Akamai Technologies, Inc.
Q2 2011 Earnings Call Transcript

Published: 28 Jul 2011

[Operator:]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Akamai Technologies, Inc. Earnings Conference Call. My name is Angela, and I will be your coordinator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. And now, I'd like to turn the conference over to your host for today, Natalie Temple, Investor Relations. Please proceed.

[Natalie Temple:]

Good afternoon, and thank you for joining Akamai's investor conference call to discuss our second quarter 2011 financial results. Speaking today will be Paul Sagan, Akamai's Chief Executive Officer; and J.D. Sherman, Akamai's Chief Financial Officer. Before we get started, please note that today's comments include forward-looking statements, including statements regarding revenue and earnings guidance. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information concerning these factors is contained in Akamai's filings with the SEC, including our annual report on Form 10-K and quarterly report on Form 10-Q. The forward-looking statements included in this call represent the company's view on July 27, 2011. 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.

[Paul Sagan:]

Thanks, Natalie, and thank you, all, for joining us today. Akamai posted revenue of $277 million in Q2, up 13% from the same period last year. Results included normalized net income of $66 million or $0.35 per diluted share, up $0.01 from Q2 of last year. Normalized EPS would have been about $0.03 higher in the quarter but for a change in our tax rate that J.D. will explain in a moment. Cash flow continued to be very strong with $112 million of cash from operations in the quarter or $200 million year-to-date. In total, revenue, profit and cash flow performance for the first 6 months of the year were records for Akamai. We also saw solid progress in the field, setting a record for the most new customers signed in a single quarter in Q2. However, while our results were in line with our guidance, they did not achieve the highest expectations that we have for the business, and I suspect that many of you have as well. So I'll back in a few minutes to talk about the steps we're taking to reaccelerate top line growth to capture the massive opportunity that we believe is ahead of us on the Internet. But first, let me turn the call over to J.D. for the details on Q2. J.D.?

[J. Sherman:]

