阿卡邁科技 (AKAM) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2010 Akamai Technologies Incorporated earnings conference call. (Operator Instructions)

As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Noelle Faris, Director of Investor Relations. You may proceed.

Good afternoon, and thank you for joining Akamai's investor conference call. This (inaudible) our second quarter 2010 financial results. Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer, and J.D. Sherman, Akamai's Chief Financial Officer.

Before we get started, please note that today's comments include (inaudible) forward-looking statements including statements regarding revenue and earnings guidance. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from (inaudible) factors (inaudible) filings with the SEC including our annual report, form 10-K, quarterly report, and form 10-Q. Forward-looking statements included in this call represent (inaudible) July 28, 2010. Akamai disclaims any obligation to update these statements to reflect future events (inaudible). As a reminder, we will be referring to some non-GAAP financial metrics during today's call. The details of reconciliation of GAAP and non-GAAP metrics can be found under the News and Events portion of the Investor Relations section of our website.

Now I'll turn the call over to Paul.

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

Akamai performed very well in Q2, record revenue of $245 million. We continue to see strong demand for our services across all verticals, and topline growth accelerated for the third consecutive quarter up 20% from the same period last year. We generated fully normalized net income of $65 million, or $0.34 per diluted share. That was up 18% from Q2 of last year. We have seen continued signs of traction in all of our key markets, especially increasing need for Cloud Computing Optimization services for Enterprise clients. Growing traction in digital video being delivered in high quality and at massive scale over the Akamai HD network, and expanded interest for mobile content delivery solutions in the rapid growing market for Smartphones, an area where we made an important acquisition in Q2.

We're also very excited to announce today that David Kenny will be joining our management team as President. I'll be back in a few minutes to talk more about David's appointment as well as other important trends in the business.

First let me turn the call over to J.D. for the details on Q2. J.D.?

Thanks, Paul.

As Paul just highlighted, our business performed very well in the second quarter. We grew revenue $5 million sequentially, and 20% year-over-year to $245.3 million. Coming in at the upper end of our expected range for the quarter, with solid growth in every vertical.

In media and entertainment, we continued to see strong traffic growth, building on the trend that began in the middle of last year. As a result, media and entertainment revenue grew by 22% from Q2 of last year, and 3% from the prior quarter.

In the quarter, the World Cup was a marquis event for us, demonstrating the potential of HD video over the internet at truly impressive scale. As we have noted in the past, no single event has a significant impact on our revenue growth in a given period, and this is even truer today as we approach $1 billion of revenue and delivery literally thousands of events large and small throughout the year.

E-Commerce continued to demonstrate strong results as well, increasing 21% over Q2 of last year, and increasing 4% compared to last quarter. This was a very solid performance in what is generally a seasonally slower quarter, driven by increasing adoption of our value-added solutions in this vertical.

The high-tech vertical declined 3% from Q1 due to timing of some big software releases, but grew 8% year-to-year. We have continued to see growth with our application performance solutions among [fast] spenders in this vertical. And public sector was up 51% from Q2 of last year, and 9% from last quarter, continuing the solid performance we've seen for the past several quarters from government contracts. We're please with our continued traction across our portfolio of value-added solutions. In Q2, 54% of our revenue came from value-added solutions, up from 48% in Q2 of last year.

Signings in the quarter, both from new customers and from existing customers that are upgrading and added additional applications, were very strong. In fact, the dollar of new customer signings for our value added solutions, was up nearly 36% from last quarter.

During the second quarter, sales outside North America represented 28% of total revenue, consistent with the prior quarter. International revenue grew 2% sequentially and 20% year-over-year, despite the currency headwind. The sharp strengthening of the dollar had a negative sequential impact of about $3.5 million, and on a year-over-year basis, the currency impact was negative by just under $1 million. Currency impact ended up being about $2 million worse than we assumed back in April, when we gave our revenue guidance. Excluding the impact of currency, international revenue grew 7% sequentially and about 20% on a year-over-year basis.

Revenue from North America also grew 20% year-over-year, and was up 2% sequentially. And resellers represented 19% of total revenue, up 1 point from the prior quarter. As expected, cash gross margin of 82% was down a point from the 83% level we achieved last quarter, but was up roughly a point from the same period last year. GAAP gross margins, which includes both depreciation and stock based compensation, was 71% for the quarter, also down a point from the prior quarter, but consistent with Q2 of last year.

GAAP operating expenses were $116.6 million in the second 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 $88.6 million, up $8.5 million from Q1, and up 28% on a year-over-year basis as we continue to invest in the business. This included one month of operating expenses from our acquisition of Velocitude, which closed in June.

Adjusted EBITDA for the second quarter was $112.1 million. That's up 15% from the same period last year, and down 5% from Q1 levels. Our adjusted EBITDA margin came in at about 46% as expected, even with the acquisition, down about two points from the same period last year and down three points from the prior quarter. For the second quarter, total depreciation and amortization was $34.7 million. These charges include $26.5 million of network-related depreciation, $4 million of G&A depreciation, and $4.2 million of amortization of intangible assets. Net interest income for the second quarter was $2.8 million, up slightly from first quarter levels and down $700,000 from Q2 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 $38.1 million, or $0.20 of earnings per diluted share. As a reminder, our non-GAAP -- our GAAP net income includes several primarily non-cash items including $22.1 million of stock-based compensation, including amortization of capitalized equity based compensation, and $4.2 million of amortization of acquired intangible assets. As a reminder, beginning this year, we are including GAAP taxes when we report our normalized earnings each quarter, although they are primarily non-cash. For Q2 that tax charge was $21.3 million. The supplemental metrics sheet posted in the Investor Relations 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 second quarter was $65 million, up 18% from Q2 of last year, and down 1% from Q1. In the second quarter we earned $0.34 per diluted share on a fully taxed normalized basis, coming in at the top end of our guidance range. That's up $0.05 from Q2 of 2009, and down $0.01 from Q1 of last year -- of this year. Our weighted average diluted share count for the second quarter was 190.5 million shares.

