Limelight Networks, Inc.
Q3 2016 Earnings Call Transcript

Published: 27 Oct 2016

[Operator:]

Good day, ladies and gentlemen. Welcome to the Limelight Networks' 2016 Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. At the end of the prepared remarks, we will provide instructions for those interested in entering the queue for a question-and-answer session. I will now turn the call over to Mr. Dan Boncel, Limelight's Chief Accounting Officer.

[Dan Boncel:]

Good afternoon and thank you for joining Limelight Networks’ 2016 financial results conference call. This call is being recorded on October 26, 2016, and will be archived on our website for approximately 10 days. Let me start by quickly covering the Safe Harbor. We would like to remind everyone that we will be making forward-looking statements on this call. Forward-looking statements are all statements that are not strictly statements of historical facts, such as our outlook for the fourth quarter of 2016 and beyond, our priorities, our expectations regarding pending litigations, and our operational plans, and business strategies. Actual results could differ materially from those contemplated by our forward-looking statements, and reported results should not be considered as an indication of future performance. For more information, please refer to the risk factors discussed in our periodic filings, including our most recent Annual Report on Form 10-K. The forward-looking statements on this call are based on information available to us as of today's date, and we disclaim any obligation to update any forward-looking statements, except as required by law. Joining me on the call today are Bob Lento, our Chief Executive Officer; and Sajid Malhotra, our Chief Financial Officer. We will be available during the Q&A session at the end of the prepared remarks from Bob and Sajid. I would now like to turn the call over to Bob Lento.

[Bob Lento:]

Thanks, Dan, and good afternoon. Today, we announced our third quarter results. This was another quarter that demonstrated our continued progress to improve our financial and operating performance. Revenue in the quarter was $39.5 million, down 6% from the third quarter of 2015. Despite lower revenue, our GAAP gross margin expanded to 41.1% this quarter, up 330 basis points from 37.8% in the year-ago quarter. We are pleased with our management of operating expenses, which were down 20% from the year-ago quarter, excluding the $2.8 million of litigation cost this quarter. As a result of this financial discipline, our adjusted EBITDA has increased 15 times over the year-ago quarter, and our cash balance has increased year-over-year for the last three quarters. We also reported a GAAP loss of $0.06 per share and break-even non-GAAP EPS, which are both improved from a year-ago quarter. We're very proud of our ability to continue to expand margins. Despite increased competitive pressure, we remain disciplined on pricing this quarter to ensure we did not generate revenue at the expense of margins. Our margins also benefited from our continued work managing our quote of goods sold. The strategy is working and I expect this positive margin trend to continue. I’m also pleased with our cash position of $74.4 million at the end of the third quarter. We generated $1 million in cash from operations during the quarter, despite making our first $4.5 million payment to Akamai related to our 703 patent settlement. We also chose to payoff our $4.2 million capital lease financing and invested $3 million in CapEx. Even with these relatively large payments, our cash position remains strong. We are now debt free and have a solid balance sheet. During the quarter, we continue to expand and optimize our network. Our $3 million investment in CapEx was one-third of the $8.7 million we invested in the third quarter of 2015. Despite significantly lower spending in Q3 and year-to-date, we added nearly twice as much capacity this year as compared to last year to roughly one-third of the spend. This was due to our continued improvement in server performance through software optimization, our ability to add capacity at an accelerated rate, while bringing down our CapEx spend is a very positive outcome for our customers and our shareholders. While expanding our network, we’ve also focused this year on enhancing our software, future functionality, and improving network performance. The results have been very positive for our customers, as evidenced by our latest net promoter score, which is up over 70 points from our initial survey in the spring of 2013. We’ve had three years of strong gains in our net promoter score, which we believe plays a strong foundation to expand our market share and drive revenue growth. We've been recent developments on a couple of fronts with respect to our ongoing litigation with Akamai, our longstanding dispute with Akamai over the 703 patent is now permanently behind us. In August, we converted the $51 million judgment in that case into a $54 million settlement agreement. The $54 million we paid quarterly over three years, we made our first payment in Q3. The settlement allows us to operate our business under a license from the 703 patent and certain related patents through the end of their life. The patent infringement dispute that we filed against Akamai and XO Communications in the Eastern District of Virginia continues to move at a rapid pace with trial set to commence on January 3. We continue to believe that we’re net plaintiffs in this case and we intend to vigorously enforce, protect, and defend our intellectual property rights. During the quarter, we had a few successes I'd like to share. In early September, we announced our new Limelight Web Application Firewall, a cloud-based security service that detects and starts application attacks in real time. The new service is integrated with our global content delivery network and gives customers the secure, distributed architecture that delivers cost effective protection for Web Applications. Limelight was also in the middle of the action during the third quarter of several high profile live video streaming events. We believe that for some of these events, we deliver more traffic than any of our competitors due to our performance advantages. In the third quarter, we continue to add important new customers to a roster across all regions and in our key use cases of software download, video on demand, and live streaming. Limelight continues to innovate and enable customers to securely deliver online content with greater speed and better reliability. Customer satisfaction remains our top priority and based on our efforts and as reflected in our net promoter score has improved. Our financial priorities for 2016 continue to be cash generation, margin expansion, and revenue growth. Until recently, we were forced to exhibit higher pricing discipline and more stringent cost control to preserve cash, given the uncertain outcome of the 703 patent litigation. Now with the 703 litigation permanently behind us we believe that we’re well positioned to compete more aggressively and accelerate revenue growth. We built momentum as the third quarter progressed and 26 days into the fourth quarter, we are seeing positive momentum. In October, we began delivering traffic for an advertising supported video on demand service. And we have recently signed a deal to deliver traffic for one of Europe’s largest broadcasters. Limelight is delivering better financial performance than it ever has in a number of metrics. We have developed a cost structure that we believe will enable us to be aggressive in the market, while expanding margins and generating cash. We have also dramatically improved our operational performance, customer support, and software functionality, which we believe will allow us to better compete in the market. We have built a good foundation, we have a structural advantage, and we’re focused on profitable growth. I expect to see results of that focus in the fourth quarter. In fact, we believe that the fourth quarter will be our best financial performance of 2016 on a number of metrics. With that, I’ll turn the call over to Sajid to discuss this quarter’s financial performance in greater detail and provide an update to our guidance for 2016.