Thanks, Paul. And as Paul just highlighted, our revenue came in towards the high end of our guidance range at $277 million, up 13% year-over-year and up $1 million sequentially. And we delivered $66 million of normalized net income or $0.35 per diluted share, roughly at the midpoint of our guidance. Also as Paul mentioned, these results include a higher tax rate than we anticipated at the time of our last quarterly earnings call. The higher rate was primarily due to increased costs attributable to our investment in the network outside of North America. As a result, our full year projected taxable income outside the U.S. decreased and our U.S. projected taxable income increased, resulting in a higher overall tax rate. For the quarter, the impact on our taxes was about $5 million or about $0.03 per share on both the GAAP and normalized basis. We believe our willingness to invest in our network asset is a strong sign about the market opportunities we see for Akamai, and we've talked about the opportunity to grow the business faster in Asia-Pac, Europe and Latin America. Our investment in these regions recognizes the need to invest in the platform ahead of new business to capture future customer demand. Now for the year, we expect our tax rate to be approximately 35% compared to the 32% to 33% range that we forecast earlier. We still believe that the tax rate for our long-term financial model will be in the low 30s, assuming our business outside the U.S. continues to grow in the coming year. Now moving back to revenue, during Q2, we saw continued solid growth for our value-added solutions. Enterprise, our fastest-growing vertical, grew 28% year-over-year and 4% sequentially, as our customers transitioned more of their businesses to the cloud. Our commerce vertical increased 21% over Q2 of last year and decreased 1% sequentially. In what is typically a slower seasonal quarter for e-commerce, we saw healthy growth driven by demand for our dynamic site solutions, particularly Dynamic Site Accelerator or DSA. We had a record quarter in terms of unit growth for new DSA signing. Revenue from our media and entertainment customers grew 11% year-over-year and declined 1% sequentially in the second quarter. We did see signs of accelerating traffic growth in what tends to be a more modest growth quarter. However, we have not yet seen a return to the accelerated rate of traffic growth that we experienced last year. The high-tech vertical is up 1% year-over-year and up 2% on a sequential basis as demand for our Application Performance Solutions by Software-as-a-Service customers offset declines in software download revenue. Public sector revenue grew 5% sequentially and 11% year-over-year in Q2, off a very strong 2010. During the second quarter, sales outside North America were 30% of total revenue, consistent with the prior quarter. International revenue grew 20% year-over-year and was flat sequentially in Q2. The weaker dollar had a positive sequential impact of about $2.6 million, and on a year-over-year basis, the currency impact was favorable by about $9 million, which is about $1 million less of a benefit than we anticipated during our call last quarter. Excluding the impact of currency, international revenue grew 7% on a year-over-year basis. We had very strong growth in Asia-Pacific outside of Japan, but a more difficult macro environment in Japan, as well as in Europe, continues to weigh somewhat on our growth in these regions. Revenue from North America grew 10% on a year-over-year basis and was flat sequentially, and resellers represented 19% of total revenue, up 1 point from the prior quarter. Our cash gross margin for the quarter was 80%, consistent with last quarter and down 2 points from the same period last year. GAAP gross margin, which includes both depreciation and stock-based compensation, was 68% for the quarter, which is consistent with the prior quarter and down about 3 points from last year, driven by depreciation growth as we continue to invest in our platform. GAAP operating expenses were $114.1 million in the second quarter. These GAAP numbers include depreciation, amortization of intangible assets and stock-based compensation. Excluding noncash charges, our operating expenses for the quarter were $94.9 million, up about $4 million from Q1. This was slightly below our guidance range as some investments flipped from the second quarter to Q3. Adjusted EBITDA for the second quarter was $126.2 million. That's up 13% from the same period last year and down about 2% from Q1 level. Our adjusted EBITDA margin came in at 46%, down 1 point from the prior quarter and consistent with Q2 of last year. For the second quarter, total depreciation and amortization was $41.3 million. These charges include $33.1 million of network-related depreciation, $3.9 million of G&A depreciation and $4.3 million of amortization of intangible assets. Net interest income for the second quarter was $3 million, roughly flat with the first quarter level and Q2 of last year. Moving on to earnings. GAAP net income for the quarter was $47.9 million or $0.25 of earnings per diluted share. As a reminder, our GAAP net income includes several primarily noncash items, including $13.6 million of stock-based compensation, including amortization of capitalized equity-based compensation and $4.3 million from amortization of acquired intangible assets. We are including GAAP taxes in our normalized earnings, and that tax charge was $28.3 million based on a full year GAAP tax rate of 35%. And as I mentioned, this tax rate is higher for the year than previously estimated due to increased costs attributable to investment in our network outside North America. Again, this was about a $5 million or $0.03 per share impact relative to our forecast coming into the quarter. Based on this methodology, our normalized net income for the second quarter was $65.8 million, up 1% from Q2 of last year and down 9% from Q1 of this year. In the second quarter, we earned $0.35 per diluted share on a normalized basis. That's up $0.01 from Q2 of last year and down $0.03 from Q1. Our weighted average diluted share count for the second quarter was 190.2 million shares. Our cash generation continue to be very strong, with cash from operations for the second quarter at $111.8 million, and year-to-date, we've generated $200.4 million in cash from operations. At the end of Q2, we have $1.3 billion in cash, cash equivalents and marketable securities on the balance sheet. Capital expenditures, excluding equity compensation, were $42.7 million, below our forecast coming into the quarter due mostly to the timing of investment. This number includes both investment in our network as well as capitalized software development. During the quarter, we spent $50.5 million in share repurchases, buying back about 1.5 million shares at an average price of about $32.90. From program inception in April of 2009 through last quarter, we have spent a total of $251.5 million buying back 8.3 million shares at an average price of just over $30. Finally, days sales outstanding for the quarter was 57 days. We delivered record first half performance and have seen continued strong demand for our value-added solutions, which made up 58% of our revenue in the first 6 months of the year. As we began 2011, we set an objective to achieve 15%-plus revenue growth. We talked about the 3 elements needed to get there

[Paul Sagan:]

Thanks, J.D. In the first half of this year, we produced solid and even record operating results

[Operator:]

[Operator Instructions] And your first question will come from the line of Mark Kelleher with Dougherty & Company.

[Mark Kelleher:]

If you look at the traffic growth not outpacing the pricing declines, you can see why the CDN might be a little bit on the slow side. But the fact that you got 58% of your revenue, which is flat from last quarter, coming from value-added services, it seems to imply that the value-added services is also seeing a little bit of slowdown. I would have thought value-added services would be growing faster than CDN. Can you kind of explain that dynamic there?

