Edgar Filing: AKAMAI TECHNOLOGIES INC

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________

FORM 10-Q

______________________________________________

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the quarterly period ended June 30, 2016



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the transition period from to

Commission file number 0-27275

______________________________________________

Akamai Technologies, Inc.

(Exact name of registrant as specified in its charter)



Delaware		04-3432319
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

150 Broadway

Cambridge, MA 02142

(617) 444-3000

(Address, Including Zip Code, and Telephone Number,

Including Area Code, of Registrant’s Principal Executive Offices)

______________________________________________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares outstanding of the registrant’s common stock as of August 4, 2016: 174,724,451

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AKAMAI TECHNOLOGIES, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016

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		Page
PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	3
	Consolidated Balance Sheets at June 30, 2016 and December 31, 2015	3
	Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015	4
	Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015	5
	Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015	6
	Notes to Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32

PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
Item 6.	Exhibits	43

SIGNATURES		45

EXHIBIT INDEX		46

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

AKAMAI TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS



(in thousands, expect share data)	June 30, 2016			December 31, 2015
ASSETS
Current assets:
Cash and cash equivalents	$	326,644		$	289,473
Marketable securities	542,062			460,088
Accounts receivable, net of reserves of $8,487 and $7,364 at June 30, 2016, and December 31, 2015, respectively	364,401			380,399
Prepaid expenses and other current assets	132,477			123,228
Total current assets	1,365,584			1,253,188
Property and equipment, net	786,835			753,180
Marketable securities	731,232			774,674
Goodwill	1,150,137			1,150,244
Acquired intangible assets, net	142,668			156,095
Deferred income tax assets	2,455			4,700
Other assets	90,811			89,603
Total assets	$	4,269,722		$	4,181,684
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	68,249		$	61,982
Accrued expenses	234,013			216,166
Deferred revenue	67,163			54,154
Other current liabilities	7,117			138
Total current liabilities	376,542			332,440
Deferred revenue	3,735			4,163
Deferred income tax liabilities	10,248			12,888
Convertible senior notes	628,970			618,047
Other liabilities	99,754			93,268
Total liabilities	1,119,249			1,060,806
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized; 700,000 shares designated as Series A Junior Participating Preferred Stock; no shares issued or outstanding	—			—
Common stock, $0.01 par value; 700,000,000 shares authorized; 179,061,970 shares issued and 175,110,207 shares outstanding at June 30, 2016, and 177,212,181 shares issued and outstanding at December 31, 2015	1,791			1,772
Additional paid-in capital	4,508,376			4,437,420
Accumulated other comprehensive loss	(31,616		)	(41,453		)
Treasury stock, at cost, 3,951,763 shares at June 30, 2016, and no shares at December 31, 2015	(199,710		)	—
Accumulated deficit	(1,128,368		)	(1,276,861		)
Total stockholders’ equity	3,150,473			3,120,878
Total liabilities and stockholders’ equity	$	4,269,722		$	4,181,684

The accompanying notes are an integral part of the consolidated financial statements.

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AKAMAI TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF INCOME



	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(in thousands, except per share data)	2016			2015			2016			2015
Revenue	$	572,135		$	540,723		$	1,139,860		$	1,067,259
Costs and operating expenses:
Cost of revenue (exclusive of amortization of acquired intangible assets shown below)	206,323			179,910			401,059			349,204
Research and development	37,690			36,693			78,532			72,521
Sales and marketing	103,223			111,501			205,434			214,980
General and administrative	107,538			99,152			209,821			188,744
Amortization of acquired intangible assets	6,711			6,752			13,427			13,532
Restructuring charges	470			455			7,288			497
Total costs and operating expenses	461,955			434,463			915,561			839,478
Income from operations	110,180			106,260			224,299			227,781
Interest income	3,393			2,541			6,713			5,542
Interest expense	(4,639		)	(4,678		)	(9,292		)	(9,254		)
Other income (expense), net	415			(1,605		)	226			(1,906		)
Income before provision for income taxes	109,349			102,518			221,946			222,163
Provision for income taxes	35,714			35,318			73,453			77,217
Net income	$	73,635		$	67,200		$	148,493		$	144,946
Net income per share:
Basic	$	0.42		$	0.38		$	0.84		$	0.81
Diluted	$	0.42		$	0.37		$	0.84		$	0.80
Shares used in per share calculations:
Basic	175,499			178,682			175,951			178,614
Diluted	176,420			180,738			176,980			180,782

The accompanying notes are an integral part of the consolidated financial statements.

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AKAMAI TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME



	For the Three Months Ended June 30,						For the Six Months Ended June 30,
(in thousands)	2016			2015			2016		2015
Net income	$	73,635		$	67,200		$	148,493	$	144,946
Other comprehensive (loss) income:
Foreign currency translation adjustments	(3,728		)	607			5,925		(7,808		)
Change in unrealized gain (loss) on investments, net of income tax (provision) benefit of $(529), $639, $(2,311) and $(574) for the three and six months ended June 30, 2016 and 2015, respectively	904			(1,073		)	3,912		1,040
Other comprehensive (loss) income	(2,824		)	(466		)	9,837		(6,768		)
Comprehensive income	$	70,811		$	66,734		$	158,330	$	138,178

The accompanying notes are an integral part of the consolidated financial statements.

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AKAMAI TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS



	For the Six Months Ended June 30,
(in thousands)	2016			2015
Cash flows from operating activities:
Net income	$	148,493		$	144,946
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	165,783			144,449
Stock-based compensation	66,652			61,920
Excess tax benefits from stock-based compensation	(2,632		)	(22,737		)
Provision (benefit) for deferred income taxes	2,785			(16,275		)
Amortization of debt discount and issuance costs	9,292			9,253
Other non-cash reconciling items, net	3,501			1,146
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable	17,786			(14,292		)
Prepaid expenses and other current assets	(10,991		)	12,022
Accounts payable and accrued expenses	12,282			31,673
Deferred revenue	12,126			7,023
Other current liabilities	6,971			199
Other non-current assets and liabilities	1,062			4,425
Net cash provided by operating activities	433,110			363,752
Cash flows from investing activities:
Cash paid for acquired businesses, net of cash acquired	—			(122,945		)
Purchases of property and equipment	(86,820		)	(159,495		)
Capitalization of internal-use software development costs	(73,661		)	(73,587		)
Purchases of short- and long-term marketable securities	(384,585		)	(405,989		)
Proceeds from sales of short- and long-term marketable securities	50,541			2,008
Proceeds from maturities of short- and long-term marketable securities	301,802			527,677
Other non-current assets and liabilities	(1,512		)	(1,909		)
Net cash used in investing activities	(194,235		)	(234,240		)
Cash flows from financing activities:
Proceeds related to the issuance of common stock under stock plans	27,095			36,512
Excess tax benefits from stock-based compensation	2,632			22,737
Employee taxes paid related to net share settlement of stock-based awards	(32,410		)	(39,354		)
Repurchases of common stock	(199,710		)	(126,068		)
Other non-current assets and liabilities	—			(1,250		)
Net cash used in financing activities	(202,393		)	(107,423		)
Effects of exchange rate changes on cash and cash equivalents	689			(3,291		)
Net increase in cash and cash equivalents	37,171			18,798
Cash and cash equivalents at beginning of period	289,473			238,650
Cash and cash equivalents at end of period	$	326,644		$	257,448

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AKAMAI TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS, continued



	For the Six Months Ended June 30,
(in thousands)	2016		2015
Supplemental disclosure of cash flow information:
Cash paid for income taxes, net of refunds received in the six months ended June 30, 2016 and 2015 of $457 and $17,964, respectively	$	38,228	$	12,055
Non-cash investing activities:
Purchases of property and equipment and capitalization of internal-use software development costs included in accounts payable and accrued expenses	28,113		41,874
Capitalization of stock-based compensation	11,424		8,615

The accompanying notes are an integral part of the consolidated financial statements.

