Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________
FORM 10-Q
______________________________________________
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the quarterly period ended June 30, 2018 |
or
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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)
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| | |
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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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| | | | |
Large accelerated filer x | Accelerated filer o | Non-accelerated filer o | Smaller reporting company o | Emerging growth company o |
(Do not check if a smaller reporting company) |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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 6, 2018: 169,504,628
AKAMAI TECHNOLOGIES, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018
TABLE OF CONTENTS
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Item 1. | | |
| Consolidated Balance Sheets at June 30, 2018 and December 31, 2017 | |
| Consolidated Statements of Income for the three and six months ended June 30, 2018 and 2017 | |
| Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2018 and 2017 | |
| Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and 2017 | |
| Notes to Unaudited Consolidated Financial Statements | |
Item 2. | | |
Item 3. | | |
Item 4. | | |
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Item 1. | | |
Item 1A. | | |
Item 2. | | |
Item 6. | | |
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
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| | | | | | | |
(in thousands, except share data) | June 30, 2018 | | December 31, 2017 |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 977,488 |
| | $ | 313,382 |
|
Marketable securities | 879,483 |
| | 398,554 |
|
Accounts receivable, net of reserves of $1,065 and $1,281 at June 30, 2018, and December 31, 2017, respectively | 479,865 |
| | 461,457 |
|
Prepaid expenses and other current assets | 147,324 |
| | 172,853 |
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Total current assets | 2,484,160 |
| | 1,346,246 |
|
Property and equipment, net | 852,950 |
| | 862,535 |
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Marketable securities | 411,746 |
| | 567,592 |
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Goodwill | 1,494,311 |
| | 1,498,688 |
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Acquired intangible assets, net | 184,934 |
| | 201,259 |
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Deferred income tax assets | 44,230 |
| | 36,231 |
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Other assets | 132,373 |
| | 136,365 |
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Total assets | $ | 5,604,704 |
| | $ | 4,648,916 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current liabilities: | | | |
Accounts payable | $ | 84,167 |
| | $ | 80,278 |
|
Accrued expenses | 253,241 |
| | 283,743 |
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Deferred revenue | 100,314 |
| | 70,495 |
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Convertible senior notes | 674,629 |
| | — |
|
Other current liabilities | 23,977 |
| | 22,178 |
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Total current liabilities | 1,136,328 |
| | 456,694 |
|
Deferred revenue | 6,075 |
| | 6,062 |
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Deferred income tax liabilities | 18,236 |
| | 17,823 |
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Convertible senior notes | 855,378 |
| | 662,913 |
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Other liabilities | 143,409 |
| | 142,955 |
|
Total liabilities | 2,159,426 |
| | 1,286,447 |
|
Commitments and contingencies (Note 9) |
| |
|
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; 171,763,861 shares issued and 169,311,093 shares outstanding at June 30, 2018, and 169,893,324 shares issued and outstanding at December 31, 2017 | 1,718 |
| | 1,699 |
|
Additional paid-in capital | 4,303,531 |
| | 4,073,362 |
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Accumulated other comprehensive loss | (41,970 | ) | | (21,930 | ) |
Treasury stock, at cost, 2,452,768 shares at June 30, 2018, and no shares at December 31, 2017 | (185,512 | ) | | — |
|
Accumulated deficit | (632,489 | ) | | (690,662 | ) |
Total stockholders’ equity | 3,445,278 |
| | 3,362,469 |
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Total liabilities and stockholders’ equity | $ | 5,604,704 |
| | $ | 4,648,916 |
|
The accompanying notes are an integral part of the consolidated financial statements.
AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
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| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
(in thousands, except per share data) | 2018 | | 2017 | | 2018 | | 2017 |
Revenue | $ | 662,759 |
| | $ | 605,832 |
| | $ | 1,331,483 |
| | $ | 1,206,125 |
|
Costs and operating expenses: | | | | | | | |
Cost of revenue (exclusive of amortization of acquired intangible assets shown below) | 235,487 |
| | 214,680 |
| | 470,312 |
| | 420,407 |
|
Research and development | 59,709 |
| | 53,373 |
| | 124,774 |
| | 105,535 |
|
Sales and marketing | 131,680 |
| | 117,944 |
| | 254,233 |
| | 232,436 |
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General and administrative | 170,206 |
| | 123,518 |
| | 324,591 |
| | 238,527 |
|
Amortization of acquired intangible assets | 8,294 |
| | 7,753 |
| | 16,725 |
| | 15,322 |
|
Restructuring charges | 266 |
| | 2,971 |
| | 15,174 |
| | 2,971 |
|
Total costs and operating expenses | 605,642 |
| | 520,239 |
| | 1,205,809 |
| | 1,015,198 |
|
Income from operations | 57,117 |
|
| 85,593 |
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| 125,674 |
| | 190,927 |
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Interest income | 6,409 |
| | 4,281 |
| | 10,374 |
| | 8,905 |
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Interest expense | (9,204 | ) | | (4,646 | ) | | (14,054 | ) | | (9,243 | ) |
Other (expense) income, net | (2,769 | ) | | 563 |
| | (2,748 | ) | | (121 | ) |
Income before provision for income taxes | 51,553 |
| | 85,791 |
| | 119,246 |
| | 190,468 |
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Provision for income taxes | 8,492 |
| | 29,039 |
| | 22,471 |
| | 59,133 |
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Net income | $ | 43,061 |
| | $ | 56,752 |
|
| $ | 96,775 |
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| $ | 131,335 |
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Net income per share: | | | | | | | |
Basic | $ | 0.25 |
| | $ | 0.33 |
| | $ | 0.57 |
| | $ | 0.76 |
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Diluted | $ | 0.25 |
| | $ | 0.33 |
| | $ | 0.56 |
| | $ | 0.75 |
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Shares used in per share calculations: | | | | | | | |
Basic | 170,250 |
| | 172,674 |
| | 170,183 |
| | 172,916 |
|
Diluted | 172,307 |
| | 173,439 |
| | 172,156 |
| | 174,305 |
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The accompanying notes are an integral part of the consolidated financial statements.
AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
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| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
(in thousands) | 2018 | | 2017 | | 2018 | | 2017 |
Net income | $ | 43,061 |
| | $ | 56,752 |
| | $ | 96,775 |
| | $ | 131,335 |
|
Other comprehensive (loss) income: | | | | | | | |
Foreign currency translation adjustments | (24,558 | ) | | 13,568 |
| | (18,275 | ) | | 23,495 |
|
Change in unrealized gain (loss) on investments, net of income tax (provision) benefit of $(299), $(193), $572 and $(681) for the three and six months ended June 30, 2018 and 2017, respectively | 921 |
| | 320 |
| | (1,765 | ) | | 1,130 |
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Other comprehensive (loss) income | (23,637 | ) | | 13,888 |
| | (20,040 | ) | | 24,625 |
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Comprehensive income | $ | 19,424 |
| | $ | 70,640 |
| | $ | 76,735 |
| | $ | 155,960 |
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The accompanying notes are an integral part of the consolidated financial statements.
AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
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| For the Six Months Ended June 30, |
(in thousands) | 2018 | | 2017 |
Cash flows from operating activities: | | | |
Net income | $ | 96,775 |
| | $ | 131,335 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 210,393 |
| | 175,739 |
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Stock-based compensation | 92,183 |
| | 80,255 |
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(Benefit) provision for deferred income taxes | (12,116 | ) | | 35,223 |
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Amortization of debt discount and issuance costs | 13,759 |
| | 9,243 |
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Restructuring-related software charges | 2,818 |
| | — |
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Other non-cash reconciling items, net | 8,015 |
| | 1,609 |
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Changes in operating assets and liabilities, net of effects of acquisitions: | | | |
Accounts receivable | (16,889 | ) | | (4,265 | ) |
Prepaid expenses and other current assets | 8,578 |
| | (51,224 | ) |
Accounts payable and accrued expenses | (27,091 | ) | | (17,541 | ) |
Deferred revenue | 29,552 |
| | 9,811 |
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Other current liabilities | 5,655 |
| | 5,901 |
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Other non-current assets and liabilities | 59 |
| | (8,835 | ) |
Net cash provided by operating activities | 411,691 |
| | 367,251 |
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Cash flows from investing activities: | | | |
Cash paid for acquired businesses, net of cash acquired | (79 | ) | | (197,201 | ) |
Purchases of property and equipment | (98,300 | ) | | (104,881 | ) |
Capitalization of internal-use software development costs | (103,409 | ) | | (83,305 | ) |
Purchases of short- and long-term marketable securities | (467,886 | ) | | (181,219 | ) |
Proceeds from sales of short- and long-term marketable securities | 16,196 |
| | 180,215 |
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Proceeds from maturities of short- and long-term marketable securities | 124,370 |
| | 232,901 |
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Other non-current assets and liabilities | (479 | ) | | (1,143 | ) |
Net cash used in investing activities | (529,587 | ) | | (154,633 | ) |
Cash flows from financing activities: | | | |
Proceeds from the issuance of convertible senior notes | 1,132,622 |
| | — |
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Proceeds from the issuance of warrants | 119,945 |
| | — |
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Purchase of note hedge related to convertible senior notes | (261,740 | ) | | — |
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Proceeds related to the issuance of common stock under stock plans | 34,103 |
| | 25,680 |
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Employee taxes paid related to net share settlement of stock-based awards | (41,308 | ) | | (41,338 | ) |
Repurchases of common stock | (185,512 | ) | | (177,615 | ) |
Other non-current assets and liabilities | (4,844 | ) | | (1,096 | ) |
Net cash provided by (used in) financing activities | 793,266 |
| | (194,369 | ) |
Effects of exchange rate changes on cash, cash equivalents and restricted cash | (11,460 | ) | | 10,252 |
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Net increase in cash, and cash equivalents and restricted cash | 663,910 |
| | 28,501 |
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Cash, cash equivalents and restricted cash at beginning of period | 314,429 |
| | 324,626 |
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Cash, cash equivalents and restricted cash at end of period | $ | 978,339 |
| | $ | 353,127 |
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AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
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| | | | | | | |
| For the Six Months Ended June 30, |
(in thousands) | 2018 | | 2017 |
Supplemental disclosure of cash flow information: | | | |
Cash paid for income taxes, net of refunds received of $8,656 and $2,481 for the six months ended June 30, 2018 and 2017, respectively | $ | 28,088 |
| | $ | 54,146 |
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Non-cash investing activities: | | | |
Purchases of property and equipment and capitalization of internal-use software development costs included in accounts payable and accrued expenses | 34,016 |
| | 46,988 |
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Capitalization of stock-based compensation | 16,891 |
| | 14,026 |
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| | | |
Reconciliation of cash, cash equivalents and restricted cash: | | | |
Cash and cash equivalents | $ | 977,488 |
| | $ | 352,501 |
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Restricted cash | 851 |
| | 626 |
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Cash, cash equivalents and restricted cash | $ | 978,339 |
| | $ | 353,127 |
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The accompanying notes are an integral part of the consolidated financial statements.
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 more than 200,000 servers across 130 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, 2017, filed with the Securities and Exchange Commission on March 1, 2018.
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 May 2014, the Financial Accounting Standards Board ("FASB") issued updated guidance and disclosure requirements for recognizing revenue. The new revenue recognition standard provides a five-step model for recognizing revenue from contracts with customers. 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. The new standard can be adopted using one of two methods: retrospectively to each prior period presented or a modified retrospective application by recognizing a cumulative-effect adjustment as a component of equity as of the date of adoption. The Company adopted this new standard on a retrospective basis on January 1, 2018. The changes to the Company's revenue recognition approach under this new standard primarily impact the timing of recognizing revenue from a small number of licensed software customers. There is little impact on revenue recognized for the Company's core services. As a result of the change, the Company also began capitalizing certain commission and incentive payments.
In November 2016, the FASB issued guidance that requires restricted cash to be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The Company adopted this new standard on a retrospective basis on January 1, 2018.
The following table details the changes to the consolidated balance sheet as of December 31, 2017 as a result of the retrospective adoption of the new revenue recognition standard (in thousands):
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| | | | | | | | | | | |
| As Previously Reported | | Revenue Recognition Standard Adjustments | | As Revised |
ASSETS | | | | | |
Current assets: | | | | | |
Accounts receivable | $ | 459,127 |
| | $ | 2,330 |
| | $ | 461,457 |
|
Prepaid expenses and other current assets | 137,809 |
| | 35,044 |
| | 172,853 |
|
Total current assets | 1,308,872 |
| | 37,374 |
| | 1,346,246 |
|
Deferred income tax assets | 51,069 |
| | (14,838 | ) | | 36,231 |
|
Other assets | 112,829 |
| | 23,536 |
| | 136,365 |
|
Total assets | 4,602,844 |
| | 46,072 |
| | 4,648,916 |
|
LIABILITIES AND STOCKHOLDERS' EQUITY | | | | | |
Current liabilities: | | | | | |
Deferred revenue | $ | 77,705 |
| | $ | (7,210 | ) | | $ | 70,495 |
|
Total current liabilities | 463,904 |
| | (7,210 | ) | | 456,694 |
|
Deferred revenue | 6,839 |
| | (777 | ) | | 6,062 |
|
Deferred income tax liabilities | 15,510 |
| | 2,313 |
| | 17,823 |
|
Total liabilities | 1,292,121 |
| | (5,674 | ) | | 1,286,447 |
|
Stockholders' equity: | | |
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| | |
Accumulated deficit | (742,408 | ) | | 51,746 |
| | (690,662 | ) |
Total stockholders' equity | 3,310,723 |
| | 51,746 |
| | 3,362,469 |
|
Total liabilities and stockholders' equity | 4,602,844 |
| | 46,072 |
| | 4,648,916 |
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The following table details the changes to the consolidated statements of income for the three and six months ended June 30, 2017 as a result of the retrospective adoption of the new revenue recognition standard (in thousands, except per share data):
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| For the Three Months Ended | | For the Six Months Ended |
| June 30, 2017 | | June 30, 2017 |
| As Previously Reported | | Revenue Recognition Standard Adjustments | | As Revised | | As Previously Reported | | Revenue Recognition Standard Adjustments | | As Revised |
Revenue | $ | 608,908 |
| | $ | (3,076 | ) | | $ | 605,832 |
| | $ | 1,218,145 |
| | $ | (12,020 | ) | | $ | 1,206,125 |
|
Costs and operating expenses: | | |
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| | | | | | | | |
Cost of revenue (exclusive of amortization of acquired intangible assets) | 214,650 |
| | 30 |
| | 214,680 |
| | 420,353 |
| | 54 |
| | 420,407 |
|
Sales and marketing | 119,432 |
| | (1,488 | ) | | 117,944 |
| | 232,998 |
| | (562 | ) | | 232,436 |
|
Total costs and operating expenses | 521,697 |
| | (1,458 | ) | | 520,239 |
| | 1,015,706 |
| | (508 | ) | | 1,015,198 |
|
Income from operations | 87,211 |
| | (1,618 | ) | | 85,593 |
| | 202,439 |
| | (11,512 | ) | | 190,927 |
|
Income before provision for income taxes | 87,409 |
| | (1,618 | ) | | 85,791 |
| | 201,980 |
| | (11,512 | ) | | 190,468 |
|
Provision for income taxes | 29,637 |
| | (598 | ) | | 29,039 |
| | 63,278 |
| | (4,145 | ) | | 59,133 |
|
Net income | 57,772 |
| | (1,020 | ) | | 56,752 |
| | 138,702 |
| | (7,367 | ) | | 131,335 |
|
Net income per share: | | |
|
| | | | | | | | |
Basic | $ | 0.33 |
| | $ | — |
| | $ | 0.33 |
| | $ | 0.80 |
| | $ | (0.04 | ) | | $ | 0.76 |
|
Diluted | $ | 0.33 |
| | $ | — |
| | $ | 0.33 |
| | $ | 0.80 |
| | $ | (0.05 | ) | | $ | 0.75 |
|
The statements of comprehensive income for the three and six months ended June 30, 2017 was also impacted by the adjustments to net income of $1.0 million and $7.4 million, respectively.
