阿卡邁科技 (AKAM) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the 2012 Akamai Technologies, Inc., third-quarter earnings conference call.

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

(Operator Instructions).

As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Natalie Temple with investor relations.

Please proceed.

Good afternoon, and thank you for joining Akamai's investor conference call to discuss our third-quarter 2012 financial results.

Speaking today will be Paul Sagan, Akamai's President and Chief Executive Officer, and Jim Benson, 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 reports on Form 10-Q.

The forward-looking statements included in this call represent the Company's view on October 24, 2012.

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

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

A detailed 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, let me turn the call over to Paul.

Thanks, Natalie.

Thank you all for joining us today.

Q3 was Akamai's best quarter ever.

We delivered record revenue of $345 million, up 23% from the same period last year, making it our fourth consecutive quarter of accelerating revenue growth.

The topline was strong across all key verticals in all major geographies, and for both cloud infrastructure and content delivery solutions.

Gross margins also expanded in the quarter, sequentially and year over year.

Further, we grew the bottom line even faster than revenue, generating normalized EPS of $0.43 per diluted share, up 26% from Q3 of last year.

Finally, we had another solid quarter of cash flow generation with $141 million of cash from operations in the quarter and $384 million year to date.

I am extremely pleased with the Company's performance and the team's continued execution.

I'll have more to say in a few minutes about trends we're seeing in the marketplace.

But first, let me turn the call over to Jim for details on Q3.

Jim?

Thank you, Paul.

As Paul just highlighted, we had a great third quarter.

Revenue came in above our guidance range at $345 million, up 23% year over year and up 4%, or $14 million, sequentially, our best Q2 to Q3 sequential growth ever, with solid growth across the board.

Fundamentally, we saw continued strong performance in our cloud infrastructure solutions, which grew 22% year over year, and we saw acceleration in our content delivery solutions, which grew 23% year over year.

This growth was aided by the timing of significant software releases that have historically occurred in Q4, as well as some one-time sporting events and the completion of some large custom government projects.

Overall, cloud infrastructure solutions made up 58% of our total revenue in the quarter.

Turning to our key verticals, media and entertainment was our fastest-growing vertical, benefiting from particularly strong traffic and revenue growth for some of our largest, most strategic accounts.

In the quarter, the Olympics was a two-week marquee event for us, demonstrating the potential of HD video over the Internet of scale.

Broadcasters around the globe leveraged our HD network to deliver a high-quality, interactive experience, and relied on our KONA security solutions to protect their websites from attacks.

Revenue from our media and entertainment vertical grew 26% over Q3 of last year and 7% sequentially.

This was a particularly strong performance in what is generally a seasonally slower quarter, driven in part by the large traffic-related events that I just mentioned, and was a key driver to our revenue overachievement.

Revenue from our enterprise vertical grew 22% year over year and 6% sequentially.

This growth was driven by companies leveraging the reliability and performance of the Akamai intelligent platform as they shift their content and applications from private data center environments to hybrid and public clouds.

Our commerce vertical grew 21% over Q3 of last year and 4% sequentially.

Commerce customers continued to show strong demand for both newer products introduced in the last year, like security and mobile solutions, as well as our flagship Web acceleration solutions.

High-tech revenue grew 17% year over year and was down one point off a robust Q2.

Growth in the quarter was driven by strong software download volumes and Software as a Service providers adopting more of our cloud infrastructures solutions.

Finally, public sector revenue was up 20% from Q3 of last year and was down 4% from a very strong Q2.

Q3 revenue benefited from some large custom projects that were completed within the quarter.

Turning to our geographies, sales outside North America represented 29% of total revenue in Q3, up two points from the prior quarter.

This revenue grew 9% sequentially and 22% year over year, despite currency headwinds.

Foreign exchange was roughly neutral on a sequential basis, but had a negative impact of about $6 million year over year.

Excluding the impact of currency, revenue growth outside North America accelerated from Q2 levels, growing 30% year over year.

Both the EMEA and Asia-Pacific markets were strong contributors to this quarterly growth.

Revenue from North America grew 23% year over year in the quarter and was up 2%, sequentially.

Resellers represented 22% of total revenue in the quarter.

Turning to costs, we were extremely pleased with our continued execution on managing cost of goods sold and gross margins within the quarter.

Our cash gross margin was 81%, up a point from the prior quarter and up two points from the same period last year.

GAAP gross margin, which includes depreciation and stock-based compensation, was 68% for the quarter, up slightly from the prior quarter and up one point from the same period last year.

These gross margin results were better than the guidance we provided for the quarter, driven partly by our revenue overachievement, but primarily by the ongoing platform efficiency initiatives of our network operations and engineering teams.

GAAP operating expenses were $155 million in the third quarter.

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

Excluding these charges, our operating expenses for the quarter were $122 million, up about $1 million sequentially and in line with our expectations for the quarter.

Adjusted EBITDA for the third quarter was $157 million.

That's up 28% from the same period last year and up 9% from Q2 levels.

Our adjusted EBITDA margin came in at 45%, better than our guidance and up two points from the prior quarter and from the same period last year.

For the third quarter, total depreciation and amortization was $53 million.

These charges include $43 million of network-related depreciation, $5 million of G&A depreciation, and $5 million of amortization of intangible assets.

Net interest income for the third quarter was about $1.5 million.