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AKAMAI TECHNOLOGIES, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Nature of Business and Basis of Presentation

Akamai Technologies, Inc. (the “Company”) provides cloud services for delivering, optimizing and securing content and business applications over the Internet. The Company's globally-distributed platform comprises over 219,000 servers in more than 1,500 networks in approximately 125 countries. The Company was incorporated in Delaware in 1998 and is headquartered in Cambridge, Massachusetts. The Company currently operates in one industry segment: providing cloud services for delivering, optimizing and securing content and business applications over the Internet.

The accompanying interim consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. These financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying financial statements.

Certain information and footnote disclosures normally included in the Company’s annual audited consolidated financial statements and accompanying notes have been condensed in, or omitted from, these interim financial statements. Accordingly, the unaudited consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s annual report on Form 10-K for the year ended December 31, 2015, filed with the Securities and Exchange Commission (the "Commission") on February 29, 2016.

The results of operations presented in this quarterly report on Form 10-Q are not necessarily indicative of the results of operations that may be expected for any future periods. In the opinion of management, these unaudited consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair statement of the results of all interim periods reported herein.

Newly-Adopted Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board (“FASB”) issued updated guidance to simplify the presentation of debt issuance costs on the balance sheets. This guidance moved debt issuance costs from the assets section of the balance sheet to the liabilities section as a direct deduction from the carrying amount of the debt issued. The Company retrospectively adopted the guidance on January 1, 2016. The prior period consolidated balance sheet presented, as of December 31, 2015, was revised to reclassify $6.2 million of debt issuance costs included in other assets to convertible senior notes. This had the impact of reducing the Company's total assets and total liabilities by $6.2 million, as of December 31, 2015. The revision had no impact on the Company's results of operations, financial position or cash flows.

In September 2015, the FASB issued updated guidance that eliminates the requirement to restate prior period financial statements for measurement period adjustments. In an effort to reduce complexity in financial reporting, the new guidance requires that the cumulative impact of a measurement period adjustment, including the impact on prior periods, be recognized in the reporting period in which the adjustment is identified. The standard was effective for and adopted by the Company on January 1, 2016. This guidance did not have an impact on the Company's results of operations, financial condition or cash flows as the measurement periods for the Company's 2015 acquisitions were closed as of December 31, 2015.

Recent Accounting Pronouncements

In May 2014, the FASB issued updated guidance and disclosure requirements for recognizing revenue. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This standard will be effective for the Company on January 1, 2018, and may be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the potential impact of adopting this new accounting guidance.

In February 2016, the FASB issued guidance that requires companies to present assets and liabilities arising from leases on the consolidated balance sheets. The updated standard aims to increase transparency and comparability among organizations by requiring lessees to recognize lease assets and lease liabilities on the balance sheet and requiring disclosure of key information about leasing arrangements. This standard will be effective for the Company on January 1, 2019, and is to be

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applied using a modified retrospective approach. Early adoption is permitted. The Company is evaluating the potential impact of adopting this new accounting guidance.

In March 2016, the FASB issued guidance that is intended to simplify aspects of how share-based payments are accounted for and presented in financial statements. This guidance requires that entities record all tax effects of share-based payments at settlement or expiration through the income statement. The standard also amends how windfall tax benefits are recognized, the minimum statutory tax withholding requirements and how entities elect to recognize share-based payment forfeitures. This guidance will be effective for the Company on January 1, 2017, and portions will be required to be applied on a retrospective or modified retrospective basis. Early adoption is permitted. The Company is evaluating the potential impact of adopting this new accounting guidance.

2. Fair Value Measurements

The following is a summary of available-for-sale marketable securities held as of June 30, 2016 and December 31, 2015 (in thousands):



			Gross Unrealized							Classification on Balance Sheet
	Amortized Cost		Gains		Losses			Aggregate Fair Value		Short-Term Marketable Securities		Long-Term Marketable Securities
As of June 30, 2016
Commercial paper	$	18,376	$	—	$	(13	)	$	18,363	$	18,363	$	—
Corporate bonds	979,799		2,178		(111		)	981,866		458,619		523,247
U.S. government agency obligations	269,712		362		(23		)	270,051		65,080		204,971
	$	1,267,887	$	2,540	$	(147	)	$	1,270,280	$	542,062	$	728,218

As of December 31, 2015
Commercial paper	$	2,491	$	—	$	(4	)	$	2,487	$	2,487	$	—
Corporate bonds	995,100		73		(3,365		)	991,808		432,585		559,223
U.S. government agency obligations	239,587		41		(575		)	239,053		25,016		214,037
	$	1,237,178	$	114	$	(3,944	)	$	1,233,348	$	460,088	$	773,260

The Company offers certain eligible employees the ability to participate in a non-qualified deferred compensation plan. The mutual funds held by the Company that are associated with this plan are classified as restricted trading securities. These securities are not included in the available-for-sale securities table above but are included in marketable securities in the consolidated balance sheets.

Unrealized gains and unrealized temporary losses on investments classified as available-for-sale are included within accumulated other comprehensive loss in the consolidated balance sheets. Upon realization, those amounts are reclassified from accumulated other comprehensive loss to interest income in the consolidated statements of income. As of June 30, 2016, the Company held for investment corporate bonds with a fair value of $51.4 million, which are classified as available-for-sale marketable securities and had been in a continuous unrealized loss position for more than 12 months. The unrealized losses are not significant and are attributable to changes in interest rates. The Company does not believe any unrealized losses represent other than temporary impairments based on the evaluation of available evidence. As of December 31, 2015, the Company held for investment corporate bonds with a fair value of $71.4 million that had been in a continuous unrealized loss position for more than 12 months.