The following table details the changes to the consolidated statement of cash flows for the six months ended June 30, 2017 as a result of the retrospective adoption of the new revenue recognition and statement of cash flow standards (in thousands):
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| | | | | | | | | | | | | | | |
| As Previously Reported | | Revenue Recognition Standard Adjustments | | Cash Flow Standard Adjustments | | As Revised |
Cash flows from operating activities: | | |
|
| | | | |
Net income | $ | 138,702 |
| | $ | (7,367 | ) | | $ | — |
| | $ | 131,335 |
|
Adjustments to reconcile net income to net cash provided by operating activities: | | |
|
| | | | |
Provision for deferred income taxes | 39,368 |
| | (4,145 | ) | | — |
| | 35,223 |
|
Changes in operating assets and liabilities, net of effects of acquisitions: | | |
|
| | | | |
Accounts receivable | (17,873 | ) | | 13,608 |
| | — |
| | (4,265 | ) |
Prepaid expenses and other current assets | (50,108 | ) | | (1,116 | ) | | — |
| | (51,224 | ) |
Deferred revenue | 10,406 |
| | (595 | ) | | — |
| | 9,811 |
|
Other non-current assets and liabilities | (8,450 | ) | | (385 | ) | | — |
| | (8,835 | ) |
Net cash provided by operating activities | 367,251 |
| | — |
| | — |
| | 367,251 |
|
Cash flows from investing activities: | | | | | | | |
Other non-current assets and liabilities | (1,249 | ) | | — |
| | 106 |
| | (1,143 | ) |
Net cash used in investing activities | (154,739 | ) | | — |
| | 106 |
| | (154,633 | ) |
Effects of exchange rate changes on cash, cash equivalents and restricted cash | 10,189 |
| | — |
| | 63 |
| | 10,252 |
|
Net increase in cash, and cash equivalents and restricted cash | 28,332 |
| | — |
| | 169 |
| | 28,501 |
|
Cash, cash equivalents and restricted cash at beginning of period | 324,169 |
| | — |
| | 457 |
| | 324,626 |
|
Cash, cash equivalents and restricted cash at end of period | 352,501 |
| | — |
| | 626 |
| | 353,127 |
|
In October 2016, the FASB issued guidance that requires an entity to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The Company adopted this new standard on January 1, 2018 using the modified retrospective basis, recognizing a cumulative-effect adjustment as a component of equity as of the date of adoption. Upon adoption, the Company reclassified $11.6 million from prepaid and other current assets and $27.0 million from other assets to beginning retained earnings.
In January 2017, the FASB issued guidance that changes the definition of a "business" to assist entities with evaluating whether transactions should be accounted for as transfers of assets or business combinations. The Company adopted this guidance on January 1, 2018 and will apply it prospectively to future transactions. The adoption of this new accounting guidance had no immediate impact on the Company's consolidated financial statements; however, it may result in a future transaction being recorded as a transfer of assets, whereas previously the Company may have concluded it was a business combination.
Recent Accounting Pronouncements
In February 2016, the FASB issued guidance that requires companies to present assets and liabilities arising from leases with terms greater than 12 months on the consolidated balance sheets. The updated standard aims to increase transparency and comparability among organizations by requiring lessees to recognize right-of-use assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements. This will impact all leases, including leases for real estate and co-location facilities, among other arrangements currently under evaluation. The Company plans to adopt this standard in the first quarter of 2019 and expects to record significant right-of-use assets and lease liabilities on its consolidated balance sheets. The Company has formed a project team to assess the current state of accounting for leases, to understand the gaps between the current state and required future state and to implement the new processes, systems and controls required. To date, the
Company has completed its gap analysis, selected a software tool to assist with the accounting for leases and has begun its data collection and migration efforts. The Company is also in the process of finalizing its accounting policies and designing the related processes and internal controls. The Company expects the adoption of this standard to require changes to its processes, systems and controls over financial reporting.
In June 2016, the FASB issued guidance that introduces a new methodology for accounting for credit losses on financial instruments, including available-for-sale debt securities. The guidance establishes a new "expected loss model" that requires entities to estimate current expected credit losses on financial instruments by using all practical and relevant information. Any expected credit losses are to be reflected as allowances rather than reductions in the amortized cost of available-for-sale debt securities. This guidance will be effective for the Company on January 1, 2020. The Company is evaluating the potential impact of adopting this new accounting guidance on its consolidated financial statements.
In February 2018, the FASB issued guidance that allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the U.S. Tax Cuts and Jobs Act (the "TCJA") that was enacted in 2017. The amendments in this update are effective either in the period of adoption or retrospectively, to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the TCJA is recognized, during interim and annual periods beginning after December 15, 2018, with early adoption permitted. The Company is evaluating the potential impact of adopting this new accounting guidance on its consolidated financial statements.
2. Significant Accounting Policies Update
The Company's significant accounting policies are detailed in Note 2 of its annual report on Form 10-K for the year ended December 31, 2017. As a result of the FASB's updated guidance for revenue recognition and related changes, as described in Note 1, the following policies have been updated as of the Company's adoption date of January 1, 2018, with retrospective application to the historical periods presented.
Revenue Recognition
The Company primarily derives revenue from the sale of services to customers executing contracts having terms of one year or longer. Services included in the Company's contracts consist of its core services – the delivery of content, applications and software over the Internet – as well as security solutions and professional services. Revenue is recognized upon transfer of control of promised services in an amount that reflects the consideration the Company expects to receive in exchange for those services.
The Company enters into contracts that may include various combinations of these services, which are generally capable of being distinct and accounted for as separate performance obligations. These contracts generally commit the customer to a minimum of monthly, quarterly or annual levels of usage and specify the rate at which the customer must pay for actual usage above the stated minimum. Based on the typical structure of the Company's contracts, which are generally for monthly recurring services that are essentially the same over time and have the same pattern of transfer to the customer, most performance obligations represent a promise to deliver a series of distinct services over time.
The Company's contracts with customers sometimes include promises to deliver multiple services to a customer. Determining whether services are distinct performance obligations often requires the exercise of judgment by management. For example, advanced features that enhance a service and are highly interrelated are generally not considered distinct; rather, they are combined with the service they relate to into one performance obligation. Different determinations related to combining services into performance obligations could result in differences in the timing and amount of revenue recognized in a period.