Moving onto earnings, GAAP net income for the quarter was $48 million, or $0.27 of earnings per diluted share.

As a reminder, our GAAP net income includes several non-cash or nonrecurring items, including $25 million of stock-based compensation, including the amortization of capitalized equity-based compensation, and $5 million from amortization of acquired intangible assets.

Taxes included in our GAAP and normalized earnings were $33 million, based on an estimated full-year GAAP tax rate of about 40%, approximately a point higher than our guidance range.

Including these tax charges, our normalized net income for the third quarter was $79 million.

That translates to $0.43 per diluted share on a normalized basis, up $0.09 from Q3 of last year and consistent with Q2 levels, and even better than our guidance range.

Our weighted average diluted share count for the third quarter was 181 million shares.

Now let me review some balance-sheet items.

Cash from operations for the third quarter was $141 million.

Year to date, we have generated $384 million of cash from operations, or 39% of revenue.

At the end of Q3, we had over $1 billion in cash, cash equivalents, and marketable securities on the balance sheet.

Capital expenditures, excluding equity compensation, were $60 million, at the low end of our guidance range.

This number includes both investments in the network, as well as capitalized software development.

During the quarter we spent $37 million on share repurchases, buying back just over 1 million shares at an average price of $31.50.

Since the beginning of the year, we have spent $112 million buying back almost 4 million shares at an average price of about $31.

And finally, days sales outstanding for the quarter were 59 days.

In summary, Q3 was strong by all measures with very robust revenue growth and margin expansion.

As we look ahead to Q4, we are forecasting another strong quarter with revenue in the range of $373 million to $385 million.

This represents 15% to 19% year-over-year growth and sequential growth of 8% to 11%, a slightly more modest Q3 to Q4 growth rate than we've seen historically.

As I mentioned earlier, Q3 was aided by the timing of significant software releases that have typically occurred in Q4 during the holiday season.

The online holiday shopping season plays a large role in our fourth-quarter performance, and the strength of this year's online retail season will primarily drive where we land for the quarter.

At current spot rates, foreign exchange should be about a $2 million benefit on a sequential basis and about a $1 million negative impact on a year-over-year basis.

We expect fourth-quarter gross margins to improve from Q3 levels with cash gross margins of roughly 81% to 82% and GAAP gross margins of roughly 70%.

We have continued to find ways to make our network even more efficient while taking advantage of our scale.

These are critical factors in our ability to deliver gross margins at these levels.

Q4 operating expenses are projected to be up $14 million to $16 million from Q3 levels, driven by typical year-end expenses and continued investments in the business.

We expect EBITDA margins to remain flat with Q3 levels at 45%.

We expect to see normalized EPS of $0.48 to $0.50 for the quarter.

At the midpoint of this range, this represents 9% year-over-year EPS growth.

This EPS guidance includes taxes of $34 million to $38 million, based on a full-year GAAP tax rate estimate of roughly 39%.

This is lower than the full-year rate we have accrued for in Q3 as we expect the federal R&D tax credit to be reinstated in Q4.

This guidance also reflects a fully diluted share count of 182 million to 183 million shares, up 1 million to 2 million shares sequentially.

On CapEx, we expect to spend $60 million to $65 million in the quarter, excluding equity compensation, putting us at 16% of revenue for the full year.

With our third-quarter results and fourth-quarter guidance, we are expecting full-year revenue growth of about 18% to 19% and EPS to grow 15% to 16%.

We are looking forward to seeing many of you at our annual investor summit in Cambridge on December 12.

We plan to share more details about Akamai's growing portfolio of cloud-based solutions, the underlying technology, and the opportunities they present.

Now let me return the call back over to Paul.

Paul?

Thanks, Jim.

Given our very positive outlook for Q4, we are looking at an incredibly strong 2012, with revenue growth accelerating over last year, improved gross margins, and a solid bottom-line expansion.

At the beginning of this year, we outlined the four major trends that we thought would drive significant short- and long-term growth opportunities for our business.

We told you we were investing to expand Akamai's capabilities in the areas of cloud computing, Web security, mobile services, and online media.

Because our customers were looking to us to help them capitalize on these very trends, those investments, coupled with a relentless focus on managing our network operations, has paid off.

We believe they've positioned us extremely well to benefit further as those four trends continue to reshape the industry.

Just this month, I spoke to many of our clients at our annual user conference, and their feedback validated that we've been focusing on helping them solve the right problems.

We also heard loud and clear that we are at the beginning of another major shift in how businesses interact with their customers online.

The ways in which we all use the web have gone far beyond the basic PC and browser.

Businesses no longer want people to just visit a site.

They want to deliver a meaningful and engaging Web experience, uniquely tailored to individual customers, no matter where they are or how they're connected.

There are major challenges to overcome to ensure that, well, say a customer on a 3G smartphone has an equally engaging experience as a user on a WiFi-connected tablet.

To address these challenges, we recently introduced AQUA Ion, a dynamic service that combines internal innovation with technology from our acquisition of Blaze and Cotendo.

AQUA Ion is designed to remove the complexities inherent in delivering content to end users across multiple browsers, devices, locations, and networks.

Optimizing Web experiences across a wide range of end-user situations is critically important to success in hot today's hyperconnected world.

But optimizing the Web experience only addresses one of the challenges CIOs are facing.

This past quarter, Web attacks made the headlines almost daily, and I don't believe anyone thinks that that's going to change anytime soon.

