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AKAM > SEC Filings for AKAM > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for AKAMAI TECHNOLOGIES INC

Form 10-Q for AKAMAI TECHNOLOGIES INC


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

This quarterly report on Form 10-Q, particularly Management's Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our unaudited consolidated financial statements included herein contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management as of the date hereof based on information currently available to our management. Use of words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," "should," "forecasts," "if," "continues," "goal," "likely" or similar expressions indicates a forward-looking statement. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions. Actual results may differ materially from the forward-looking statements we make. See "Risk Factors" elsewhere in this quarterly report on Form 10-Q for a discussion of certain risks associated with our business. We disclaim any obligation to update forward-looking statements as a result of new information, future events or otherwise.
We provide services for accelerating and improving the delivery of content and applications over the Internet. We primarily derive income from sales of services to customers executing 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 that apply to actual usage above the monthly minimum. In recent years, however, we have also entered into an increasing number of customer contracts that have minimum usage commitments that are based on quarterly, twelve-month or longer periods. 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 lost monthly, quarterly or annual recurring revenue due to customer cancellations or terminations and limiting the impact of price reductions reflected in contract renewals, and build on that base by adding new customers and increasing the number of services, features and functionalities that our existing customers purchase. At the same time, we must ensure that our expenses do not increase faster than, or at the same rate as, our revenues. Accomplishing these goals requires that we compete effectively in the marketplace on the basis of quality, price and the attractiveness of our services and technology.
Overview of Financial Results
The following sets forth, as a percentage of revenues, consolidated statements of operations data, for the periods indicated:

                                                   For the Three Months        For the Nine Months
                                                    Ended September 30,        Ended September 30,
                                                    2012           2011         2012          2011
Revenues                                           100.0  %       100.0  %     100.0 %       100.0  %
Cost of revenues                                    31.8           33.1         32.1          32.6
Research and development expense                     5.6            4.8          5.4           4.4
Sales and marketing expense                         22.0           19.3         22.0          19.3
General and administrative expense                  15.8           18.0         16.9          16.9
Amortization of other intangible assets              1.6            1.5          1.6           1.5
Restructuring charge                                   -            0.1            -             -
Total costs and operating expenses                  76.8           76.8         78.0          74.7
Income from operations                              23.2           23.2         22.0          25.3
Interest income                                      0.5            1.0          0.5           1.0
Other (expense) income, net                         (0.1 )         (0.1 )          -          (0.2 )
Gain on investments, net                               -            0.1            -           0.1
Income before provision for income taxes            23.6           24.2         22.5          26.2
Provision for income taxes                           9.6            9.2          8.9           9.4
Net income                                          14.0  %        15.0  %      13.6 %        16.8  %


We were profitable in 2011 and for the three and nine months ended September 30, 2012; however, we cannot guarantee continued profitability or profitability for any period in the future at the levels we have recently experienced. We have observed the following trends and events that are likely to have an impact on our financial condition, results of operations or cash flows in the foreseeable future:
Revenues and Customers
During each of the first three quarters of 2012, we were able to offset lost committed recurring revenues by adding new customers and increasing sales of incremental services to our existing customers. A continuation of this trend could lead to increased revenues. Overall revenues are also impacted favorably by amounts we are paid for items such as traffic usage in excess of committed amounts and one-time events but negatively impacted by price declines.

Our unit prices offered to some customers have declined as a result of increased competition. These price reductions primarily impacted customers for which we deliver high volumes of traffic over our network, such as digital media customers. If we continue to experience decreases in unit prices and are unable to offset such reductions with increased traffic, enhanced efficiencies in our network, lower co-location and bandwidth expenses, or increased sales of incremental services to existing customers, our revenues and profit margins would decrease.

During each of the first three quarters of 2012, we experienced an increase in the rate of traffic growth in our video and software download solutions as compared to the fourth quarter of 2011. If this trend does not continue, our ability to generate revenue growth could be adversely impacted.

Although our revenues in the second and third quarters of 2012 were higher than our revenues in the fourth quarter of 2011, we have historically experienced seasonal variations of higher revenues in the fourth quarter of the year and lower revenues during the summer months. We primarily attribute such variations to patterns of usage of e-commerce services by our retail customers. If this trend continues, our ability to generate quarterly revenue growth on a sequential basis could be impacted.

For the nine months ended September 30, 2012, revenues derived from customers outside the United States accounted for 28% of our total revenues. For the remainder of 2012, we anticipate revenues from such customers as a percentage of our total revenues to be consistent with the first nine months of 2012.