Generally, the transaction price in a contract is equal to the committed price stated in the contract, less any discounts or rebates. The Company's typical contracts qualify for series accounting and the pricing terms generally do not require estimation of the transaction price beyond the reporting period. As a result, any incremental fees generated as a result of usage or “bursting” over committed contract levels are recorded in the period to which the services relate. The amount of consideration recognized for usage above contract minimums is limited to the amount the Company expects to be entitled to receive in exchange for providing the services. Once the transaction price has been determined, the Company allocates such price among all performance obligations in the contract on a relative standalone selling price (“SSP”) basis.
Determination of SSP requires the exercise of judgment by management. SSP is based on observable inputs such as the price the Company charges for the service when sold separately, or the discounted list price per management’s approved price
list. In cases where services are not sold separately or price list rates are not available, a cost-plus-margin approach or adjusted market approach is used to determine SSP.
Most content delivery and security services represent stand-ready obligations that are satisfied over time as the customer simultaneously receives and consumes the benefits provided by the Company. Accordingly, revenue for those services is recognized over time, generally ratably over the term of the arrangement due to consistent monthly traffic commitments that expire each period. Any bursting over given commitments is recognized in the period in which the traffic was served. For services that involve traffic consumption, revenue is recognized in an amount that reflects the level of traffic served to a customer in a given period. For custom arrangements, other methods may be used as a measure of progress towards satisfying the performance obligations.
Some of the Company's services are satisfied at a point in time, such as one-time professional services contracts, integration services and most license sales where the primary obligation is delivery of the license at the start of the term. In these cases, revenue is recognized at the point in time of delivery or satisfaction of the performance obligation.
From time to time, the Company enters into contracts to sell its services or license its technology to unrelated enterprises at or about the same time that it enters into contracts to purchase products or services from the same enterprises. Consideration payable to a customer is reviewed as part of the transaction price. If the payment to the customer does not represent payment for a distinct service, revenue is recognized only up to the net amount of consideration after customer payment obligations are considered. The Company may also resell the licenses or services of third parties. If the Company is acting as an agent in an arrangement with a customer to provide third party services, the transaction price reflects only the net amount to which the Company will be entitled, after accounting for payments made to the third party responsible for satisfying the performance obligation.
Incremental Costs to Obtain a Contract with a Customer
The Company capitalizes incremental costs associated with obtaining customer contracts, specifically certain commission and incentive payments. The Company pays commissions and incentives up-front based on contract value upon signing a new arrangement with a customer and upon renewal and upgrades of existing contracts with customers if the renewal and upgrades result in an incremental increase in contract value. To the extent commissions and incentives are earned, the expenses, including estimated payroll taxes, are deferred on the Company's consolidated balance sheet and amortized over the expected life of the customer arrangement on a straight-line basis. The Company also incurs commission expense on an ongoing basis for renewals of existing contracts with no increase in contract value, based upon revenue recognized. In these cases, no incremental costs are deferred, as the commissions are earned and expensed in the same period for which the associated revenue is recognized.
Based on the nature of the Company's unique technology and services, and the rate at which the Company continually enhances and updates its technology, the expected life of the customer arrangement is determined to be approximately 2.5 years. Amortization is primarily included in sales and marketing expense in the consolidated statements of income. The current portion of deferred commission and incentive payments is included in prepaid expenses and other current assets, and the long-term portion is included in other assets on the Company's consolidated balance sheets.
Contract Liabilities
Contract liabilities primarily represent payments received from customers for which the related performance obligations have not yet been satisfied. These balances consist of the unearned portion of monthly service fees and integration fees, and prepayments made by customers for future periods. The current and long-term portions of the Company's contract liabilities are included in deferred revenue in the respective sections of the Company's consolidated balance sheets.
3. Fair Value Measurements
The following is a summary of available-for-sale marketable securities held as of June 30, 2018 and December 31, 2017 (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, 2018 | | | | | | | | | | | |
Certificates of deposit | $ | 75,000 |
| | $ | — |
| | $ | (8 | ) | | $ | 74,992 |
| | $ | 74,992 |
| | $ | — |
|
Commercial paper | 284,414 |
| | — |
| | (125 | ) | | 284,289 |
| | 284,289 |
| | — |
|
Corporate bonds | 870,509 |
| | 2 |
| | (7,164 | ) | | 863,347 |
| | 501,251 |
| | 362,096 |
|
U.S. government agency obligations | 58,634 |
| | — |
| | (635 | ) | | 57,999 |
| | 18,841 |
| | 39,158 |
|
| $ | 1,288,557 |
| | $ | 2 |
| | $ | (7,932 | ) | | $ | 1,280,627 |
| | $ | 879,373 |
| | $ | 401,254 |
|
| | | | | | | | | | | |
As of December 31, 2017 | | | | | | | | | | | |
Commercial paper | $ | 6,951 |
| | $ | — |
| | $ | (9 | ) | | $ | 6,942 |
| | $ | 6,942 |
| | $ | — |
|
Corporate bonds | 736,902 |
| | 2 |
| | (3,829 | ) | | 733,075 |
| | 289,378 |
| | 443,697 |
|
U.S. government agency obligations | 220,014 |
| | — |
| | (1,764 | ) | | 218,250 |
| | 102,234 |
| | 116,016 |
|
| $ | 963,867 |
| | $ | 2 |
| | $ | (5,602 | ) | | $ | 958,267 |
| | $ | 398,554 |
| | $ | 559,713 |
|
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, 2018, the Company held for investment corporate bonds with a fair value of $352.1 million, which are classified as available-for-sale marketable securities and have been in a continuous unrealized loss position for more than 12 months. The unrealized losses of $3.0 million related to these corporate bonds are included in accumulated other comprehensive income as of June 30, 2018. The unrealized losses are attributable to changes in interest rates. Based on the evaluation of available evidence, the Company does not believe any unrealized losses represent other than temporary impairments.
The following table details the fair value measurements within the fair value hierarchy of the Company’s financial assets and liabilities as of June 30, 2018 and December 31, 2017 (in thousands):
|
| | | | | | | | | | | | | | | |
| Total Fair Value | | Fair Value Measurements at Reporting Date Using |
| | Level 1 | | Level 2 | | Level 3 |
As of June 30, 2018 | | | | | | | |
Cash Equivalents and Marketable Securities: | | | | | | | |
Money market funds | $ | 254,736 |
| | $ | 254,736 |
| | $ | — |
| | $ | — |
|
Certificates of deposit | 74,992 |
| | 74,992 |
| | — |
| | — |
|
Commercial paper | 284,289 |
| | — |
| | 284,289 |
| | — |
|
Corporate bonds | 863,347 |
| | — |
| | 863,347 |
| | — |
|
U.S. government agency obligations | 57,999 |
| | — |
| | 57,999 |
| | — |
|
Mutual funds | 10,602 |
| | 10,602 |
| | — |
| | — |
|
| $ | 1,545,965 |
| | $ | 340,330 |
| | $ | 1,205,635 |
| | $ | — |
|
| | | | | | | |
Liabilities: | | | | | | | |
Contingent consideration related to a completed acquisition | $ | (6,100 | ) | | $ | — |
| | $ | — |
| | $ | (6,100 | ) |
| | | | | | | |
As of December 31, 2017 | | | |
Cash Equivalents and Marketable Securities: | | | | | | | |
Money market funds | $ | 22,649 |
| | $ | 22,649 |
| | $ | — |
| | $ | — |
|
Commercial paper | 10,928 |
| | — |
| | 10,928 |
| | — |
|
Corporate bonds | 733,075 |
| | — |
| | 733,075 |
| | — |
|
U.S. government agency obligations | 218,248 |
| | — |
| | 218,248 |
| | — |
|
Mutual funds | 7,879 |
| | 7,879 |
| | — |
| | — |
|
| $ | 992,779 |
|
| $ | 30,528 |
|
| $ | 962,251 |
|
| $ | — |
|
| | | | | | | |
Liabilities: | | | | | | | |
Contingent consideration related to a completed acquisition | $ | (8,631 | ) | | $ | — |
| | $ | — |
| | $ | (8,631 | ) |
As of June 30, 2018 and December 31, 2017, the Company grouped certificates of deposit, 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, 2018 and December 31, 2017, 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 three months ended June 30, 2018.
