Limelight Networks, Inc.
Q2 2013 Earnings Call Transcript

Published: 8 Aug 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to the Limelight Networks Second Quarter 2013 Financial Results Conference Call. [Operator Instructions] I will now turn the call over to Gillian Reckler, Limelight's Director of Investor Relations. You may begin.

[Gillian Reckler:]

Good afternoon, and thank you for joining the Limelight Networks Second Quarter 2013 Financial Results Conference Call. This call is being recorded on August 7, 2013, and will be archived on our website for approximately 10 days. At the end of this call, we will post an updated investor presentation online, and you can find it in PDF format within the Investor section of our website. Some portions of this conference call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are all statements that are not strictly statements of historical fact, such as statements regarding future events or future financial performance including, but not limited to, statements relating to Limelight Networks' market opportunity and future business prospects, guidance on financial results, statements concerning anticipated future growth and profitability, as well as management's plans, goals, strategies, expectations, hopes and beliefs, and statements concerning the anticipated effects of pending or completed business combinations or other strategic transactions. These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those contained, projected or implied in the forward-looking statements, including the inherent risks associated with litigation, particularly intellectual property based litigation. Reported results should not be considered an indication of future performance. Factors that could cause actual results to differ are included in the company's periodic filings with the Securities and Exchange Commission. I would now like to introduce Bob Lento, Limelight's Chief Executive Officer.

[Robert A. Lento:]

Thanks, Gillian. This afternoon we announced our second quarter results. We reported revenue of $42.8 million, of which 36% was generated by our value-added services. When I took the reign as CEO of Limelight and began implementing change, I knew that the road ahead would not be solely up and to the right. We are pleased with our progress accelerating time-to-market for our product releases adding capacity to our network and improving processes to drive sales efficiencies. We continued our selective approach to accepting business by establishing a clear process for identifying customers that value quantity, performance, availability and service, while moving away from contracts that do not provide long-term economic value. These changes, while necessary, contributed to continued customer and employee churn and led to revenue and gross margin declines. This quarter, we delineated 3 strategic intents

[Douglas S. Lindroth:]

