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AKAM > SEC Filings for AKAM > Form 10-Q on 12-May-2014All Recent SEC Filings

Show all filings for AKAMAI TECHNOLOGIES INC

Form 10-Q for AKAMAI TECHNOLOGIES INC


12-May-2014

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.

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. 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, 2013 for further discussion of our critical accounting policies and estimates.

Overview

We provide cloud services for delivering, optimizing and securing online content and business applications. 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 these longer-term contracts generally 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 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 overall 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 in recent years:

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

The unit prices offered to some customers have declined, reflecting the impact of competition. These price reductions have primarily impacted customers for which we deliver high volumes of traffic over our network, such as media customers.

We have experienced increases in the rate of traffic delivered to our customers who use our solutions for video, gaming, social media and software downloads.

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


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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 in recent years:

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 Advertising Decision Solutions, or ADS, business in the first quarter of 2013. We hired an additional 382 employees during the first quarter of 2014, including approximately 200 employees who were part of the acquisition of Prolexic Technologies, Inc., or Prolexic. We expect to continue to hire additional employees and expand globally in support of our strategic initiatives.

We have continued to reduce our network bandwidth costs per unit and to invest in internal-use software development with the goal of improving 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.

In February 2014, we completed the acquisition of Prolexic, which is expected to be slightly dilutive to our earnings per share. Revenues and expenses from the acquisition have been included in our earnings since the acquisition date of February 18, 2014. Also in February 2014, we completed an offering of $690.0 million par value of convertible senior notes. The notes do not bear regular interest, but have an effective interest rate of 3.2% attributable to the conversion feature.

Results of Operations

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

                                              For the Three Months
                                                Ended March 31,
                                               2014           2013
Revenue                                       100.0  %        100.0 %
Cost of revenue                                30.8            32.7
Research and development expense                6.2             6.0
Sales and marketing expense                    17.9            17.0
General and administrative expense             16.8            15.0
Amortization of acquired intangible assets      1.5             1.6
Restructuring charges                           0.2             0.1
Total costs and operating expenses             73.4            72.4
Income from operations                         26.6            27.6
Interest income                                 0.4             0.4
Interest expense                               (0.4 )             -
Other expense, net                             (0.2 )             -
Income before provision for income taxes       26.4            28.0
Provision for income taxes                     10.3             8.5
Net income                                     16.1  %         19.5 %


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Revenue

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

For the Three Months
Ended March 31,
2014 2013 % Change Revenue $ 453,502 $ 368,046 23.2 %

During the three months ended March 31, 2014, the increase in our revenue was driven by continued strong demand for our services across all of our solutions and geographies. The increase in our revenue was also attributed to the acquisition of Prolexic, which contributed $7.0 million in revenue during the three months ended March 31, 2014.

For the three-month periods ended March 31, 2014 and 2013, no single customer accounted for 10% or more of revenue.

For the three months ended March 31, 2014 and 2013, approximately 28% 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 either of these periods. Effective in the first quarter of 2014, we elected to revise our method for determining the split of revenue derived from our operations located outside the United States. Previously, revenue was split based on our invoicing location and has been revised to reflect the location in which the sale originated. Prior period amounts have been revised to reflect the new method.

During the quarter, we continued to see strong revenue growth from our operations in the Asia Pacific region and improvement in our operations in Europe, the Middle East and Africa. Changes in foreign currency exchange rates negatively impacted our revenue by $1.7 million during the first quarter of 2014 as compared to the same period in 2013.

For the three months ended March 31, 2014, resellers accounted for 24% of revenue as compared to 20% of revenue for the three months ended March 31, 2013. The increase in revenue from resellers was attributed to continued traction with our carrier channel partners, as well as contributions from Prolexic's reseller relationships.

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

                                                For the Three Months
                                                   Ended March 31,
                                            2014         2013      % Change
Media Delivery Solutions                 $ 214,833    $ 181,188      18.6  %
Performance and Security Solutions         197,977      156,642      26.4
Service and Support Solutions               40,692       27,465      48.2
Advertising Decision Solutions and other         -        2,751    (100.0 )
Total revenue                            $ 453,502    $ 368,046      23.2  %

The increase in Media Delivery Solutions revenue for the three-month period ended March 31, 2014, as compared to the same period in 2013, was due to strong demand across most of our customer base. There was particularly strong growth from our software download and gaming customers.