Costs and Expenses
During the first three quarters of 2012, we continued to reduce our network bandwidth costs per unit and to invest in internal-use software development to improve the performance and efficiency of our network. Our total bandwidth costs increased during the first three quarters of 2012 as compared to the first three quarters of 2011 due to traffic growth on our network. We believe that our overall bandwidth costs will continue to increase as a result of expected higher traffic levels, partially offset by anticipated continued reductions in bandwidth costs per unit. If we do not experience lower per unit bandwidth pricing or we are unsuccessful at effectively routing traffic over our network through lower cost providers, total network bandwidth costs could increase more than expected for the remainder of 2012.

Co-location costs are a significant percentage of total cost of revenues. By improving our internal-use software and managing our hardware deployments to enable us to use servers more efficiently, we believe we can manage the growth of co-location costs by deploying fewer servers. If we are unable to achieve such cost reductions, our profitability will be negatively impacted.

Depreciation and amortization expense related to our network equipment and internal-use software development costs increased by $20.1 million during the first three quarters of 2012 as compared to the first three quarters of 2011. Due to expected future purchases of network equipment during 2012, we believe that depreciation expense related to our network equipment will continue to increase during the remainder of 2012. We also expect to continue to enhance and add functionality to our service offerings, which would increase our internal-use software development costs attributable to employees working on such projects. As a result, we believe that the amortization of internal-use software development costs, which we include in cost of revenues, will be higher in 2012 as compared to 2011. All of these increased costs could negatively affect our profitability.

We expect to continue to grant restricted stock units, or RSUs, to employees in the future; therefore, we anticipate that stock-based compensation expense will increase compared to 2011 levels. As of September 30,


2012, our total unrecognized compensation costs for stock-based awards were $141.0 million, which we expect to recognize as expense over a weighted average period of 1.3 years. We expect to recognize this expense through 2016.
During the nine months ended September 30, 2012, our effective income tax rate was 39.4%. We expect our annual effective income tax rate in 2012 to remain relatively consistent in the remaining quarter of 2012; this expectation does not take into consideration the effect of discrete items recorded as a result of our compliance with the accounting guidance for stock-based compensation, any tax planning strategies or the effect of changes in tax laws and regulations.

Based on our analysis of, among other things, the aforementioned trends and events, as of the date of this quarterly report on Form 10-Q, we expect to continue to generate net income on a quarterly and annual basis during 2012; however, our future results are likely to be affected by the factors discussed in the paragraphs above as well as those identified in the section captioned "Risk Factors" and elsewhere in this quarterly report on Form 10-Q, including our ability to:
innovate and respond to emerging technological trends and customers' changing needs;

manage expected growth and other changes to our business;

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

maintain our network bandwidth and co-location costs and other operating expenses consistent with our revenues.

As a result, there is no assurance that we will achieve our expected financial objectives, including generating positive net income, in any future period. Our management's discussion and analysis of our financial condition and results of operations is based upon our unaudited consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which we have prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim periods and with Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The preparation of these unaudited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related items, including, but not limited to, revenue recognition, accounts receivable and related reserves, valuation and impairment of investments and marketable securities, goodwill and other intangible assets, capitalized internal-use software costs, impairment and useful lives of long-lived assets, tax reserves, loss contingencies and stock-based compensation costs. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances at the time they are made. Actual results may differ from our estimates. See the section entitled "Application of Critical Accounting Policies and Estimates" in our annual report on Form 10-K for the year ended December 31, 2011 for further discussion of our critical accounting policies and estimates.
Recent Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board, or FASB, issued amended guidance and disclosure requirements for fair value measurements. This guidance provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between U.S. GAAP and international financial reporting standards. The guidance changes certain fair value measurement principles and enhances the disclosure requirements, particularly for Level 3 fair value measurements. We adopted this guidance during the first quarter of 2012. The adoption of the guidance did not have a material impact on our consolidated financial statements. In June 2011, the FASB issued amended disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income, or OCI, as part of the statement of changes in equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. We adopted this guidance during the first quarter of 2012. There was no impact on our consolidated financial results as the amendments relate only to changes in financial statement presentation.
In September 2011, the FASB issued amended guidance that simplifies how entities test goodwill for impairment. Under the amended guidance, after assessment of certain qualitative factors, if an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative tests are optional. We adopted this guidance during