The damage these attacks can do, both financially and in terms of reputation, is potentially devastating.

And our customers are more concerned than ever about the risks.

This past summer's London Olympics and Paralympic Games were a perfect example.

Prominent events like these aren't just about high-performance online delivery; they're about uninterrupted high-performance online delivery.

Realizing that high-profile websites make for high-profile targets, the London Organizing Committee took advantage of Akamai's KONA Security solutions to protect their sites and their applications from hackers intent on bringing them down.

Beyond security, this year's Games, already a highly viewed television event, attracted the largest aggregate online audience ever for a sporting competition.

So this was a great example of how online video is maturing and becoming the way more and more content is being consumed.

With our support for the online initiatives of 22 different broadcasters around the world, we saw that viewers were watching across a variety of connected devices while they were watching on their television sets, to enhance the traditional TV viewing experience.

Another recent example of this multi-screen phenomenon is the presidential debates.

This is where audiences were viewing and interacting with real-time commentary through social media news outlets, while watching the debates live on TV.

The opportunities for our customers is for them to engage audiences in new ways, but this creates new challenges to prepare content and have it ready for a wide variety of devices and network conditions.

Producers either have to meet the audience's higher expectations or risk having the audience turn away.

So to address this, we introduced Akamai's SOLA Media solutions portfolio.

This cloud-based offering, including new transcoding and video stream packaging capabilities, provides customers with a powerful but easy-to-use platform for online media workflow storage and delivery.

The introduction of SOLA Media solutions, plus AQUA Ion and KONA Site Defender, are just three of the latest product rollouts from Akamai that we delivered in 2012.

We told our customers that we would make enhancements in every one of our solution lines this year and we have delivered on that promise.

Part of our continuing effort to enhance our product portfolio includes integrating strategic acquisitions, and we've completed three this year, FastSoft being the most recent, following Blaze and Cotendo.

We believe the FastSoft technology will help us to realize additional efficiencies in our network.

At the same time that we've been driving cost savings in our operations and enhancements to our product lines, we've also been expanding our global footprint to find, sign, and retain new clients.

We've opened new offices this year in several go-to-market theaters, now giving us a total of 39 regional offices, to better meet the needs of our global customer base and provide more topline growth outside the United States.

These are exciting times at Akamai.

We executed very well on both the top and bottom lines in the third quarter.

We are innovating and introducing new products designed to help make the most of the trends driving online business, and at the same time, we're expanding our go-to-market efforts worldwide to capture the opportunities that we believe are unfolding right in front of us.

Thank you for joining us today.

It's a pleasure to report these results.

We look forward to seeing many of you at our investor summit in December.

Now Jim and I would be pleased to take your questions.

Please limit yourself to one, so that we can try to get through everybody.

Operator, the first question, please.

Jennifer Lowe, Morgan Stanley.

Hi, guys.

Great quarter.

So since I'm limited to one question, I'll try and lump two together -- as a way around it.

Just drilling into the strong performance in the media and entertainment business, I was just sort of looking back and I think that's the strongest growth that we've seen from you all in that space over the last four years.

So one is, this has been sort of a volatile business, historically, in terms of the growth rates, and we seem to be at a level now that's consistent with where we've seen peak growth in the past.

So how are you thinking about the trajectory going there forward?

Is that something that we could see start to cycle down again or is there something more durable this time around?

And then, two, related to that, and looking at some of the cost initiatives, I think having above-normal M&E and coupled with CapEx at the low end of guidance is not something we typically hear from you all.

So as you go through some of these initiatives on the cost side, is that reducing the capital intensity of the volume business or the content delivery business, or was there just something specific in this quarter that maybe that was a little bit less of a relationship than it has been historically?

Thank you.

Okay, great.

Great, one question weaving those together.

So I think what we've seen is strong growth in rich media online, both pure video, longer form, higher quality, and then this two-screen phenomenon driving particularly gaming, social, around news and sports.

And that's creating whole new use cases that just weren't there before.

And while it's too soon to call this as a trajectory over multiple years going forward, we're very encouraged by what our customers have been doing and telling us about their plans for doing more online with video and rich media, and particularly using applications and multiple devices to enhance the user experience.

And consumers seem to love it and seem to be doing more.

So it's been a very strong driver for us, particularly as we head into the holiday season.

This year, I was really pleased -- I think we were all really pleased -- about being able to drive this kind of growth not just in the cloud infrastructure services, which performed extremely well, but in media and continue to drive better bottom-line performance, really, wherever you looked across the balance sheet.

And you are right and picking up on something.

It's been this ongoing effort to drive efficiency in our network through better software, better management of the hardware, and effectively over time trying to drive down the capital intensity even of the content delivery business, which, as you know, has a higher capital intensity than the cloud infrastructure services.

You've seen some of the benefits of that work.

It paid off even faster than we expected this year so far.

Things like FastSoft ought to help us drive more of those kinds of benefits going forward, so we're just very pleased and the team is going to stay very focused because we think we can continue -- not necessarily always at that same rate and pace, but to make the operations even more efficient across the entire set of products.

Operator, next question.

Mark Kelleher, Dougherty & Company.

Thanks for taking the questions.

Congrats on a great quarter.

I was wondering, you know, you typically touch on the pricing dynamics over on the CDN side.

Typically you're seeing 20% year-over-year declines.

I was just wondering if you could touch on that.