The increase in Performance and Security Solutions revenue for the three-month period ended March 31, 2014, as compared to the same period in 2013, was partially due to increased revenue attributable to Prolexic. The acquisition of Prolexic contributed $7.0 million in revenue during the first quarter of 2014. Additionally, there was an increase in demand for our web experience and web security solutions, which also contributed to the year-over-year increase.

The increase in the Service and Support Solutions revenue for the three-month period ended March 31, 2014, as compared to the same period in 2013, was 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. During the first quarter of 2014


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we also experienced an increase in Service and Support Solutions revenue as compared to the same period in 2013, from event-driven revenues as our customers relied on our service professionals to help them execute live media events.

The ADS 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 Three Months
                                                                Ended March 31,
                                                       2014          2013        % Change
Bandwidth and service-related fees                  $  27,421     $  24,792         10.6  %
Co-location fees                                       32,240        32,557         (1.0 )
Network build-out and support                           7,243         4,451         62.7
Payroll and related costs                              31,418        25,227         24.5
Stock-based compensation, including amortization of
prior capitalized amounts                               4,625         4,446          4.0
Depreciation of network equipment                      24,791        18,471         34.2
Amortization of internal-use software                  11,874        10,448         13.6
Total cost of revenue                               $ 139,612     $ 120,392         16.0  %
As a percentage of revenue                               30.8 %        32.7 %

The increase in total cost of revenue was primarily due to increases in:

          amounts paid to network providers for bandwidth and service-related
           fees to support the increase in traffic served on our network;


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


          depreciation and amortization of network equipment and internal-use
           software as we continued to invest in our infrastructure.

In recent years, we have reduced our network bandwidth costs per unit, co-location fees and other network-related expenses, which contributed to the decrease in our cost of revenue as a percentage of revenue during the three months ended March 31, 2014 as compared to the same period in 2013.

We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. Our minimum commitments related to bandwidth usage and co-location services are consistent with the amounts reported in our annual report on Form 10-K for the year ended December 31, 2013.

We believe that cost of revenue will increase during the remaining quarters of 2014 as compared to the first quarter of 2014, primarily because 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. Such costs are likely to be partially offset by lower bandwidth costs per unit and continued efficiency in network deployment. Additionally, for the remaining quarters of 2014, we anticipate amortization of internal-use software development costs to increase, along with higher payroll and related costs associated with an increase in headcount of 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 and sales of our services to existing customers will also continue to grow.


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Research and Development Expenses

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

                                              For the Three Months
                                                 Ended March 31,
                                          2014         2013      % Change
Payroll and related costs              $ 42,431     $ 31,822       33.3  %
Stock-based compensation                  4,477        4,369        2.5
Capitalized salaries and related costs  (20,000 )    (15,496 )    (29.1 )
Other expenses                            1,326        1,210        9.6
Total research and development         $ 28,234     $ 21,905       28.9  %
As a percentage of revenue                  6.2 %        6.0 %

The increase in research and development expenses during the three-month period ended March 31, 2014, as compared to the same period in 2013, was 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 months ended March 31, 2014 and 2013, we capitalized $3.8 million and $2.8 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 the remainder of 2014 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 consisted of the following for the periods
presented (in thousands):

                                            For the Three Months
                                               Ended March 31,
                                        2014         2013      % Change
Payroll and related costs            $ 54,684     $ 41,075        33.1 %
Stock-based compensation               10,532        9,431        11.7
Marketing programs and related costs   10,520        7,847        34.1
Other expenses                          5,329        4,337        22.9
Total sales and marketing            $ 81,065     $ 62,690        29.3 %
As a percentage of revenue               17.9 %       17.0 %

The increase in sales and marketing expenses during the three-month period ended March 31, 2014, as compared to the same period in 2013, was primarily due to higher payroll and related costs, as we invested in our sales organization, and an increase in marketing programs and related costs in support of our go-to-market strategy and ongoing geographic expansion.