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.
The valuation technique used to measure fair value of the Company's Level 3 liabilities, which consist of contingent consideration related to the acquisition of Cyberfend, Inc. in 2016, was primarily an income-based approach. The significant unobservable input used in the fair value measurement of the contingent consideration was the likelihood of achieving certain post-closing financial results.
Contractual maturities of the Company’s available-for-sale marketable securities held as of June 30, 2018 and December 31, 2017 were as follows (in thousands):
|
| | | | | | | |
| June 30, 2018 | | December 31, 2017 |
Due in 1 year or less | $ | 879,373 |
| | $ | 398,554 |
|
Due after 1 year through 3 years | 401,254 |
| | 559,713 |
|
| $ | 1,280,627 |
| | $ | 958,267 |
|
The following table reflects the activity for the Company’s major classes of liabilities measured at fair value using Level 3 inputs during the six months ended June 30, 2018 (in thousands):
|
| | | |
| Other Liabilities: Contingent Consideration Obligation |
Balance as of January 1, 2018 | $ | (8,631 | ) |
Fair value adjustment to contingent consideration included in general and administrative expense | (1,635 | ) |
Cash paid upon achievement of milestone | 4,166 |
|
Balance as of June 30, 2018 | $ | (6,100 | ) |
4. Accounts Receivable
Net accounts receivable consisted of the following as of June 30, 2018 and December 31, 2017 (in thousands):
|
| | | | | | | |
| June 30, 2018 | | December 31, 2017 |
Trade accounts receivable | $ | 343,526 |
| | $ | 320,001 |
|
Unbilled accounts receivable | 137,404 |
| | 142,737 |
|
Gross accounts receivable | 480,930 |
| | 462,738 |
|
Allowance for doubtful accounts and other reserves | (1,065 | ) | | (1,281 | ) |
Accounts receivable, net | $ | 479,865 |
| | $ | 461,457 |
|
5. Incremental Costs to Obtain a Contract with a Customer
The following table summarizes the deferred costs associated with obtaining customer contracts, specifically commission and incentive payments, as of June 30, 2018 and December 31, 2017 (in thousands):
|
| | | | | | | |
| June 30, 2018 | | December 31, 2017 |
Deferred costs included in prepaid and other current assets | $ | 36,162 |
| | $ | 35,044 |
|
Deferred costs included in other assets | 22,072 |
| | 23,536 |
|
Total deferred costs | $ | 58,234 |
| | $ | 58,580 |
|
During the three and six months ended June 30, 2018, the Company recognized $10.8 million and $21.7 million, respectively, of amortization expense related to deferred commissions. During the three and six months ended June 30, 2017, the Company recognized $8.9 million and $18.0 million, respectively, of amortization expense related to deferred commissions. Amortization expense related to deferred commissions is primarily included in sales and marketing expense in the consolidated statements of income.
6. Goodwill and Acquired Intangible Assets
The change in the carrying amount of goodwill for the six months ended June 30, 2018 was as follows (in thousands):
|
| | | |
Balance as of January 1, 2018 | $ | 1,498,688 |
|
Measurement period adjustments | (1,986 | ) |
Foreign currency translation | (2,391 | ) |
Balance as of June 30, 2018 | $ | 1,494,311 |
|
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, 2018 and December 31, 2017 (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2018 | | December 31, 2017 |
| Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
Completed technology | $ | 145,091 |
| | $ | (73,436 | ) | | $ | 71,655 |
| | $ | 145,091 |
| | $ | (65,283 | ) | | $ | 79,808 |
|
Customer-related intangible assets | 245,710 |
| | (136,811 | ) | | 108,899 |
| | 245,310 |
| | (128,835 | ) | | 116,475 |
|
Non-compete agreements | 710 |
| | (214 | ) | | 496 |
| | 4,710 |
| | (3,975 | ) | | 735 |
|
Trademarks and trade names | 7,200 |
| | (3,316 | ) | | 3,884 |
| | 7,200 |
| | (2,959 | ) | | 4,241 |
|
Acquired license rights | 490 |
| | (490 | ) | | — |
| | 490 |
| | (490 | ) | | — |
|
Total | $ | 399,201 |
| | $ | (214,267 | ) | | $ | 184,934 |
| | $ | 402,801 |
| | $ | (201,542 | ) | | $ | 201,259 |
|
Aggregate expense related to amortization of acquired intangible assets for the three and six months ended June 30, 2018 was $8.3 million and $16.7 million, respectively. Aggregate expense related to amortization of acquired intangible assets for the three and six months ended June 30, 2017 was $7.8 million and $15.3 million, respectively. Based on the Company’s acquired intangible assets as of June 30, 2018, aggregate expense related to amortization of acquired intangible assets is expected to be $16.6 million for the remainder of 2018, and $36.6 million, $33.9 million, $28.0 million and $22.4 million for 2019, 2020, 2021 and 2022, respectively.
7. Debt
Convertible Notes – Due 2025
In May 2018, the Company issued $1,150.0 million in par value of convertible senior notes due 2025 (the "2025 Notes"). The 2025 Notes are senior unsecured obligations of the Company, bear regular interest of 0.125%, payable semi-annually on May 1 and November 1 of each year, and mature on May 1, 2025, unless repurchased or converted prior to maturity.
At their option, holders may convert their 2025 Notes prior to the close of business on the business day immediately preceding January 1, 2025, only under the following circumstances:
| |
• | during any calendar quarter commencing after the calendar quarter ending on June 30, 2018 (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, and including, 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; |
| |
• | during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of 2025 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 January 1, 2025, holders may convert all or any portion of their 2025 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 10.5150 shares of the Company's common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $95.10 per share, subject to adjustments in certain events, and represents a potential conversion into 12.1 million shares.
In accounting for the issuance of the 2025 Notes, the Company separated the 2025 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 2025 Notes. The difference between the principal amount of the 2025 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 2025 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 2025 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 2025 Notes, and transaction costs attributable to the equity component are netted against the equity component of the 2025 Notes in stockholders’ equity.
The 2025 Notes consist of the following components as of June 30, 2018 (in thousands):
|
| | | |
| June 30, 2018 |
Liability component: | |
Principal | $ | 1,150,000 |
|
Less: debt discount and issuance costs, net of amortization | (294,622 | ) |
Net carrying amount | $ | 855,378 |
|
| |
Equity component: | $ | 285,225 |
|
The estimated fair value of the 2025 Notes at June 30, 2018 was $1,157.2 million. The fair value was determined based on the quoted price of the 2025 Notes in an inactive market on the last trading day of the reporting period and has been classified as Level 2 within the fair value hierarchy. Based on the closing price of the Company's common stock of $73.23 on June 30, 2018, the value of the 2025 Notes if converted to common stock was less than the principal amount of $1,150.0 million.