Cash generation continued to be very strong. Cash from operations for the second quarter was $86.4 million, and year-to-date, we have generated $174.1 million of cash from operations, or 36% of revenue. At the end of Q2, we had $1.1 billion in cash, cash equivalents, and marketable securities on the balance sheet. This balance including $178 million of highly rated, federally insured, student loan auction rate securities. This amount is down from the prior quarter as we had about $68 million of these bonds redeemed at par during Q2. In addition, we exercised our right to sell back an additional $30 million of our portfolio at par to one of our money managers on July 1, a change that will be reflected on our balance sheet in Q3, and after that transaction, we'll be left with $151 million in federally insured, student loan auction rate securities.

Also during the quarter, $136 million of our convertible bonds were converted into 8.8 million shares of stock, leaving the convertible bond balance at $64 million as of the end of Q2. These shares were, of course, already included in our diluted share calculation, so there is no impact to our fully diluted earnings per share numbers as a result.

Capital expenditures, excluding equity compensation, were $66.1 million as we continue to build out our network to capture the accelerating volume growth we expect to see, as well as increase our investments in capitalized software development. During the quarter, we spent $20.4 million in share repurchases, buying back about 537,000 shares at an average price of just over $38. And since the beginning of our share repurchase program last year, we have spent $108.6 million buying back a total of 4.7 million shares at an average price of $23. And finally, our day sales outstanding for the quarter was 58 days, consistent with Q1.

We're very pleased with how our business has performed through the first half of the year, and with 20% top line growth in Q2, we're confident that we'll achieve our goal of $1 billion dollars in revenue for the year. And while there is still some caution about the macro-economic environment, we have seen some very positive trends that we think bode well for our near term, and long term prospects. We see significant opportunity across all of our verticals, and we're making substantial investments both internally and externally to capture this opportunity. Our recent $15 million cash acquisition of Velocitude is a great example of our investment for the future, with this investment focused on the mobile opportunity. We expect that the acquisition will be roughly neutral to our earnings over the next twelve to eighteen months, but over the near term, our expenses will exceed revenues from the acquisition, which we expect to be less than $1 million for the year.

For the near term, we are expecting Q3 revenue of $242 million to $252 million. At the mid-point of this range, that translates to 20% year-over-year growth. Remember, that we have traditionally seen slower traffic growth in the mid-summer months as people head outdoors. Assuming current spot rates, foreign exchange will have a negative impact of approximately $2 million on a year-over-year basis in Q3, so excluding the impact of currency, the mid-point of our revenue guidance implies revenue growth of about 21%. We expect the cash gross margin will continue to be in the range of 81% to 82% in Q3, down slightly from Q2 driven by media growth, but still within the range of the last two to three years. We believe GAAP gross margins, including equity compensation, will be approximately 69% in Q3 due to investment in the network.

We expect operating expenses in Q3 to grow modestly from Q2 levels, and we expect adjusted EBITDA margins to be in the range of 44% to 45% for the quarter. This is slightly below our long term model, driven by the investments we're making, which we think can drive significant growth for the future. After a large investment in Q2, we expect capital expenditures, excluding equity compensation, to decline to about $40 million in Q3.

For the full year on CapEx we're tracking to about 17% of revenue for CapEx. This is slightly higher than our long-term model, driven by the strength we see in terms of volume growth, as well as the increased investment in capitalized software development, we plan to continue to add engineers focused on our value added solutions.

Given our revenue guidance of $242 million to $252 million in Q3, we expect fully taxed normalized earnings per share for the third quarter to be in the range of $0.32 to $0.34 cents, including the impact of Velocitude. At the mid-point, that's up 18% year-over-year. This assumes a full year GAAP tax rate of roughly 35% to 36%, or GAAP taxes of approximately $18 million to $22 million for Q3.

Overall, we've had a very solid first half, and we expect strong performance through the second half of the year as well. We see promising momentum across the business, and we're making investments that we believe can drive meaningful growth for Akamai beyond 2010.

Now let me turn the call back over to Paul.

Thanks J.D.

As J.D. just detailed, we had a very strong first half. Looking ahead, we continue to see proof point for the three major trends that support our growth strategy, and we're aggressively positioning the Company to benefit from these trends. In Cloud Computing, as more and more companies move to the Cloud, experience new performance and reliability challenges that are inherent in using the Internet. To address these challenges, we are partnering with companies big and small to make the Cloud work better. One such partnership for example is the Akamai Ready Initiative that IBM announced the at the Impact Conference in May. By pre-tuning IBM's WebSphere products to leverage Akamai technology, customers can see significant benefits for their enterprise applications delivered over the Internet. These benefits include not only improved performance, but also reduced capital expenditures and faster time to integration.