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The following table details the fair value measurements within the fair value hierarchy of the Company’s financial assets at June 30, 2016 and December 31, 2015 (in thousands):



	Total Fair Value		Fair Value Measurements at Reporting Date Using
	Total Fair Value		Level 1		Level 2		Level 3
As of June 30, 2016
Cash Equivalents and Marketable Securities:
Money market funds	$	3,789	$	3,789	$	—	$	—
Commercial paper	18,363		—		18,363		—
Corporate bonds	981,866		—		981,866		—
U.S. government agency obligations	270,051		—		270,051		—
Mutual funds	3,014		3,014		—		—
	$	1,277,083	$	6,803	$	1,270,280	$	—

As of December 31, 2015
Cash Equivalents and Marketable Securities:
Money market funds	$	1,250	$	1,250	$	—	$	—
Commercial paper	2,487		—		2,487		—
Corporate bonds	991,808		—		991,808		—
U.S. government agency obligations	239,053		—		239,053		—
Mutual funds	1,414		1,414		—		—
	$	1,236,012	$	2,664	$	1,233,348	$	—

As of June 30, 2016 and December 31, 2015, the Company grouped money market funds and mutual funds using a Level 1 valuation because market prices for such investments are readily available in active markets. As of June 30, 2016 and December 31, 2015, the Company grouped commercial paper, corporate bonds and U.S. government agency obligations using a Level 2 valuation because quoted prices for identical or similar assets are available in markets that are inactive. The Company did not have any transfers of assets between Level 1, Level 2 or Level 3 of the fair value measurement hierarchy during the six months ended June 30, 2016.

When developing fair value estimates, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. When available, the Company uses quoted market prices to measure fair value. The valuation technique used to measure fair value for the Company's Level 1 and Level 2 assets is a market approach, using prices and other relevant information generated by market transactions involving identical or comparable assets. If market prices are not available, the fair value measurement is based on models that use primarily market-based parameters including yield curves, volatilities, credit ratings and currency rates. In certain cases where market rate assumptions are not available, the Company is required to make judgments about assumptions market participants would use to estimate the fair value of a financial instrument.

Contractual maturities of the Company’s available-for-sale marketable securities held as of June 30, 2016 and December 31, 2015 were as follows (in thousands):



	June 30, 2016		December 31, 2015
Due in 1 year or less	$	542,062	$	460,088
Due after 1 year through 5 years	728,218		773,260
	$	1,270,280	$	1,233,348

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3. Accounts Receivable

Net accounts receivable consisted of the following as of June 30, 2016 and December 31, 2015 (in thousands):



	June 30, 2016			December 31, 2015
Trade accounts receivable	$	264,645		$	262,885
Unbilled accounts receivable	108,243			124,878
Gross accounts receivable	372,888			387,763
Allowance for doubtful accounts	(1,391		)	(906		)
Reserve for cash-basis customers	(7,096		)	(6,458		)
Total accounts receivable reserves	(8,487		)	(7,364		)
Accounts receivable, net	$	364,401		$	380,399

4. Goodwill and Acquired Intangible Assets

The change in the carrying amount of goodwill for the six months ended June 30, 2016 was as follows (in thousands):



Balance as of January 1, 2016	$	1,150,244
Foreign currency translation	(107		)
Balance as of June 30, 2016	$	1,150,137

The Company tests goodwill for impairment at least annually. Through the date the consolidated financial statements were issued, no triggering events had occurred that would indicate a potential impairment exists.

Acquired intangible assets that are subject to amortization consisted of the following as of June 30, 2016 and December 31, 2015 (in thousands):



	June 30, 2016							December 31, 2015
	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Completed technology	$	120,791	$	(64,951	)	$	55,840	$	120,791	$	(58,633	)	$	62,158
Customer-related intangible assets	191,710		(108,540		)	83,170		191,710		(102,872		)	88,838
Non-compete agreements	6,540		(4,518		)	2,022		6,540		(3,374		)	3,166
Trademarks and trade names	3,700		(2,064		)	1,636		3,700		(1,767		)	1,933
Acquired license rights	490		(490		)	—		490		(490		)	—
Total	$	323,231	$	(180,563	)	$	142,668	$	323,231	$	(167,136	)	$	156,095

Aggregate expense related to amortization of acquired intangible assets for the three and six months ended June 30, 2016 was $6.7 million and $13.4 million, respectively. Aggregate expense related to amortization of acquired intangible assets for the three and six months ended June 30, 2015 was $6.8 million and $13.5 million, respectively. Based on the Company’s acquired intangible assets as of June 30, 2016, aggregate expense related to amortization of acquired intangible assets is expected to be $13.1 million for the remainder of 2016, and $27.8 million, $23.7 million, $21.7 million and $17.7 million for 2017, 2018, 2019 and 2020, respectively.

5. Convertible Senior Notes

In February 2014, the Company issued $690.0 million in par value of convertible senior notes due 2019 (the "Notes"). The Notes are senior unsecured obligations of the Company, do not bear regular interest and mature on February 15, 2019, unless repurchased or converted prior to maturity.

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At their option, holders may convert their Notes prior to the close of business on the business day immediately preceding August 15, 2018 only under the following circumstances:

•

during any calendar quarter commencing after the calendar quarter ended June 30, 2014 (and only during such calendar quarter), if the last reported sale price of the Company's common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; or


•	during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the conversion rate on each such trading day; or upon the occurrence of specified corporate events.

On or after August 15, 2018, holders may convert all or any portion of their Notes at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date, regardless of the foregoing circumstances.

Upon conversion, the Company, at its election, may pay or deliver to holders cash, shares of the Company's common stock or a combination of cash and shares of the Company's common stock. The initial conversion rate is 11.1651 shares of the Company's common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $89.56 per share, subject to adjustments in certain events, and represents a potential conversion into 7.7 million shares.

In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying cost of the liability component was calculated by measuring the fair value of a similar debt obligation that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes. The difference between the principal amount of the Notes and the proceeds allocated to the liability component (“debt discount”) is amortized to interest expense using the effective interest method over the term of the Notes. The equity component is recorded in additional paid-in capital in the consolidated balance sheet and will not be remeasured as long as it continues to meet the conditions for equity classification.

In accounting for the transaction costs related to the issuance of the Notes, the Company allocated the total transaction costs incurred to the liability and equity components based on their relative values. Transaction costs attributable to the liability component are being amortized to interest expense over the term of the Notes, and transaction costs attributable to the equity component are netted against the equity component of the Notes in stockholders’ equity.

The Notes consist of the following components (in thousands):



	June 30, 2016			December 31, 2015
Liability component:
Principal	$	690,000		$	690,000
Less: debt discount and issuance costs, net of amortization	(61,030		)	(71,953		)
Net carrying amount	$	628,970		$	618,047

Equity component:	$	101,276		$	101,276

The estimated fair value of the Notes at June 30, 2016 was $669.3 million. The fair value was determined based on data points other than quoted prices that are observable, either directly or indirectly, and has been classified as Level 2 within the fair value hierarchy. Based on the closing price of the Company's common stock of $55.93 on June 30, 2016, the value of the Notes if converted to common stock was less than the principal amount of $690.0 million.

The Company used $62.0 million of the proceeds from the offering to repurchase shares of its common stock, concurrently with the issuance of the Notes. The repurchases were made in accordance with the share repurchase program previously approved by the Board of Directors (Note 7). Additionally, $23.3 million of the proceeds was used for the net cost of

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convertible note hedge and warrant transactions. The remaining net proceeds are for working capital, share repurchases and other general corporate purposes, as well as for potential acquisitions and strategic transactions.