The Company used $46.2 million of the proceeds from the offering to repurchase shares of its common stock, concurrent with the issuance of the 2025 Notes. The repurchase was made in accordance with a share repurchase program previously approved by the Board of Directors. Additionally, $141.8 million of the proceeds was used for the net cost of convertible note hedge and warrant transactions. The remaining net proceeds are intended to be used for the repayment at maturity of the $690.0 million in par value of convertible senior notes due 2019 as well as for working capital, share repurchases, potential acquisitions and strategic transactions and other corporate purposes.
Note Hedge
To minimize the impact of potential dilution upon conversion of the 2025 Notes, the Company entered into convertible note hedge transactions with respect to its common stock in May 2018. The Company paid $261.7 million for the note hedge transactions. The note hedge transactions cover approximately 12.1 million shares of the Company’s common stock at a strike price that corresponds to the initial conversion price of the 2025 Notes, also subject to adjustment, and are exercisable upon conversion of the 2025 Notes. The note hedge transactions are intended to reduce dilution in the event of conversion of the 2025 Notes.
Warrants
Separately, in May 2018, the Company entered into warrant transactions, whereby the Company sold warrants to acquire, subject to anti-dilution adjustments, up to 12.1 million shares of the Company’s common stock at a strike price of approximately $149.18 per share. The Company received aggregate proceeds of $119.9 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 2025 Notes to approximately $149.18 per share.
Convertible Notes – Due 2019
In February 2014, the Company issued $690.0 million in par value of convertible senior notes due 2019 (the "2019 Notes"). The 2019 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.
At their option, holders may convert their 2019 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 2019 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 2019 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 2019 Notes, the Company separated the 2019 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 2019 Notes. The difference between the principal amount of the 2019 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 2019 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 2019 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 2019 Notes, and transaction costs attributable to the equity component are netted against the equity component of the 2019 Notes in stockholders’ equity.
The 2019 Notes consist of the following components as of June 30, 2018 and December 31, 2017 (in thousands):
|
| | | | | | | |
| June 30, 2018 | | December 31, 2017 |
Liability component: | | | |
Principal | $ | 690,000 |
| | $ | 690,000 |
|
Less: debt discount and issuance costs, net of amortization | (15,371 | ) | | (27,087 | ) |
Net carrying amount | $ | 674,629 |
| | $ | 662,913 |
|
| | | |
Equity component: | $ | 101,276 |
| | $ | 101,276 |
|
The estimated fair value of the 2019 Notes at June 30, 2018 was $692.0 million. The fair value was determined based on the quoted price of the 2019 Notes in an inactive market on the last trading day of the reporting period and has been classified as Level 2 within the fair value hierarchy. Based on the closing price of the Company's common stock of $73.23 on June 30, 2018, the value of the 2019 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, concurrent with the issuance of the 2019 Notes. The repurchase was made in accordance with a share repurchase program previously approved by the Board of Directors. Additionally, $23.3 million of the proceeds was used for the net cost of 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 2019 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 2019 Notes, also subject to adjustment, and are exercisable upon conversion of the 2019 Notes. The note hedge transactions are intended to reduce dilution in the event of conversion of the 2019 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 2019 Notes to approximately $104.49 per share.
Revolving Credit Facility
In May 2018, the Company entered into a $500.0 million five-year, revolving credit agreement (the “Credit Agreement”). Borrowings under the Credit Agreement may be used to finance working capital needs and for general corporate purposes. The Credit Agreement provides for an initial $500.0 million in revolving loans. Under specified circumstances, the facility can be increased to up to $1.0 billion in aggregate principal amount.
Borrowings under the Credit Agreement bear interest, at the Company's option, at a base rate plus a spread of 0.00% to 0.25% or an adjusted LIBOR rate plus a spread of 0.875% to 1.25%, in each case with such spread being determined based on the Company's consolidated leverage ratio specified in the Credit Agreement. Regardless of what amounts, if any, are outstanding under the Credit Agreement, the Company is also obligated to pay an ongoing commitment fee on undrawn amounts at a rate of 0.075% to 0.15%, with such rate being based on the Company's consolidated leverage ratio specified in the Credit Agreement.
The Credit Agreement contains customary representations and warranties, affirmative and negative covenants and events of default. Principal covenants include a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio. There were no outstanding borrowings under the Credit Agreement as of June 30, 2018.
Interest Expense
The 2025 Notes bear interest at a fixed rate of 0.125%. The interest is payable semi-annually on May 1 and November 1 of each year, commencing in November 2018. The 2025 Notes have an effective interest rate of 4.26% attributable to the conversion feature. The 2019 Notes do not bear regular interest, but have an effective interest rate of 3.2% attributable to the conversion feature. The Company is also obligated to pay ongoing commitment fees under the terms of the Credit Agreement. The following table sets forth total interest expense included in the consolidated statements of income for the three and six months ended June 30, 2018 and 2017 (in thousands):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Amortization of debt discount and issuance costs | $ | 9,917 |
| | $ | 5,681 |
| | $ | 15,749 |
| | $ | 11,313 |
|
Coupon interest payable on 2025 Notes | 156 |
| | — |
| | 156 |
| | — |
|
Revolving credit facility contractual interest expense | 139 |
| | — |
| | 139 |
| | — |
|
Capitalization of interest expense | (1,008 | ) | | (1,035 | ) | | (1,990 | ) | | (2,070 | ) |
Total interest expense | $ | 9,204 |
| | $ | 4,646 |
| | $ | 14,054 |
| | $ | 9,243 |
|
8. Restructuring
During the fourth quarter of 2017, management committed to an action to restructure certain parts of the Company, with the intent of shifting focus to more critical areas of the business and away from products that have not seen expected commercial success. The restructuring is also intended to facilitate cost efficiencies and savings. As part of the cost efficiency and savings plans, certain headcount and facility reductions were made in 2017 and the first half of 2018. Certain capitalized internal-use software charges have also been realized for software not yet placed into service that will not be completed and implemented due to this action. The Company has incurred $62.7 million of restructuring charges as part of this action, of which $13.4 million was recognized during the six months ended June 30, 2018, and $49.3 million was recognized during the three months ended December 31, 2017. The Company expects to record additional restructuring charges in the remainder of 2018, primarily related to consolidating facilities. The Company does not expect the incremental charges to be material.
The Company also recognized restructuring charges for redundant employees, facilities and contracts associated with acquisitions completed in 2017.
The following table summarizes the activity of the Company's restructuring accrual during the six months ended June 30, 2018 (in thousands):
|
| | | | | | | | | | | | | | | |
| Employee Severance and Related Benefits | | Software Charges | | Excess Facilities, Contract Terminations and Other | | Total |
Balance as of January 1, 2018 | $ | 12,857 |
| | $ | — |
| | $ | 1,386 |
| | $ | 14,243 |
|
Costs incurred | 6,761 |
| | 2,818 |
| | 5,595 |
| | 15,174 |
|
Cash disbursements | (17,831 | ) | | — |
| | (4,777 | ) | | (22,608 | ) |
Software and other non-cash charges | — |
| | (2,818 | ) | | (1,787 | ) | | (4,605 | ) |
Translation adjustments and other | — |
| | — |
| | (181 | ) | | (181 | ) |
Balance as of June 30, 2018 | $ | 1,787 |
| | $ | — |
| | $ | 236 |
| | $ | 2,023 |
|
9. Commitments and Contingencies
Legal Matters
In April 2018, as part of the resolution of multiple existing lawsuits between Limelight Networks, Inc. ("Limelight") and the Company, including in the U.S. District Court for the Eastern District of Virginia and in the U.S. District Court for the District of Massachusetts, the Company and Limelight entered into an agreement to settle the cases and request that the U.S. Patent Trial and Appeal Board terminate certain proceedings related to patents at issue in the litigation. The Company recorded
a $14.9 million charge, which is included in general and administrative expenses in the consolidated statement of income, during the six months ended June 30, 2018 related to this settlement.
