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LLNW > SEC Filings for LLNW > Form 10-Q on 9-Nov-2011All Recent SEC Filings

Show all filings for LIMELIGHT NETWORKS, INC.

Form 10-Q for LIMELIGHT NETWORKS, INC.


9-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this quarterly report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2010 included in our annual report on Form 10-K filed with the Securities and Exchange Commission (SEC) on March 11, 2011. This quarterly report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements as to industry trends and future expectations of ours and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" set forth in Part II, Item 1A of this quarterly report on Form 10-Q and in our other SEC filings. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Prior period information has been modified to conform to current year presentation.

Overview

We were founded in 2001 as a provider of content delivery network (CDN) services to deliver digital content over the Internet. We began development of our infrastructure in 2001 and began generating meaningful revenue in 2002. We derive revenue from the sale of services to our customers. These services include the delivery of digital media, including video, music, games, software and social media, the acceleration of web sites and web-based applications, and value-added services such as mobility, storage, video and web content management and consulting. We also provide on-demand software, platform, and infrastructure services that help global businesses reach and engage audiences on mobile or connected devices, enabling them to enhance their brand presence, build stronger customer relationships, manage video assets, analyze viewer preferences, optimize their advertising, and monetize their digital assets. We operate in one business segment. We provide services to customers in North America, EMEA, and the Asia Pacific region. As of September 30, 2011, we had approximately 1,602 active customers worldwide.

Our CDN and web content management customers generally execute contracts with terms of one year or longer, which we refer to as recurring revenue contracts or long-term contracts. These contracts generally commit the customer to a minimum monthly level of usage with additional charges applicable for actual usage above the monthly minimum commitment. We define usage as customer data sent or received using our CDN service, or content that is hosted or cached by us at the request or direction of our customer. Usage is tracked using a software system that measures either the gigabytes transferred (GB Transfer) or megabits per second (Mbps) of usage per customer per month. GB Transfer measures usage by counting each GB of a customer's content that is sent or received using our network. Mbps measures usage by determining the rate at which a customer's content moves across our network. We have entered into an increasing number of customer contracts that have minimum usage commitments that are based on twelve-month or longer periods and in some cases, other arrangements. The nature of services provided as part of the minimum commitment may vary by customer; but substantially all of the services provided by us and associated with a minimum commitment


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are core CDN services. We believe that having a consistent and predictable base level of revenue is important to our financial success. Accordingly, to be successful, we must maintain our base of recurring revenue contracts by eliminating or reducing any customer cancellations or terminations and build on that base by adding new customers and increasing the number of services, features and functionalities our existing customers purchase. We also derive revenue from services and events sold as discrete, non-recurring events or based solely on usage. For these services, we recognize revenue after an enforceable contract has been signed by both parties, the fee is fixed or determinable, the event or usage has occurred and collection is reasonably assured.

We have continued to expand our value-added services as more content and advertising dollars shift online, there is continued growth in mobile devices, and software applications and information technology services are shifting to cloud computing. We believe that these industry-wide trends may drive demand for our value-added services. In the third quarter of 2011, we introduced new releases of software-as-a-service (SaaS), and platform-as-a-service solutions that are synergistic with our CDN, such as the Limelight Video Platform, our online video platform solution, Limelight Dynamic Site Platform, our web content management platform, Limelight Dynamic Site for Mobile, our mobile publishing service, Limelight Accelerate, our web and application acceleration service and Limelight Agile Storage, our cloud storage solution, which we believe may drive growth and higher margins over time.

In addition to expanding our value-added services, we have also continued to expand the capacity and capabilities, and to enhance the performance and efficiency of our CDN platform. Although we believe that we may have improved margins in our CDN as we expand our customer base and use a greater proportion of our capacity, we expect the majority of our margin increases to result from our value-added services increasing as a percentage of our revenue.