Note Hedge

To minimize the impact of potential dilution upon conversion of the Notes, the Company entered into convertible note hedge transactions with respect to its common stock in February 2014. The Company paid $101.3 million for the note hedge transactions. The note hedge transactions cover approximately 7.7 million shares of the Company’s common stock at a strike price that corresponds to the initial conversion price of the Notes, also subject to adjustment, and are exercisable upon conversion of the Notes. The note hedge transactions are intended to reduce dilution in the event of conversion of the Notes.

Warrants

Separately, in February 2014, the Company entered into warrant transactions, whereby the Company sold warrants to acquire, subject to anti-dilution adjustments, up to 7.7 million shares of the Company’s common stock at a strike price of approximately $104.49 per share. The Company received aggregate proceeds of $78.0 million from the sale of the warrants. The convertible note hedge and warrant transactions will generally have the effect of increasing the conversion price of the Notes to approximately $104.49 per share.

Interest Expense

The Notes do not bear regular interest, but have an effective interest rate of 3.2% attributable to the conversion feature. The following table sets forth total interest expense included in the consolidated statements of income related to the Notes (in thousands):



	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2016			2015			2016			2015
Amortization of debt discount and issuance costs	$	5,485		$	5,297		10,923			10,548
Capitalization of interest expense	(846		)	(619		)	(1,631		)	(1,294		)
Total interest expense	$	4,639		$	4,678		$	9,292		$	9,254

6. Contingencies

During the three months ended June 30, 2016, the Company completed an internal investigation, with the assistance of outside counsel, relating to improper sales practices by a former employee. The internal investigation included a review of compliance with the requirements of the U.S. Foreign Corrupt Practices Act ("FCPA") and other applicable laws and regulations. In February 2015, the Company voluntarily contacted the Commission and Department of Justice to advise both agencies of this internal investigation. In June 2016, the Company signed a non-prosecution agreement with the Commission and agreed to disgorge $0.7 million to resolve this matter, including interest. The amount was accrued and paid during the six months ended June 30, 2016.

In July 2016, as part of the resolution of a patent infringement lawsuit filed by the Company against Limelight Networks, Inc. (“Limelight”) in 2006, the Company has agreed to license to Limelight technology covered by certain of the Company’s patents. The terms of the agreement require Limelight to pay the Company $54.0 million in 12 equal installments over three years, beginning in August 2016.

7. Stockholders’ Equity

Share Repurchase Program

In October 2013, the Board of Directors authorized a $750.0 million share repurchase program, effective from October 16, 2013 through December 31, 2016. In February 2016, the Board of Directors authorized a $1.0 billion share repurchase program that superseded the October 2013 program and is effective from February 9, 2016 through December 31, 2018. The Company's goal for the share repurchase program is to offset the dilution created by its employee equity compensation programs and provide the flexibility to return capital to shareholders as business and market conditions warrant. During the six months ended June 30, 2016, the Company repurchased 4.0 million shares of its common stock for $199.7 million.

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Stock-Based Compensation

The following table summarizes stock-based compensation included in the Company’s consolidated statements of income for the three and six months ended June 30, 2016 and 2015 (in thousands):



	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2016			2015			2016			2015
Cost of revenue	$	4,553		$	3,502		$	8,523		$	6,665
Research and development	6,752			6,009			13,190			11,375
Sales and marketing	13,259			12,847			25,611			25,830
General and administrative	10,347			9,893			19,328			18,050
Total stock-based compensation	34,911			32,251			66,652			61,920
Provision for income taxes	(12,388		)	(10,405		)	(24,521		)	(22,107		)
Total stock-based compensation, net of income taxes	$	22,523		$	21,846		$	42,131		$	39,813

In addition to the amounts of stock-based compensation reported in the table above, the Company’s consolidated statements of income for the three and six months ended June 30, 2016 include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $3.6 million and $6.9 million, respectively, before taxes. For the three and six months ended June 30, 2015, the Company's consolidated statements of income include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $3.4 million and $6.4 million, respectively, before taxes.

8. Accumulated Other Comprehensive Loss

The following table summarizes the changes in accumulated other comprehensive loss, which is reported as a component of stockholders' equity, for the six months ended June 30, 2016 (in thousands):



	Foreign Currency Translation			Net Unrealized Gains on Investments		Total
Balance as of January 1, 2016	$	(44,936	)	$	3,483	$	(41,453	)
Other comprehensive gain	5,925			3,912		9,837
Balance as of June 30, 2016	$	(39,011	)	$	7,395	$	(31,616	)

The tax effect on accumulated unrealized gains on investments was insignificant as of June 30, 2016 and December 31, 2015. Amounts reclassified from accumulated other comprehensive loss to net income were insignificant for the six months ended June 30, 2016.

9. Income Taxes

The Company’s effective income tax rate was 33.1% and 34.8% for the six months ended June 30, 2016 and 2015, respectively. The effective income tax rate is based on estimated income for the year, the estimated composition of the income in different jurisdictions and discrete adjustments, if any, in the applicable quarterly periods, including retroactive changes in tax legislation, settlements of tax audits or assessments, the resolution or identification of tax position uncertainties and acquisitions of other companies.

For the six months ended June 30, 2016, the effective income tax rate was lower than the federal statutory tax rate due to the composition of income from foreign jurisdictions that is taxed at lower rates compared to the statutory tax rates in the U.S. and the U.S. federal, state and foreign research and development credits, partially offset by the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments and state income taxes. For the six months ended June 30, 2015, the effective income tax rate was lower than the federal statutory tax rate due

to the domestic production activities deduction and the composition of income from foreign jurisdictions that is taxed at lower

rates compared to the statutory tax rates in the U.S., partially offset by the effects of accounting for stock-based compensation

in accordance with the authoritative guidance for share-based payments and state income taxes.

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10. Net Income per Share

Basic net income per share is computed using the weighted average number of common shares outstanding during the applicable period. Diluted net income per share is computed using the weighted average number of common shares outstanding during the period, plus the dilutive effect of potential common stock. Potential common stock consists of shares issuable pursuant to stock options, restricted stock units (“RSUs”), deferred stock units ("DSUs"), convertible senior notes and warrants issued by the Company. The dilutive effect of outstanding awards and convertible securities is reflected in diluted earnings per share by application of the treasury stock method.