10. Stockholders’ Equity
Share Repurchase Program
In February 2016, the Board of Directors authorized a $1.0 billion repurchase program effective from February 2016 through December 2018. In March 2018, the Company announced that its Board had increased its share repurchase authorization by $416.7 million, such that the amount that is authorized and available for repurchase in 2018 is $750.0 million. The Company's goal for the share repurchase program is to return capital to shareholders, as business and market conditions warrant, and to offset the dilution created by its employee equity compensation programs.
During the three and six months ended June 30, 2018, the Company repurchased 2.2 million and 2.5 million shares of its common stock, respectively, for $165.7 million and $185.5 million, respectively.
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, 2018 and 2017 (in thousands):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Cost of revenue | $ | 5,553 |
| | $ | 5,074 |
| | $ | 10,849 |
| | $ | 9,759 |
|
Research and development | 10,926 |
| | 9,614 |
| | 21,435 |
| | 18,643 |
|
Sales and marketing | 16,749 |
| | 13,951 |
| | 32,708 |
| | 29,108 |
|
General and administrative | 14,269 |
| | 12,630 |
| | 27,191 |
| | 22,745 |
|
Total stock-based compensation | 47,497 |
| | 41,269 |
| | 92,183 |
| | 80,255 |
|
Provision for income taxes | (18,802 | ) | | (12,221 | ) | | (29,890 | ) | | (30,206 | ) |
Total stock-based compensation, net of income taxes | $ | 28,695 |
| | $ | 29,048 |
| | $ | 62,293 |
| | $ | 50,049 |
|
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, 2018 include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $5.8 million and $11.4 million, respectively, before taxes and, for the three and six months ended June 30, 2017, include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $3.9 million and $7.4 million, respectively, before taxes.
11. Accumulated Other Comprehensive Loss
The following table summarizes the changes in accumulated other comprehensive loss, net of tax, which is reported as a component of stockholders' equity, for the six months ended June 30, 2018 (in thousands):
|
| | | | | | | | | | | |
| Foreign Currency Translation | | Net Unrealized Gains (Losses) on Investments | | Total |
Balance as of January 1, 2018 | $ | (24,319 | ) | | $ | 2,389 |
| | $ | (21,930 | ) |
Other comprehensive loss | (18,275 | ) | | (1,765 | ) | | (20,040 | ) |
Balance as of June 30, 2018 | $ | (42,594 | ) | | $ | 624 |
| | $ | (41,970 | ) |
Amounts reclassified from accumulated other comprehensive loss to net income were insignificant for the six months ended June 30, 2018.
12. Revenue from Contracts with Customers
The Company sells its services through a sales force located both domestically and abroad. Revenue derived from operations outside of the U.S. is determined based on the country in which the sale originated. Other than the U.S., no single country accounted for 10% or more of the Company’s total revenue for any reported period. The following table summarizes revenue by geography included in the Company’s consolidated statements of income for the three and six months ended June 30, 2018 and 2017 (in thousands):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
U.S. | $ | 413,129 |
| | $ | 400,236 |
| | $ | 836,468 |
| | $ | 799,106 |
|
International | 249,630 |
| | 205,596 |
| | 495,015 |
| | 407,019 |
|
Total revenue | $ | 662,759 |
| | $ | 605,832 |
| | $ | 1,331,483 |
| | $ | 1,206,125 |
|
While the Company sells its services through a geographically disbursed sales force, it manages its customer relationships in two divisions: the Web Division and the Media and Carrier Division. These divisions manage a portfolio of customers that predominately purchase solutions managed by the division; however, customers may purchase solutions managed by the other division as well. The following table summarizes revenue by division included in the Company’s consolidated statements of income for the three and six months ended June 30, 2018 and 2017 (in thousands):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Web Division | $ | 351,084 |
| | $ | 317,408 |
| | $ | 703,921 |
| | $ | 620,896 |
|
Media and Carrier Division | 311,675 |
| | 288,424 |
| | 627,562 |
| | 585,229 |
|
Total revenue | $ | 662,759 |
| | $ | 605,832 |
| | $ | 1,331,483 |
| | $ | 1,206,125 |
|
Most content delivery and security services represent obligations that are satisfied over time as the customer simultaneously receives and consumes the benefits provided by the Company. Accordingly, the majority of the Company's revenue is recognized over time, generally ratably over the term of the arrangement due to consistent monthly traffic commitments that expire each period. A small percentage of the Company's services are satisfied at a point in time, such as one-time professional services contracts, integration services and most license sales where the primary obligation is delivery of the license at the start of the term. In these cases, revenue is recognized at a point in time of delivery or satisfaction of the performance obligation.
During the six months ended June 30, 2018 and 2017, the Company recognized $56.6 million and $40.6 million of revenue that was included in deferred revenue as of December 31, 2017 and 2016, respectively.
As of June 30, 2018, the aggregate amount of remaining performance obligations from contracts with customers was $2.3 billion. The Company expects to recognize more than 70% of its remaining performance obligations as revenue over the next 12 months, with the remaining recognized thereafter. Remaining performance obligations represent the amount of the transaction price within contracts with customers that relates to performance obligations that are unsatisfied or partially satisfied at the reporting date. This consists of future committed revenue for monthly, quarterly or annual periods within current contracts with customers, as well as deferred revenue arising from consideration invoiced in prior periods for which the related performance obligation has not been satisfied. It excludes estimates of variable consideration such as usage-based contracts with no committed contract as well as anticipated renewed contracts.
13. Income Taxes
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. Potential discrete adjustments include tax charges or benefits related to stock-based compensation, changes in tax legislation, settlements of tax audits or assessments, uncertain tax positions and acquisitions, among other items.
The Company is currently under audit in multiple jurisdictions and, in certain cases, is involved in litigation related to adverse audit determinations. In the second quarter of 2018, the Company filed an appeal with the Massachusetts Appellate Tax Board contesting adverse audit findings related to certain tax benefits and exemptions. Over the next 12 months, the Company’s current assumptions and positions could change based on audit determinations and other events impacting its analysis. Such events, if resolved unfavorably, could significantly impact the Company’s effective income tax rate.
The Company’s effective income tax rate was 18.8% and 31.0% for the six months ended June 30, 2018 and 2017, respectively. The lower effective tax rate for the six months ended June 30, 2018, is primarily due to a reduction in the U.S. federal statutory tax rate from 35.0% to 21.0% as part of the TCJA and an increase in the excess tax benefit related to stock-based compensation.
For the six months ended June 30, 2018, the effective income tax rate was lower than the federal statutory tax rate due to foreign income taxed at lower rates, the excess tax benefit related to stock-based compensation and the benefit of U.S. federal, state and foreign research and development credits, partially offset by U.S. federal taxes on Global Intangible Low-Taxed Income (“GILTI”) enacted as part of the TCJA and an intercompany sale of intellectual property.
For the six months ended June 30, 2017, the effective income tax rate was lower than the federal statutory tax rate due to foreign income taxed at lower rates and the benefit of 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.