the first quarter of 2012. The adoption of the guidance did not have a material impact on our financial condition or results of operations.
In July 2012, the FASB issued amended guidance on the periodic testing of indefinite-lived intangible assets for impairment. This guidance will allow entities to assess qualitative factors to determine if it is more likely than not that the indefinite-lived intangible asset might be impaired and whether it is necessary to perform the quantitative impairment test required under current accounting standards. The updated accounting guidance is effective for interim and annual periods beginning after September 15, 2012 with early adoption permitted. We will adopt the updated guidance in the fourth quarter of fiscal year 2012. The adoption of the guidance is not expected to have a material impact on our consolidated financial statements. Results of Operations
Revenues. Total revenues increased 23%, or $63.5 million, to $345.3 million for the three months ended September 30, 2012 as compared to $281.9 million for the three months ended September 30, 2011. Total revenues increased 19%, or $161.3 million, to $996.1 million for the nine months ended September 30, 2012 as compared to $834.8 million for the nine months ended September 30, 2011. The following table quantifies the contribution to growth in revenues during the periods presented from the different industry verticals in which we sell our services (in millions):

                             For the                  For the
                        Three Months Ended       Nine Months Ended
                        September 30, 2012       September 30, 2012
                       as compared to 2011      as compared to 2011
Media & Entertainment $                31.0    $                70.0
Commerce                               12.6                     37.5
Enterprise                              8.4                     21.5
High Tech                               8.4                     24.3
Public Sector                           3.1                      8.0
Total net increase    $                63.5    $               161.3

A significant portion of the increase in revenues attributable to our media and entertainment vertical was driven by traffic growth stemming from increased online media consumption. Revenues from our commerce and enterprise verticals increased due to growth in application and cloud performance solutions sold to customers in these verticals. Revenues from our high tech vertical grew due to increased demand for cloud performance solutions and higher software download volumes. Our revenues from the public sector vertical for the three and nine months ended September 30, 2012 as compared to the same periods in 2011 grew due to the timing of completion of certain elements of government agency contracts. For the three and nine months ended September 30, 2012, approximately 29% and 28%, respectively, of our revenues were derived from our operations located outside of the United States, including 16% and 17%, respectively, derived from Europe. For each of the three- and nine-month periods ended September 30, 2011, approximately 29% and 29%, respectively, of our revenues were derived from operations outside of the United States, including 18% derived from Europe in each of these periods. No single country outside of the United States accounted for 10% or more of revenues during any of these periods. For each of the three- and nine-month periods ended September 30, 2012, resellers accounted for 22% and 21%, respectively, of revenues as compared to 19% of revenues for each of the three- and nine-month periods ended September 30, 2011. For each of the three- and nine-month periods ended September 30, 2012 and 2011, no single customer accounted for 10% or more of revenues.
Cost of Revenues. Cost of revenues was comprised of the following (in millions) for the periods presented:


                                              For the Three Months             For the Nine Months
                                              Ended September 30,              Ended September 30,
                                               2012           2011              2012             2011
Bandwidth and service-related fees        $       28.4     $    21.8     $      84.4          $    63.5
Co-location fees                                  32.9          33.7            99.7               96.3
Payroll and related costs of network
operations personnel                               5.1           3.9            14.5               11.3
Stock-based compensation, including
amortization of prior capitalized amounts          2.6           2.2             7.8                7.3
Depreciation and impairment of network
equipment                                         30.8          24.8            86.3               71.2
Amortization of internal-use software             10.2           6.9            27.3               22.4
Total cost of revenues                    $      110.0     $    93.3     $     320.0          $   272.0

Cost of revenues increased 18%, or $16.7 million, to $110.0 million for the three months ended September 30, 2012 as compared to $93.3 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, cost of revenues increased 18%, or $48.0 million, to $320.0 million as compared to $272.0 million for the nine months ended September 30, 2011. For each period, this increase was primarily due to:

          an increase in amounts paid to network providers for bandwidth due to
           higher traffic levels, partially offset by reduced bandwidth costs per
           unit; and


          an increase in depreciation expense of network equipment as we
           continued to invest in our infrastructure.