Maybe there is some gross margin effect that that is not -- if that's getting a little better.

And then, connected to that, maybe a few words on the relative growth expectations between the cloud and the CDN.

It's been pretty steady as a percent of revenue on both sides for many quarters.

Do you ever see one side kind of elbowing out the other side?

Thanks.

Sure.

So we always hold off on the pricing declines so that you can ask the question because I know everybody's always dying to ask us the question.

I think we've been managing that well.

I think that that environment has been very consistent, and we didn't see a major change there.

So the benefit in the improving margin you're seeing is, I think, in the team's work here to much more efficiently utilize our assets and our resources and make the most of the software we deploy, and then the CapEx and the operating costs.

In terms of long-term growth opportunities, I think what you've heard me say is I think these are both great markets to be in.

I do think the overall spend on corporate IT as corporations move more and more of their computing to hybrid cloud environments, both for consumer and business-facing applications, is just an enormous market, overall a bigger opportunity worldwide even than online media.

We have the opportunity to execute in both, and that will have some -- help determine to some extent which grows faster.

When you've got both of them growing as balanced as they have been this year, that's the best possible situation.

Really, the cloud infrastructure business, which today is close to 60% of our business, basically didn't even exist five years ago or a little bit before.

So it's come from behind to this strong position.

I'd like to see them both growing in the future, but I certainly wouldn't mind if cloud infrastructure grew even faster over time because I think it would just recognize across mobility, across cloud, and across security the wallet share that's available for us to tap into.

(Operator Instructions).

Rob Sanderson, ABR Investment Strategy.

Hi, everyone.

Thanks.

Question for me is on just the distribution of these fine products that you've launched.

So last I checked, you have about 4,000 customers.

Like Paul just finished saying, IT is an enormous market.

I think Oracle has like 380,000 customers.

I think cloud, security, mobile, certainly applicable to a broader audience as we move forward here.

How do you -- it seems like there's great opportunity and also there's great challenge for the organization.

How do you really scale up and grow from 4,000 to something substantially larger than that?

I think the first answer is just as cloud and Internet-based computing grows, more and more organizations will increase their budgets to the scale that they would be buying the kinds of solutions that Akamai offers, and that just takes a little bit of time.

The other has been our effort to build our partner ecosystem to allow for far more feet on the street, if you will, through partners and resellers.

You've seen some of those announcements this year where it's effectively click to deploy Akamai capability through partners and channels without ever having to talk or touch an Akamai person.

You'll see more of that over the coming years because I think that there's a great opportunity to grow both our business outside of North America, because it's only -- it's a little under 30% now, and to grow our channel to partner business because that only stands at about one in five dollars today.

So I think we are doing some of those things.

I think there is a lot more opportunity.

Particularly as you have more and more people in the ecosystem offering solutions to take people to the hybrid cloud environment, they look to services like Akamai to give global reach and capability that partners can't do on their own.

And I think that those are ways that we'll drive customer growth even beyond the great customer stuff that we have today.

I also think because we've not been focused solely on numbers of customers -- it's been size and quality, and I don't think we're fully penetrated in most of the accounts that we're in today, so one of the things that we try to do is we broaden the product portfolio, such as with the introduction of the KONA Site Defender security suite this year, is to be able to go back where we have trusted relationships and try to grow our share in those accounts of IT spending where it makes sense.

Operator?

David Hilal.

Great.

Thank you.

Paul, I wanted to talk about KONA and your efforts in security.

I know you had recently changed the pricing mechanism, which we had understood kind of under the old way maybe it was a little bit of a road block in getting customer adoption.

I guess, how has the new pricing structure helped in that effort?

And I think a year ago or so, I think you quoted about 300 security customers, and I was hoping you could maybe update us there.

Thank you.

Sure.

I think some of those updates will wait for our investor day.

But I think the key is first explaining the problem the customers are dealing with, and then how our product has changed.

In the past, we certainly did some bespoke security work, particularly around DDoS protection for some customers, going back a long ways.

It's one of the ways we developed the expertise that we have, as well as in the last couple of years a Web application firewall capability.

What we did this year was combine them in a product with a unified interface and reporting in metrics in KONA.

And it provides customers with the DDoS protection, as well as the Web application firewall capabilities.

The pricing dynamic that you talked about, I think, was the comments I've made in the past where for DDoS alone, we would protect you for a little bit of money, but if you got hit, you'd get a bill for all that traffic.

And sometimes that was an awfully large bill, and customers said, and that wasn't traffic I even wanted to have.

And we would say, that's not our problem.

What are we going to do about the bill?

Not a good customer conversation.

Because there is such a widespread understanding now that people need protection from distributed denial of service attacks, we've been able to come in with a pricing dynamic that's effectively much more like an insurance premium across a broad customer set, so that for the people who get hit, because of our scale and economics we can absorb that traffic without an unexpected cost to the customer, and so it's a much more affordable solution.

I don't consider it a cheap pricing solution, and it's very sophisticated, especially when you marry the Web application firewall capabilities, but at least it's a known price to the customers who are adopting it.

In terms of the numbers, we're certainly above where we were at the beginning of the year when we started.

I'm not sure exactly which number you were using before when you quoted that.

That was probably the total of people who bought one point solution or another, clearly not the number that they had bought KONA a year ago because it's only been out this year.

We'll give you some more updates on that and the addressable market opportunity as we see it in a couple of months or a month and a half in Boston, if you join us then.