Bob, thank you for the kind words. The past 5 years at Limelight has been a terrific experience, working with a dedicated team of employees, and I look forward to working with you, Pete and the rest of the Limelight team during the transition. The following financial results that I will be discussing are for continuing operations. For more information regarding discontinued operations, please see our Form 10-Q that will be filed in the next couple of days. During the second quarter, Limelight Networks recorded total revenue of $42.8 million, which was down 4% year-over-year and down 7% sequentially. Our Content Delivery revenue for the quarter was down 9% sequentially and declined 10% year-over-year primarily due to the decline in our reseller revenue from Global Crossing, whose reseller contract ended during Q2 of 2012, the decline in our transit and collocation revenue services revenue, a decline in our average unit selling price offset by growth in traffic delivered over our network and to foreign currency headwinds. Our core CDN traffic revenue, excluding items such as transit and collocation services, increased approximately 1% on a year-over-year basis. The sequential decrease was driven primarily by decreases in traffic amongst some of our top accounts. The traffic declines were due to conscious choices we made to not renew contracts with certain customers that do not meet our profitability expectations, as well as other customers that decreased traffic prior to our capacity expansion. In addition, we also saw a sequential decrease in the traffic we are delivering for Netflix, after an exceptionally high traffic level in Q1 of this year. As we have previously discussed, our contract was scheduled to end at the end of 2013. However, we have recently entered into an agreement to extend our relationship into 2014. As Bob mentioned, our value-added services revenue was 36% of total revenue during the second quarter with 10% year-over-year growth compared to the second quarter of 2012 and a sequential decline of 2% from Q1 2013. We had another strong quarter of year-over-year growth from our Video and our Performance Services, offset by our Content Management and Professional Services solutions. The decline in Professional Services revenue in Q2 was driven primarily by 2 large engagements completed in Q2 2012 that were not tied to our underlying Limelight Digital Presence solutions. As we have said previously, we are migrating the types of services that this team offers to services tied to our Digital Presence Management solutions. Our Content Management solutions was down modestly on both the sequential and year-over-year basis for customer churn impacted our recurring revenue stream. Our storage revenue also had a slight decline both on a sequential and year-over-year basis, and as we have said before, this is still largely tied to our CDN business. Our Agile Storage revenue continues to show both strong sequential and year-over-year growth. It is now nearly 30% of total storage revenue, up from approximately 23% last quarter. During the second quarter, Limelight's international operations represented 33% of total revenue, up from 31% in Q2 of 2012. During Q2, our international revenue was negatively impacted by approximately $600,000 due to the strength of the U.S. dollar primarily against the yen. We reported a second quarter adjusted EBITDA loss of approximately $500,000 compared to adjusted EBITDA of $2.5 million for the second quarter of 2012 and $2.8 million last quarter. Our Q2 GAAP loss from continuing operations was $11.2 million or $0.12 per basic share, compared to a GAAP loss from continuing operations of $9.4 million or $0.10 per basic share in the same period in 2012, and compared to $8.1 million or $0.08 per basic share last quarter. We also reported a second quarter non-GAAP net loss of approximately $7.2 million or $0.07 per basic share compared to a non-GAAP net loss of approximately $5.5 million or $0.05 per basic share in Q2 of 2012. Please refer to the tables included in our press release for the reconciliation of GAAP measures to these non-GAAP measures. GAAP gross margin was 35% during Q2 compared to 38% in Q2 of last year and down from 37% in Q1 2013. Gross margin decreased from last quarter, primarily due to the decline in Content Delivery revenue, offset by the increase in value-added services revenue and the decrease in network depreciation. On a year-over-year basis, gross margin decreased, primarily due to the decline in Content Delivery revenue and increased Professional Services costs, offset by the increase in value-added services revenue and decreases in our network depreciation. Cash gross margin was 50% for Q2, down from 53% last quarter and 55% during the same period last year. During the second quarter, our total operating expenses were approximately $26 million, up approximately $400,000 from last quarter and a decrease of approximately $100,000 from Q2 2012. Operating expenses increased from Q1 primarily due to an increase in non-income related tax expense of approximately $600,000 as we received a refund in Q1 and increased marketing expenses related to the launch of our Orchestrate 2.0. These expenses were offset by reductions in employee-related cost and the fact that we held our annual sales kickoff in Q1. Total depreciation and amortization for the second quarter was $7.6 million, down from $8.1 million last quarter and down from $8.6 million in the second quarter of 2012. Stock-based compensation expense for the quarter was $3.2 million compared to $3.4 million last quarter and $3.2 million in Q2 of 2012. Moving on to the balance sheet. Our combined cash and cash equivalents and short-term marketable securities balance on June 30 was approximately $119 million, down from $120 million in the first quarter of 2013. Our cash flow from operations during the second quarter was approximately $4.7 million. During the second quarter, we spent approximately $4.5 million on capital expenditures. Day sales outstanding for the quarter were 52 days, down from 54 days during Q1 of 2013 and down from 57 days in the same period last year. With that, I'll turn it back to Bob.

[Robert A. Lento:]

Thanks, Doug. This provides a status update on what we've done during the second quarter as we worked toward a long-term vision. We believe that we are poised to create shareholder value from the changes we are making and from the increasing demand for our services that we see from organizations who are looking for help, engaging and retaining their target audience across all digitally-delivered touch points. At this time, we will open up the line for questions.

[Operator:]

[Operator Instructions] Our first question is from David Hilal of FBR.

[Samad Samana:]

This is Samad Samana in for David. I'd like to follow up on the Netflix contract. Could you give us some details whether there's minimum traffic commitments or what level have they'd agreed to for the 2014 extension?

[Douglas S. Lindroth:]

Unfortunately, we're not going to go into contract details on specific elements of the contract, just like we never did in the past. All I can really say is that we've been working with them, as you know, for several months on helping them migrate to their own delivery platform. And so we're working with them now over an extended period of time.

[Samad Samana:]

Could you tell us what the reasoning was for them extending out? Is it their own buildout or they had liked the security of having a backup as well?

[Douglas S. Lindroth:]

I think it's better for them to address that for you. We're the service provider for them, and we've been great partners with each other, and we're happy to continue our relationship with them. And so that's what we're doing.

[Samad Samana:]

Okay. And then on the headcount, what is the company doing to retain and attract new salespeople as it continues to this transition and hopes to drive new sales on the other side?