[J. Sherman:]

Well, I think if you look on a year-over-year basis, Mark, our value-added services are growing faster, growing at about 20% rate. Last -- 2Q, value-added services were 53% or 54% of our revenue. So on a year-over-year basis, they absolutely are much like we saw last 1Q to 2Q. The ratio stayed relatively stable between volume and value sort of on a sequential basis. And some of that has to do just with the seasonality, particularly in the commerce vertical, where the revenue tends to level out and even decline just a tad from Q1 to Q2. So I think we're still seeing better growth on the value-added solutions side and not as much growth in the volume side, although we did see probably a little bit of volume growth sequentially year-over-year -- a little bit of revenue growth on the volume side year-over-year.

[Operator:]

And gentlemen, your next question will come from the line of Mark Mahaney with Citi.

[Mark Mahaney:]

I just want to ask a question about the interactions with customers in the commerce vertical. Have you seen any change in pricing in that vertical or any market share shifts that you think are interesting to call out in that, just in the commerce vertical?

[Paul Sagan:]

No, that continues to be one of our strongest. That's one of the verticals that's most interested in adding things like security capabilities because they feel so vulnerable, both as a target for theft but also that if their site is taken down, it's losses is per second or per minute. It's not theoretical. It's real dollars because their end users simply will go to another site to make a purchase or book something. The largest competitive dynamic there continues to be do-it-yourself. These are large enterprises that first start and say, "What do we need help with?" And then they turn to Akamai, and I think they find the platform approach, the holistic approach very appealing. And I think we see that in our ability to continue to grow in that space. So I would say that that dynamic is really relatively unchanged and continues to be a very strong category for us, Mark.

[Operator:]

And your next question will come from the line of Philip Winslow with Crédit Suisse.

[Philip Winslow:]

I just had a question actually on co-location and bandwidth costs. Just what trends are you seeing there this last quarter? And what do you think about just the outlook, sort of what are your expectations? And obviously, this relates back to the sort of gross margins.

[Paul Sagan:]

You're not asking us to comment on the hosting marketplace, Phil.

[Philip Winslow:]

Correct, no, just sort of your costs that flows through the COGS line.

[J. Sherman:]

Okay, so sure. I mean, we're still seeing in the bandwidth market sort of consistent price to cost declines, if you will, from our perspective, with the cost of bandwidth driving that down. And we're starting -- you can see some -- it depends on the market, really, on co-location prices. There are some places -- it's like a real estate market. There are some places where our prices are holding. There are other places where there are very aggressive price declines, and we try to take advantage of that gain in terms of how we deploy our network assets and try to leverage that. The other lever we have on co-location costs, of course, is to make our servers more efficient and get effectively more throughput for our footprint in the co-lo facility. A lot of our build-out, though, has been outside of the U.S. And as we've added to footprint, that has driven some co-location costs up this year. I think that's a sort of a normal thing you should expect as we build out for what we think is a future investment. Hopefully, we scale over that over time and get some further leverage on that point. Did that answer your question, Phil? [Technical Difficulty]

[Operator:]

And your next question comes from the line of Tim Klasell with Stifel, Nicolaus.

[Tim Klasell:]

I just want to maybe reconcile the slower growth internationally with the faster investment. Is it carrying traffic from -- accelerating traffic from North America internationally? Is that what you're investing in? Or maybe you could help us get our arms around the strategy there.

[J. Sherman:]

Yes, Tim, I think part of it is, as I was just answering the other question, that we're building footprint outside of the U.S. as we expand into new markets. I think this quarter alone or within the last 6 months, we've opened up 5 new markets that we're going to sell in. And obviously, that requires some build-out. We are seeing more growth outside of our traditional markets in the Asia-Pac area, which is driving some additional growth. I think this year in general, most of our -- majority of our network investment has been outside of the U.S. So what that does is it shifts both the depreciation and the cost of running the network outside the U.S. versus inside the U.S. As far as international growth, it hasn't sort of met our expectations. I think we are facing some headwinds there. There's probably -- we're focused on what we can do better to drive more opportunity there. We've made investments in international that we believe are going to pay off in terms of market reach, in terms of building new partner channels, in terms of getting our products tailored for the markets outside the U.S. And we believe that that's going to drive growth in the future, and we want to make sure that we have the capacity and the capability and the footprint in place to meet those needs.

[Paul Sagan:]

To add a little color to that, Tim, I think maybe what was implied in there is that all media traffic that's coming in, that's certainly part of the expectations, but it's also application acceleration as businesses go more global and need to reach end users, upping B2B applications in even more places. And to connect all the ends and do the acceleration that we do, we need to be close to either the source data or the end user. So that's driven some of our growth. And on the macro headwinds in some markets, 2 places that would be just anecdotal examples would be Japan and the impact that we've seen, slowing down a little bit the enterprise business growth as a result of all of the turmoil that they went through in the first half of the year, one issue. Another would be, just anecdotally, some of what we've seen in bandwidth, though the economic malaise and uncertainty there had slowed down some of the enterprise investment. And I think those are the headwinds we're seeing in some of the more mature markets where we've operated for a while.

