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AKAM > SEC Filings for AKAM > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for AKAMAI TECHNOLOGIES INC

Form 10-K for AKAMAI TECHNOLOGIES INC


3-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, should be read in conjunction with our consolidated financial statements and notes thereto that appear elsewhere in this annual report on Form 10-K. See "Risk Factors" elsewhere in this annual report on Form 10-K for a discussion of certain risks associated with our business. The following discussion contains forward-looking statements. The forward-looking statements do not include the potential impact of any mergers, acquisitions, divestitures, or other events that may be announced after the date hereof.

Overview

We primarily derive income from sales of services to customers executing contracts with terms of one year or longer. We believe that this emphasis on longer-term contracts generally allows us to have a consistent and predictable base level of


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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 and quality 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 the quality, price and the attractiveness of our services and technology.

Our revenue is impacted by a number of factors, including our ability to maintain our base of committed recurring revenues, the timing and variability of customer-specific one-time events, prices we are able to charge for our services, the amount of traffic we serve on our network and the impact of seasonal variations on our business. We have observed the following trends related to our revenue during 2013:

We have been able to offset lost committed recurring revenue by adding new customers and increasing sales of incremental services to our existing customers.

Consistent with prior years, the unit prices offered to some customers have 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 media customers.

We experienced an increase in the rate of traffic in our video, gaming, social media and software download solutions as compared to 2012.

We experienced variations in certain types of revenue from quarter to quarter in 2013; in particular, we experienced higher revenue in the fourth quarter of the year for some of our solutions as a result of the holiday season. We also saw lower revenue in the summer months, particularly in Europe, from both e-commerce and media customers because overall Internet use declined during that time. We also experienced quarterly variations in revenue attributable to the nature and timing of software releases by our customers using our software download solutions.

Our profitability is also impacted by our expense levels, including direct costs to support our revenue, such as co-location and bandwidth costs, and expenses incurred to support strategic initiatives that we anticipate will generate revenue in the future. We observed the following trends during 2013 and discuss our expectations related to our cost of revenue and operating expenses:

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 may increase in the future as a result of expected higher traffic levels, but we believe such costs would 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 revenue. By improving our internal-use software and managing our hardware deployments to enable us to use servers more efficiently, we have been able to manage the growth of co-location costs. We expect to continue to scale our network in the future and will need to manage our co-location costs to maintain current levels of profitability.

Effective January 1, 2013, we increased the expected average useful lives of our network assets, primarily servers, from three to four years to reflect software and hardware related initiatives to manage our global network more efficiently. This change decreased depreciation expense related to our network equipment during 2013, as compared to 2012 and 2011. Conversely, we expect to continue to enhance and add functionality to our service offerings, which increases our internal-use software development costs attributable to employees working on such projects.

We increased our headcount by more than 800 employees in 2013 to 3,908 employees at year end, which is net of approximately 70 employees who were part of the divestiture of our ADS business in the first quarter of 2013. We expect to continue to hire additional employees as we release new products and services, as well as continue our global expansion.

During 2013 we completed two acquisitions, and in 2012 we completed four acquisitions. The acquisitions were not material, individually or in the aggregate, to our consolidated financial results. In December 2013, we also entered into a definitive agreement to acquire Prolexic for approximately $390.0 million in cash and the assumption of unvested options, subject to post-closing adjustments. The acquisition closed in February 2014. Prolexic has approximately 200 employees, and the acquisition is expected to be slightly dilutive to our earnings per share.


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Results of Operations

The following sets forth, as a percentage of revenue, consolidated statements of operations data for the years indicated:

                                             2013      2012      2011
Revenue                                    100.0  %   100.0 %   100.0 %
Costs and operating expenses:
Cost of revenue                             32.4       38.6      39.2
Research and development                     5.9        5.4       4.5
Sales and marketing                         17.8       16.3      14.1
General and administrative                  16.2       15.3      15.3
Amortization of acquired intangible assets   1.4        1.5       1.5
Restructuring charges                        0.1          -       0.4
Total costs and operating expenses          73.8       77.1      74.9
Income from operations                      26.2       22.9      25.1
Interest income, net                         0.4        0.5       0.9
Other (expense) income, net                    -          -       0.5
Income before provision for income taxes    26.6       23.4      26.5
Provision for income taxes                   8.0        8.6       9.2
Net income                                  18.6  %    14.8 %    17.3 %

Revenue

Revenue during the periods presented is as follows (in thousands):

For the Years Ended December 31, For the Years Ended December 31, 2013 2012 % Change 2012 2011 % Change Revenue $ 1,577,922 $ 1,373,947 14.8 % $ 1,373,947 $ 1,158,538 18.6 %

The increase in our revenue from 2012 to 2013 was driven by continued strong demand for our services. The increase was attributable to the addition of new customers, increased sales of incremental services to our existing customers and amounts earned for traffic usage in excess of committed amounts and customer-specific one-time events. These contributions to higher revenue were partially offset by lost committed recurring revenue, price declines and the divestiture of ADS.