In media, online video is creating real business opportunities for our customers. We have continued to serve increasingly large online audiences and set records for peak traffic every quarter. There's little doubt that the migration online is happening at an accelerated pace. The highly publicized World Cup was just one example. BBC estimated that 5% of its World Cup audience watched online. That's an incredible statistic. We have talked about being at the 1% line for online video for a while, and now we're seeing events like the World Cup surpass that mark by a wide margin to reach ever-larger internet audiences. During the World Cup we successfully delivered live and online demand content for twenty-four different global broadcasters into sixty-five countries, and in most cases these clients were leveraging the Akamai HD network less than a year after we introduced it. And for online advertising, we continue to see encouraging signs of traction. A key differentiator for our advertising decision solutions is the ability to launch targeted ad campaigns for clients without using pixels. This unique Akamai capability enables our clients' larger campaigns to come to market faster and without draining their IT resources. Already in Q2, 20% of the revenue for our advertising decision solution was on our pixel-free platform introduced just last year.

In addition to these three trends that we've talked about for a while, Cloud Computing, HD video online, and better targeted online advertising, we believe that one of the most exciting future opportunities for Akamai is delivering content and applications to Internet-enabled mobile devices. These devices are expected to outnumber traditional PCs in just three years. This trend is part of the reason behind our recent acquisition of Velocitude, whose technology helps businesses adapt and optimize their web content for delivery to mobile devices. Many online businesses are embracing the mobile channel to reach customers, prospects, partners, and employees, creating a need for easy to navigate mobile websites. We built a great business optimizing internet content and applications access over personal computers. We believe that mobile will be an important part of the internet's growth, and as a natural extension of our product portfolio.

So with solid performance from our entire team, we've got the $1 billion revenue objective firmly in our sights, and I expect to get there this year. But we're even more excited about the future opportunities for Akamai, beyond 2010, and we're very pleased to be announcing today that we're adding David Kenny to our experienced and successful management team as President to help us drive the next wave of growth here. As many of you know, David is not new to Akamai. He has been a member of our board since 2007. He knows our industry, our business, our technology, our people, and most importantly, our customers. As one of the most respected and able executives in the online world, David's a great fit for Akamai, and I look forward to partnering with him for years to come.

Now J.D. and I would like to take your questions. Operator, the first question please? Operator?

(Operator Instructions) We'll take just a moment to compile a list of questions. Your first question comes from the line of Michael Turits with Raymond James.

Hey, guys.

Hi Michael.

Good evening. Two sets of questions. First, you talked about investments that you're making that will impact both the GAAP gross margin, which I assume that, that flows through on the basis of depreciation, but maybe you can be more specific about that, and the -- will also have an impact on EBITDA, so maybe you could be more specific about those investments? What they are, and how they impact OpEx? And then I have a follow-up.

Why don't you give us both, Michael, just so we have them in case we lose you.

Sure. The other question is just the thing I'm always most curious about, which is the rate of growth in customer's consumption of bandwidth. Whether that seems to be -- where that is relative to, say, a trough we might have hit a year or two ago, and peaks we might have hit several years ago, if we're starting to re-accelerate or not.

Okay. Great. So let me talk about the kind of the products that we're working on investing in across the business, and then I'll let J.D. take the impact on, on the -- our performance and rate of consumption on the network.

So I think if we focus on -- our you focus on the areas that we believe are the key trends, the investments and the build out, aside from the pure network buildout for capacity and performance in increasing parts of the world, is around the features and functionality that make our services more valuable to our customers. So if you look at media online, if you look at HD, it's all about saying to the customer, this is a very complex world, you have users everywhere across three screen sizes and many, many kinds of devices, and you're trying to deliver them an optimal and economic experience. And so the idea with the evolution of the Akamai HD network is to deliver a high-quality HD picture to any device with the simplest input. So, today customers have lots of formats, lots of bit rates, and lots of effectively a spaghetti method. We're trying to move them the world, because you can deliver us a file in any format and then we will figure our where the user is, what kind of device, what access capability, and deliver them that experience, and then give you full data back on what happens. So the investment there is around ease of use for our customers, and managing the complexity for them inside the Akamai HD network with this TV-quality picture with whatever level of interactivity they want to build into the player, whether that player is on a mobile device, on a PC, or on a big screen.

Across the value-added services, you really have to look at the industry. In commerce, it's around increasing the value to commerce, so for example, around security, like the web app firewall web functionality we rolled out, or the new service around tokenization to help shield protect credit card numbers, all areas of engineering investment, this is effectively software that we deploy and make available to our customers. Mobile is another one where we made the acquisition in Velocitude and we'll work to build out and enhance their technology for transforming standard websites across mobile devices.

So those are kinds of investment that we're making when we turn to J.D. to pick up the, the impact in the shorter and the long term and the question of usage of network.

Right. And I would also add, on the investment side, that you'll see us making a lot of investments in our go to market. That's where most of the new headcount is going in our sales and services and support organizations, particularly as we go into new verticals, that's going to be an important investment, and I think it's one that we are already starting to see pay off with that traction in places like financial services and healthcare.

On the -- and then of course, Michael, on the GAAP gross profit question, that's obviously the timing of when we put servers on, and then the traffic grows over time, so a little bit of that we had a very big CapEx quarter in Q2.