[Sajid Malhotra:]

Thanks, Bob, and good afternoon. Third quarter 2016 revenue was $39.5 million, gross margin was 41.1%, and cash gross margin was 52.8%. We had a GAAP EPS loss of $0.06 and break-even non-GAAP EPS. Adjusted EBITDA was positive $5.1 million. In the quarter, the impact of foreign exchange fluctuations was immaterial, as changes in the Japanese Yen and South Korean Won offset the devaluation in British Pound. For the quarter, our revenue was down 6% compared to prior year. In Q3, international customers accounted for 39% of total revenue, compared to 47 – compared to 42% a year ago, and approximately 18% of the third quarter revenue was in non-U.S. dollar denominated currency. In Q3 2016, our top 20 customers accounted for approximately 60% of total revenue. Our top 20 customers are the most sensitive to pricing conditions in the market, given their large volumes. Despite facing significant pricing pressure in the industry, we have remained disciplined when extending volume discounts for existing customers, as well as introductory pricing to potential new customers. As in the last quarter, we did not devalue our services in exchange for volume. When comparing to third quarter of 2016 to 2015, volumes declined slightly. However, we’re encouraged that our average selling price on our delivered traffic remained flat, especially in contrast to an industry with historically declining prices. We saw some very aggressive pricing in the market in the third quarter and what appeared to be the availability of unconstrained capacity from our largest competitor. To avoid price compression compared to the prior year quarter is quite a feat in this environment. On the flip side, our restraint in participating in what we consider undesirable pricing opportunities is evidenced in our fast expanding gross margin. This was a strategic choice we made entering the year. We continue to believe that we must expand our margins. Gross margin of 41.1% is up a very strong 330 basis points from 37.8% in the prior year quarter. Cash gross margin of 52.8% is also up 300 basis points from 49.8% in the third quarter of 2015. This is the third consecutive quarter of significant year-over-year margin improvement. The consolidation and upgrade of our network equipment in our data centers resulted in our colocation fees decreasing by more than 20% year-over-year. Payroll and related employee costs were also lower by a similar percentage. Both of these decreases contributed to our gross margin improvement. Our continuing discipline over our operating expenses was evident in the third quarter. Total GAAP operating expenses were $22 million, which is a decrease of $2.2 million from the third quarter of 2015. Excluding $2.8 million of litigation related expense, which was slightly higher than expected, our operating expenses would have been $19.1 million, compared to $24 million in the same quarter last year, a decrease of $4.9 million or 20%. G&A expense increased by $1.4 million or 21% versus the year-ago quarter. However, excluding litigation expense incurred this quarter of $2.8 million, G&A expense decreased $1.4 million or 21%. Sales and marketing expense decreased by $1.8 million or 19% versus the year-ago quarter. R&D expense was lower by $1.8 million or 24% versus Q3 of 2015. These decreases are largely due to lower payroll and related expenses. Interest and other income and expense was $250,000 of expense in the third quarter of 2016 compared to income of $550,000 in Q3 2015. The fluctuation is primarily driven by changes in foreign currencies and interest expense related to our revolving credit facility and capital leases in the third quarter of 2016 that we did not incur in the prior year. GAAP net loss was $0.06 per share in the third quarter of 2016, compared to an $0.08 loss last year. We achieved breakeven non-GAAP earnings per share in the third quarter of 2016, compared to a non-GAAP net loss of $0.04 per share in the third quarter of 2015. Adjusted EBITDA was approximately $5.1 million in the third quarter of 2016, up from $300,000 in the third quarter of 2015. Year-to-date adjusted EBITDA is $15.3 million, an increase of 966% from the same period in 2015. We continue to generate meaningful adjusted EBITDA and I'm very pleased with this result. Moving to the balance sheet. At the end of the second quarter of 2016 we had cash and restricted cash of $93.7 million, which included a draw on our revolving credit facility of $12.8 million. At the end of the third quarter, our cash balance was $74.4 million. During the quarter, we repaid the $12.8 million drawn on the revolver and we repaid all our capital lease obligations totaling $4.2 million. We generated $1 million in cash flow from operations. Excluding the $4.5 million payment under our settlement agreement with Akamai, cash flows from operations would have been $5.5 million. Thus at this time, we are debt free