On September 12, 2011, our board of directors approved a repurchase plan in compliance with Rules 10b-18 and 10b5-1 of the Securities Exchange Act of 1934 that authorizes us to repurchase up to $25 million of our shares of common stock, exclusive of any commissions, markups or expenses, from time to time through March 12, 2012. Any repurchased shares will be cancelled and return to authorized but unissued status. During the three month period ended September 30, 2011, we repurchased and cancelled 3,809,800 shares at an average price per share of approximately $2.40 per share. The price range of the shares repurchased was between $2.23 and $2.55 per share. The total amount expended before commissions, markups and expenses was approximately $9,133,841.

On September 1, 2011, we completed the sale of our EyeWonder LLC and chors GmbH video and rich media advertising services business (EyeWonder and chors) to DG FastChannel, Inc. (DG) for net proceeds of $61.0 million ($66.0 million gross cash proceeds less $5.0 million held in escrow) plus an estimated $10.9 million receivable. Accordingly, the results related to the sale of EyeWonder and chors for the third quarter and prior periods have been reclassified to discontinued operations and have not been included in our management's discussion and analysis of financial condition and results of operations. At the time of purchase, we were pursuing a strategy of business growth through our core content delivery services and our value added services offerings which through the acquisition provided us access directly to the "Rich Media" advertising market. Rich Media refers to online advertising that uses a range of interactive digital media, including streaming video and audio. We subsequently determined to concentrate our value added services in mobility, web and video content management, web application acceleration, cloud storage, and consulting which we collectively refer to as our software-as-a-service solutions (SaaS). This transaction will enable us to focus on continuing to grow and invest in our globally distributed computing platform and our rapidly expanding SaaS solutions. See Note 5 of Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this quarterly report on Form 10-Q for additional information about the sale of our EyeWonder and chors rich media advertising services business.

On March 2, 2011 we completed an underwritten public offering of our common stock in which we sold and issued 11,500,000 shares of our common stock, including 1,500,000 shares subject to the underwriters' over-allotment option, at a price to the public of $7.10 per share. The newly issued common shares began trading on the Nasdaq Global Select Market on March 2, 2011. We raised a total of approximately $81.7 million in gross proceeds from the offering, or approximately $77.1 million in net proceeds after deducting underwriting discounts and commissions of approximately $4.0 million and other offering costs of approximately $0.6 million. The offering was made pursuant to the effective registration statement on Form S-3 (Registration Statement No. 333-170609) previously filed with and declared effective by the SEC on November 26, 2010 and the prospectus supplement thereunder filed with the SEC on February 28, 2011.

On May 2, 2011, we acquired all of the issued and outstanding shares of Clickability Inc. (Clickability), a privately-held SaaS provider of web content management located in San Francisco, California. The aggregate purchase price consisted of approximately $4.9 million of cash paid at the closing (cash paid net of cash acquired was $2.8 million), $0.1 million held by us to cover future claims and 732,000 shares of our common stock with an estimated fair value of approximately $4.6 million on the date of acquisition. We issued 382,000 common shares at the closing with an estimated fair value of approximately $2.4 million. Under the terms of the merger agreement, approximately 350,000 shares of the common stock portion of the purchase price or approximately $2.2 million and $0.1 million of cash will remain unissued for a period of up to 18 months following the closing date to satisfy any unresolved future claims. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this quarterly report on Form 10-Q for additional information about our Clickability acquisition. As of September 30, 2011, there had been no claims made against the unissued shares.

On May 9, 2011, we acquired all of the issued and outstanding shares of AcceloWeb, (IL) Ltd. (AcceloWeb), a Tel Aviv, Israel based privately-held provider of advanced technology that helps speed the presentation of web sites and applications. The aggregate purchase price consisted of approximately $5.0 million of cash paid at the closing (cash paid net of cash acquired was $4.7 million) and 1,100,629 shares of our common stock issued at closing with an estimated fair value of approximately $7.0 million on the acquisition date. In addition, the purchase price included contingent consideration with an aggregate value of $0.8 million ($0.4 million payable in cash and $0.4 million payable in our common stock) which may be earned upon the achievement of certain performance milestones which will be measured quarterly during the eight full consecutive quarters ending June 30, 2013. The fair value of the contingent consideration at September 30, 2011 was $0.8 million. See Note 4 of Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this quarterly report on Form 10-Q for additional information about our AcceloWeb acquisition.