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


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General and Administrative Expenses

General and administrative expenses consisted of the following for the periods
presented (in thousands):
                                        For the Three Months
                                           Ended March 31,
                                    2014         2013      % Change
Payroll and related costs        $ 32,310     $ 23,829       35.6  %
Stock-based compensation            7,310        6,504       12.4
Depreciation                        8,173        5,576       46.6
Facilities-related costs           12,994        9,621       35.1
Provision for doubtful accounts      (103 )        363     (128.4 )
Acquisition-related costs           3,392          337      906.5
Professional and other fees        12,085        9,150       32.1
Total general and administrative $ 76,161     $ 55,380       37.5  %
As a percentage of revenue           16.8 %       15.0 %

The increase in general and administrative expenses for the three-month period ended March 31, 2014, as compared to the same period in 2013, was primarily due to the expansion of company infrastructure to support investments in engineering, go-to-market capacity and enterprise scaling initiatives. In particular, we increased general and administrative headcount, external consulting support and our facility footprint. These actions increased payroll and related costs, facilities-related costs, depreciation and professional and other fees for the three-month period ended March 31, 2014, as compared to the same period in 2013. In addition, acquisition-related costs increased for the three-month period ended March 31, 2014 due to the acquisition of Prolexic.

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

Amortization of Acquired Intangible Assets

                                                 For the Three Months
                                                    Ended March 31,
(in thousands)                               2014        2013      % Change
Amortization of acquired intangible assets $ 6,848     $ 6,060        13.0 %
As a percentage of revenue                     1.5 %       1.6 %

The increase in amortization of acquired intangible assets for the three-month period ended March 31, 2014 as compared to the same period in 2013 was primarily due to the amortization of assets related to the acquisition of Prolexic. Based on our intangible assets at March 31, 2014, we expect amortization of acquired intangible assets to be approximately $25.2 million for the remainder of 2014, and $26.8 million, $25.2 million, $23.1 million and $16.2 million for 2015, 2016, 2017 and 2018, respectively.

Restructuring Charges

                                 For the Three Months
                                   Ended March 31,
(in thousands)                2014       2013     % Change
Restructuring charges      $   735      $ 431        70.5 %
As a percentage of revenue     0.2 %      0.1 %

The restructuring charges for the three-month period ended March 31, 2014 consisted of severance and related expenses as a result of the acquisition of Prolexic. The charges for the three-month period ended March 31, 2013 consisted of pending


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workforce claims prior to 2013. We expect to incur a small amount of additional restructuring charges during the remainder of 2014 as a result of the transition of certain Prolexic employees.

Interest Income

                                 For the Three Months
                                    Ended March 31,
(in thousands)               2014        2013      % Change
Interest income            $ 1,639     $ 1,608        1.9 %
As a percentage of revenue     0.4 %       0.4 %

Interest income consists of interest earned on invested cash balances and marketable securities.

Interest Expense

                                 For the Three Months
                                   Ended March 31,
(in thousands)                2014        2013    % Change
Interest expense           $ (1,941 )    $  -       100.0 %
As a percentage of revenue     (0.4 )%      - %

Interest expense consists of the amortization of the debt discount and debt issuance costs related to our convertible senior notes issued in February 2014.

Other Expense, Net

                                 For the Three Months
                                   Ended March 31,
(in thousands)               2014        2013     % Change
Other expense, net         $ (881 )    $ (132 )     567.4 %
As a percentage of revenue   (0.2 )%        - %

Other expense, net primarily represents net foreign exchange gains and losses incurred and other non-operating expense and income items. The fluctuations in other expense, net for the three months ended March 31, 2014, as compared to the same period in 2013, was primarily due to foreign currency exchange rate fluctuations on inter-company and other non-functional currency transactions. Other expense, net may fluctuate in the future based upon changes in foreign exchange rates or other events.

Provision for Income Taxes

                                  For the Three Months
                                     Ended March 31,
(in thousands)                2014         2013      % Change
Provision for income taxes $ 46,864     $ 31,177        50.3 %
As a percentage of revenue     10.3 %        8.5 %
Effective income tax rate      39.2 %       30.4 %

For the three months ended March 31, 2014, our effective income tax rate was higher than the statutory rate due primarily to the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments and state income tax. For the three-month period ended March 31, 2013, our effective income tax rate was lower than the federal statutory tax rate mainly due to the reinstatement of the federal research and development credit at the beginning of 2013, which included a one-time retroactive impact for fiscal year 2012, as well as the composition of income in foreign jurisdictions


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that is taxed at lower rates compared to the statutory tax rates in the United States. The effective income tax rate is based upon the estimated income for the . . .

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