and generating cash with a strong balance sheet, which is a direct result of the improvements we've made in our operating structure. During the quarter, we spent $3 million in capital expenditures. This was approximately one-third of our CapEx in the year-ago quarter and a $1.6 million increase sequentially. We increased our CapEx compared to the second quarter in anticipation of increased delivery traffic requirements in the fourth quarter and into 2017. As I just mentioned, we also eliminated our vendor financing program and paid off all outstanding balances, which contributed to the increase in CapEx. DSO as of September 30, 2016 was 49 days versus 57 days at the end of the third quarter of 2015. Based on our global revenue distribution, we typically expect DSO in the range of 50 days to 55 days. As of September 30, we had approximately 105 million shares outstanding. Total headcount at the end of the quarter was 502, down 10 from the end of second quarter 2016 and down 54 from the third quarter year-ago. We are encouraged by our ability to expand gross margins and control operating expenses despite lower than expected revenue in the third quarter. Software enhancements have allowed for a significant increase in infrastructure capacity and improved performance in our network as measured by independent third party, all while reducing the capital requirements of our business. Excluding the payments of our revolving line of credit, capital leases, and our first settlement instalment to Akamai, we have now generated cash in four consecutive quarters, something we've never done before. We started to see increased momentum in the sales cycle towards the end of the third quarter and that momentum has continued through the first few weeks of the fourth quarter. This gives us confidence in revenue growth for the fourth quarter and beyond. Since much of our infrastructure is on a fixed rate contract, we believe a material portion of our projected revenue growth will flow through to our bottom line. Thus we believe we are well positioned to continue to generate cash and meaningful adjusted EBITDA. With that, let me discuss forward guidance. As I mentioned last quarter, in the near term, which I consider the next two or three years, we believe our success should be measured in the form of revenue, gross margin, and operating margin growth rates at or above the market leader. Based on current market conditions, we can provide the forward guidance as follows. For the fourth quarter 2016, we expect revenue to be between $43 million and $45 million. We are maintaining our gross margin guidance and expect margins to expand above 250 basis points compared to fourth quarter and full-year of 2015. As a result, we expect positive non-GAAP earnings per share. We expect CapEx to be below $15 million for the year inclusive of any vendor financing, down from our previous expectation of less than $17 million. We believe this path builds a strong balance sheet, generates cash flows from a business that we believe will return to growth in the fourth quarter and 2017, and is one that creates prolonged shareholder value. We are currently in the budgeting cycle and will confirm 2017 guidance on our fourth quarter conference call in February. My early expectation is mid single-digit revenue growth, another triple digit gross margin improvement, 2x to 3x improvement in our non-GAAP EPS, adjusted EBITDA approaching $25 million to $30 million, and CapEx around $20 million. In closing, this quarter was light on revenue lighter than we expected. Some of that is explained by external factors including excess capacity and irrational pricing in the market and some due to internal priorities such as our focus on profitability and cash generation. Pursuing incremental revenue in the face of irrational pricing without fixing the cost and expense structure is a wasted effort I firmly believe that. So, we set out to fix our cost and expense structure. We believe we have attained the necessary immediate goals where we can pursue revenue growth in the fourth quarter and into 2017 and external conditions appear to be improving. It was obviously very difficult to achieve the margin and expense goals that we had in the face of lighter revenue during the quarter. It took a complete team effort. A big thank you to the 500 employees that made it happen. We believe we are building traction in our business for the fourth quarter and beyond. We see further room for improvement in our financial performance. In other words, we like where we are in absolute terms and appreciate where we are in relative terms. I can report to you all we believe our competitive position and offerings have never been stronger and our financial performance has never been better. With that, let's open the call up for your questions. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Sameet Sinha with B. Riley. Your line is now open.