Gray Powell, Wells Fargo.

Hi.

Thanks for taking the question.

So digging into the cost of goods sold line, co-location fees as a percentage of revenue has been declining nicely this year.

I have to imagine that happened again this quarter.

Should that continue going forward, and how should we think about the other component of cost of goods sold, bandwidth and service-related fees trending?

Thanks.

Sure.

I'll take that, Paul.

So, you're right.

We've talked about in past quarters that we continue to do a bunch of things to drive our co-location costs down.

One, making sure that our servers are in kind of not the most expensive facilities.

We've moved also to areas of metered power because power is a huge component of our co-location costs.

We've made very good progress there.

We continue to look at the network and make sure that we've made software updates in different areas.

So the servers that we have on the network, we get more throughput out of.

We're ensuring that we buy new servers that have higher throughput.

So there's a bunch of -- there's a large playbook of activities that we're using to drive co-location costs down, and we believe we can continue to do that.

You mentioned bandwidth.

Again, we continue to benefit as the rest of the industry benefits with the cost of bandwidth going down over time.

So certainly, we get the buying leverage for being a huge buyer of bandwidth.

So we continue to be able to drive bandwidth prices -- or bandwidth costs down as well.

So as far as these initiatives, we're going to continue going forward, and I would expect that -- there's a bunch of things.

It depends upon what traffic volumes do and a bunch of other things, but those initiatives, we believe, are going to allow us to continue to manage our network costs very well.

Probably the last area is it's important to note that the other area that's in our cost of goods sold is -- we've talked about the pace of innovation and the pace of innovation that the Company has actually seen in the wave of product introductions that have taken place over the last year.

A lot of that is driven by the fact that we actually capitalize this innovation through capitalized software development.

So what you're seeing in our cost of goods sold is you should see a larger percentage of our cost of goods sold start to become related to internal software development that, once we introduce products, gets depreciated and will be included in cost of goods sold.

So in general, there is a bunch of things going on between bandwidth that we're driving down, co-location that we're driving down, and continued product innovation that will really introduce new costs at probably at a greater pace than we've seen historically.

And the only thing I would add to that is that one differentiator for Akamai is that as an engineering and software development company, there are lots of things that we do that are unique to Akamai to make, if you will, the same footprint more productive, more efficient every time we can roll out major changes in our software.

So we are very focused on those kinds of benefits that are things that we can control and do that we don't believe others can do as well.

Operator?

Sterling Auty, JPMorgan.

Thanks.

Hi, guys.

For the last couple of years, you've preached to us that no single event is moving the needle, so it's kind of ironic that you finally have one here with the Olympics.

I guess my question would be, can you give us a sense of what it contributed?

And maybe an add-on would be, since you have the Cotendo acquisition, can you give us a sense what organic growth was in the quarter?

Yes, I'll take the first half.

I think there are a couple of important points that we are trying to explain.

Not only we made the guidance, we jumped way over it, and it was a whole bunch of things.

The Olympics was one that was even bigger than we expected.

Some software delivery was bigger.

Growth across the board, every geo, including EMEA, doing well.

You put all those things together and you get that explanation.

The other piece about the Olympics, which was really interesting, was that it was a media and a security event.

And so, we were able to sign up so many broadcasters and do so much business because it wasn't just a video delivery event.

It was a two-screen interactive event with a huge security threshold.

And so, you put the power of the platform together, and that was a terrific win for us and demonstrated, I think, where a lot of the world of online media is going.

But it alone does not explain why we did so well.

It's all of those things together.

And then, I'll let Jim comment on the organic growth versus acquisitions.

Okay.

Yes, I just want to make sure that we're clear in what we're trying to message.

We certainly saw a strong performance in the Olympics.

Obviously, the Olympics is a multiple-week event versus some other events.

So we certainly get some benefit from that.

But as Paul said, there were a bunch of things.

And one of the things very notably that I mentioned is the timing of very large software releases that historically have happened in Q4 that actually happened earlier and occurred in Q3.

So we had strong growth across the board, across the Company, but we saw particularly strong growth in software releases that occurred in late Q3 that historically have taken place in Q4.

I also mentioned that we had a very robust public sector performance with some custom projects that completed within the quarter.

So one of the ways to look at it is that I mentioned in our guidance for Q4 that we're guiding to a slightly lower sequential growth Q3 to Q4.

Some of that is driven by the fact that seasonally some revenue that occurred in Q4, actually we received some of that in Q3.

One way to look at it is if you look at Q3 and Q4 combined and kind of look at the half and say, what has been the growth Half 2 versus Half 1?

And if you look at our guidance at the midpoint, we are growing kind of from Half 1 to Half 2 about 10%.

Very consistent with what we've grown over the last few years, about 10% from Half 1 to Half 2.

So some of it is the timing of when these things happen.

But again, very strong Q3 performance across the board.

We got a little bit of a lift from some things that historically we get in Q4, but we're expecting a very strong performance again in Q4.

And then, the organic question was the second piece, I think, of that.

So I think organically, our sequential growth was -- if you look at the benefits that we get from Cotendo I mentioned before that Cotendo was about a $2 million a month run rate.

So you pull that out, you're talking $6 million.

We had a currency headwind of $6 million.

Our organic growth is exactly the same as our growth, including acquisitions.

Mark Mahaney.