The following table sets forth the components used in the computation of basic and diluted net income per share for the three and six months ended June 30, 2016 and 2015 (in thousands, except per share data):



	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2016		2015		2016		2015
Numerator:
Net income	$	73,635	$	67,200	$	148,493	$	144,946
Denominator:
Shares used for basic net income per share	175,499		178,682		175,951		178,614
Effect of dilutive securities:
Stock options	396		912		400		954
RSUs and DSUs	525		1,144		629		1,214
Convertible senior notes	—		—		—		—
Warrants related to issuance of convertible senior notes	—		—		—		—
Shares used for diluted net income per share	176,420		180,738		176,980		180,782
Basic net income per share	$	0.42	$	0.38	$	0.84	$	0.81
Diluted net income per share	$	0.42	$	0.37	$	0.84	$	0.80

For the three and six months ended June 30, 2016 and 2015, certain potential outstanding shares from stock options, service-based RSUs, convertible notes and warrants were excluded from the computation of diluted net income per share because the effect of including these items was anti-dilutive. Additionally, certain performance-based RSUs were excluded from the computation of diluted net income per share because the underlying performance conditions for such RSUs had not been met as of these dates. The number of potentially outstanding shares excluded from the computation of diluted net income per share for the three and six months ended June 30, 2016 and 2015 are as follows (in thousands):



	For the Three Months Ended June 30,		For the Six Months Ended June 30,
	2016	2015	2016	2015
Stock options	80	—	92	13
Service-based RSUs	1,904	28	3,283	325
Performance-based RSUs	1,280	1,148	704	1,148
Convertible senior notes	7,704	7,704	7,704	7,704
Warrants related to issuance of convertible senior notes	7,704	7,704	7,704	7,704

The calculation of assumed proceeds used to determine the diluted weighted average shares outstanding under the treasury stock method in the periods presented was adjusted by tax windfalls and shortfalls associated with all of the Company’s outstanding stock awards. Such windfalls and shortfalls are computed by comparing the tax deductible amount of outstanding stock awards to their grant-date fair values and multiplying the results by the applicable statutory tax rate. A positive result creates a windfall, which increases the assumed proceeds, and a negative result creates a shortfall, which reduces the assumed proceeds.

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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 marketable securities, goodwill and acquired intangible assets, capitalized internal-use software development costs, impairment and useful lives of long-lived assets, income tax, 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, 2015 for further discussion of our critical accounting policies and estimates.

Overview

We provide cloud services for delivering, optimizing and securing content and business applications over the Internet. For many of our core solutions, we rely on a recurring revenue model with customers executing contracts having terms of one year or longer. We believe this emphasis on longer-term contracts allows us to have a consistent and predictable base level of revenue, which is important to our financial success. We are also dependent on media customers where usage of our services is less predictable; as a result, our revenue is impacted by the amount of media and software download traffic we serve on our network, the rate of adoption of social media and video platform capabilities, the timing and variability of customer-specific one-time events and the impact of seasonal variations on our business. The prices we are able to charge for our services is also a key variable impacting income.

We have observed the following trends related to our revenue in recent years:


•	Increased sales of our Cloud Security Solutions have made a significant contribution to revenue growth, and we expect to continue our focus on security solutions in the future.


•	We have increased committed recurring revenue by adding new customers and increasing sales of incremental services to our existing customers. These increases helped to limit the impact of reductions in usage of our services and contract terminations by certain customers, as well as the effect of price decreases negotiated as part of contract renewals.

•

In recent years, we have experienced increases in the amount of traffic delivered for our customers that use our solutions for video, gaming, social media and software downloads. After seeing a slower sequential quarterly growth rate in revenue from these services across the second half of 2015 and the first quarter of 2016, we experienced a decline in traffic delivered in the second quarter as compared to the first quarter of this year. We believe that this development is primarily attributable to an increase in the use of "do-it-yourself" approaches by several of our largest Internet platform customers based in the U.S., which has led to a moderation in the overall rate of growth of customer traffic on our network. We are likely to experience continued decreases in revenue from these customers during the remainder of the year.

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•	The unit prices paid by some of our customers have declined, reflecting the impact of competition. Our profitability would have been higher absent these price declines.

•

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 holiday season activity. 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. In addition, we experience quarterly variations in revenue attributable to, among other things, the nature and timing of software and gaming releases by our customers using our software download solutions; whether there are large live sporting or other events that increase the amount of media traffic on our network; and the frequency and timing of purchases of custom services.

Our level of profitability is also impacted by our expenses, including direct costs to support our revenue such as bandwidth and co-location costs. We have observed the following trends related to our profitability in recent years:

•

Network bandwidth costs represent a significant portion of our cost of revenue. Historically, we have been able to mitigate increases in these costs by reducing our network bandwidth costs per unit and investing 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 and serving more traffic to higher cost regions. We will need to continue to effectively manage our bandwidth costs to maintain current levels of profitability.

•

Co-location costs are also a significant portion of our 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 also need to effectively manage our co-location costs to maintain current levels of profitability.


•	Due to the fixed nature of some of our co-location and bandwidth costs over a minimum time period, it may not be possible to quickly reduce those costs. If our revenue growth rate declines, our profitability could decrease.

•

Payroll and related compensation costs have grown as we have increased headcount to support our revenue growth and strategic initiatives. We increased our headcount by 979 employees during the year ended December 31, 2015. We expect to continue to hire additional employees in 2016, both domestically and internationally, in support of our strategic initiatives. We have hired 179 employees during the first half of 2016.

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Results of Operations

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



	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2016		2015		2016		2015
Revenue	100.0	%	100.0	%	100.0	%	100.0	%
Costs and operating expenses:
Cost of revenue (exclusive of amortization of acquired intangible assets shown below)	36.1		33.3		35.2		32.7
Research and development	6.6		6.8		6.9		6.8
Sales and marketing	18.0		20.6		18.0		20.1
General and administrative	18.8		18.3		18.4		17.7
Amortization of acquired intangible assets	1.2		1.2		1.2		1.3
Restructuring charges	0.1		0.1		0.6		—
Total costs and operating expenses	80.8		80.3		80.3		78.6
Income from operations	19.2		19.7		19.7		21.4
Interest income	0.6		0.5		0.6		0.5
Interest expense	(0.8	)	(0.9	)	(0.8	)	(0.9	)
Other income (expense), net	0.1		(0.3	)	—		(0.2	)
Income before provision for income taxes	19.1		19.0		19.5		20.8
Provision for income taxes	6.2		6.5		6.4		7.2
Net income	12.9	%	12.5	%	13.1	%	13.6	%

Revenue

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



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016		2015		% Change		% Change at Constant Currency		2016		2015		% Change		% Change at Constant Currency
Revenue	$	572,135	$	540,723	5.8	%	5.6	%	$	1,139,860	$	1,067,259	6.8	%	7.1	%

During the three- and six-month periods ended June 30, 2016, the increase in our revenue as compared to the same periods in 2015 was primarily the result of continued strong growth from our Cloud Security Solutions, which grew 42% and 44%, respectively. Our overall revenue growth rate is lower than it has been in the past due to the "do-it-yourself" efforts of our two largest customers, which are Internet platform companies. Total revenue from our six large Internet platform customers was $61.5 million and $134.0 million during the three- and six- month periods ended June 30, 2016, respectively, as compared to $96.5 million and $192.3 million during the three and six months ended June 30, 2015, respectively.

Changes in foreign currency exchange rates impacted our revenue positively by $1.2 million and negatively by $2.7 million during the three- and six-month periods ended June 30, 2016, respectively, as compared to the same periods in 2015. For the three- and six-month periods ended June 30, 2016 and 2015, no single customer accounted for 10% or more of revenue.

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As part of a reorganization we announced on February 9, 2016, we have adjusted the categorization of our revenue solution categories. Certain of our services that were previously included in Media Delivery Solutions are now presented in Performance and Security Solutions. Beginning in the first quarter of 2016, revenue from these services was classified in its respective product solution category; accordingly, we have revised prior period amounts in the following table.