[Sameet Sinha:]

Yes, thank you very much. Couple of questions. So, let's talk about 2017 the confidence that you have. Do you see any major initiatives that are out there, which give you the confidence about accelerating growth and of course the EBITDA and other metrics that you've given out? Second question is your number of employees declined sequentially, can you comment on that? Is that any seasonality or was that planned declines and how should we think about it going forward? And then I have a follow-up question.

[Bob Lento:]

This is Bob. Let me take the question on the markets. So, obviously we see continued growth in traffic. But more importantly working closely with some of our largest customers, we see not only expansion in terms of the geographies that they may participate in, but also the amount of content growing. And so I think what we believe is that as we go into 2017, we're going to finally see some of the growth that I think some people were projecting what happened way back in early 2015. We're starting to see momentum building and some of that becoming real as we enter into 2017.

[Sajid Malhotra:]

And then Sameet, on employees I think the comparison versus prior year where there's a 50 employee delta, that is largely driven by the headcount post reduction we'd done in the fourth quarter of last year. The delta that you see sequentially of 10 I think is just nominal and will correct itself over time. I suspect that that's just ebbs and flows and it's to be expected, some variance of that magnitude is to be expected in our business.

[Sameet Sinha:]

Okay. One final question. Can you talk about litigation cost, how should we think about it? Obviously the Virginia case is closing up pretty quickly and you had elevated expenses this quarter. So, any anticipation for how much should we expect for next year?

[Bob Lento:]

I'll let Sajid weigh in as well. In the fourth quarter, we expect it to be pretty similar to what it was in the third quarter. First quarter, the trial wraps up by the end of January so I think that that will likely be about half of what we're seeing in the third and the fourth quarter and then beyond that I think it gets to a pretty minimal number as far as we can see sitting here today.

[Sajid Malhotra:]

And over the course of the last nine months, we've been talking about modeling expectations of around $1.5 million a quarter. Clearly this quarter was higher and we expect fourth quarter, like Bob said, to be similar to what it was this quarter, but that just is a function of where we are in the cycle of that settlement. And we absolutely anticipate that next year our litigation expense will be significantly less than what it is this year with the completion of this case behind us sometime late January, early first quarter.

[Sameet Sinha:]

Thank you.

[Operator:]

Our next question comes from the line of Rishi Jaluria with JMP Securities. Your line is now open.