Just one quick question.

A brief update on the CEO succession plans.

Thank you.

Don't have one for you.

I said I wouldn't give regular updates.

The Board has a thorough process underway, and when it's concluded, they will make an announcement.

I want to remind you that I said I would complete the job and deliver on our expectations.

I think we're doing that.

In fact, I think we're doing a little better than that.

And when the Board is ready to announce the next phase, we'll send you that announcement.

But I don't have it for you today.

Operator?

Richard Fetyko, Janney Capital.

Good evening.

On international growth, which has accelerated and is growing faster than domestic, just curious what you're seeing and what regions are particularly strong.

And are these markets typically a few years behind in terms of the US maturity, and therefore, do you expect these markets to grow -- continue to grow faster than the US?

Sure.

I'll take that.

So I think we've talked about this in the past.

We've continued to make investments in our go-to-market resources in the US as well, but more specifically in our international markets, both EMEA and APJ because there's huge untapped market opportunity for Akamai.

So we've made investments there.

And I think what you're starting to see is you're starting to see some of those investments pay off.

We had strong growth in EMEA.

We had strong growth in APJ.

We had strong growth in our emerging markets.

So we had pretty much strong growth across the board.

Certainly, we're not immune to some of the economic headwinds that are taking place in Europe, so some of the southern economies of Europe are not growing as fast as other economies.

But in general, we're seeing very solid growth in the international business, and I think it's really driven by, one, the investments we're making and, two, just the market opportunity and really the offering that Akamai has.

In many cases, these offerings can actually help customers lower costs through offloads of their infrastructure.

So actually, it's a very compelling value proposition for even economies that are struggling from a macroeconomic perspective.

Colby Synesael, Cowen.

Great.

Thank you.

You added, I think, 230 employees in the quarter, if my math is right, and just looking back through my model, it looks like that's the most you've ever added in the Company's history.

Just curious where those employees are going in terms of divisions and geographies.

I imagine some of them are to help with that international go-to-market strategy that you're referring to, but any more additional color would be helpful.

Thanks.

Sure.

You're absolutely right.

As I mentioned, we continue to invest in the business.

We added over 100 employees in Q2.

We added over 200 in Q3.

And the specific areas that we're adding them in, it's -- I mentioned go to market, but we're also adding a significant number of resources in our R&D and engineering organizations as we continue these huge market opportunities that we believe we need more engineering resources to basically build and develop the solutions that we believe the market is really looking for.

So the growth that you saw, that roughly 230 headcount, was largely in our go-to-market area, but it was also in the kind of our engineering area.

And in particular for our go-to-market area, yes, there was some in international, but it's international, US, and in particular, it's sales resources and also services resources that go along to support our sales force.

James Breen, William Blair.

Thanks.

I also just want to ask a quick question on the international side.

I think what started a lot of the growth in CDN, or helped accelerate it, was the increase in smartphone penetration here in the US and mobile data in general.

And we're starting to see that more internationally, but those levels are still pretty low.

What's your view on some of the assets internationally in terms of data centers and fiber and how that growth is continuing?

Do you think the right assets are being put in place to help you really accelerate there over the next couple of years?

Thanks.

Sure.

So I want to clarify something there because maybe I misunderstood you or there's a misconception.

Certainly, smartphones are driving all sorts of new use cases, but mobile, particularly cellular usage, isn't driving nearly as much data because the bandwidth isn't there as broadband connections.

So that actually hasn't been driving most of the content delivery growth.

Often those complex applications to mobile devices, including the bring your own device to work, is growing -- driving the demand for some of our acceleration and, call it, infrastructure services as much, or frankly, I think more, than the content delivery solutions.

What drives a lot of the growing demand for the content delivery solutions is the growth of video, particularly broadband video, and certainly some of it is to smartphones, at least when they're on WiFi, and software and application delivery and updates on a global basis.

I'm not sure if you mean third-party assets.

If you do, please jump in and correct me.

If you mean Akamai assets, we now have more network relationships worldwide that in the history of the Company.

Our network is as broadly deployed as ever.

I think the strength of our network relationships is as strong as I've seen it in a long time because networks recognize the value of having Akamai technology inside makes their performance to their end-user subscribers better and it actually reduces their costs and some of the CapEx that they'd have to deploy on their own.

And then, frankly, not even get paid for having deployed.

So I think that certainly broadband infrastructure continues to grow.

In fact, outside the US it's often better than in North America.

And we continue to follow the growth in usage in most corners of the world and are increasing our footprint and the kinds of services that we are offering into the answer a couple of questions back.

I do think there is a lag in the adoption of some of these services, which gives us the opportunity essentially for even more growth internationally.

And then, there are certainly some markets that are, in some use cases, advanced and ahead of the US because of either more broadband, higher speeds, or mobile -- faster or higher growth of mobility there already, and we're trying to mine those opportunities sometimes even ahead of some of what we see here in North America or the US, specifically.

Sameet Sinha, B. Riley.

My question was regarding fourth-quarter guidance.

I know you mentioned software downloads ahead of the third quarter.

We had iOS 6 and Mountain Lion, but Windows 8 launches in the fourth quarter.

I think that could be one of the key drivers.

Also, in terms of the efficiencies that you're working on, Jim, could you give us, help us think about -- I mean, are you 10%, 20%, 30% through looking at the products, the infrastructure, and everything to wring out these efficiencies?