[Robert A. Lento:]

So this is Bob. I'll answer that question. We're actually -- I've seen the turnover specifically within sales, stabilize. And at this point, other than maybe an opening here or there, we are at -- given our budget and our expectations, we're pretty much at full force right now, and so the focus is less on recruiting but more on training and driving productivity. And there's a lot of internal effort around that. And George Vonderhaar, who is responsible for that, and his team, their focus is really looking at now that we've got the people on board that match the profile of what we're looking for, how do we provide them the right level of training, the right support and the right systems to ensure that they are productive going forward.

[Samad Samana:]

Okay. And then one last question for me. You've been working through new contracts and not resigning customers that had unprofitable contracts. How much more of that is left as you look at your customer base? How much more churn do you expect from these types of customers?

[Robert A. Lento:]

I think it's hard to say that. I think the good news is we're starting to see price rationalization in the market, which is encouraging. But there's always somebody out there who's willing to give a price that we may think is unreasonable. So I think that's at this point why we're investing so heavily in ensuring that we can deliver high quality on a reliable and consistent basis so that becomes less about price and more about the quality of our network. And so it's hard to predict that. I think that -- yes, I think we'll have to wait and see. But the encouraging thing is we're starting to see some rationalization to pricing in the market.

[Douglas S. Lindroth:]

Yes, and the other thing I would say, too, is it doesn't mean that the contract that we had initially signed was unprofitable. Some of it is the level or the expectation of the customer, what their new contract pricing ought to be, and that's where we've oftentimes said that is not going to be business that we want to continue with. And so that's where we make the decision to not renew that customer and we'll let them go somewhere else if they believe that they can get the same level of service for a lower price. We don't necessarily think they can get that level of service, but that's where we're going to make that decision is normally at renewal time.

[Samad Samana:]

Okay. And any consideration of bringing the buyback back with the balance sheet having so much cash?

[Douglas S. Lindroth:]

It's often a discussion that we have at board meetings. Looking at the whole balance sheet structure and how to best deploy our capital. That's a decision that's up to the board and decision that gets made yes or no with each board discussion. So at this point in time, we're not doing a buyback. But that's evaluated from time to time.

[Operator:]

Our next question as from Aaron Schwartz of Jefferies.

[Aaron Schwartz:]

I just had a question on sort of the revenue in the quarter -- in the last quarter and you have sort of indicated this is going to be somewhat of a disruptive period. You made a bunch of sales changes, et cetera. But when you look at the revenue outcome, I mean, is there any way that you could sort of point to how much of it was maybe from some of the changes you made in the sales model and you should be maybe moving through that disruptive period? Or how much of it was or what you just spoke about in terms of not renewing contracts that were not profitable to you?

[Robert A. Lento:]

Go ahead, Doug.

[Douglas S. Lindroth:]

Yes, I mean, it's definitely both. We certainly can see on our side the quantification of it. We don't go down to those levels of details, but it's definitely a mix. And as I said in the prepared remarks, it's really a split of things that is driving it down, both year-over-year and sequential. Some of it is those top accounts on a sequential basis, that we chose not to renew. And then others, where they saw what our performance was end of last year and Q1 because of capacity constraints that we're running into. And so those customers left from a performance standpoint. We're going to move our traffic where we're going to get better performance to make sure they're not disruptive to their audiences and their customers. So as we started adding capacity, we started moving into the phase going back to those customers because the good news was we didn't churn a lot of those customers that dropped traffic. They just reduced the level of traffic that we're delivering on their behalf. So we are back engaging conversation, showing them the performance of the network with the additional 2 terabits capacity we added and talking to them about that migration of traffic back towards our network.

[Aaron Schwartz:]

So in those examples, I mean, have you seen the traffic rebound yet, or is it just sort of still a customer engagement phase?

[Robert A. Lento:]

Based on the conversations we've had, we see a desire on the part of those customers to reengage and look to put more traffic through our network, and several of them are doing testing as we speak. So it's not an immediate turn on of more traffic. But I think over the next quarter or 2, we'll see their confidence in our network rebound and, therefore, the traffic will as well.

[Aaron Schwartz:]

Okay, and then -- go ahead, Doug.

[Douglas S. Lindroth:]

The other thing that maybe got lost and I just want reiterate too what I've indicated too, when you look at it on a year-over-year basis on the pure CDN traffic, that when you strip out the co-location and the transit, so COLO is rack and stack services that we used to provide and then transit services, when you take those out, our CDN traffic revenue was actually up. It was only up slightly, 1%, but at least we are seeing traffic growth there and less price compression.