[Tim Klasell:]

Okay, great. And then just a quick follow-up, what percentage of your media customers, all of your media traffic is on the HD Network right now?

[Paul Sagan:]

We don't give that number. I don't actually know that number today. It's been growing rapidly more and more events and users, but I don't happen to know the percentage.

[J. Sherman:]

Yes, off the top of my head, I don't know either, but what we've seen is that sort of the traditional streaming format growth, it's not -- really haven't seen any much growth at all in the traditional format, and most of the growth has been on the HTTP side, which is where our HD Network is. So I think as you look forward, that's where we're driving all the growth. It's certainly where all of the sort of marquee events leverage the HD Network.

[Paul Sagan:]

And one of the opportunities that we see is our customers, they need scale for sure and quality, but they're also looking for simplification because in some ways, while things like HTML 5 and HTTP Delivery have simplified some aspects, the proliferation of network and devices and screen sizes is driving a different kind of complexity and, frankly, costs for media customers. And one of our goals with the HD Network is massive simplification. Give us one copy of the asset and let us transform it on the fly to the right user, in the right format, with the right bit rate, to the right screen size, with the right player. And that level of simplification, ease of use and then unified data back, we believe, is very valuable to our customers and one of the things that is resonating with them.

[Operator:]

And your next question comes from the line of Jennifer Swanson with Morgan Stanley.

[Jennifer Swanson:]

I just wanted to drill in a little bit on some of the commentary around traffic, and in particular, I think when we talked about patterns, seasonal patterns in traffic, the summer's always been a slower period, and it's really fall when you see the acceleration, which obviously is still ahead of us at this point. What are you seeing out there that's making you a little more conservative at this point, even with some of the seasonally stronger periods for traffic ahead of us? And to the extent that you are moving a little more conservative, is it just a rate of content moving online that's happening a little more slower, consumption that's been a little slower? Where sort of are the deltas in the demand drivers that maybe changed from when you initially set that 15% a couple of quarters ago?

[Paul Sagan:]

Yes, I think that we certainly talked about the pricing dynamics that we've set of large customer contracts at the beginning of the year the expectation that traffic would grow, and it has. Sometimes, people think we're saying it's not growing. That's not the case at all. It's really the rate, and we've seen the rate of growth later in Q2 start to accelerate, but it is not at the level that we saw acceleration from '09 to '10 last year, and that's making us be more conservative. We certainly still have an objective as a company to meet the growth targets. But I think at this midpoint, realistically as we look at the 3 things that we said we needed to have happen to happen, and we had a very strong first half of the year, but we aren't seeing the rate of acceleration that will give us the confidence in the objectives we've set before, so we're being, we think, realistic. We're not backing off, and we're not continuing to push with our customers. We see them adding and building their plans to go online, and we certainly expect and have seen the normal seasonality. And I think we expect to see it, which will be an uptick in the second half of the year. But I just think being more realistic about it, the figures we're giving out today are probably more likely. They're not the only scenario, but I think they're much more likely, and we're trying to be practical and very direct about that.

[Operator:]

And your next question will come from the line of Scott Kessler with Standard & Poor's Equity.

[Scott Kessler:]

Paul, I think you alluded to some efforts to accelerate growth, and I'm wondering if you could provide some specifics related to the strategies and/or initiatives. And J.D., could you possibly explain a little bit further some of the dynamics related to the international network investment increasing the tax rate?

[J. Sherman:]

You want me to take that first?

[Paul Sagan:]

Yes, I will just do the tax rate. It's a very straightforward calculation.

[J. Sherman:]

So, Scott, basically as you probably know, how you apportion your costs impacts where you earn your profit. And a big driver for us of costs, of course, is our network. What we've seen is we've increased the amount, the percentage, basically, of our investment in the network has moved outside of the U.S. And so as a result, that percentage of our depreciation in co-location costs which go with the network has moved outside of the U.S. as well. And that's based on the relative growth we've seen and the relative investment we made in footprint outside the U.S. So as we look at that and as we make an estimate going forward of what we think those costs are going to look like for this year, that's basically shifted where we're going to earn our income during the year by a couple of points on the tax rate. And really, that's the impact that we're seeing.