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Traffic on our network and our value-added services business has continued to grow. This traffic growth is primarily the result of growth in the traffic delivered to existing customers and to a lesser extent on behalf of new customers. Our CDN revenue is generated by charging for traffic delivered. While our traffic continued to grow, our revenue generated from such traffic grew at a much slower rate as a result of unit price compression. Our value-added services revenue represented substantially all of our revenue growth during the three month period ended September 30, 2011. During 2010, we added new customers both through new business and through our business acquisitions. During the three month period ended September 30, 2011, we continued to add new customers and also elected not to renew certain customers as we continue to focus on customer quality. Our average number of products per customer is 1.8.

Historically, we have derived a portion of our revenue from outside of the United States. Our international revenue has grown recently, and we expect this trend to continue as we focus on our strategy of expanding our network and customer base internationally. For the year ended December 31, 2010, revenue derived from customers outside North America accounted for approximately 27% of our total revenue. For the year ended December 31, 2010 we derived approximately 57% of our international revenue from EMEA and approximately 43% of our international revenue from Asia Pacific. For the three month periods ended September 30, 2011 and 2010, revenue derived from customers outside North America accounted for approximately 32% and 30%, respectively, of our total revenue. For the nine month periods ended September 30, 2011 and 2010 revenue derived from customers outside North America accounted for approximately 31% and 28%, respectively, of our total revenue. For the three and nine month periods ended September 30, 2011, we derived approximately 46% and 50%, respectively, of our international revenue from EMEA and approximately 54% and 50%, respectively, of our international revenue from Asia Pacific. We expect foreign revenue to continue to increase in absolute dollars in 2011. Our international business is managed as a single-geographic segment, and we report our financial results on this basis.

During any given fiscal period, a relatively small number of customers typically account for a significant percentage of our revenue. For example, in 2010 sales to our top 10 customers, in terms of revenue, accounted for approximately 34% of our total revenue and we had no customer that accounted for more than 10% of our revenue. For the three and nine month periods ended September 30, 2011, sales to our top 10 customers, in terms of revenue, accounted for approximately 35% and 34%, respectively, of our total revenue. During the three and nine month periods ended September 30, 2011 we had one customer, Netflix, Inc. (Netflix) that accounted for more than 10% of our revenue during the period. During the three and nine month periods ended September 30, 2011, Netflix represented approximately 12% and 11%, respectively, of our total revenue. We anticipate customer concentration levels will remain consistent with 2010. In addition to selling to our direct customers, we maintain relationships with a number of resellers that purchase our services for resale to their end customers. Revenue generated from sales to reseller customers accounted for approximately 5% of our total revenue for the year ended December 31, 2010. For the three and nine month periods ended September 30, 2011, revenue generated from sales to reseller customers accounted for approximately 4% of our total revenue.

In addition to these revenue related business trends, our cost of revenue increased in absolute dollars and as a percentage of revenue for the three and nine month periods ended September 30, 2011 compared to the three and nine month periods ended September 30, 2010. The three month period ended September 30, 2011 includes a full quarter of cost of revenue for Clickability and AcceloWeb that we acquired in May 2011. The nine month period ended September 30, 2011 includes five months of cost of revenue for Clickability and AcceloWeb. The increase in absolute dollars was primarily due to increased bandwidth and co-location fees, due to increased traffic and expansion of our CDN, increased depreciation expense on our network equipment, as we continue to build-out our expanding network and refresh our network equipment, and increased payroll and related employee costs for operations personnel, who are responsible for managing and monitoring our CDN and delivery of our value-added services.

