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AKAM > SEC Filings for AKAM > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for AKAMAI TECHNOLOGIES INC


9-Aug-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 minimizing 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. 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:

                                             Three Months Ended June 30,        Six Months Ended June 30,
                                               2013              2012             2013             2012
Revenues                                        100.0 %          100.0  %          100.0 %          100.0 %
Cost of revenues                                 33.0             39.6              32.8             39.3
Research and development expense                  5.5              5.3               5.7              5.4
Sales and marketing expense                      17.9             17.0              17.5             16.2
General and administrative expense               16.2             16.2              15.6             16.2
Amortization of acquired intangible assets        1.5              1.7               1.6              1.6
Restructuring charge (benefit)                    0.1                -               0.1                -
Total costs and operating expenses               74.2             79.8              73.3             78.7
Income from operations                           25.8             20.2              26.7             21.3
Interest income                                   0.4              0.5               0.4              0.5
Other income, net                                 0.1              0.4                 -              0.1
Gain on investments, net                            -                -                 -                -
Income before provision for income taxes         26.3             21.1              27.1             21.9
Provision for income taxes                        9.9              7.7               9.2              8.5
Net income                                       16.4 %           13.4  %           17.9 %           13.4 %

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 two quarters 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 favorably impacted by amounts we were paid for traffic usage in excess of committed amounts and other one-time events.

In recent years, our unit prices offered to some customers declined as a result of increased competition. These price reductions have primarily impacted customers for which we deliver high volumes of traffic over our network, such as


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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, increased sales of incremental services to existing customers, enhanced efficiencies in our network and lower co-location and bandwidth expenses.
During each of the first two quarters of 2013, we experienced an increase in the rate of traffic in our video and software download solutions as compared to the first two quarters of 2012. Our ability to generate revenue growth would be enhanced if the rate of traffic continues to increase.

We have historically experienced variations in revenue from quarter to quarter. We see seasonal impacts of higher revenues in the fourth quarter of the year and lower revenues during the summer months, which we primarily attribute such to patterns of usage of e-commerce services by our retail customers. We have also experienced quarterly variations in revenues attributable to our software download solutions due to the nature and timing of software releases by our customers. If these variable trends continue, our ability to generate quarterly revenue growth on a sequential basis could be impacted.

For the six months ended June 30, 2013, revenues derived from customers outside the United States accounted for 29% 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 half of 2013.

Costs and Expenses

During each of the first two quarters 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. We believe our total bandwidth costs will continue to increase as a result of expected higher traffic levels, but will be 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 and continue to reduce our overall bandwidth pricing.

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 $13.4 million during the first two quarters of 2013 as compared to the first two quarters 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 continue to decrease depreciation expense related to our network equipment during 2013, as compared to 2012. Conversely, we 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 will increase in 2013 as compared to 2012. As of June 30, 2013, our total unrecognized compensation costs for stock-based awards were $164.0 million, which we expect to recognize as expense over a weighted average period of 1.3 years. We expect to recognize this expense through 2017.

During the six months ended June 30, 2013, our effective income tax rate was 34.0%. We expect our annual effective income tax rate in 2013 to increase slightly in the remaining quarters of 2013. This expectation does not take into consideration the effect of other discrete items that may be 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.

During the six months ended June 30, 2013, we have increased our headcount by 379 full-time employees and expect to continue to add resources as we continue to release new products and services, as well as continue our global expansion.

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;


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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.

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

                      Three Months Ended June 30,                  Six Months Ended June 30,
(in millions)         2013             2012     % Change          2013            2012     % Change
Revenues      $     378.1            $ 331.3       14.1 %   $    746.2          $ 650.8       14.7 %

During the three and six months ended June 30, 2013, the increase in our revenues was driven by strong demand for our services across our solution categories and in each geographic region. The increase in our revenues is attributable to the addition of new customers, increased sales of incremental services to our existing customers, amounts earned for traffic usage in excess of committed amounts and other one-time events. These contributions to higher revenues were partially offset by lost committed recurring revenues and price declines. Changes in foreign currency exchange rates negatively impacted our revenues during the second quarter of 2013 as compared to 2012.


