvement and how it progressed from February to now where we are sitting here now at the end of April?

Our business is -- the nice thing about our business is it's a recurring revenue so you can start to see the build, but there are a lot of variables in the business and so it was hard to say exactly how things were going to look after seeing January or even February results.

But it looked like -- it looked, after even the January results came in, that it would be a strong quarter and we kept that momentum up through the quarter.

But you would not say -- it was a steady build through those intervening months, there wasn't any real hockey stick once we got into March and that surge continued into April.

Any other color would be great.

I don't think there was any hockey stick or any event or anything like that.

The really nice thing and the hardest thing to predict, obviously is what happens after you see a very large seasonal quarter in Q4 and to see some sequential growth off of that, particularly as our advertising business declined naturally was a pretty good surprise.

Great.

Congratulations next quarter.

Thank you.

Your final question comes from the line of [Mark Clark] from FBR.

Please proceed.

Hi.

I have two questions for you.

First with respect to the growth in MP and volumes space, do you attribute that more to Akamai taking market share or just overall growth than just consumer consumption that is benefiting the (Inaudible) as a whole.

If it's a combination of the two, can you give us a composition?

And the second question is in the value-added service market and specifically whole side delivery and DSA, can you talk about the competition in that market and what you are seeing?

And I know that limelight [unexpected deterioration of it's full side] delivery product and you have other smaller CDMs like Nintendo that are focused on DSA.

I'm kind of curious of what you are seeing in that market with regards to the competitive makeup.

Thanks.

We are seeing a lot of press releases.

You'll have to ask them about their traction because we don't see them with our customers.

I think it's one thing to talk about when you do this as a hosting company, it's really different to accelerate people's content applications and handle their mission critical businesses online when billions of dollars are at stake.

And we've spent 12 years working with our customers to deliver their sites reliably and now to optimize the performance of their applications and building proprietary technology using a distributed model.

And other people are in the hosting business and the mirroring business and tried to run a backbone to figure out how to peer their content through the congestion on the Internet and that doesn't work very well.

We saw that in spades with live sports recently.

We see it with e-commerce and we see it with acceleration.

And so fundamentally we take a different approach.

We think our customers recognize it and other people take a different approach, which we do not think really applies to what we do.

So it's -- we don't think it's the best of breeds solution and we think that's why we've done so well.

Other people will come out with other solutions and frankly, they'll have to prove the ROI to their customers.

Any way thanks for the call.

Want me to answer quickly the M&E part of that?

Do it quickly because we have gone over an hour.

So Michael, over the last three or four quarters we've had some nice wins in the M&E space, but I think largely what we're starting to see now is the organic volume growth that those wins have sort of led to.

All right.

So with that one, we're a little over our time.

Thank you all for dialing in.

It was great to give you an update.

We'll see you back here in another quarter.

Bye-bye.

Ladies and gentlemen, this concludes the presentation.

Thank you for your participation in today's conference.

You may now disconnect.

Have a great day.