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



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016		2015		% Change		% Change at Constant Currency		2016		2015		% Change		% Change at Constant Currency
Performance and Security Solutions	$	326,642	$	282,391	15.7	%	15.6	%	$	642,505	$	554,350	15.9	%	16.3	%
Media Delivery Solutions	197,077		217,151		(9.2	)	(9.5	)	403,016		432,016		(6.7	)%	(6.5	)
Services and Support Solutions	48,416		41,181		17.6		17.1		94,339		80,893		16.6	%	16.7
Total revenue	$	572,135	$	540,723	5.8	%	5.6	%	$	1,139,860	$	1,067,259	6.8	%	7.1	%

The increase in Performance and Security Solutions revenue for the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was due to increased demand across all major product lines, with especially strong growth in our Cloud Security Solutions. Cloud Security Solutions revenue for the three- and six-month period ended June 30, 2016 was $87.0 million and $167.6 million, respectively, as compared to $61.5 million and $116.6 million for the three- and six-month periods ended June 30, 2015, respectively.

The decline in the year-over-year revenue growth rate in Media Delivery Solutions revenue for the three- and six-month periods ended June 30, 2016 was primarily the result of decreased traffic from several of our largest Internet platform customers resulting from their "do-it-yourself" efforts in delivering their content, and in particular from two of our largest customers. Excluding six of our largest Internet platform customers, the rest of our Media Delivery Solutions revenue grew 11% and 10% for the three- and six-month periods ended June 30, 2016, respectively, as compared to the same periods in 2015, with particularly strong growth among our over-the-top, or OTT, video delivery customers.

The increase in Services and Support Solutions revenue for the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was due to strong customer attachment rates for our higher-end enterprise class professional services, particularly for customers buying our Web Performance and Cloud Security Solutions.

As a result of our reorganization in 2016, our sales, marketing and product development functions are now organized into three divisions. The following table quantifies the contribution to revenue during the periods presented from the customers in each division (in thousands):



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016		2015		% Change		% Change at Constant Currency		2016		2015		% Change		% Change at Constant Currency
Media Division	$	288,432	$	294,551	(2.1	)%	(2.2	)%	$	580,365	$	588,517	(1.4	)%	(1.1	)%
Web Division	271,327		236,017		15.0		14.6		535,070		460,257		16.3		16.5
Enterprise and Carrier Division	12,376		10,155		21.9		21.8		24,425		18,485		32.1		32.0
Total revenue	$	572,135	$	540,723	5.8	%	5.6	%	$	1,139,860	$	1,067,259	6.8	%	7.1	%

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The decline in the year-over-year revenue growth rate in Media Division revenue for the three- and six-month periods ended June 30, 2016 was the result of decreased traffic from several of our largest Internet platform customers, as discussed above. The year-over-year revenue growth rates were 14% and 13% for the three- and six- month periods ended June 30, 2016, as compared to the same periods 2015, respectively, excluding revenue for six of our large Internet platform customers.

The increase in Web Division revenue during the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was due to growth in this customer base, particularly with our Cloud Security Solutions.

The following table quantifies revenue derived in the U.S. and internationally (in thousands):



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016		2015		% Change		% Change at Constant Currency		2016		2015		% Change		% Change at Constant Currency
U.S.	$	395,085	$	399,103	(1.0	)%	(1.0	)%	$	792,368	$	788,076	0.5	%	0.5	%
International	177,050		141,620		25.0		24.1		347,492		279,183		24.5		25.5
Total revenue	$	572,135	$	540,723	5.8	%	5.6	%	$	1,139,860	$	1,067,259	6.8	%	7.1	%

The reduced revenue from our largest Internet platform customers weighed heavily on U.S. revenue as these customers are based in the U.S. Revenue derived from our operations located outside of the U.S. for the three- and six-month periods ended June 30, 2016 was approximately 31% and 30%, respectively, of total revenue, as compared to 26% for each of the three- and six-month periods ended June 30, 2015. No single country outside of the U.S. accounted for 10% or more of revenue during these periods. During the first six months of 2016, we continued to see strong revenue growth from our operations in the Asia Pacific region.

Cost of Revenue

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



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016			2015			% Change		2016			2015			% Change
Bandwidth fees	$	42,597		$	36,088		18.0	%	$	83,777		$	71,601		17.0	%
Co-location fees	33,223			31,569			5.2		65,817			61,260			7.4
Network build-out and supporting services	16,895			15,533			8.8		30,672			26,960			13.8
Payroll and related costs	46,616			39,600			17.7		91,306			77,152			18.3
Stock-based compensation, including amortization of prior capitalized amounts	7,977			6,797			17.4		14,990			12,775			17.3
Depreciation of network equipment	35,911			31,933			12.5		70,481			63,432			11.1
Amortization of internal-use software	23,104			18,390			25.6		44,016			36,024			22.2
Total cost of revenue	$	206,323		$	179,910		14.7	%	$	401,059		$	349,204		14.8	%
As a percentage of revenue	36.1		%	33.3		%			35.2		%	32.7		%

The increase in total cost of revenue for the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was primarily due to increases in:


•	amounts paid to network providers for bandwidth fees to support the increase in traffic served on our network; the fees paid to our bandwidth providers were also impacted by the type of traffic delivered and the region in which it was served;


•	amounts paid for network build-out and supporting services related to the increase in server deployments and investments in network expansion;

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•	payroll and related costs, as well as stock-based compensation, of service personnel due to headcount growth in our services organization to support our increase in Services and Support revenue, and our network operations personnel to support our other solution revenue; and


•	depreciation of network equipment and amortization of internal-use software as we continued to invest in our infrastructure and release internally developed software onto our network.

Our cost of revenue as a percentage of revenue also increased during the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015. The increase was primarily the result of our increased investments in the strategic expansion of our network.

We have long-term purchase commitments for co-location services and bandwidth usage with various vendors and network and Internet service providers. Our minimum commitments related to bandwidth usage and co-location services may vary from period to period depending on the timing and length of contract renewals with our service providers. There have been no significant changes to the commitments reported in our annual report on Form 10-K for the year ended December 31, 2015, other than normal period-to-period variations.

We believe that cost of revenue will increase during 2016 as compared to 2015 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. Additionally, during 2016, we anticipate amortization of internal-use software development costs to increase as compared to 2015, along with increased payroll and related costs associated with our network and professional services personnel and related expenses. We plan to continue making investments in our network with the expectation that our customer base will continue to expand and that we will continue to deliver more traffic to existing customers.