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The following table quantifies the contribution to revenues during the periods presented from our solution categories (in millions):

                              Three Months Ended June 30,                    Six Months Ended June 30,
                           2013            2012        % Change          2013            2012        % Change
Media Delivery
Solutions              $    179.4       $   158.0         13.5  %   $    360.6        $   313.0         15.2  %
Performance and
Security Solutions          167.9           140.6         19.4           324.5            274.6         18.2
Service and Support
Solutions                    31.4            22.2         41.4            59.0             42.6         38.5
Advertising Decision
Solutions and other          (0.6 )          10.5       (105.7 )           2.1             20.6        (89.8 )
Total revenues         $    378.1       $   331.3         14.1  %   $    746.2        $   650.8         14.7  %

The increase in Media Delivery Solutions revenues for the three and six month periods ended June 30, 2013, as compared to the same periods in 2012, was due to increased online media consumption and higher software download volumes. The increase was partially offset by a large media customer finalizing the removal of its video content from our platform during the second quarter of 2013 and the resulting loss in revenues as compared to the same period in 2012.

The increase in Performance and Security Solutions revenues for the three and six month periods ended June 30, 2013, as compared to the same periods in 2012, was due to increase in demand for our performance and security solutions from both new and existing customers.

The increase in the Service and Support Solutions revenues for the three and six month period ended June 30, 2013, as compared to the same periods in 2012, was due to an increase in sales of our enterprise-class services and support offerings with our core solution offerings.

The following table quantifies the contribution to revenues during the periods presented from the industry verticals in which we sell our services (in millions):

                              Three Months Ended June 30,                   Six Months Ended June 30,
                            2013           2012        % Change          2013             2012        % Change
Media and entertainment $     162.1     $   139.6         16.1 %   $    322.3          $   274.1         17.6 %
Commerce                       77.5          70.9          9.3          154.3              142.5          8.3
Enterprise                     57.2          44.6         28.3          110.8               87.2         27.1
High tech                      61.2          56.9          7.6          120.9              111.4          8.5
Public sector                  20.1          19.3          4.1           37.9               35.6          6.5
Total revenues          $     378.1     $   331.3         14.1 %   $    746.2          $   650.8         14.7 %

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 a moderate increase in our software download volumes as compared to 2012.

For the three and six months ended June 30, 2013, approximately 29% of our revenues were derived from our operations located outside of the United States, including 17% derived from Europe. For the three and six months ended June 30, 2012, approximately 27% and 28%, respectively, 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. During the quarter, we had strong growth in our Asia Pacific geography.

For the three and six months ended June 30, 2013, resellers accounted for 20% of revenues as compared to 21% of revenues for the three and six months ended June 30, 2012. For the three and six months ended June 30, 2013 and 2012, no single customer accounted for 10% or more of revenues.


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Cost of Revenues

Cost of revenues was comprised of the following for the periods presented (in
millions):

                              Three Months Ended June 30,                  Six Months Ended June 30,
                           2013            2012        % Change         2013          2012        % Change
Bandwidth, network
build-out and
support-related fees   $     30.0       $    33.2         (9.6 )%   $     59.2     $    64.5         (8.2 )%
Co-location fees             32.4            33.0         (1.8 )          65.0          66.8         (2.7 )
Payroll and related
costs                        27.5            22.1         24.4            52.8          42.9         23.1
Stock-based
compensation,
including amortization
of prior capitalized
amounts                       4.6             5.0         (8.0 )           9.0           9.4         (4.3 )
Depreciation and
impairment of network
equipment                    20.0            28.7        (30.3 )          38.5          55.5        (30.6 )
Amortization of
internal-use software        10.2             9.3          9.7            20.6          17.1         20.5
Total cost of revenues $    124.7       $   131.3         (5.0 )%   $    245.1     $   256.2         (4.3 )%
As a percentage of
revenues                     33.0 %          39.6 %                       32.8 %        39.3 %

We have continued to reduce our network bandwidth costs per unit, which contributed to the decrease in our cost of revenues in the three and six months ended June 30, 2013 as compared to the same periods in 2012. These decreases were the result of recent initiatives to manage our global network more efficiently.