Operating expenses increased in absolute dollars and as a percentage of revenue for the three month period ended September 30, 2011 compared to the three month period ended September 30, 2010. The three month period ended September 30, 2011 includes a full quarter of operating expenses from our recent acquisitions of Clickability and AcceloWeb. This increase was primarily due to increased general and administrative costs (primarily increased bad debt expense, increased facilities and facilities related costs and increased litigation expenses), increased research and development costs (primarily payroll and related employee costs due to increased staffing), and increased non-network related depreciation and amortization (primarily due to increased amortization of intangible assets from our business acquisitions). These increases in general and administrative expense and research and development expense were offset by lower sales and marketing expenses. The decrease in sales and marketing expense was primarily due to decreased payroll and related employee costs.

For the nine month period ended September 30, 2011, operating expenses increased in absolute dollars and remained constant as a percentage of revenue compared to the nine month period ended September 30, 2010. The nine month period ended September 30, 2011 includes five months of operating expenses from our recent acquisitions of Clickability and AcceloWeb. This increase was primarily due to increased general and administrative costs (primarily payroll and related employee costs, due to increased staffing, and increased facility and facilities related costs, offset by lower litigations expenses and lower bad debt expense), increased sales and marketing expenses (primarily increased marketing expenses and increased employee events, offset by a decrease in share-based compensation), increased research and development costs (primarily payroll and related employee costs due to increased staffing and increased share-based compensation) and increased non-network related depreciation and amortization (primarily due to increased amortization of intangible assets from our business acquisitions).


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We make our capital investment decisions based upon careful evaluation of a number of variables, such as the amount of traffic we anticipate on our network, the cost of the physical infrastructure required to deliver that traffic, and the forecasted capacity utilization of our network. Our capital expenditures have varied over time, in particular as we purchased servers and other network equipment associated with our network build-out. For example, in 2008, 2009, and 2010 we made capital purchases of $17.4 million, $20.4 million, and $33.6 million, respectively. For the nine month period ended September 30, 2011, we made capital investments of $26.9 million. We expect to have ongoing capital expenditure requirements as we continue to invest in, refresh and expand our CDN. For 2011, we currently anticipate making aggregate capital expenditures of approximately 17%-18% of total revenue for the year.

For the three and nine month periods ended September 30, 2011, we generated revenue from certain customers that are entities related to certain of our executives or members of our board of directors. For the three and nine month periods ended September 30, 2011, revenue generated from related parties was less than 1% of our total revenue. For the year ended December 31, 2010, we did not generate any revenue from related parties.

We are currently engaged in litigation with one of our principal competitors, Akamai Technologies, Inc. (Akamai) and its licensor, the Massachusetts Institute of Technology (MIT) in which these parties have alleged that we are infringing three of their patents. In February 2008, a jury returned a verdict in this lawsuit, finding that we infringed four claims of the patent at issue (United States Patent No. 6,108,703 (the '703 patent) and rejecting our invalidity defenses. The court conducted a bench trial in November 2008, regarding our equitable defenses; and we filed a motion for reconsideration of the court's earlier denial of our motion for Judgment as a Matter of Law (JMOL). Our motion for reconsideration of JMOL was based largely upon a clarification in the standard for a finding of joint infringement articulated by the Federal Circuit in the case of Muniauction, Inc. v. Thomson Corp. (the Muniauction Case), released after the court denied our initial motion for JMOL. On April 24, 2009 the court issued its order and memorandum setting aside the adverse jury verdict and ruling that we did not infringe Akamai's '703 patent and that we are entitled to judgment as a matter of law. Based upon the court's April 24, 2009 order we reversed the $65.6 million provision for litigation previously recorded for this lawsuit as we no longer believe that payment of any amounts represented by the litigation provision is probable. The court entered final judgment in favor of us on May 22, 2009. Akamai filed a notice of appeal of the court's decision on May 26, 2009; and the Court of Appeals for the Federal Circuit heard arguments by both parties on June 7, 2010. On December 20, 2010 the Court of Appeals for the Federal Circuit issued its opinion affirming the District Court's entry of judgment in our favor. On February 18, 2011, Akamai filed a motion with the Court of Appeals for the Federal Circuit seeking a rehearing and rehearing en banc. On April 21, 2011, the Court of Appeals for the Federal Circuit issued an order denying the petition for rehearing, granting the petition for rehearing en banc, vacating the December 20, 2010 opinion affirming the District Court's entry of judgment in our favor, and reinstated the appeal. The Federal Circuit will hear oral arguments on November 18, 2011, and issue its opinion after that date. We believe that we do not infringe Akamai's patents and will continue to vigorously defend our position. We are not able at this time to estimate the range of potential loss nor, in light of the favorable United States district court order, do we believe that a loss is probable. Therefore, we have made no provision for this lawsuit in our financial statements.