[Scott Kessler:]

And if I could just also follow up on that, so you obviously provide some guidance for this year in terms of the tax rate, presumably accounting for this kind of shift. Is it fair to say that you're going to continue to make comparable investments in the international network in, say, the next year or 2 as well?

[J. Sherman:]

I think we're going to have to continue to invest in the network. I hope we are because that will mean that our business is growing outside of U.S. I do believe, continue to believe, as we've talked about externally, that over time, more and more of our revenue and profit are going to be earned outside of the United States. And therefore, I do believe, as we've talked about with our long-term model, that our tax rate will be in the low 30s, just not happening as rapidly as we anticipated based on the upfront investments we're making now.

[Paul Sagan:]

And I'll talk to the strategy point. I'd go back to the big drivers that we think are driving business on the Internet. And our goal is to align with those macro drivers that our customers are most interested in, concerned in and believe that's the biggest opportunity to grow their businesses. And then we need to exploit our unique position and ability to provide value to them for better performance, scale, reliability and security. So without going into great detail again, and I'm certainly happy to dive in on any one, if you will. Specific question, one is this drive the cloud in the complexity of using your own IT resources, which most corporations are consolidating to fewer locations and combine that with third-party, whether that's a SaaS provider, who's offering a Software-as-a-Service product into your -- that your employees or customers or prospects use if you're a business. Or just the idea of renting or using capabilities from a third-party cloud provider and combining it with your corporation resources creates a huge performance challenge between the company's resources and the third-party and then out to the end users. And we believe that our acceleration technology, particularly in these partner models, like were done with Riverbed, RackSpace, IBM and others, is a large growth opportunity for us. Clearly, the rise of more and more malicious behavior online is driving the IT security market. And what customers are and just users are figuring out is that the traditional model of defense at your backdoor isn't the only thing that you should be doing in defense in depth. Where the old model was defend your desktop, defend your data center with a firewall, your desktop with antivirus, that's just not sufficient anymore to handle the threats out there. And secondly, our model says, "Part of your defense ought to start where the bad guys are operating." And because our servers and our network are deployed around the world, we can often identify bad traffic, like a denial of service attack, where it starts, not where it's going to terminate. And we can see and bury that bad traffic there and completely shield our customers from the threat. Our Web Application Firewall has a similar idea. Move the idea of the firewall from the edge of your data center out to the perimeter, to the edge of the Internet where the bad request comes from. [indiscernible] never let the road traffic get inside your computing environment. So I think there's large room to continue to build that platform of security capability. We talked about the proliferation of connected devices and what that's doing to drive complexity and demand. And our ability to accelerate traffic through landline connections and wireless connections and cellular connections by cooperating with cellular networks, we think, is a dramatic capability. And then this explosion of online video, which is still only 1% or 2% or 3% of video in the home over the Internet. We believe that will -- it took 15 years to get to 1%. It will double more quickly. And we believe that's an opportunity for us, especially if we can simplify the workflow and the challenge customers have of taking their video access and delivering them to so many users in so many forms across so many devices with good monetization. And we believe if we execute in those categories with a focus on site performance above all, we'll continue to drive growth, and then we can drive faster growth over time in the business. Hopefully, that's helpful, Scott.

[Operator:]

And your next question will come from the line of David Hilal with FBR Capital Markets.

[Samad Samana:]

Samad Samana here for David. I was going to ask you a question. We've heard that some of the major ISPs are cracking down on imbalanced pairing relationships. One can make the argument that this helps and hurts you. Could you give us a little bit more perspective on that?

[Paul Sagan:]

Well, I think I can't comment specifically since you haven't given me a specific network example, and it probably has more to do with their relationship with other traditional telcos. Our basic value propositions, at one level, to networks have been -- there are 2 things that you need to manage in your business

[Samad Samana:]

And if I could ask one more question, have you experienced any pricing pressure on the value-added services side, with some of your smaller competitors partnering up and claiming that they offer similar services at lower costs? Are you seeing any pressure on the value-added services side?