The increase in our revenue from 2011 to 2012 was primarily due to the continued growth in use of the Internet by businesses and consumers, leading to increased purchases of our solutions by our customers. Additionally, our growth rate in 2012 benefited from revenues from our acquisitions in 2012.

For the year ended December 31, 2013, resellers accounted for 21% of revenue as compared to 22% and 19% of revenue, respectively, for the years ended December 31, 2012 and 2011. For the years ended December 31, 2013, 2012 and 2011, no single customer accounted for 10% or more of revenue.

For the years ended December 31, 2013, 2012 and 2011, approximately 29%, 28% and 29%, respectively, of our revenue was derived from our operations located outside of the United States. No single country outside of the United States accounted for 10% or more of revenue during any of these periods. During 2013 we continued to see strong growth from our operations in the Asia Pacific region, and our operations in Europe, the Middle East and Africa performed well, despite continued macroeconomic factors.

Changes in foreign currency exchange rates negatively impacted our revenue by $15.0 million during fiscal year 2013 as compared to 2012.


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

                              For the Years Ended December 31,                   For the Years Ended December 31,
                             2013              2012         % Change             2012               2011         % Change
Media Delivery
Solutions              $     757,147       $   652,968         16.0  %   $      652,968         $   567,586         15.0 %
Performance and
Security Solutions           690,559           583,818         18.3             583,818             478,605         22.0
Service and Support
Solutions                    128,087            93,830         36.5              93,830              69,170         35.7
Advertising Decision
Solutions and other            2,129            43,331        (95.1 )            43,331              43,177          0.4
Total revenue          $   1,577,922       $ 1,373,947         14.8  %   $    1,373,947         $ 1,158,538         18.6 %

The increases in Media Delivery Solutions revenue for 2013 as compared to 2012, and 2012 as compared to 2011, were due to increased consumption of our customers' online media offerings and higher software download volumes. During 2013, we experienced strong growth in usage by some of our largest, most strategic accounts driven by increased software downloads, gaming, video delivery and social media consumption, all of which contributed to our year-over-year revenue growth. These increases were partially offset by a large media customer finalizing the removal of its video content from our platform during 2013 resulting in loss of revenue as compared to 2012.

The increases in Performance and Security Solutions revenue for 2013 as compared to 2012, and 2012 as compared to 2011, were due to increases in demand for our Performance and Security Solutions from both new and existing customers. During 2013, we experienced strong demand for our website and application acceleration solutions as well as our security offerings.

The increases in the Service and Support Solutions revenue for 2013 as compared to 2012, and 2012 as compared to 2011, were due to increases in sales of our services and support offerings due to strong service attachment rates for both customers of our core Media Delivery and Performance and Security Solutions.

The Advertising Decision Solutions business was divested in the first quarter of 2013.

Cost of Revenue

Cost of revenue consisted of the following for the periods presented (in
thousands):

                             For the Years Ended December 31,                For the Years Ended December 31,
                            2013             2012        % Change          2012               2011         % Change
Bandwidth and
service-related fees   $    100,964       $ 114,595        (11.9 )%   $    114,595       $     92,015         24.5 %
Co-location fees            129,382         131,942         (1.9 )         131,942            130,879          0.8
Network build-out and
support                      21,173          16,919         25.1            16,919             14,820         14.2
Payroll and related
costs                       112,806          91,954         22.7            91,954             72,399         27.0
Stock-based
compensation,
including amortization
of prior capitalized
amounts                      18,568          18,731         (0.9 )          18,731             16,827         11.3
Depreciation and
impairment of network
equipment                    83,811         117,997        (29.0 )         117,997             96,741         22.0
Amortization of
internal-use software        44,383          37,762         17.5            37,762             30,024         25.8
Total cost of revenue  $    511,087       $ 529,900         (3.6 )%   $    529,900       $    453,705         16.8 %
As a percentage of
revenue                        32.4 %          38.6 %                         38.6 %             39.2 %

In recent years, we have continued to reduce our network bandwidth costs per unit, co-location fees and other network-related expenses, which has had the impact of decreasing cost of revenue as a percentage of revenue.