Research and Development Expenses

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



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016			2015			% Change		2016			2015			% Change
Payroll and related costs	$	61,173		$	54,619		12.0	%	$	125,807		$	109,554		14.8	%
Stock-based compensation	6,752			6,009			12.4		13,190			11,375			16.0
Capitalized salaries and related costs	(31,617		)	(25,845		)	22.3		(63,128		)	(52,087		)	21.2
Other expenses	1,382			1,910			(27.6	)	2,663			3,679			(27.6	)
Total research and development	$	37,690		$	36,693		2.7	%	$	78,532		$	72,521		8.3	%
As a percentage of revenue	6.6		%	6.8		%			6.9		%	6.8		%

The increase in research and development expenses during the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was due to increases in payroll and related costs as a result of headcount growth within the past year to support investments in new product development and network scaling, 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 payroll and related costs for personnel and external consulting expenses involved in the development of internal-use software used to deliver our services and operate our network. During the three- and six-month periods ended June 30, 2016, we capitalized $5.7 million and $10.6 million, respectively, of stock-based compensation. During the three- and six-month periods ended June 30, 2015, we capitalized $4.1 million and $7.8 million, respectively, of stock-based compensation. These capitalized internal-use software development costs are amortized to cost of revenue over their estimated useful lives, which is generally two years.

We believe that research and development expenses will increase in absolute dollars during the remaining quarters of 2016 as compared to the first two quarters of 2016, 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.

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Sales and Marketing Expenses

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



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016			2015			% Change		2016			2015			% Change
Payroll and related costs	$	74,948		$	79,461		(5.7	)%	$	150,828		$	151,529		(0.5	)%
Stock-based compensation	13,259			12,847			3.2		25,611			25,830			(0.8	)
Marketing programs and related costs	9,495			9,101			4.3		15,608			20,877			(25.2	)
Other expenses	5,521			10,092			(45.3	)	13,387			16,744			(20.0	)
Total sales and marketing	$	103,223		$	111,501		(7.4	)%	$	205,434		$	214,980		(4.4	)%
As a percentage of revenue	18.0		%	20.6		%			18.0		%	20.1		%

The decrease in sales and marketing expenses during the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was primarily due to a decrease in commissions expense and other expenses, which consists primarily of costs associated with sales and marketing events and related travel expenses as we moderate discretionary spending to align with our revenue growth rates. The decrease during the three-month period ended June 30, 2016, as compared to the same period in 2015, was also impacted by the timing of large marketing events year-over-year.

During the remaining quarters of 2016, we believe that sales and marketing expenses will increase in absolute dollars as compared to the first two quarters of 2016, due to increases in corporate marketing expenditures and payroll and related costs.

General and Administrative Expenses

General and administrative expenses consisted of the following for the periods presented (in thousands):



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
	2016			2015			% Change		2016			2015			% Change
Payroll and related costs	$	39,175		$	40,885		(4.2	)%	$	80,363		$	82,022		(2.0	)%
Stock-based compensation	10,347			9,893			4.6		19,328			18,050			7.1
Depreciation and amortization	15,964			13,620			17.2		31,393			25,353			23.8
Facilities-related costs	17,800			15,955			11.6		35,208			30,187			16.6
Provision for doubtful accounts	342			345			(0.9	)	828			336			146.4
Acquisition-related costs	352			88			300.0		163			806			(79.8	)
Professional fees and other expenses	23,558			18,366			28.3		42,538			31,990			33.0
Total general and administrative	$	107,538		$	99,152		8.5	%	$	209,821		$	188,744		11.2	%
As a percentage of revenue	18.8		%	18.3		%			18.4		%	17.7		%

The increase in general and administrative expenses for the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, was primarily due to the expansion of company infrastructure throughout 2015 to support investments in engineering, go-to-market capacity and enterprise expansion initiatives. In particular, we increased our facility footprint, which increased facilities-related costs and depreciation and amortization. In the three- and six-month periods ended June 30, 2016, we also incurred higher legal fees due to ongoing litigation and higher other professional fees to support our operations, as compared to the same periods in 2015.

During the remaining quarters of 2016, we expect general and administrative expenses to increase in absolute dollars as compared to the first two quarters of 2016, due to anticipated facilities-related costs attributable to increased hiring, investment in information technology and facility expansion. We also expect legal fees associated with ongoing litigation to remain higher than we experienced in 2015.

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Amortization of Acquired Intangible Assets



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
(in thousands)	2016			2015			% Change		2016			2015			% Change
Amortization of acquired intangible assets	$	6,711		$	6,752		(0.6	)%	$	13,427		$	13,532		(0.8	)%
As a percentage of revenue	1.2		%	1.2		%			1.2		%	1.3		%

Based on our intangible assets at June 30, 2016, we expect amortization of acquired intangible assets to be approximately $13.1 million for the remainder of 2016, and $27.8 million, $23.7 million, $21.7 million and $17.7 million for 2017, 2018, 2019 and 2020, respectively.

Restructuring Charges



	For the Three Months Ended June 30,							For the Six Months Ended June 30,
(in thousands)	2016			2015			% Change	2016			2015			% Change
Restructuring charges	$	470		$	455		3.3%	$	7,288		$	497		1,366.4	%
As a percentage of revenue	0.1		%	0.1		%		0.6		%	—		%

The restructuring charges for the three- and six-month periods ended June 30, 2016 were primarily the result of changes to our organizational structure to reorganize our products and development groups and global sales, services and marketing teams into divisions centered on our solutions. The restructuring charges relate to severance expenses for impacted employees in the six-month period ended June 30, 2016 and also reflect a charge for internal-use software not yet placed into service that will not be completed and launched due to changing priorities as part of the reorganization.

Non-Operating Income (Expense)



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
(in thousands)	2016			2015			% Change		2016			2015			% Change
Interest income	$	3,393		$	2,541		33.5	%	$	6,713		$	5,542		21.1	%
As a percentage of revenue	0.6		%	0.5		%			0.6		%	0.5		%
Interest expense	$	(4,639	)	$	(4,678	)	(0.8	)	$	(9,292	)	$	(9,254	)	0.4
As a percentage of revenue	(0.8		)%	(0.9		)%			(0.8		)%	(0.9		)%
Other income (expense), net	$	415		$	(1,605	)	(125.9	)	$	226		$	(1,906	)	(111.9	)
As a percentage of revenue	0.1		%	(0.3		)%			—		%	(0.2		)%

For the periods presented, interest income consists of interest earned on invested cash balances and marketable securities, and 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 income (expense), net primarily represents net foreign exchange gains and losses and other non-operating expense and income items. The fluctuations in other income (expense), net for the three- and six-month periods ended June 30, 2016, as compared to the same periods in 2015, were primarily due to foreign currency exchange rate fluctuations on intercompany and other non-functional currency transactions. Other income (expense), net may fluctuate in the future based on changes in foreign currency exchange rates or other events.

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Provision for Income Taxes



	For the Three Months Ended June 30,								For the Six Months Ended June 30,
(in thousands)	2016			2015			% Change		2016			2015			% Change
Provision for income taxes	$	35,714		$	35,318		1.1	%	$	73,453		$	77,217		(4.9	)%
As a percentage of revenue	6.2		%	6.5		%			6.4		%	7.2		%
Effective income tax rate	32.7		%	34.5		%			33.1		%	34.8		%

For the six months ended June 30, 2016, our effective income tax rate was lower than the federal statutory tax rate due to the composition of income from foreign jurisdictions that is taxed at lower rates compared to the statutory tax rates in the U.S., the domestic production activities deduction and the treatment of stock-based compensation in intercompany arrangements. These benefits were partially offset by the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments and state income taxes.