Our future results will be affected by many factors, including those identified in the section captioned "Risk Factors," in this quarterly report on Form 10-Q, and our ability to:

increase our revenue by adding customers and limiting customer cancellations and terminations, as well as increasing the amount of monthly recurring revenue that we derive from our existing customers;

manage the prices we charge for our services, as well as the costs associated with operating our network in light of increased competition;

successfully manage our litigation with Akamai to a favorable conclusion;

prevent disruptions to our services and network due to accidents or intentional attacks;

continued ability to deliver a portion of our traffic through settlement free peering relationships which significantly reduce our cost of delivery; and

successfully integrate the businesses we have acquired.

As a result, we cannot assure you that we will achieve our expected financial objectives, including positive net income.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which have been prepared by us in accordance with United States generally accepted accounting principles (GAAP) for interim periods. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, cash flow and related disclosure


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of contingent assets and liabilities. Our estimates include those related to revenue recognition, accounts receivable and related reserves, useful lives and realizability of long-term assets, capitalized software, acquired intangibles, provision for litigation, income and other taxes, the fair value of stock-based compensation and other contingent liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. We review these estimates and judgments on an ongoing basis. We also have other policies that we consider key accounting policies, such as our policy regarding foreign currency translation described below; however, we do not believe this policy requires us to make estimates or judgments that are as difficult or subjective as those noted above and disclosed in our annual report on Form 10-K for the year ended December 31, 2010, filed with the SEC on March 11, 2011.

Foreign Currency Translation

We analyze the functional currency for each of our international subsidiaries periodically to determine if a significant change in facts and circumstances indicate that the primary economic currency has changed. As of December 31, 2010, the international subsidiaries we acquired as part of the EyeWonder, Inc. and chors acquisitions had local currencies as their functional currencies, while our remaining international subsidiaries had the United States dollar as their functional currencies. During the first quarter of 2011, we analyzed the various economic factors of our international subsidiaries and determined that the operations of our subsidiaries that were previously determined to operate in a United States dollar functional currency environment had changed and that their functional currencies should be changed to the local currencies. Effective January 1, 2011, the adjustment from translating these subsidiaries' financial statements from the local currency to the United States dollar was recorded as a separate component of accumulated other comprehensive loss. These foreign currency translation adjustments reflect the translation of the balance sheet at period end exchange rates and the income statement at an average exchange rate in effect during each period. Upon the change in functional currency, we recorded a cumulative translation adjustment (CTA) of approximately $0.5 million, which is included in the condensed consolidated balance sheet. Because of the change in exchange rates between reporting periods and changes in certain account balances, the foreign currency translation adjustment will change from period to period.

As of September 30, 2011, there have been no material changes to any of the critical accounting policies as described in our annual report on Form 10-K for the year ended December 31, 2010, filed with the SEC on March 11, 2011.

Results of Continuing Operations

Revenue



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