So this is Paul.

Let me take it.

We're not going to comment on any specific client software.

Certainly some got delivered in Q3 that historically might have dropped in Q4.

But you're right.

There's more software-delivery potential coming in Q4 from a number of our long-standing clients across PCs, devices, and gaming businesses as well, and we're very excited about that.

And it's part of what's embedded in the guidance that I think says Q4 should be strong and it's going to be a terrific year.

The nice thing about the efficiency goals is as long as we stay focused on them, and have now for close to 15 years, we never get to the end of the list of things that we can do.

So we just keep raising the bar every year on the team and ask them to go back and wring more efficiency out, and part of the reason we can do that is that the hardware gets better and faster and the capabilities grow, including the multi-core devices that we're now deploying that didn't exist a few years ago.

So I think there is more that we can do.

It's on the road map.

FastSoft brings us even more and that's not deployed yet.

So I think there's a lot more efficiency that we're going to be able to drive in the next few years.

And while I don't know what we'll be doing beyond that, we've never run out of new ideas, particularly as the hardware continues to advance.

So I think we need to stay focused on it, but our goal would be to raise the bar on that every year to help us continue to be very profitable.

Scott Kessler, S&P Capital IQ.

Hi, guys.

So a lot of my questions have been asked and answered, but I did want to ask, it seems that your patent infringement lawsuit against Limelight was recently revived, to some extent, at least.

And I'm wondering if you could remind us why this is potentially important to the Company.

Thanks.

Sure.

As you know, that's gone on a long time and it's hard to predict its final outcome, but yes, we got what we thought was the right, but it was a terrific, ruling from our point of view in the appeals court in Washington.

The case is not done, and we know these things can take a long time and take a lot of twists and turns, but the fundamental thing is that we believe that this is an innovation shop, that we invent new things, that those are of shareholder value, and that we need to not just try to commercially exploit these, in the good sense, in Akamai's services for which we can get paid, but we need to defend the value of those things when we think other people are stepping on them or transgressing our shareholders' rights.

And so, that's why sometimes we wind up in court when we don't think we can get appropriate protection another way.

I won't go into the details of that case.

One, they are too lengthy for even an all-day call, I guess, and it's hard to know exactly how they will come out.

There have been twists and turns, but we were very pleased that the Court of Appeals, we think, saw it the right way, and we're optimistic that as long as we're patient, we will prevail, and that will accrue to the value of our shareholders.

Aaron Schwartz, Jeffries.

Good afternoon.

You provided some color on how you think about COGS going forward here, and also talked about the hiring on go to market and engineering.

If you see a continued mix shift to cloud infrastructure, would you expect more or an OpEx mix as well?

I mean, would you expect more of your costs to shift down to the OpEx line?

I'm just wondering if you could provide some color on how you think about the model longer term.

Sure.

I think we talked about it a little bit before, but let me kind of clarify a little bit.

We obviously have our content delivery solutions business, which is kind of a lower gross margin business, but a lower OpEx business.

And then, we have our cloud solutions business, which, obviously, has higher gross margins, but it also has a higher operating expense.

So as the Company continues to innovate and build out our suite of solutions not just in content delivery, but more specifically in the cloud solutions area, you can expect that the OpEx investments that we're going to need to make are going to increase.

And so, you can expect we're going to continue to make investments in R&D.

We're going to continue to make investments in go to market at a greater pace for that part of the business.

Now, that part of the business, because it has higher gross margins, will have a little bit higher EBITDA.

And actually, it has a lower CapEx structure, so it actually has higher free cash flow from a company.

So you can continue to see as we shift more of our business to cloud solutions, if the mix shifts that way, you can expect that you'll see kind of a higher operating expense percent, but you'll see, hopefully, a lower CapEx percent and maybe a stronger free cash flow percent, maybe in the kind of -- the model we talked about is in the low 30s.

Ed Maguire, CLSA.

Good afternoon.

This quarter, you were at a number of events focused on the mobile opportunity.

And I was wondering if you could just address the partnership with Ericsson and the expectation that mobile content delivery can become a really meaningful part of revenues, rather than just kind of a strategic direction.

Thanks.

Well, I think it's already one of the things that's driving this whole shift from deliver the site to ensure the Web experience.

And a big piece of some of the technology acquisitions we've done this year and the rollout of AQUA Ion is around improving that experience, and that's especially to mobile devices, whether they are smartphones or tablets, and whether they are on cellular connection, 3G or 4G, LTE, or on WiFi, and making sure that those work in every case.

And so, we already think that there is a strategic imperative and a payoff for what we're doing.

Beyond that, we think that there's a new opportunity to partner with hardware and solution providers inside wireless networks because they have their own particular challenges.

They were not built for data.

Ironically, they're new networks and they weren't built for data; they were built for voice or they were built for narrow-band applications to talk between two people.

And that's actually not what people want to do on these devices most of the time.

And so, we think that there is opportunity -- long-term opportunity -- to create new solutions and create new revenue streams, but already we believe that it's strategic, and we're seeing the value in things like the Ion release and what we're doing for mobile interaction optimization and better performance to a site or to an application over a mobile device, particularly a smartphone.

And our customers are already buying for that reason.

So I think we're seeing the benefit even as we do the long-term development and product testing of some of these in-network or network provider solutions that we think, long term, have additional benefit for us as well.

Michael Turits, Raymond James.