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

          depreciation expense of network equipment in place as of January 1,
           2013 of approximately $39.0 million reflecting the increase in the
           expected average useful lives of our network assets, primarily
           servers, from three to four years to reflect software and hardware
           related initiatives to manage our global network more efficiently;


          bandwidth and service-related fees of our ADS business, which we
           divested in January 2013; these expenses were $1.6 million and $24.2
           million for the years ended December 31, 2013 and 2012, respectively;
           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 Service and Support Solutions revenue growth and our
           efforts to efficiently scale our network; and


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

Cost of revenue increased in 2012 as compared to 2011, primarily due to an increase in amounts paid to network providers for bandwidth due to higher traffic levels. The increases were partially offset by reduced bandwidth costs per unit, an increase in depreciation expense of network equipment and amortization of internal-use software as we continued to invest in our infrastructure.

Cost of revenue for the years ended December 31, 2013, 2012 and 2011 also included credits received of approximately $9.1 million, $10.8 million and $6.9 million, respectively, from billing settlements and renegotiations related to bandwidth contracts.

We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. See Note 9 to our consolidated financial statements included elsewhere in this annual report on Form 10-K for further discussion.

We believe that cost of revenue will increase during 2014 as compared to 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, during 2014, we anticipate amortization of internal-use software development costs as comparted to 2013 to increase, along with increased payroll and related costs associated with our network and professional services personnel and related expenses. We plan to continue to make investments in our network in the expectation that our customer base will continue to expand.

We have revised cost of revenue reported in 2012 and 2011 in the table above as a result of a reevaluation of our business model. Costs that were previously classified as sales and marketing and general and administrative are now classified as cost of revenue. See Note 1 to our consolidated financial statements included elsewhere in this annual report on Form 10-K for additional information and amounts revised.

Research and Development Expenses

Research and development expenses consisted of the following for the periods
presented (in thousands):

                              For the Years Ended December 31,                 For the Years Ended December 31,
                            2013               2012         % Change          2012              2011         % Change
Payroll and related
costs                  $    139,018       $    104,244         33.4 %   $     104,244       $    78,425         32.9 %
Stock-based
compensation                 17,472             17,275          1.1            17,275            11,124         55.3
Capitalized salaries
and related costs           (67,935 )          (50,648 )       34.1           (50,648 )         (40,383 )       25.4
Other expenses                5,324              3,873         37.5             3,873             3,167         22.3
Total research and
development            $     93,879       $     74,744         25.6 %   $      74,744       $    52,333         42.8 %
As a percentage of
revenue                         5.9 %              5.4 %                          5.4 %             4.5 %


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The increases in research and development expenses for 2013 as compared to 2012, and 2012 as compared to 2011, 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 consist 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. For the years ended December 31, 2013, 2012 and 2011, we capitalized $11.5 million, $8.9 million and $7.1 million, respectively, of stock-based compensation. These capitalized internal-use software costs are amortized to cost of revenue over their estimated useful lives of two years.

We believe that research and development expenses will increase in absolute dollars during 2014 as compared to 2013 as we expect to continue to hire additional development personnel in order to make improvements to our core technology and support the development of new services and engineering innovation.

Sales and Marketing Expenses

Sales and marketing expenses consisted of the following for the periods
presented (in thousands):

                              For the Years Ended December 31,                 For the Years Ended December 31,
                            2013               2012         % Change         2012               2011         % Change
Payroll and related
costs                  $    191,554       $    147,571         29.8 %   $    147,571       $    113,553         30.0 %
Stock-based
compensation                 39,290             34,322         14.5           34,322             20,697         65.8
Marketing programs and
related costs                26,449             23,508         12.5           23,508             13,137         78.9
Other expenses               23,087             17,947         28.6           17,947             15,630         14.8
Total sales and
marketing              $    280,380       $    223,348         25.5 %   $    223,348       $    163,017         37.0 %
As a percentage of
revenue                        17.8 %             16.3 %                        16.3 %             14.1 %

The increases in sales and marketing expenses for 2013 as compared to 2012, and 2012 as compared to 2011, were primarily due to higher payroll and related costs, including commissions for sales and support personnel and stock-based compensation. We increased hiring in our sales organization in support of our go-to-market capacity and ongoing geographic expansion, which contributed to the increases. Other expenses, which consists primarily of sales and marketing events and related travel expenses, increased as we supported our revenue goals.