And to your question on the traffic. You know, we've seen the media and entertainment vertical go from this time last year shrinking almost 10% to now growing over 20%. Over that period of time, pricing has been relatively constant. I mean, we actually have seen for a period of time, a little bit more aggressive pricing, I think we've seen that sort of stabilize a little bit. The key thing is the rate of volume growth has, has continued to accelerate, and our bet is that that continues with HD over a long period of time, and that's what we're trying to make sure we stay in front of.

Great. Operate wish next question, please?

Your next question comes from the line of Mark Kelleher with Brigantine Advisors.

Hi, Mark.

Hi. Thanks for taking the question. I wanted to talk about some of your international investments. Can you maybe break out what you see as an opportunity in AMEA versus Asia? And do you expect that the international might grow faster than the domestic? Didn't this quarter, seemed to be at the same rate? And are the re any differences in the vertical market concentration in those foreign markets? Thanks.

Sure. Well, I always am cautious to generalize, people talk about Europe like it's one country. It's many countries, it's not a bunch of states as we tend to, obviously, think about the US. We need to be very careful there. The markets have their own dynamic, and I think if you look at the growth, you have to also remember the currency headwind was even more severe. So the growth there, if you normalize there, was on par with the rest of the business.

And we continue to believe that there is more opportunity, there are just more people on the internet, and in many places with better broadband. It would -- I did recommend you look at our state of the internet report offline that came out earlier in the week, and you'll see that broadband access and growth, fastest cities in the world, most of them are not in North America, as it turns out. So we see opportunity there, and uptake across the board. Strong uptake for our application acceleration services, particularly there are global companies all around the world where -- and they're trying to, to reach their partner's prospects, customers, suppliers around the world. They to use our application acceleration services to improve a business process and raise satisfaction with their customers for what they do.

At the same time, there is our traditional media and video delivery, and we were doing HD of the World Cup for, as I said, several dozen broadcasters that were only, I think, two with the right -- in the US, the rest were all elsewhere. So they were in-country broadcasters with those local rights, or rights in a couple of geographies, and they were using the HD network like never before.

So I wouldn't say it's all in the volume side or the value added side. It's both. We're going very well in Asia and in many places in Europe. I think, in a macro sense, we're probably a little more concerned with the economy in Europe for all the widely-known reasons, and I think that's slowed things down, but not dramatically, but it gives us certainly some pause and some worry. We will continue to invest, most of that investment internationally is in opening or expanding regions, and then localizing products, often that's really a language question. Sometimes it's a customization of the product, a little bit as well to sell it.

Okay. Thanks.

Thanks, Mark.

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

Hi, Mark.

Thank you. Just one question, please, J.D., I think you mentioned a little data point there about the dollars of new customers signings for VAS was something like up 36% quarter to quarter. I want to make sure I heard that right. Could you put some context around that, what that was like in previous quarters? That obviously shows very dramatic growth, but is there -- is that over an lengthy period of time? Is there a particular reason why that isn't as dramatic as it sounds?

Yes, well no, I think we've seen pretty steady growth there. I think we had a very solid signings quarter with new customers and particularly with the value-added solutions there, that drives revenue out in the future. I don't expect that every quarter will grow that 36%. That would be nice, but think that was a real strong data point this quarter which is why I shared it.

Thank you, J.D.

Yes.

Your next question comes from the line of Egbert Cochran with Jefferies.

Hi, this is Katherine Egbert.

That was close, Katherine.

That was close.

A couple of things. You did call out the World Cup, J.D., and you said it wasn't material, but can you just -- since you called it out, could you just tell us, I know it's not material, but what effect did these one-time events have for you, and what do they actually mean in terms of traffic or revenue or any color you can give us? Thanks.

You know, I think what they mean is, we've seen this over and over with the large events, which is we hit new traffic peaks, and then within three to six months, those peaks are normal peaks. So I think to there's sort of the chance for consumers to have a new and different experience on the internet, and then start to demand more of that kind of experience. So we love those events in terms of what they mean for the future of traffic. So, you know, when we thought about building out our capacity for this quarter, we knew that we would want to make sure we had plenty of capacity for the World Cup, and we knew that very rapidly we would grow into that capacity. So, again, events aren't -- are, are very interesting and I think helpful for driving traffic, but they're -- you know, they're short term. What matters for overall growth of our business and growth of usage on the internet is a sustained usage over a long period of time, and, you know, that's what drives revenue, not necessarily these individual events.

Is the reason that they don't contribute is because they're kind of flat fee, or there's no possible overages, or they're part of the broader contract? Why don't we see a little bit of revenue?

Well, I think, I think, Katherine, this is Paul, you do, it's just that we seem to have one every quarter so it's just a normal part of business and no one is just so much bigger than any other, and we go from Super Bowl to March Madness, to World Cup to the Olympics, to elections, and they're just a few in every quarter, and so they just kind of are a regular part of what we do. And certainly there is some overage, but they just sort of roughly balance out.

And another comment on that. The World Cup, as you know, is a June and July event, and so some of it's in our June quarter, and some of it's in our July quarter, so that even spreads it out more.

Got it. Okay. And then one quick one. What assumption are you using for the Euro on you're exchange rate for September?

The stat that I gave where we think the Euro will be -- or the current foreign exchange will be about a $2 million, $2.5 million year-over-year headwind. That assumes the spots as of yesterday.