[Robert A. Lento:]

And then one last comment on that. We had several contracts that contributed to Q1 revenue, where that came up for renewal and we were not willing to renew at the prices that were being requested. And So obviously that traffic comes out immediately and, therefore, the revenue and the customers that are interested in doing more business with us and are now testing, there is a little bit of a timing issue that traffic will come back over the next couple of quarters. But we want to do business on a long-term profitable basis, and we're willing to live through short-term hit.

[Aaron Schwartz:]

Okay. And Doug, on that call on the transit, it seems like that had a steeper decline here. Was the reason sort of similar, I mean, it's just an economic decision? Or is there any sort of thing on that part of the traffic of why it declined to the degree it did?

[Robert A. Lento:]

So that's an area of the market that we've chosen not to participate in. It was a big piece of our 2012 revenue, and it's been declining. And we've made a strategic decision. Yes, that's revenue that we had don't really add any value to, therefore it's hard to build profitable long-term relationships that have some stickiness to them. And so we decided to get off of that revenue based on the fact that we don't think it is revenue that we add value to and, therefore, not sustainable over the long term.

[Douglas S. Lindroth:]

And it fits into as Bob said earlier, to getting the sales force really focused, having them participate, sometimes not other times, in those certain types of deals. It was a distraction for them. So it's really about our focus in making sure people are focused on the primary products that we want to sell and selling just those products, not dabbling in something that's not value add for the long term.

[Robert A. Lento:]

We've got to be very clear with our sales forces to what success looks like.

[Aaron Schwartz:]

Okay. And maybe last question, if I could. I know you're not giving guidance right now. But as we build our models and given you've just -- the COLO trend is not a strategic area of interest for you, is there any way to sort of guide us a little bit in terms of when that bottoms or how much is still left to go on that side of the house?

[Douglas S. Lindroth:]

Yes, it's difficult without getting real specific because we've never broken it down to that level. It is down to a level where it's not nearly as big a number as it was. There was one real big customer that we had in there that has now come off the network. So we're not talking about where we're going to see real big drops anymore like we saw in the past.

[Operator:]

Our next question is from James Wesman of Raymond James.

[James Wesman:]

Doug, just looking at the CDN business, how much visibility do you guys have into the quarter-over-quarter stabilization of that? Do you feel like there's a point this year where we can start to see it either flatten or grow again on a quarter-over-quarter basis?

[Douglas S. Lindroth:]

Well, on the pure CDN, like I indicated, I think we are seeing that year-over-year growth, so purely looking at CDN traffic. That's where really why the foundation starts, and it's just a base traffic when you take out some of the -- like we said, the Global Crossing reseller and the transit and the COLO. That base, CDN traffic is growing. And what we would be hopeful of is that where we are today with the customer churn, the employee churn that were at or nearing that bottom, in terms of seeing those levels of churn, and we start building from here. So as we said we're not guiding to it. All we can say is at least at the level we saw in Q2, that was the foundation for seeing that traffic levels and price compression at reasonable levels that did drive 1% year-over-year growth.

[James Wesman:]

Right. And then just looking at traffic growth, I know you'd mentioned a number, about 50% year-over-year last quarter. What did it grow at this quarter, roughly?

[Douglas S. Lindroth:]

Well, it was lower and for the reasons that we said. And the 2 primary ones are, obviously, the Netflix traffic that is migrating away. So there -- if you even look at them individually, their year-over-year growth was quite a bit lower than it has been in the last couple of quarters. So that's leading towards it being lower as well as the other customers that either we chose not to do business with or that migrated some of their traffic away, waiting for our expansion. So that drove the lower growth on a year-over-year, so we roughly in the mid-30s on traffic growth rates for the quarter, and price compression was around the mid-20s. Yes, so we did see improvement in price compression, and we saw, as you would expect, given what we have talked about on traffic with customers, we saw a lower growth rate in traffic on a year-over-year.

[Operator:]

Our next question is from Michael Olson of Piper Jaffray.

[Michael J. Olson:]

A couple of quick questions. In order to bring some of the volume of CDN customers back that may have gone elsewhere due to the capacity issues, what kinds of tactics are you able to use? Is price a strategy that you might use to win traffic of some of those customers back? Or what other strategies could you use to bring them back into the fold?