[Rishi Jaluria:]

Hey, guys. Thank you so much for talking my questions. Couple of ones here. So the first one is the Q4 guidance on revenue, it implies not just a return to growth but at the midpoint about a sequential growth number around 14%. What gives you the confidence in that revenue guidance specifically for Q4 especially with the year-over-year declines we've seen in the past three quarters on the revenue side?

[Bob Lento:]

Let me make one comment and then I'll turn it over to Sajid to see if we can get a little bit more specific. But obviously when you look at it sequentially, Q4 is the largest quarter of the year. There is some seasonality to this business and that occurs in the fourth quarter and so we always expect that the fourth quarter will be the largest of the year. And then – Sajid, if you want to comment further on kind of the year-over-year comparison?

[Sajid Malhotra:]

I think it looks like a harder hill than what is typical for us if you look back in terms of going from third to fourth quarter. But I think it's a function of the business momentum that we see, the deals that we are signing. We are now 26 days into the quarter and based on everything that we've seen and the traction showed up late in the third quarter, continued into the fourth quarter. And the business momentum we see, the deals we've signed with the anticipated traffic coming on board; I feel like while it seems like it's a big number going from Q3 to Q4, it's clearly one that we should be able to make.

[Bob Lento:]

Just so we're clear on the numbers though. I mean from Q4 2015 to Q4 2016 I think it's something like a 3% growth rate and sequentially it's in the 10% to 12% range using the midpoint of the range. So Q4 2015 was 42.7% and with the 43% to 45% range, 44% would be 3% above that.

[Rishi Jaluria:]

Okay, great. And Sajid, you talked a little bit about the vendor financing program, which you mentioned was a contributor to CapEx in the quarter. Can you expand a little bit on what exactly this is and how it's contributing to the business going forward?

[Sajid Malhotra:]

Sure. So late last year when we were faced with the litigation we had, we went into a cash preservation mode, which focused on all of the initiatives that I've talked about, the focus on trying to generate cash versus using cash from the balance sheet. And along with that to secure any kind of adverse impact, we signed up with a bank for a credit line and at the same time we signed up with one of the vendors to do vendor financing for our usual CapEx equipment purchases that we do. Now all along we kept talking about all of that equipment as CapEx, so we've been disclosing what that has been, but that line carries a cost and that interest cost I think now that we have the cash we figured that that's not something that we should continue to pursue and we've just gone ahead and shut that line down.

[Bob Lento:]

Yeah, keep in mind when we were sitting here a year ago, Akamai's request to the Court of Massachusetts was for $99 million. We didn't think that that was a reasonable request, but we still had to prepare for the worst.

[Rishi Jaluria:]

Got it, got it. Okay. And I guess with perhaps a greater focus on revenue growth going forward given your balance sheet being in a better position and the Akamai lawsuit largely in the rearview mirror, what investments do you think you'll have to make to get that growth in Q4, in 2017, and beyond? And what impact do you think that's going to have on EBITDA margins in let's call it the near to medium term?

[Bob Lento:]

So, I'll let Sajid talk about the margin piece, but let me give you some perspective. From a capacity standpoint, we've done a really good job and I think industry game changing job of figuring out how to add capacity in a very cost effective manner. So, we are going to continue with that program and I think that helps to change our cost structure over time which gives us flexibility. But the other thing that we did and you can see in our numbers is we cut our sales and marketing expense between 2015 and 2016 pretty dramatically to the tune of 20%-ish. And so obviously when growing revenue becomes more of a focus, that's not an action that a company would normally take and so you can expect to see that we'll place more investments in sales and marketing going forward and make a different choice going into 2017 than we did coming into 2016. So, the good news for us is I think we can continue to generate the kind of advances that we have in capacity going forward, which helps our economic model, but we will have to invest more aggressively in sales and marketing.

[Sajid Malhotra:]

And so just to add to that, I think we have a structural advantage. I talked about it at the end of the last quarter and I can repeat it again because our ability to add capacity is a fraction of what it is for the other competitors whose numbers are published.

[Bob Lento:]

And what it was for us even two years ago, the order of magnitude difference is huge.