We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2012 and for the years ending December 31, 2013, 2014, 2015 and 2016, our minimum commitments related to bandwidth usage and co-location services as of September 30, 2012 were approximately $38.6 million, $57.3 million, $4.4 million, $0.3 million and $0.1 million, respectively.
We believe that cost of revenues will increase during the fourth quarter of 2012 as compared to each of the first three quarters of 2012. We expect to deploy more servers and deliver more traffic on our network, which would result in higher expenses associated with the increased traffic; however, such costs are likely to be partially offset by lower bandwidth costs per unit. Additionally, for the fourth quarter of 2012, we anticipate increases in depreciation expense related to our network equipment and amortization of internal-use software development costs, along with increased payroll and related costs, as we continue to make investments in our network with the expectation that our customer base will continue to expand.
Research and Development. Research and development expenses consist primarily of payroll and related costs and stock-based compensation expense for research and development personnel who design, develop, test and enhance our services and our network. Research and development expenses increased 43%, or $5.8 million, to $19.4 million for the three months ended September 30, 2012 as compared to $13.5 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, research and development expenses increased 46%, or $17.2 million, to $54.4 million as compared to $37.1 million for the nine months ended September 30, 2011. The increases during the three and nine months ended September 30, 2012 as compared to the same periods in 2011 were due to increases in payroll and related costs and stock-based compensation, partially offset by increases in capitalized salaries and related costs.
Research and development costs are expensed as incurred, other than certain internal-use software development costs eligible for capitalization. During the three and nine months ended September 30, 2012, we capitalized software development costs of $12.5 million and $37.4 million, respectively. During the three and nine months ended September 30, 2011, we capitalized software development costs of $8.8 million and $28.1 million, respectively. These development costs consisted of external consulting expenses and payroll and payroll-related costs for personnel involved in the development of internal-use software used to deliver our services and operate our network. Additionally, during the three and nine months ended September 30, 2012, we capitalized $2.5 million and $6.4 million, respectively, of stock-based compensation as compared to $1.8 million and $5.2 million, respectively, for the three and nine months


ended September 30, 2011. These capitalized internal-use software costs are amortized to cost of revenues over their estimated useful lives of two years. The following table quantifies the changes in the various components of our research and development expenses for the periods presented (in millions):

                                                           For the                   For the
                                                     Three Months Ended         Nine Months Ended
                                                     September 30, 2012        September 30, 2012
                                                     as compared to 2011       as compared to 2011
Payroll and related costs                          $              6.9        $             18.9
Stock-based compensation                                          1.8                       5.7
Capitalized salaries and related costs                           (3.0 )                    (8.5 )
Other expenses                                                    0.1                       1.1
Total net increase                                 $              5.8        $             17.2

We believe that research and development expenses, in absolute dollar terms, will increase during the fourth quarter of 2012 as compared to each of the first three quarters of 2012 because we expect to continue to hire additional development personnel in order to make improvements to our core technology, develop new services and make refinements to our existing service offerings. Sales and Marketing. Sales and marketing expenses consist primarily of payroll and related costs, stock-based compensation expense and commissions for personnel engaged in marketing, sales and support functions, as well as advertising and promotional expenses.
Sales and marketing expenses increased 39%, or $21.4 million, to $75.9 million for the three months ended September 30, 2012 as compared to $54.5 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, sales and marketing expenses increased 36%, or $58.4 million, to $219.1 million as compared to $160.7 million for the nine months ended September 30, 2011. The increase in sales and marketing expenses during the three and nine months ended September 30, 2012 as compared to the same periods in 2011 was primarily due to higher payroll and related costs, increases in stock-based compensation and marketing and related costs.
The following table quantifies the changes in the various components of our sales and marketing expenses for the periods presented (in millions):

                                   For the                  For the
                              Three Months Ended       Nine Months Ended
                              September 30, 2012       September 30, 2012
                             as compared to 2011      as compared to 2011
Payroll and related costs   $                15.6    $                34.8
Stock-based compensation                      3.9                     12.9
Marketing and related costs                   1.9                      8.1
Other expenses                                  -                      2.6
Total net increase          $                21.4    $                58.4

We believe that sales and marketing expenses will increase, in absolute dollar terms, during the fourth quarter of 2012 as compared to the first three quarters of 2012 due to an expected increase in commissions on higher forecasted sales of our services and an increase in payroll and related costs due to continued headcount growth in our sales and marketing organization.
General and Administrative. General and administrative expenses consist primarily of the following components:
payroll, stock-based compensation expense and other related costs, including expenses for executive, finance, legal, business applications, network management, human resources and other administrative personnel;

depreciation and amortization of property and equipment we use internally;

fees for professional services;


. . .

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