We believe that sales and marketing expenses will increase in absolute dollars during 2014 as compared to 2013 due to an expected increase in payroll and related costs as a result of anticipated continued headcount growth in our sales and marketing organization.

General and Administrative Expenses

General and administrative expenses consisted of the following for the periods
presented (in thousands):
                             For the Years Ended December 31,              For the Years Ended December 31,
                            2013             2012        % Change          2012            2011        % Change
Payroll and related
costs                  $    105,205       $  83,845         25.5  %   $    83,845       $  67,298         24.6  %
Stock-based
compensation                 28,255          27,679          2.1           27,679          19,830         39.6
Depreciation                 26,991          20,018         34.8           20,018          12,876         55.5
Facilities-related
costs                        44,030          34,570         27.4           34,570          33,951          1.8
Provision for doubtful
accounts                        475          (1,402 )      133.9           (1,402 )           367       (482.0 )
Acquisition-related
costs                         1,842           5,788        (68.2 )          5,788             580        897.9
Professional and other
fees                         48,420          39,602         22.3           39,602          41,976         (5.7 )
Total general and
administrative         $    255,218       $ 210,100         21.5  %   $   210,100       $ 176,878         18.8  %
As a percentage of
revenue                        16.2 %          15.3 %                        15.3 %          15.3 %


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General and administrative expenses include costs of our finance, human resources, information technology, legal and administrative network infrastructure functions, in addition to our facility-related costs and deprecation of facility-related capital assets. The increases in general and administrative expenses for 2013 as compared to 2012, and 2012 as compared to 2011, were primarily due to the expansion of company infrastructure to support investments in engineering, network scaling and go-to-market capacity. Specifically, we had increases to headcount, external consulting support and our facility footprint. These actions increased payroll and related costs, network procurement costs, facilities-related costs and depreciation during 2013 as compared to 2012, and 2012 as compared to 2011.

During 2014, we expect general and administrative expenses to increase in absolute dollars as compared to 2013 due to anticipated higher payroll and related costs and facilities-related costs attributable to increased hiring, investment in information technology, network scaling and planned facility expansion.

Amortization of Acquired Intangible Assets

                              For the Years Ended December 31,                  For the Years Ended December 31,
(in thousands)              2013               2012         % Change          2012               2011         % Change
Amortization of
acquired intangible
assets                 $     21,547       $     20,962          2.8 %    $     20,962       $     17,070         22.8 %
As a percentage of
revenue                         1.4 %              1.5 %                          1.5 %              1.5 %

The increase in amortization of acquired intangible assets during 2013 as compared to 2012 was due to the acquisition of strategic network assets from AT&T Services, Inc. and also a full year of amortization from the acquisitions occurring throughout 2012, which was partially offset by the write-off of intangible assets recorded as part of the divestiture of ADS in 2013 and the completion of amortization of intangible assets acquired in previous years. The increase in amortization of acquired intangible assets during 2012 as compared to 2011 was due to the amortization of assets related to the acquisitions of Blaze Software, Inc., or Blaze, Cotendo, Inc., or Cotendo, FastSoft, Inc., or FastSoft, and Verivue, Inc., or Verivue, during 2012.

Based on acquired intangible assets at December 31, 2013, future amortization was expected to be approximately $20.6 million, $18.9 million, $14.5 million, $10.2 million and $4.4 million for the years ending December 31, 2014, 2015, 2016, 2017 and 2018, respectively. We anticipate that these amortization amounts will increase in future periods as a result of our acquisition of Prolexic, which closed in February 2014.

Restructuring Charges

                                 For the Years Ended December 31,                 For the Years Ended December 31,
(in thousands)                  2013             2012          % Change        2012              2011          % Change
Restructuring charges      $     1,843       $      406          353.9 %   $      406       $     4,886          (91.7 )%
As a percentage of revenue         0.1 %              - %                           - %             0.4 %

During 2013, we recorded a restructuring charge for leasehold improvements that are no longer in use as a result of an early lease termination. In addition, we incurred severance and relocation expenses for employees impacted by the closing of the facility. In 2012, we recorded restructuring charges related to work force reductions in connection with the 2012 acquisitions of FastSoft and Verivue. In 2011, we implemented a company-wide workforce reduction and vacated excess facilities. As a result, we recorded severance and estimated future lease payments, net of sublease income, in 2011. We do not expect to incur additional restructuring charges as a result of these actions.

Interest Income, Net

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