[Sajid Malhotra:]

Right. So, they are about 4 times, 4.5 times our size in revenue. But even if I use kind of some element of what capacity and what CapEx might be applied to this side of the business, they're spending 20 times as what we might be in rough terms from a CapEx standpoint that we do. So when I look at those numbers, it appears to me that one, we have a structural advantage on the CapEx add. Software is helping us a lot, the investments we've made in R&D are helping us tremendously in terms of adding to that capacity and to improve our quality. So like Bob said, expect us to invest in sales, in marketing, G&A as a percentage of revenue we've already suggested should stay roughly the same as we model this out. And because the business is better structurally, more of the revenue if and when we get it flows through to the bottom line and that's the element that we see when we talk about EBITDA next year, adjusted EBITDA being between $25 million and $30 million. But like I said this is early days, I wanted to kind of give you some idea of where we are headed, but we will confirm a detailed number when we speak with you in February when we report our full-year results.

[Rishi Jaluria:]

Okay. That’s really helpful. Thank you so much Bob and Sajid.

[Sajid Malhotra:]

Thank you.

[Operator:]

Our next question comes from the line of Jonathan Charbonneau with Cowen and Company. Your line is now open.

[Jonathan Charbonneau:]

Great. Thanks for taking the questions. You recently introduced your Web Application Firewall security product. Can you maybe talk about the early traction you're seeing from that and then maybe more broadly, the trends you're seeing from the other value-added products in general that you offer? Thanks.

[Bob Lento:]

Sure, I can make some headline comments on it. We don't report out on a per product basis for revenue. So, we have signed some customers up on the new product offering. Obviously, it's early days and we're building a pipeline, but there's definitely a need for security products in the marketplace as evidenced by the not only recent happenings, but things that have happened over the last year or so. So, lots of interest from customers. Obviously, there are lot of alternatives in the market. But within our customer base, we think we can do a pretty good job of attaching additional products, security being one of them. The other product that's grown for us quite nicely this year is our storage offering and our plan is to expand not only the capability, but our sales and marketing spend against that product as well. So, we see security as really something that our customers want and need. They can obviously get that from other places and our product I think competes well, but there's nothing in there that's industry game changing. We do believe we have that opportunity with our storage product and obviously more to come on that. But we think we've got some real advantages in terms of how that system is architected feature functionality or content that is destined for a content delivery network.

[Sajid Malhotra:]

Also just as a reminder, the agreement that we entered into with Neustar was to address exactly the kind of attack that everybody is talking about and experienced, the DDoS type attack and the architecture and the available capacity was in anticipation of attacks like this. So I think when complete, we will very much be at the forefront in terms of capacity and the ability to handle those kind of attacks, but today that is still planning, deployment, and development stages and that's still a 2017 revenue item for us.

[Jonathan Charbonneau:]

And then just what percent of revenue do your value-added products comprise today?

[Sajid Malhotra:]

So, we stopped breaking out what we used to traditionally call VAS versus the regular business, but it's still stays right around 75%

[Jonathan Charbonneau:]

Got it. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from Michael Turits with Raymond James. Your line is now open.

[Austin Dietz:]

Hi, guys. This is Austin Dietz for Michael. I know you said last quarter that Akamai's customers aren't necessarily your own so maybe you could talk to us about trends you're seeing with your largest customers and has there been any notable change in the past couple of months?

[Bob Lento:]

I don't know there has been any notable change. I mean clearly in Akamai we have a lot of shared customers, some of those customers as they have indicated are building networks internally, the do-it-yourself model. At the same time, we don't think those customers intend to or will bring 100% of their volume in-house and so we think that there is opportunity for us. And so, I don't think there's anything really new on that front to kind of share with you.

[Sajid Malhotra:]

Here's another way to think about this. We have overlap. They disclosed six customers that were taking the business in-house and we have overlap with those customers. So if you think about it, that business is going away…

[Bob Lento:]

With some of those customers.

[Sajid Malhotra:]

…with some of those customers. Our revenue decline was 6% compared to 15% at the other end even as we expanded margin by 330 basis points.

[Austin Dietz:]

Great. That’s helpful. Thanks.

[Sajid Malhotra:]

You are welcome.

[Operator:]

This does conclude our Q&A session for today. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, you may all disconnect. Everyone have a wonderful day.