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AKAM > SEC Filings for AKAM > Form 10-Q on 10-May-2013All Recent SEC Filings

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Form 10-Q for AKAMAI TECHNOLOGIES INC


10-May-2013

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. This allows us to have a consistent and predictable base level of revenue which is important to our financial success. Accordingly, to be successful, we must maintain our base of recurring revenue contracts by eliminating or reducing 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.
Recent Events
On April 12, 2013, C. Kim Goodwin notified us that she is voluntarily resigning from our Board of Directors effective as of May 10, 2013.


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
                                                Ended March 31,
                                              2013           2012
Revenues                                     100.0  %       100.0  %
Cost of revenues                              32.7           39.1
Research and development expense               6.0            5.5
Sales and marketing expense                   17.0           15.3
General and administrative expense            15.1           16.2
Amortization of acquired intangible assets     1.6            1.5
Restructuring charge                           0.1              -
Total costs and operating expenses            72.5           77.6
Income from operations                        27.5           22.4
Interest income                                0.4            0.5
Other expense, net                               -           (0.1 )
Gain on investments, net                         -              -
Income before provision for income taxes      27.9           22.8
Provision for income taxes                     8.5            9.3
Net income                                    19.4  %        13.5  %

We were profitable in 2012 and for the three months ended March 31, 2013; 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 the first quarter of 2013, 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 were also impacted favorably by amounts we were paid for items such as traffic usage in excess of committed amounts and one-time events but negatively impacted by price declines.

In recent years, our unit prices offered to some customers 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. To increase or maintain revenues and our profit margin, it is important that we continue to offset price declines with increased traffic, enhanced efficiencies in our network, lower co-location and bandwidth expenses and increased sales of incremental services to existing customers.

During the first quarter of 2013, we experienced an increase in the rate of traffic growth in our video and software download solutions as compared to the fourth quarter of 2012. If this trend continues, our ability to generate revenue growth would be enhanced.

We historically experience 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 three months ended March 31, 2013, revenues derived from customers outside the United States accounted for 30% of our total revenues. For the remainder of 2013, we anticipate revenues from such customers as a percentage of our total revenues to be consistent with the first three months of 2013.


Costs and Expenses
During the first quarter of 2013, 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 quarter of 2013 as compared to the first quarter of 2012 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. To achieve these lower bandwidth costs per unit, we must effectively route traffic over our network through lower cost providers.

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. We will need to continue to achieve such cost reductions to maintain and improve our profitability.

Depreciation and amortization expense related to our network equipment and internal-use software development costs decreased by $5.7 million during the first quarter of 2013 as compared to the first quarter of 2012. We implemented software and hardware initiatives to manage our global network more efficiently, and as a result, the expected average useful life of our network assets, primarily servers, increased from three to four years effective January 1, 2013. This change is expected to decrease depreciation expense related to our network equipment during 2013, as compared to 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 2013 as compared to 2012.

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 2012 levels. As of March 31, 2013, our total unrecognized compensation costs for stock-based awards were $190.9 million, which we expect to recognize as expense over a weighted average period of 1.4 years. We expect to recognize this expense through 2017.

During the three months ended March 31, 2013, our effective income tax rate was 30.4%. We expect our annual effective income tax rate in 2013 to increase slightly in the remaining quarters of 2013 due to the full benefit of the 2012 federal research and development credit booked as a discrete item in the first quarter of 2013 as a result of the reinstatement of the credit on January 2, 2013; this expectation does not take into consideration the effect of other 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 2013; 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:
increase our revenue by adding customers through recurring revenue contracts and limiting customer cancellations and terminations;

offset unit price declines for our services with higher volumes of traffic delivered over our network as well as increased sales of value-added services;