Hi, Michael.

Michael?

Operator, I think we lost Michael.

Jeff Van Rhee, Craig-Hallum.

Just one clarification.

As you commented to looking at the growth rates and that we should look at H2 versus H1 and historical patterns being the norm, if I look back at the years I've followed you, and then I compare that to the description you're giving of the various segments of the business, this doesn't feel like that typical H2 to H1.

It feels like you've got a lot of separate factors that are accelerating here.

So can you just reconcile the two as to why, on the one hand, it should be typical, and on the other hand, it sounds like from the commentary things are getting better than they normally would be here?

Certainly if you look historically Half 2 to Half 1 for the last, say, three to four years, we have grown Half 1 to Half 2 roughly 10%.

And that's effectively what we're guiding here at this midpoint.

I think I shared with you that I think seasonally when you see things, what we've seen this quarter is that some things that maybe in some years happen in Q4 actually happened in Q3 this year.

So, the reason I tried to provide some color around Half 1 to Half 2 was to just give some color maybe to our Q3 to Q4 sequential growth being a little bit lower than it's been historically.

For sure, you are right, we are seeing very strong growth and very strong demand for our cloud solutions.

You can see that we've grown them consistently for the last couple of quarters in the lower 20s.

We saw a very significant acceleration in the content delivery part of our business in Q3.

As I mentioned, some of that growth acceleration was aided by the things that I mentioned.

But for sure, I think Paul mentioned this earlier, we're seeing very healthy growth across the board, across most of our customer sets.

But I think you have to make sure that you balance that with the fact that some of what aided Q3 were the software releases that I mentioned, these custom government projects that I mentioned, and just, I'd say, to a smaller extent, the events that I mentioned.

But in general, we're very pleased with the performance of the business.

I don't want you to have a takeaway that we think the business growth is slowing down because it's not.

We still think there is significant demand.

It's just a matter of timing between quarters.

Yes, I think what you're seeing is very strong growth, which you're identifying, and we're just trying to explain why we think, if people build their models out.

If there's any question about what's going on between Q3 and Q4, it's only a little bit in timing.

But we expect a very strong quarter, as I think our guidance indicates.

The piece that's hardest for us, and why we always have a little bit bigger range in Q4 and we just don't know, is our customers anticipate a very strong commerce season.

It's driven Q4 growth every year to be ahead of the other quarters.

Last year, it was exceptional, particularly as we were really fully recovered or were recovering even faster out of the recession of a couple of years before when, really, spending was really, really slow.

And last year we grew 15% to Q3 to Q4, driven by what, really, we don't have insight into today.

That doesn't start for a few more weeks.

So we just don't know exactly where the commerce season will go, and yes, it could provide even more upside than we built into the model, but based on what we can see and trying to estimate these accounts, that's how we've called it.

Chad Bartley, Pacific Crest.

Thank you very much.

I definitely understand what you're saying about the timing issues, Q3, Q4, from a sequential perspective.

But one follow-up on year-over-year growth.

So you talked about, early on the call, four straight quarters of accelerating growth.

It looks like for Q4, adjusting for acquisitions, adjusting for currency, you are looking for year-over-year growth to decelerate.

So I'm curious what's driving that?

Is it a particular segment, a particular vertical (multiple speakers)

It's just really the wraparound of really an unbelievable Q4 last year.

Just when everybody was saying, where is your growth going to come from, the total growth last year was 11%.

You saw it start in Q4, and we jumped 15% quarter over quarter, and you're just seeing the wraparound to that exceptional Q4 last year.

But we're coming closer and at the high end of our guidance to close to doubling the growth rate we had year over year.

So we've got four straight quarters of growth.

You're seeing us wrap around to the single biggest jump we had had.

So we're expecting a great Q4.

We're just sort of reminding you that compared to last year's jump, Q3 to Q4, it's a little hard to duplicate, even though we're very bullish on how we think the year is going to go.

Donna Jaegers, DA Davidson.

One just quick question, I guess.

On the software downloads, those are in the high-tech vertical or are those in entertainment, and can you give us some magnitude of how much that added to the quarter?

Yes, I mean, so obviously we put customers in each one of our verticals, and so we have some customers that really represent their high-tech customer and a media customer and a commerce customer.

We only put them in one vertical, so we happened to have software download activity.

It's primarily in our high-tech vertical, but we also have customers that also drive software download activity that's also in our M&E vertical and other verticals.

Sure.

You could think of a gaming company, for example, that's really a media and entertainment company, but what we're doing for them -- or one of the things we're doing is delivering their game.

Philip Winslow, Credit Suisse.

Hey, guys, this is Zach for Phil.

Could you just comment on any pricing trends you're seeing in M&E versus commerce, anything you've seen in the last few quarters or you expect to see going forward?

Very stable environment, same kind of long-term trends, particularly in M&E around volumes, but we think we have that well measured, and same kind of trends and stability in commerce that we've seen as well.

There, we're certainly seeing, along with enterprise, strong uptake of our new security suite, which I think is a premium product and it's reflected in the value we're getting in the market, so we're very pleased overall with how we're doing with pricing on the top line and then profitability on the bottom line.

Thank you all for calling in.

Pleased to report these results, and we'll be back in another three months to report on how the commerce in fall season turned out.

Until then, we look forward to seeing many of you here in Cambridge in December for our annual investor day.

Thank you and have a good evening.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.