Okay. Perfect. Thanks a lot. Good job.

Okay.

Thanks.

Your next question comes from the line of David Hilal with FBR.

Hi, David.

Hey, guys. Wanted to dig a little bit deeper on gross margins. Up year-over-year, which was good. Sequentially down, I think, as expected. But because value-added services were so strong in the quarter, I would have thought that maybe that would have offset some of the gross margin decline. And, and am I thinking about that right? And maybe you can just share why, why that wasn't the case this quarter?

Yes, well you know I think last quarter was sort of an exceptional quarter in terms of gross margin. The percentage of our business that is value-added solutions actually is about flat quarter over quarter. We had such a strong growth in our media business. And so in fact, you know, the mix change there was, was pretty -- there wasn't much of a mix change from Q1 to Q2.

Okay. Let me ask you about new to customers. Obviously a big number. The biggest in quite a while, as I look back. But maybe you can share a little bit the composition of those customers? Obviously RPU was down because of that, but maybe if you can just share maybe where there is particular strengths, either product-wise or vertical, but what contributed to the large count --

Yes, definitely, I mean, it's ironic that at the end of last year, we said we're not really going to talk about new customers, and emphasize it on the call, because it has less -- less meaning as we really diversify, and then of course we have two unbelievable quarters in terms of new customer adds. But I think the important thing when we think about new customers is how many new customers are we signing in new industries where we are selling our value-added solution, really driving into new revenue opportunities, and that was very strong quarter in terms of the focus on the value-added solutions. And, you know, of course that's going to bring down the RPU for the business, and so there's always that -- when you're talking about this, a double-edged sword, but we felt very positive about the, the traction we saw in the field.

All right. Now let me ask one final question on the commerce business. This has been able to grow at a faster clip than general online commerce transactions. I think as people have been refreshing their stores and putting more multimedia out there, et cetera, but when does it get to the point where maybe that refresh is caught up and then you would expect your commerce business to track with a higher correlation to just general online commerce business?

Well, I think -- this is Paul. I'll take that. I think, one, the commerce market just keeps expanding. So if some number of years ago we could target the top fifty, then the top hundred. Now we can target the, the IR top three-hundred, we can now go to other parts of the world. That's one thing, the market, I think, the addressable market for us is expanding rapidly. The other is we keep adding services. You talked about some of them, but you think about denial of service mitigation, you think about web app firewall, now you think about the tokenization opportunity, bringing the mobile to them, going to those customers with our ADS solutions saying, how about if we also target and find in-market shoppers for your product that you're not selling.

So we have an expanding portfolio and the ability to go back to them, existing ones, and try to get more wallet share and expand as they grow online, whether they're pure online retailers, or commerce sites, or people who are bricks and clicks and trying to shift more of their business online from the physical world. So I don't know that that actually has to slow to kind of a commonality with the rest of the business.

Okay. Good. Thank you.

Thank you.

Thank you.

Your next question comes from the line of Rob Sanderson with ABR Investment Strategy.

Hi, thanks guys, good afternoon. A question on the high-tech vertical, the deceleration you saw there, sequential. You know, that's been driven by (inaudible) computing I think J.D. has, or J.D. mentioned APS for, for SAS. But is the volume side of that business really falling off quite a bit, or what's, what's going on there? And you also mentioned some timing of software releases. How might that trend in Q3 and Q4? Thank you.

Yes, so that -- basically there are two moving parts in that. One is very large software delivery business, which we have, you know, a great market position in, and, therefore, the timing of rollouts of new software from our customers are going to move that around on a quarterly basis. Underneath that, we're also tracking how we're doing with APS in that vertical, particularly with the softwares and services guides as I mentioned last quarter, we now have a base of over a hundred software and services companies using our application performance solutions, and we continue to have good traction there. But, yes, you're going to have those two parts, those two moving parts.

As far as going forward, those will be the dynamics. I think we'll continue to see good growth with software as a service, and you'll have a little bit more ups and downs in the software delivery space, but we don't give guidance by our verticals. Okay?

Operator?

Question come process them line of Scott Kessler with Standard & Poor's Equity.

Hi Scott.

Hi, guys. Thanks a lot for the -- taking my question. I wanted to know a little bit about when we should expect -- it was highlighted, for example, I think, J.D. you referenced financial services and healthcare being two verticals that you guys are, are targeting. When do you think those areas, or other verticals, might join the spreadsheet in terms of revenue by vertical breakout? Is it next year? Is it a couple of years out? And, in addition to that, obviously you guys are in investment mode. You have made. from what I can count, at least three right pretty high-profile executive hires over the last, say, month and a half or so. And I'm wondering how long you expect this kind of aggressive investment move to continue? So I think guess two timing related questions, but you get the gist of what I'm trying to get at.

Sure. Well, we get the opportunity and the need to speak more and more to the customers at scale in their language. So today we already have more than half the top global banks on our platform at one level or another with, I think, much more opportunity to go in and offer much greater benefit to them for obviously more revenues to us. And I think half of the online, major -- the top 10 online brokerages in a similar fashion.

So I think we are really penetrating there extremely effectively, and most of that is within the last year and a half or two years. Which, frankly, was a devastating time in their business overall and they were, what they did was make an investment in online. So I am very pleased with that.