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 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, marketable securities and note receivable, goodwill and acquired 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, 2012 for further discussion of our critical accounting policies and estimates.
Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board, or FASB, issued guidance and disclosure requirements for reporting of comprehensive income:
amounts reclassified out of accumulated other comprehensive income. The guidance requires that an entity provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP. The guidance became effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The adoption of this guidance in the first quarter of 2013 did not have a material impact on our consolidated financial results. Results of Operations
Revenues. Total revenues increased 15%, or $48.6 million, to $368.0 million for the three months ended March 31, 2013 as compared to $319.4 million for the three months ended March 31, 2012. The following tables quantify the contribution to revenues during the periods presented from our different service offerings and industry verticals in which we sell our services, respectively (in millions):

                                      For the Three Months
                                        Ended March 31,
                                        2013             2012
Media Delivery Solutions         $     181.2           $ 154.9
Performance & Security Solutions       156.6             134.0
Service & Support Solutions             27.5              20.4
Advertising Decision Solutions           2.7              10.1
Total revenues                   $     368.0           $ 319.4

The increase in Media Delivery Solutions revenues for the three months ended March 31, 2013 as compared to the same period in 2012 was due to increased online media consumption and higher software download volumes. The increase in Performance and Security Solutions revenues for the three months ended March 31, 2013 as compared to the same period in 2012 was due to increase in demand for web experience and security solutions. The increase in the Service and Support Solutions revenues for the three months ended March 31, 2013 as compared to the same period in 2012 was due to strong traction in service attachment rates to core media, performance and security offerings.


                           For the Three Months
                             Ended March 31,
                             2013             2012
Media & Entertainment $     160.2           $ 134.5
Commerce                     76.8              71.5
Enterprise                   53.6              42.5
High Tech                    59.6              54.6
Public Sector                17.8              16.3
Total revenues        $     368.0           $ 319.4

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, particularly security related 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 months ended March 31, 2013 did not materially change as compared to the same period in 2012.
For the three months ended March 31, 2013, approximately 30% of our revenues were derived from our operations located outside of the United States, including 17% derived from Europe. For the three months ended March 31, 2012, approximately 28% of our revenues were derived from operations outside of the United States, including 17% derived from Europe. No single country outside of the United States accounted for 10% or more of revenues during any of these periods. For the three months ended March 31, 2013, resellers accounted for 20% of revenues as compared to 21% of revenues for the three months ended March 31, 2012. For the three-month periods ended March 31, 2013 and 2012, 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
                                                Ended March 31,
                                               2013           2012
Bandwidth, network built-out and
service-related fees                       $      29.2     $   31.3
Co-location fees                                  32.6         33.8
Payroll and related costs of network
operations personnel                               5.3          4.5
Payroll and related costs of service
personnel                                         20.0         16.3
Stock-based compensation, including
amortization of prior capitalized amounts          4.4          4.4
Depreciation and impairment of network
equipment                                         18.5         26.8
Amortization of internal-use software             10.4          7.8
Total cost of revenues                     $     120.4     $  124.9

Cost of revenues decreased 4%, or $4.5 million, to $120.4 million for the three months ended March 31, 2013 as compared to $124.9 million for the three months ended March 31, 2012.
This net decrease was primarily due to decreases in:

          depreciation expense of network equipment of approximately $14.1
           million due to software and hardware initiatives we have implemented
           to manage our global network more efficiently, resulting in an
           increase in the expected average useful life of our network assets,
           primarily servers, from three to four years effective January 1, 2013;
           and


          amounts paid to network providers due to lower bandwidth and
           service-related fees due to reduced bandwidth costs per unit.


These decreases were partially offset by increases in:
amortization of internal-use software as we continued to invest in our infrastructure; and

payroll and related costs of service personnel due to headcount growth.