This net decrease in cost of revenues was primarily due to decreases in:

          depreciation expense of network equipment of approximately $11.0
           million and $25.1 million for the three and six months ended June 30,
           2013, respectively, 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:

          payroll and related costs of service personnel due to headcount growth
           to support our revenue growth; and


          amortization of internal-use software as we continued to invest in our
           infrastructure.

Additionally, for each of the three and six months ended June 30, 2013 and 2012, cost of revenues included stock-based compensation expense and amortization of capitalized stock-based compensation. Such expense decreased for the three and six months ended June 30, 2013 as compared to the same period in 2012. Cost of revenues during the three and six months ended June 30, 2013 also included credits received of approximately $1.6 million and $5.0 million, respectively, from settlements and renegotiations entered into in connection with billing disputes related to bandwidth contracts. Cost of revenues during the three and six months ended June 30, 2012 included credits received of approximately $2.8 million and $4.8 million, respectively.

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 June 30, 2013 were approximately $53.0 million, $16.2 million, $3.0 million, $0.6 million and $0.2 million, respectively.

We believe that cost of revenues will increase during the remaining quarters of 2013 as compared to the first two quarters of 2013. We expect to deploy more servers and deliver more traffic on our network, which will result in higher expenses associated with the increased traffic and additional co-location fees; however, such costs are likely to be partially offset by lower bandwidth costs per unit and continued efficiency in network deployment. 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 in the expectation that our customer base will continue to expand. We expect


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that the depreciation expense for the remainder of 2013 will be lower than depreciation expense reported in the same period in 2012 due to the change in estimated useful lives of our network equipment.

We have revised cost of revenues reported in 2012 in the table above as a result of a reevaluation of our business model. Costs which were previously classified as sales and marketing and general and administrative are now classified as cost of revenues. See Note 1 to the unaudited consolidated financial statements included in this quarterly report for additional information and amounts revised.

Research and Development Expenses

Research and development expenses were comprised of the following for the
periods presented (in millions):

                               Three Months Ended June 30,                    Six Months Ended June 30,
                           2013             2012        % Change         2013             2012        % Change
Payroll and related
costs                  $     32.5       $     24.3         33.7  %   $     64.3       $     49.2         30.7  %
Stock-based
compensation                  3.9              4.9        (20.4 )           8.2              8.8         (6.8 )
Capitalized salaries
and related costs           (17.0 )          (12.5 )       36.0           (32.4 )          (24.8 )       30.6
Other expenses                1.2              0.8         50.0             2.4              1.8         33.3
Total research and
development            $     20.6       $     17.5         17.7  %   $     42.5       $     35.0         21.4  %
As a percentage of
revenues                      5.5 %            5.3 %                        5.7 %            5.4 %

The increases during the three and six month periods ended June 30, 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 to invest in new product development, 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. These development costs consisted of external consulting expenses and payroll and related costs for personnel involved in the development of internal-use software used to deliver our services and operate our network. During the three and six months ended June 30, 2013, we capitalized $3.1 million and $5.9 million, respectively, of stock-based compensation. For the three and six months ended June 30, 2012, we capitalized $1.7 million and $3.9 million, respectively, of stock-based compensation. These capitalized internal-use software costs are amortized to cost of revenues over their estimated useful lives of two years.

We believe that research and development expenses, in absolute dollar terms, will increase during the remaining quarters of 2013 as compared to the first two quarters of 2013 as we expect to continue to hire additional development personnel in order to make improvements to our core technology and develop new services.

Sales and Marketing Expenses

Sales and marketing expenses were comprised of the following for the periods
presented (in millions):

                                   Three Months Ended June 30,                   Six Months Ended June 30,
                                2013             2012        % Change        2013            2012        % Change
Payroll and related costs   $     44.1       $     36.0         22.5 %   $     85.2       $    66.8         27.5 %
Stock-based compensation           9.8              8.8         11.4           19.2            16.9         13.6
. . .
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