For the six months ended June 30, 2015, our effective income tax rate was slightly lower than the federal statutory tax rate. The domestic production activities deduction and the composition of income from foreign jurisdictions that is taxed at lower rates compared to the statutory tax rates in the U.S. caused our tax rate to be lower than the federal statutory tax rate during the six-months ended June 30, 2015; however, those items were offset by the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments and state income taxes.

We expect our full-year effective income tax rate to decrease slightly during the remaining quarters of 2016. This expectation does not take into consideration the effect of potential one-time discrete items including settlements of tax audits and assessments, the resolution or identification of tax position uncertainties and acquisitions of other companies that may be recorded in the future. The effective tax rate could also be different depending on the nature and timing of dispositions of incentive stock options and other employee equity awards. Further, our effective tax rate may fluctuate within a fiscal year and from quarter to quarter due to items arising from one-time discrete items.

In determining our net deferred tax assets and valuation allowances, annualized effective tax rates and cash paid for income taxes, management is required to make judgments and estimates about domestic and foreign profitability, the timing and extent of the utilization of net operating loss carryforwards, applicable tax rates, transfer pricing methodologies and tax planning strategies. Judgments and estimates related to our projections and assumptions are inherently uncertain; therefore, actual results could differ materially from our projections.

We have recorded certain tax reserves to address potential exposures involving our income tax and sales and use tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. Our estimate of the value of these tax reserves reflects assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the ultimate tax liability or benefit from these matters may be materially greater or less than the amount that we have estimated.

Non-GAAP Financial Measures

In addition to providing financial measurements based on GAAP, we publicly discuss additional financial measures that are not prepared in accordance with GAAP, or non-GAAP financial measures. Management uses non-GAAP financial measures, in addition to GAAP financial measures, to understand and compare operating results across accounting periods, for financial and operational decision-making, for planning and forecasting purposes, to measure executive compensation and to evaluate our financial performance. These non-GAAP financial measures are: non-GAAP income from operations, non-GAAP operating margin, non-GAAP net income, non-GAAP net income per diluted share, Adjusted EBITDA, Adjusted EBITDA margin and impact of foreign currency exchange rates, as discussed below.

Management believes that these non-GAAP financial measures reflect our ongoing business in a manner that allows for meaningful comparisons and analysis of trends in the business, as they exclude expenses and gains that may be infrequent, unusual in nature or not reflective of our ongoing operating results. Management also believes that these non-GAAP financial measures enable investors to evaluate our operating results and future prospects in the same manner as management. These non-GAAP financial measures may also facilitate comparing financial results across accounting periods and to those of peer companies.

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The non-GAAP financial measures do not replace the presentation of our GAAP financial measures and should only be used as a supplement to, not as a substitute for, our financial results presented in accordance with GAAP.

The non-GAAP adjustments, and our basis for excluding them from non-GAAP financial measures, are outlined below:

•

Amortization of acquired intangible assets – We have incurred amortization of intangible assets, included in our GAAP financial statements, related to various acquisitions we made. The amount of an acquisition's purchase price allocated to intangible assets and term of its related amortization can vary significantly and are unique to each acquisition; therefore, we exclude amortization of acquired intangible assets from our non-GAAP financial measures to provide investors with a consistent basis for comparing pre- and post-acquisition operating results.

•

Stock-based compensation and amortization of capitalized stock-based compensation – Although stock-based compensation is an important aspect of the compensation paid to our employees, the grant date fair value varies based on the stock price at the time of grant, varying valuation methodologies, subjective assumptions and the variety of award types. This makes the comparison of our current financial results to previous and future periods difficult to interpret; therefore, we believe it is useful to exclude stock-based compensation and amortization of capitalized stock-based compensation from our non-GAAP financial measures in order to highlight the performance of our core business and to be consistent with the way many investors evaluate our performance and compare our operating results to peer companies.

•

Acquisition-related costs – Acquisition-related costs include transaction fees, advisory fees, due diligence costs and other direct costs associated with strategic activities. In addition, subsequent adjustments to our initial estimated amounts of contingent consideration and indemnification associated with specific acquisitions are included within acquisition-related costs. These amounts are impacted by the timing and size of the acquisitions. We exclude acquisition-related costs from our non-GAAP financial measures to provide a useful comparison of our operating results to prior periods and to our peer companies because such amounts vary significantly based on the magnitude of our acquisition transactions.

•

Restructuring charges – We have incurred restructuring charges that are included in our GAAP financial statements, primarily related to workforce reductions and estimated costs of exiting facility lease commitments. We exclude these items from our non-GAAP financial measures when evaluating our continuing business performance as such items vary significantly based on the magnitude of the restructuring action and do not reflect expected future operating expenses. In addition, these charges do not necessarily provide meaningful insight into the fundamentals of current or past operations of our business.

•

Amortization of debt discount and issuance costs and amortization of capitalized interest expense – In February 2014, we issued $690 million of convertible senior notes due 2019 with a coupon interest rate of 0%. The imputed interest rate of the convertible senior notes was approximately 3.2%. This is a result of the debt discount recorded for the conversion feature that is required to be separately accounted for as equity under GAAP, thereby reducing the carrying value of the convertible debt instrument. The debt discount is amortized as interest expense together with the issuance costs of the debt. All of our interest expense is comprised of these non-cash components and is excluded from management's assessment of our operating performance because management believes the non-cash expense is not representative of ongoing operating performance.

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•

Loss on investments and legal matter costs – We have incurred losses from the impairment of certain investments and the settlement of legal matters. We have also incurred costs with respect to our internal U.S. Foreign Corrupt Practices Act ("FCPA") investigation in addition to the disgorgement we were required to pay to resolve it. We believe excluding these amounts from our non-GAAP financial measures is useful to investors as the types of events giving rise to them occur infrequently and are not representative of our core business operations.

•

Income tax effect of non-GAAP adjustments and certain discrete tax items – The non-GAAP adjustments described above are reported on a pre-tax basis. The income tax effect of non-GAAP adjustments is the difference between GAAP and non-GAAP income tax expense. Non-GAAP income tax expense is computed on non-GAAP pre-tax income (GAAP pre-tax income adjusted for non-GAAP adjustments) and excludes certain discrete tax items (such as recording or release of valuation allowances), if any. We believe that applying the non-GAAP adjustments and their related income tax effect allows us to highlight income attributable to our core operations.

The following table reconciles GAAP income from operations to non-GAAP income from operations and non-GAAP operating margin for the periods presented (in thousands):



	For the Three Months Ended June 30,					For the Six Months Ended June 30,
	2016		2015			2016		2015
Income from operations	$	110,180	$	106,260		$	224,299	$	227,781
Amortization of acquired intangible assets	6,711		6,752			13,427		13,532
Stock-based compensation	34,911		32,251			66,652		61,920
Amortization of capitalized stock-based compensation and capitalized interest expense	4,071		3,636			7,679		6,744
Restructuring charges	470		455			7,288		497
Acquisition-related costs (benefits)	361		(530		)	282		(135		)
Legal matter costs	101		1,514			890