[Paul Sagan:]

So I think we have to earn our keep everyday with our customers. This has always been a competitive market. Do-it-yourself is the first competitor inside a large enterprise. Their first question is, "Why do we need to listen to anybody? Can't we do this ourselves? We've already spent a lot of money on IT and on the Internet." There have been many competitors, large and small, in and around this market. I'd say that both the competitive and the pricing dynamic has remained very consistent for years. Our goal is to continue to add value. I think at any enterprise IT sale, if you don't come with additional value and functionality of scale, speed, performance, analytics, security every year on an ongoing basis, you will erode your own value, regardless of what happens in the marketplace. So we're very focused on continuing to innovate, like the security features that we've been talking about in these new services that we've only been selling for the last year or so. So I'd say that that dynamic is consistent. We're maniacally focused on competing for business, and I say that we're continuing to do well.

[Operator:]

And your next question will come from the line of Sterling Auty with JPMorgan.

[Sterling Auty:]

If the volume is improving but not quite to the expectation, is it more the whole -- meaning is it more the consumer of the content that's just not consuming as much as maybe what you thought, or is part of it the supply? Is part of it the customer side just not kind of putting as much content through the CDN?

[Paul Sagan:]

I think it's a mixed -- part of it's the seasonal question. There's always less demand seasonally, although year-over-year, it increases. We've seen that. We continue to see more content going online, but we really went through a big inflection in high-quality video broadband over the last couple of years. We saw a huge acceleration over a year ago, and historically, we've seen that happen in intervals over time. We're not in a massive retrenchment as we saw 3 years ago in the recession, when the ad market disappeared and content providers weren't sure how to monetize content. At the same time, they're not sure always how to monetize content on the Internet as effectively as the old models. And there's a little bit of 2 steps forward, 1 step back in those models. So I think it's a combination. But again, we're seeing the traffic grow. We've even seen the rate of growth accelerate a little bit, but it is not where it was a year or 18 months ago, and we just want to be clear about that.

[Sterling Auty:]

I think that's fair. But kind of extending that, when you look at the back half, you mentioned a couple of catalysts even a quarter or so ago that you thought would accelerate the volumes. Have any of those changed, or have any of them been eliminated for one reason or another?

[Paul Sagan:]

No, and we've seen some acceleration, but it hasn't been at last year's level. And so we're just going to be very conservative about it. Until we see it, we're not going to say we know it's coming. We've seen it accelerate. We've seen some acceleration. We continue to be optimistic about it. But I just think as we're realistic where we are today, the macro pressures in some of the international markets that we've seen, we're just going to try to be very straightforward about what we think is going to happen, taken in the context of a very strong first half of the year.

[Operator:]

And your next question will come from the line of Gray Powell with Wells Fargo.

[Gray Powell:]

First, I wanted to kind of follow up on a prior question, which touched -- I mean, basically, gross profit margin has seen a little bit of pressure since 2009, and the main driver appears to be co-location cost. How should we think about trends going forward? Can you maintain margins in sort of the 79% to 80% range? And then I know you don't want to give longer-term guidance, but how should we think about EBITDA margins beyond the next quarter? Is 42% to 43% kind of the new run rate?

[Paul Sagan:]

So again, we're not going to give a new long-term model. We'll update the long-term model at the end of every year. I think that's the appropriate way to talk about the longer-term trends and how we see them in the business. The network cost is a combination of things including co-location, including the bandwidth charges. Clearly, there's been some, as we've talked about earlier, a little more pressure on keeping up co-lo prices. And energy prices have skyrocketed, and that's a big piece of co-location costs that get passed through in contracts. That's an aspect. A big piece of our focus, though, is driving efficiency into our network to get more out of the same footprint, therefore, effectively lowering the co-lo portion of the delivery per megabit of data. And I think those are the dynamics, and we've got various levers. We can work on the ones like software development that we can control and capturing the effective Moore's Law on a machine being more efficient than the last one we bought got and deployed. The piece that's more outside of our control is the real estate cost and the energy cost.

[Operator:]

And your next question will come from the line of Mike Olson with Piper Jaffray.

[Michael Olson:]

Just a couple of quick questions. Looking kind of one level deeper on what's going on in media and entertainment, do you think the perception of switching costs for media and entertainment customers is lower than maybe it used to be? And is that potentially resulting in those customers being increasingly willing to kind of switch between CDN providers more on a best-pricing-terms basis? Or is that an oversimplification of what may be impacting that portion of the business?