Additionally, for each of the three-month periods ending March 31, 2013 and 2012, cost of revenues included stock-based compensation expense and amortization of capitalized stock-based compensation. Such expense remained consistent for the three months ended March 31, 2013 as compared to the same period in 2012. Cost of revenues during the three months ended March 31, 2013 and 2012 also included credits received of approximately $3.4 million and $2.0 million, respectively, from settlements and renegotiations entered into in connection with billing disputes related to bandwidth contracts. Credits of this nature may occur in the future; however, the timing and amount of credits, if any, are unpredictable.
We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2013 and for the years ending December 31, 2014, 2015, 2016 and 2017, our minimum commitments related to bandwidth usage and co-location services as of March 31, 2013 were approximately $72.6 million, $12.9 million, $3.0 million, $0.6 million and $0.3 million, respectively.
We believe that cost of revenues will increase during the remaining quarters of 2013 as compared to the first quarter of 2013. 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 remainder of 2013, we anticipate amortization of internal-use software development costs to increase, 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. We expect that the depreciation expense for the remainder of 2013 will be lower than depreciation expense reported in the same period in 2012 because of the change in estimated useful lives of our network equipment.
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 25%, or $4.4 million, to $21.9 million for the three months ended March 31, 2013 as compared to $17.5 million for the three months ended March 31, 2012. The increases during the three months ended March 31, 2013 as compared to the same periods in 2012 were due to increases in payroll and related costs as a result of continued growth in headcount, 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 months ended March 31, 2013 and 2012, we capitalized software development costs of $15.5 million and $12.3 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 months ended March 31, 2013, we capitalized $2.8 million of stock-based compensation as compared to $2.2 million for the three months ended March 31, 2012. 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
                                         Three Months Ended
                                           March 31, 2013
                                        as compared to 2012
Payroll and related costs              $             6.9
Stock-based compensation                             0.4
Capitalized salaries and related costs              (3.2 )
Other expenses                                       0.3
Total net increase                     $             4.4


We believe that research and development expenses, in absolute dollar terms, will increase during the remaining quarters of 2013 as compared to the first quarter of 2013 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 28%, or $13.7 million, to $62.7 million for the three months ended March 31, 2013 as compared to $49.0 million for the three months ended March 31, 2012. The increase in sales and marketing expenses during the three months ended March 31, 2013 as compared to the same periods in 2012 was primarily due to higher payroll and related costs and increases in stock-based compensation, as we invested in our go-to-market strategy to support new product introductions and our ongoing geographic expansion. The following table quantifies the changes in the various components of our sales and marketing expenses for the periods presented (in millions):

                                   For the
                              Three Months Ended
                                March 31, 2013
                             as compared to 2012
Payroll and related costs   $                10.3
Stock-based compensation                      1.3
Marketing and related costs                   1.6
Other expenses                                0.5
Total net increase          $                13.7

We believe that sales and marketing expenses will increase, in absolute dollar terms, during the remaining quarters of 2013 as compared to the first quarter of 2013 due to an expected increase in payroll and related costs as a result of 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;

rent and other facility-related expenditures for leased properties;

provision for doubtful accounts;

insurance costs; and

non-income related taxes.

General and administrative expenses increased 7%, or $3.7 million, to $55.3 million for the three months ended March 31, 2013 as compared to $51.6 million for the three months ended March 31, 2012. The increase in general and administrative expenses for the three months ended March 31, 2013 as compared to the same period in 2012 was primarily due to higher payroll and related costs due to headcount growth and an increase in facilities-related costs due to office expansion. These increases were partially offset by a decrease in acquisition-related costs.
The following table quantifies the changes in various components of our general and administrative expenses for the periods presented (in millions):


                                               For the
                                          Three Months Ended
                                            March 31, 2013
                                         as compared to 2012
Payroll and related costs               $             4.8
Stock-based compensation                              0.3
Depreciation and amortization                         1.0
Legal fees                                            0.3
Non-income taxes                                      0.2
Provision for doubtful accounts                       0.2
Facilities-related costs                              1.2
Acquisition-related costs                            (4.1 )
Consulting, advisory and other expenses              (0.2 )
Total net increase                      $             3.7

During the remaining quarters of 2013, we expect general and administrative . . .

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