You're right to note that we have made a number of great hires. I think it says a few things. One, we are building for scale. We're, you know, approaching the goal of being a billion dollar business, we'll be one of five companies in technology that's tripled their revenue over the last -- five public companies that's tripled their revenue in the last five years. And that puts us in some pretty rare company among global technology companies. And we are preparing to scale beyond that, and I think it's a great testament to the opportunity, the level of people that we've brought into the Company, whether it's bringing in somebody of David Kenny's experience as President, or Chuck Neerdaels as VP of Cloud Engineering. These are really, really top notch executives who could really have their pick of anywhere they want to work, and they're picking Akamai. And I think it's a great statement about confidence the outside world has about our potential.

And just to answer your question specifically, Scott, on the breakout, you'll remember we broke that out at our last Investor Day. We split the commerce vertical into sort of B to C online commerce and B to B, which would be the catch all for all the other enterprises. We'll do that again this year, and then we'll look going forward when it makes sense in the sizes, you know they get to meaningfully enough sizes in and of themselves of breaking it out further.

All right. Thanks a lot.

Operator?

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

Thanks a lot. Just -- most of my questions have been answered, so I'm digging a little deep here. But related back to the application performance services as you, J.D., mentioned that you broke it out between B to C, B to B, at the Analyst Day. Did you also -- I don't know if you -- I don't remember this, you doing this, but any kind of the margin profile for that business? Is it the same -- should I think, should we think of it as the same as kind of the corporate overall, or is it a little bit higher, little bit lower? And then --

Well we did -- Go ahead, I'm sorry.

I was just saying my next two questions are how the advertising decision solutions are tracking? And then, finally, the growth that we saw in the media and entertainment. How much of that traffic, and I think you did at least mention this somewhat, how much of that traffic growth was on the HD network versus kind of the -- the -- I don't know if you would call it older network, but the other network, maybe?

Well, this is Paul. Let me take the last two, and I'll let J.D. take the APS question. So, we had growth in video across the board including, if you will, traditional formats and the HD network. Probably the, the bigger piece was on the HD network. I don't have an exact stat, but I'm just guessing based on the adoption for World Cup, for example --

Certainly, it was infinity year over year --

On the HD network, it was infinity, exactly. On ADS, good growth there, but that's a, and end of year seasonal business, so that's a Q3/Q4 question when we really see how that's done But the uptake on the pixel-free, which is a unique platform, has been great, and we think that that tremendous benefit because if customers like that they can't buy it anywhere else. And that gives us great advantage and we're saving them money when they use it. And I'll let J.D. talk to the APS question.

Right. Yes, we did break that out. The point we made was if you look at the commerce and the enterprise verticals, which are 70% to 80% of the revenue from those verticals comes from our value added solutions. Those solutions basically leveraged the massive scale platform we built on the media side and have software-like gross margins, high 80%'s even low 90%'s. And that drops to the bottom line. So you end up having higher overall operating margins. The media business is still a very profitable business, because although it has lower margins, gross margins, it scales very well. It scales like a -- it has a network effect to it, but you really have two almost separate sides of the coin there.

Great. Operator?

Thank you.

Your next question comes from the line of Tim Klasell with Stifel Nicolaus.

Hi Tim.

Hi. Quick question and congratulations on the quarter.

Thank you.

What is the average sized (inaudible) solutions (inaudible) relative to the other value added services?

It did fine. Again, as I said, that that's really a Q3/Q4 business. It's a back to school and then shopping business primarily, because it's about finding in-market shoppers, and that's when most of those budgets get spent disproportionately. But it performed as we expected, and we saw, as I said, strong traction in the new technology we offered, which we think is really a benefit to customers as they begin to see how much faster than can bring campaigns online and do it with fewer resources.

Great. Thank you.

Your next question comes from the line of [Shree Endona] with Oppenheimer.

Yes, thank you, J.D. or Paul. We saw a big uptick in the number of servers added, are you guys potentially ramping here for some demand that you're expecting the second half and later part of 2011?

And Paul, you also talked about strong demand from the enterprise vertical. If you were to look out over the next three to five years, what do you think is the biggest opportunity for Akamai? Is it more on the media entertainment front? Or more on the enterprise front as we begin to see -- cloud computing begins to gain traction?

Yes, so on the service side, it's just the continual buildout as we see demand and opportunity. Some of it was to make sure that we were ready for the World Cup, and some of it is, as J.D. said, whatever our peak is, suddenly is the new average not that far down the road. And we just expect increasing delivery of rich media long form, like movies online, television shows online, special events, and increasingly using the Akamai HD network.

In terms of best opportunities over the next three years, I think that they're going to be equally balanced between the media opportunity with the explosion of video that could come. We've talked about the 1% opportunity over and over again, 1% of video in the home being over IP. Took fifteen years to get to that point. I know it will double much more rapidly, and double again even more rapidly. I'm just I've more confident of that. We're positioned to capture value from that.

And on the cloud optimization side, we continue to see expansion of people using infrastructure as a service, platform as a service, and software as a service, and effectively we're then providing network optimization as a service in all three of those layers, and we continue to see increasing inquiry, demand from individual staff players to giant infrastructure players, trying to make that infrastructure as a service actually work for their end-users. And I think that that's just a tremendous opportunity going forward. Because we have this unique footprint of servers around the world, the ability to route between any two end points in real time to pick the best route, route around congestion, and do it much, much more efficiently than any dedicated network infrastructure you would ever put in. And frankly for infrastructure, or software as a service, dedicating infrastructure makes no sense, because it's about saying to any user, you can come here without telling me where you are in advance across any device. And so I think our opportunity to optimize and build a business there is fantastic.