[Paul Sagan:]

Well, we've always said it's a competitive market and I don't want to make it appear that we've lost sight of that or don't believe that it isn't a very competitive market. There are switching costs. They're not just around price. They're around analytics. They're around performance. They're around all the things, for example, that we built in and are building into the HD Network at Akamai. At the same time, particularly for a very high-volume site, delivery is a big cost, and they need to manage it as much as possible, especially in line with the monetization capabilities. So I'm not sure that I think switching costs are higher or lower. There are complexities to do it and risks to anyone when they do it. I think the real issue is this is a market of volume growth, where pricing has declined very consistently year-over-year. We continue to see very consistent kind of unit price changes year-over-year even now. And then the swing factor is how fast the volumes grow, but I don't really think it's a switch in cost phenomenon.

[Michael Olson:]

Okay. And then just one quick housekeeping. J.D., did you give a customer account number? Will you give one?

[J. Sherman:]

We did. We did say it was a record number, and it seems like every time we stop talking about something, we do really well on it. So maybe that should be our strategy. But we actually added 147 net new customers this quarter, which is, I think, an all-time record. And we had great signings. Well over half of those signings were the "first time in the door" signing a deal for a value-added solution, which is where our focus has been in the field. Churn has stayed low, in a comfortable range. So we're really pleased with the performance in terms of our new customer signings this quarter.

[Operator:]

And your next question will come from the line of Jeff Van Rhee with Craig-Hallum.

[Jeffrey Rhee:]

A couple of questions, guys. First, on the cash gross margin side, help me understand directionally. I guess you had guided down roughly 100 basis points. The mix is gradually, some quarters more so than others, shifting to VAS, and you're essentially looking for revenues on the top line to be roughly flattish at the midpoint. So what is it within the gross margin side that drives that change sequentially lower?

[J. Sherman:]

Jeff, so I do think that what we're seeing going on is that the value-added solution sort of are pretty stable in terms of the gross profit percentage. They're very high and software-like, as we've talked about. We do get a little bit of ADS seasonality, which our advertising and business solution business has sort of a 50% -- or sub-50% gross profit margins. So that's a little bit of a decline. But the issue, particularly on the volume side or on the network side is that we keep building out and adding to our co-lo cost and had a couple of points and discussions on that. That's really what has driven in the short term here some of that gross profit margin decline. We're still sort of within the range of the long-term model that we contemplated. And I do think that we'll get the benefit over time of a shift in mix. But right now, that's being offset a little bit by the co-lo cost coming on.

[Michael Olson:]

Okay. And then while you're on the VAS side, the absolute dollar looks like it's flattish sequentially here. As I take a quick look back at least in the last 4 years, I don't see a flat Q2 to 1. You did have some sequential benefits from currencies, so arguably, maybe it was down sequentially. What's different in the VAS side this year compared to past years? I mean, you've got -- you mentioned the security product ramping, and it's not volume-dependent, so it doesn't seem like you've touched on that.

[J. Sherman:]

Yes, so I think there's a couple of things. One is if you look by vertical, looking at enterprise vertical, we actually did see growth, and that's driven by value-added solutions. And that's where you would see a lot of the cloud adoption, some of the early adoption security, where you saw a bit of the sequential decline in commerce, which is also a heavily value-added solution there. I would attribute it somewhat to the seasonality. Now last year, we kind of blew through that seasonality as we were really sort of earlier in the stage of DSA adoption and growing there. We have seen a bit of a slowdown in that. I attribute some of that just to the law of size, it's a bigger space to work off of. But I think seasonality has something to do with it. And then we are still getting growth, particularly in our new products, around the cloud.

[Jeffrey Rhee:]

Okay. And just one last quick, the licensing to carriers of technology, any thoughts internally or discussions on any serious level of doing that?

[Paul Sagan:]

Well, we're not going to make new product announcements today, but we always look for better ways to partner with networks. I described the basic value proposition that continues to be, I think, as true today as it was 13 years ago when we started, maybe more so networks are, particularly mobile networks, really just being crushed by the flood of data, much of that driven by uptake in video usage. And we believe that there's is a lot of value on our platform that isn't even exposed to network providers and that if we can find a way to partner with them effectively to help them, we think that's good for them, us, our customers and the ecosystem, the Internet will continue to explore that.

[Operator:]

And your next question, sir, comes from the line of Chad Bartley with Pacific Crest.

[Chad Bartley:]

A quick follow-up on pricing commentary. I had a question on year-over-year price declines, specifically in the media segment, obviously working through some customer renewals and I think some share shifts and traffic in the first half. Did you see year-over-year price declines in the media segment actually ease or lessen in the second quarter?

[J. Sherman:]

No, I would say we saw sort of the same typical rate of price decline, relatively consistent level like that.