[Robert A. Lento:]

So I think our strategy at this point is less focused on price and more on network quality. And we think for customers that are looking for quality, we can be price competitive and be profitable. And so when we talk to those customers, they are looking for additional capacity. The most important thing to them is that it is consistent, reliable and at a level that they need and therefore that's why we're going through the testing period. And so we feel very confident that we can compete for those customers based on the quality and drive a price that allows us to return the right value to our shareholders long term.

[Michael J. Olson:]

Okay. And given the rising tides and industry drivers for kind of the underlying components of your value-added services offering, what do you think is the reason for a little bit of acceleration in growth in that segment or maybe it just being a little bit lower than you're anticipating?

[Robert A. Lento:]

I'll let Doug comment on that. And I think the story is mixed within that portfolio. Where we're very pleased with the growth that we saw in and around over video product. And we're pleased with the progress that we're making within our Performance, within storage. While overall the number was down, Agile is our next-generation, and we saw a very good growth there. So as we said, Professional Services was down. But I think that there's some really good opportunities for us in the market with the products that we have. And we're putting more of an emphasis on those products as we go forward.

[Douglas S. Lindroth:]

Yes, I think you hit most of it. The other one that was down was in the Content Management. And as Bob said in his opening remarks on some of the R&D enhancements that we've delivered is working on the user interface in our Content Management product, and that's definitely been an area of feedback from both potential customers and existing customers that, that is an area that we are lagging behind the market and needed an improvement upon. So we're making good progress there. And I think as that gets rolled out to the customers, we should see the levels of churn that we've seen in the customer base in the Content Management piece start to decelerate and the wins from new business accelerate as the product gets enhanced and that better user interface is out in the market.

[Operator:]

[Operator Instructions] Our next question is from Donna Jaegers of D.A. Davidson.

[Donna Jaegers:]

On the customer losses due to the capacity constraints, how closely do you monitor capacity? I mean, it seems like something that you guys really fell down on to starve capacity so that you lose customers. So talk to us about how much you monitor capacity on a realtime basis.

[Robert A. Lento:]

So a couple of things. It's not just about capacity. There are certain software features that our customers were requiring that we were slow to deliver that we've now started to deliver. So we talked about one of them as an example, which is the digital rights management. At the beginning of the year, we did not have any capability around that. Today the 3 big players in the market, Google, Adobe and Microsoft, were covering 2 out of the 3 today, and by the end of the year we'll have all 3. That's an example of even if we had capacity for certain customers where DRM is important, they were not going to put the traffic through our network. And so it's both the physical infrastructure, as well as some of the software functionality. We feel very good about what we're doing to deliver both. Specific to your question about the network, we're being much more proactive about our capacity planning in terms of trying to better understand the needs of our customers and planning for what we believe we'll need as opposed to reacting. And then we've also changed some of the policies internally around the networks. So for example, instead of running at 95% capacity, we moved that bar down to 80%, and that gives us obviously much better ability to handle any spikes in traffic. And so we're doing lots of stuff around network planning, but also the way we do capacity planning, the way we monitor the network and the way we manage the network.

[Donna Jaegers:]

Okay. And then on the competitive front. Obviously, your 2 big competitors showed good results in the CDN world, so we know how they're doing. How much are you running into Amazon Web Services on as a competitor?

[Robert A. Lento:]

I think for us and the type of customers that we are talking to, our competitors remain pretty much the same. It's Akamai and Level 3. We firmly believe that from an architecture standpoint and specifically for large object delivery video that we are the best architected network in the world. And so we're competing quite well across that, although obviously, as you pointed the results comps show that yet. Certainly, there are other capable competitors out there that we run into from time-to-time, but I would say the 2 big competitors are still Akamai and Level 3 for the types of customers that we are talking to.

[Donna Jaegers:]

On the Netflix renewal, is that through the end of '14 or just into '14? And what assurances given that you've had problems getting profitable customers in the past, what assurances can you give us that this new contract extension with Netflix will be a good one for you guys?

[Robert A. Lento:]

Well, we wouldn't do it if it wasn't going to be good. Obviously, they wouldn't do it if it wasn't fair and reasonable on their side. So I would say that we're happy to be extending the relationship, and we believe that it's moving forward into 2014 based on terms that are fair and reasonable to both companies.

[Donna Jaegers:]

So not to the end of 2014, just into 2014?

[Douglas S. Lindroth:]

That's correct.

[Operator:]

And I'm not showing any further questions in the queue. I'd like to conclude today's program. Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. And everyone, have a great day.

[Robert A. Lento:]

Thank you.