So I wouldn't pick either. I think to they're both very strong legs to support our growth long-term.

Great. Thank you.

Thank you.

Your next question comes from the line of Sameet Sinha with GMP securities.

Hi, guys, this is Randy Capps calling in for Sameet. Just another question on the advertising decision solutions. Can you talk about -- give us an update on what the uptake is like within the media and entertainment segment versus commerce, and perhaps speak to what, you know, growth perhaps you're seeing between those two segments?

Second question would be, as it related to the media and entertainment segment, obviously, price compression was the norm in that industry, and ultimately to really see the next leg of growth, we had to see some discounting given just the dramatic increase in traffic to make the economics work for some of your constant partners. So as we, we look at some of your value-added solutions, do you see any roadblocks down the line that perhaps you would need to, to move out of the way, whether it be, you know, pricing, regulation, site of customers to help, you know, continue the same rate of growth you're seeing there as well? Thank.

Yes, I'll let J.D. do the M&E pricing in the value add. On the ADS, just to be clear, the service we're offering today is a data callout for online shopping, so it works to target in-market shoppers for commerce sites. So today is an offer to the buy side to go find customers online. So it's not directed to media and entertainment sites. We're certainly interested in expanding the portfolio of products and expect to over the coming years, but today it's an offer to commerce sites, so that's the place it gets applied. And I'll let J.D. respond to the M&E question, and we'll try to move quickly to the last few questions to make sure we get everyone in before the hour is over.

Yes, I think the one thing you hit on, Randy, which is important, I think we're starting to see in the marketplaces. You ask the question, customers have to be able to make money on this, and we are starting to see that rollover, if you will, and start to see some profitable models, and customers starting to really -- this is becoming an integral part of their business, and I think that's been really important in the evolution off our media and entertainment growth. You obviously had the demand from end consumers, but now we see our customers pushing aggressively to meet that demand. I think that's really important.

And I think there's -- the second part of your question was something about if there are any regulatory hurdles or anything like that? I'm not aware of any.

Operator?

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

Great. Two brief questions. And, J.D., could you just give us some more color -- the expense line, specifically the S&M line, rev's are up, expense-- $5 million, expenses are up $5.4 million sequentially. Can you quantify what you did there? Who you hired? How many heads? Where?

Yes, well, we're hiring rapidly there. And really it's across the board, because what we're trying to do is build out the capability to address a lot of new enterprise verticals. We have an enterprise class focused sales force, and when you're doing that, you have to build out -- you have to build out services, support, and, you know, the capabilities that these customers need to be comfortable with their -- you know, because what we're starting to do here is bring on customers at their -- you know, their mission critical businesses online. In addition to that, we're building that out particularly internationally. Where internationally in the past we've been largely geographically focused, because we haven't gotten to scale there, we're quickly getting to scale, because we think the opportunity to go to the banks in Europe, the banks in Asia, for example, is enormous, and so we'll continue to build out that capability.

Okay. And then just one last question on the CapEx, although a minor tweak, I believe in the last quarterly call the range was 14 to 16. You're now talking 17 at the margin. What gave you the increased confidence to invest incremental dollars?

Well, I just think we continue to see traction on the volume. There is no sign that that's going to slow down. Back even when we started to talk about this in Q4, we said we don't want to let one point make a trend, and then in Q1 we said we don't want two points to make a trend. Well, we're starting to see a trend here on that.

The other aspect that I emphasized if my opening remarks which I want to re-emphasize here is we're also investing in R&D, and as we roll out new services, we capitalize the software development for that, and that's adding to our capital expenditures as well.

Great. Thank you.

I do think -- I do think that they're -- what we're hearing from the media customers is they're going to start making bets on video that were significantly different than they were talk about a year ago. I was talking to one of the largest sports broadcasters in the world, and they just said they the experience with the World Cup changed their view of the internet as part of their business going forward forever, and the -- not just the number and size of the audiences online, but how people are also using their computers and accessing this broadcaster's site while they were watching TV at the same time, allowed them to create monetization models and usage models that were new, and so I think we're, we're just going to be ready for what we think is going to be new expectations for to video and data online in these markets.

Great. Thank you.

Your next question comes from the line of Richard Fetyko with Merr-- excuse me -- Merriman and Company.

Good evening guys. With the M&E now up 20%, growth in that business accelerated, just curious if you think you're growing in line with the market or taking market share in this segment? And then curious about the impact of Smartphones and tablets and other mobile devices, as well as other internet connecting -- connected device like Game Box, what sort of -- can you discern what sort of impact those are having on your growth?

Sure. So I think, you know, on share, think we -- I don't have an exact number. We leave share to the outsiders to try to estimate, but I think we have done great in our conversation with customers, for example with the HD network. It's not a stream is a stream is a stream. They understand that this is a different offer that they cannot get this quality and this scale anywhere else, and that really, really matters and is really important.