[Chad Bartley:]

It was consistent despite the renewals and some of the other factors going on?

[Paul Sagan:]

Yes, and even in the renewals, it was consistent. It was just a number of them that all boxed together around the same time, but the dynamic has been very similar and consistent.

[Operator:]

Your next question comes from the line of Rod Ratliff with SunTrust Robinson Humphrey.

[Rodney Ratliff:]

Paul, you referenced the phenomenon of approximately 3 years ago, when there was a guide for low expectations, and there were some pretty serious macroeconomic concerns at the moment. But after that, there was a pretty significant snapback that you referenced earlier as well. Do you think that there could be any sort of phenomenon going on like that right now, in terms of the volume growth expectations that you've set forth and what you've seen to set forth those expectations?

[Paul Sagan:]

I'll let J.D. take it.

[J. Sherman:]

Well, yes, I think, Rod, what you see with our business are really the sort of 2 sides of the coin. The volume business has been, as you point out, a more cyclical business. Before that phenomenon that we saw at end of 2008 and 2009, the media business was growing 40%, and then it started to shrink. And then last year, we got to the high 20s, maybe even 30% for that business, and now we're seeing it moderate again. So I think there seems to be some natural cyclical trends in there. A piece of it is macroeconomic. A piece of it is just sort of the inflection point of a immature industry. A piece of it heavier and lighter competition. You have to factor all that in. Our value-added solution business, which is actually a business that, over that time period, we built from basically scratch, had been a pretty consistent grower. I mean, it's moderated a little bit as it's gotten bigger. We're now talking about a $600 million-plus business. But that's been a pretty consistent grower. And I think you're seeing us make a lot of investments there to keep that growth rate going and even accelerate it by expanding our product line. So I think on part of our business you're absolutely right, and it's very difficult to predict sort of the cyclicality of that and the trends in that industry. We believe long term, while there will be ups and downs, that's a great growth opportunity and a great business. And the other side of our business, that's a fundamental shift that we're benefiting from.

[Rodney Ratliff:]

If I might, one last question. If I could follow up very, very quickly, what do you think about the building wave of wireless? And does that seem to have been put off just a little bit?

[Paul Sagan:]

I'm not an expert on the build-out of those networks. And obviously, that's a worldwide question, so you'd have to be more specific. And we could certainly research it for you from our point of view. But we continue to see huge demand among our customers for wireless solutions because so many more users and so many interactions are coming from their customers on mobile devices and connected devices. So not just smartphones but tablets like iPads, et cetera. And that's driving huge demand. Even if it's a small number of the interactions, it's their same customers having a different experience, and it needs to be consistent and appropriate to the device, or they risk losing that customer. And we think that's a large opportunity for us to work with our customers but also with carriers -- or partners who work with carriers to build new offers, to help have the best delivery across wireless -- or cellular, I think you mean in this case. It's not Wi-Fi.

[Operator:]

And your last question will come from the line of Ed Maguire with CLSA.

[Edward Maguire:]

Just if you could address how much your new alliances with -- we saw BMC and you've got RackSpace under way and Ericsson and Riverbed. How much investment is required to get these ramped up relative to just developing products internally? And how does that map into your expectations for investment in 3Q and going forward?

[Paul Sagan:]

Sure. So we think that those are -- lumping them together rather crudely does not mean that they'll all be the same. But in some cases, there's an opportunity or requirement to provide engineering development upfront. Where we're developing technology, we're working together on embedding technology as we're doing in each other's products in the Riverbed solution. In the BMC case, it's making their measurement capability available to our customers who buy certain services to see the performance, gains and monitor the performance of their sites. So that's really a bring to market of some of these products, so it's not much engineering. In many of these cases, it's co-marketing work, where we have to support them as a channel, like in the RackSpace example. And then in the Ericsson example across mobile, that's a variety of things, including working together where we already have products and technology or jointly developing new things potentially even to provide wholly new solutions in the cellular world. So it's a mix. I don't want to overgeneralize, but you can assume some require more engineering and some, more marketing channel support. Engineering comes first, generally. And if we're successful, the marketing support continues to go on because it pays for itself in new business. So hopefully, that's helpful. I know we've gone over time, and we always try to keep to schedule for everybody because we know you're busy. There were a lot of questions. I know we didn't get to everyone in the queue, but we hope you understand that we were able to get to at least all of the highest-priority questions. We look forward to updating you again in another 3 months. Thank you all for joining. Bye-bye.

[Operator:]

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