On the Smartphone, the Smart devices, lots of interest to delivery of video and applications there. You know, we're so excited about it, we made a technology acquisition with Velocitude to help our customers, more and more conversations about the potential and the reality of mobile and we think that that's a long-term driver. Today it's not a large driver of bits, because obviously the bandwidth to that device is smaller, and there are more people still accessing on the traditional computer, or the big screen through an attached gaming type box. But Smartphones are a big driver.

You did mention those gaming devices, and you may have heard me in the past refer to them as really the Trojan horse in the home that connected the TV to the internet, and what we found was that because suddenly tens of million of TVs, big screen TVs were connected to the internet for reasons of gaming, suddenly the movie business online over the internet started to take off, and we saw big traffic there. So that was the first way people connected to the internet in a new way, on the big screen and Smartphone is now they way they're doing it on the small screen. So this world that we have talked about for a long time of the three-screen option is really now a reality for many of our customer asks and they are turn to us for optimized solutions.

Operator?

Your next question comes from the line of Donna Jaegers with D.A. Davidson.

Hi Donna.

Hi, hi. Just to add on to that, can you talk a little bit more about your mobile capabilities? You already had good capabilities for the iPhone. Now you have added in Velocitude. What else do you need to flesh out your mobile capabilities? Do you want to do mobile ad streaming?

Well, we today deliver content including streaming, including ads to devices. What we want to do is offer solutions that our customers find the most useful, whether they are a site trying to deliver entertainment, or commerce, or frankly whether it's a mobile network partner that's looking for help, scaling their network, and dealing with this crush of new data traffic, mostly video, that's clogging their networks. We're trying to work with many of them around the world to, to effectively optimize the infrastructure that they have, so that their end users have a better experience across these devices.

So we think there are a number or opportunities to partner and to sell services. We'll continue to do our own organic engineering on top of what we've had on the video side, and now the transformation side with Velocitude. I think we're building a pretty robust and full set of service, so I don't envision we need to do any more acquisitions there at this point, we'll continue to build and work with our customers to see what they need.

Great. Thanks Paul.

Thank you.

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

Hi Mike.

Hi, good afternoon. Just two quick numbers questions. The stat that you've shared in the last few calls is percentage of customers using at least one value added service. Do you have that number for the June quarter? And then also what do you expect will be the normalized tax rate for Q3 and for the year?

Yes, I think -- we gave, we talked about the tax rate which is our full year projection at this point in the 35% to 36% range, and then on that number, I think it's right around 77%, so more than 0.75 of our customers are using at least one value-added solution.

Thanks very much.

Next, Operator?

Your next questions from the line of Derek Bingham with Goldman Sachs.

Hey, just trying to make sure I was clear on the cash gross margin question. It's been upticking for several quarters in a row, and I think a big driver of that was value-added services mix. The mix was about the same, right, quarter over quarter, but it down ticked. So was there another factor there that I didn't pick up?

I really think it's just a matter of that we had an incredible gross margin quarter in Q1, and, you know, there's going to be small dynamics in and out in our cost and revenue and customer mix in between quarters. So I think it's more of the fact that 83% was the highest we had had for probably three years when we hit Q1. So the fact is that it was up year-over-year, we're pretty pleased with that.

And then one quick one, just on Velocitude, any sense for kind of -- is it, is there anything significant contribution at the top near term, and any significant dilution as well in terms of your back half expense outlook?

Yes, I think we think over a twelve to eighteen month period, it will be roughly neutral in terms of the bottom line. I think that it's a very early stage company with a few marquis customers, but not driving a lot of revenue. Should be about a little less than $1 million revenue in the back half. But it will be, you know, three -- at the current run rate, we're looking sort of $3 million of OpEx in the back half of the year, and I think that's important investment that we're frankly going to accelerate, because we think the opportunity next year to grow the revenue in this space is pretty, pretty awesome.

Operator, we have time for one more question.

Your final question comes from the line of Chad Bartley with Pacific Crest.

Hi, Chad.

Hi, thanks for squeezing me in. Question on the core CDN segments or kind of that non-value added services piece, I think this was the sixth straight quarter where we, we saw year-over-year declines. Can you talk about, I guess, stable pricing, pressure, accelerating traffic growth, and I assume that the churn continues to ease. So why isn't that business, or why isn't that revenue segment growing? What needs to happen?

I think it -- the media part of that segment is growing, but the part that's sort of traditional delivery is not growing, and so as a result, the overall business is relatively flat.

And a bunch of those customers have transitioned to value added services, so they have gone from static delivery to valued added and dynamic sites. So they didn't go away, they've bought a higher value service and actually are doing more on our platform than they probably were two years ago. So we have migrated them strategically from something that had closer to a commodity substitute to something that is much more differentiated in the market and value.

Right. And we're probably still doing their commodity, if you will, delivery, at a lower cost.

And that's lost in the overall, overall deal, in the multiple products that they're now buying from us. So that was a very conscious strategy.

Okay. That's helpful. Should we expect continued declines?

I think that, you know, it depends on -- at some point, that business becomes small and the media business starts to grow so rapidly that you could see a turn there. The question I always get is, in two or three years, what do you think that percentage looks like value added versus volume? The answer is it really depends on how rapidly we see the growth in the media space take off.

Yes.

Okay. Thank you.

Thank you all for tuning in. Appreciate it. We will be back in another three months to given you another update. Thank you. Bye.

Ladies and gentlemen, thank you so much for your participation in today's conference. This conclude the presentation, and you may now disconnect. Have a great day.