As of June 30, 2018, no changes have been made to the previously recorded provisional amounts related to the one-time transition tax and the re-measurement of the Company's deferred tax balances in its consolidated financial statements for the year ended December 31, 2017 due to the TCJA. Any changes to the provisional amounts will be recorded in the period in which the adjustments are made. These changes could arise from additional analysis, changes in assumptions or interpretations the Company has made, additional guidance that may be issued and actions the Company may take as a result of the TCJA.
Beginning in 2018, the TCJA provides for a modified territorial tax system imposing an incremental tax on foreign income deemed to be taxed at a “low rate” (the aforementioned GILTI provisions). Under GAAP, an election must be made to either (1) treat taxes due related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factor such amounts into the measurement of deferred taxes (the “deferred method”). The Company is still evaluating the effects of these provisions and has not yet adopted a policy to account for the related impacts.
14. 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, 2018 and 2017 (in thousands, except per share data):
|
| | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Numerator: | | | | | | | |
Net income | $ | 43,061 |
| | $ | 56,752 |
| | $ | 96,775 |
| | $ | 131,335 |
|
Denominator: | | | | | | | |
Shares used for basic net income per share | 170,250 |
| | 172,674 |
| | 170,183 |
| | 172,916 |
|
Effect of dilutive securities: | | |
| | | | |
Stock options | 268 |
| | 329 |
| | 205 |
| | 344 |
|
RSUs and DSUs | 1,789 |
| | 436 |
| | 1,768 |
| | 1,045 |
|
Convertible senior notes | — |
| | — |
| | — |
| | — |
|
Warrants related to issuance of convertible senior notes | — |
| | — |
| | — |
| | — |
|
Shares used for diluted net income per share | 172,307 |
| | 173,439 |
| | 172,156 |
| | 174,305 |
|
Basic net income per share | $ | 0.25 |
| | $ | 0.33 |
| | $ | 0.57 |
| | $ | 0.76 |
|
Diluted net income per share | $ | 0.25 |
| | $ | 0.33 |
| | $ | 0.56 |
| | $ | 0.75 |
|
For the three and six months ended June 30, 2018 and 2017, 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, 2018 and 2017 are as follows (in thousands):
|
| | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Stock options | — |
| | 10 |
| | — |
| | 6 |
|
Service-based RSUs | 204 |
| | 4,134 |
| | 1,509 |
| | 3,407 |
|
Performance-based RSUs | 1,515 |
| | 1,125 |
| | 1,522 |
| | 1,189 |
|
Convertible senior notes | 19,797 |
| | 7,704 |
| | 19,797 |
| | 7,704 |
|
Warrants related to issuance of convertible senior notes | 19,797 |
| | 7,704 |
| | 19,797 |
| | 7,704 |
|
Total shares excluded from computation | 41,313 |
| | 20,677 |
| | 42,625 |
| | 20,010 |
|
15. Akamai Foundation Endowment
During the second quarter of 2018, the Company contributed $50.0 million to the Akamai Foundation, a non-profit organization founded by certain current and former employees of the Company in 2000 (the "Foundation"). The Company has the right to appoint the directors of the Foundation. The contribution is intended to be a one-time endowment. The associated expense is included in general and administrative expenses in the consolidated statements of income for the three and six months ended June 30, 2018. The Foundation is a private corporate foundation with a mission of supporting youth education, with a focus on mathematics, as well as other charitable causes.
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 taxes 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, 2017 and the section entitled "Significant Accounting Policies Update" in the notes to our unaudited consolidated financial statements included herein 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. The key factors that influence our financial success are our ability to build on recurring revenue commitments for our performance and security offerings, increase media traffic on our network, develop new products and carefully manage our capital spending and other expenses.
Revenue
For most of our solutions, our customers commit to contracts having terms of a year or longer, which allows us to have a consistent and predictable base level of revenue. In addition to this base level of revenue, we are also dependent on media customers where usage of our services is more variable. 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 ability to expand our product portfolio and to effectively manage the prices we charge for our services are also key factors impacting our revenue growth.
We have observed the following trends related to our revenue in recent years:
| |
• | Increased sales of our security solutions have made a significant contribution to revenue growth. We plan to continue to invest in this area with a focus on further enhancing our product portfolio and extending our go-to-market capabilities. |
| |
• | We have increased committed recurring revenue from our solutions by increasing sales of incremental services to our existing customers and adding new 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. |
| |
• | The prices paid by some of our customers have declined, reflecting the impact of competition. In particular, pricing pressure related to our delivery-based web performance solutions has reduced our revenue growth rate in recent quarters. |
| |
• | We have experienced increases in the amount of traffic delivered for customers that use our solutions for video, gaming, social media and software downloads, contributing to an increase in our revenue. However, our traffic growth rates are subject to fluctuation based on, among other things, when large events occur and the “do-it-yourself” efforts by some of our customers that are among the large Internet platform companies: Amazon, Apple, Facebook, Google, Microsoft and Netflix. We refer to these companies as our Internet Platform Customers. Some of these customers have elected to develop and rely on their internal infrastructure to deliver more of their media content, particularly less performance-sensitive content, rather than use our services. As a result, we have experienced lower revenue from these customers in recent years. We have not, however, been experiencing a significant shift to internal infrastructure usage across the remainder of our media services customer base. |
| |
• | We have experienced variations in certain types of revenue from quarter to quarter. In particular, we experience higher revenue in the fourth quarter of each 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. |
Expenses
Our level of profitability is also impacted by our expenses, including direct costs to support our revenue such as bandwidth and co-location costs. Some of our bandwidth and co-location costs are fixed over a minimum time period, while others are variable and can be more easily adjusted to reflect changes in customer needs. 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 from 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 need to continue to effectively manage our co-location costs to maintain current levels of profitability. |
| |
• | We incurred significant restructuring costs in the fourth quarter of 2017 and first half of 2018 as management committed to an action to restructure certain parts of the company. The restructuring actions are intended to facilitate cost efficiencies and savings. |
| |
• | Payroll and related compensation costs have grown in the first half of 2018 as we increased headcount throughout 2017, particularly in our professional services and engineering teams to support our revenue growth and strategic initiatives. During the year ended December 31, 2017, we increased our headcount by 1,161 employees. Our headcount decreased by 207 employees during the six-month period ended June 30, 2018, primarily due to the recent restructuring actions. We anticipate our headcount growth to be modest during the remainder of 2018. |
We retrospectively adopted the new accounting standard for revenue recognition on January 1, 2018; accordingly, prior period results have been revised for the adoption of the new standard. The changes to our revenue recognition approach under this new standard primarily impact the timing of recognizing revenue from a small number of licensed software customers. There is little impact to revenue from our core Web and Media products. As a result of the change, we also began capitalizing certain commission and incentive payments. The revisions as a result of adopting the new standard did not have a material impact on our annual revenue or results of operations but did cause quarter-over-quarter fluctuations.
We primarily report our revenue by division, which is a customer-focused reporting view that reflects revenue from customers that are managed by the division. As of January 1, 2018, we now report our revenue in two divisions compared to the three divisions reported in 2017; the Media Division and Enterprise and Carrier Division were combined to form the new Media and Carrier Division. As the purchasing patterns and required account expertise of customers change over time, we may reassign a customer from one division to another. In 2018, we reassigned some of our customers from the Media and Carrier Division to the Web Division and revised historical results in order to reflect the most recent categorization and to provide a comparable view for all periods presented.
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, |
| 2018 | | 2017 | | 2018 | | 2017 |
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) | 35.5 |
| | 35.4 |
| | 35.3 |
| | 34.9 |
|
Research and development | 9.0 |
| | 8.8 |
| | 9.4 |
| | 8.7 |
|
Sales and marketing | 19.9 |
| | 19.5 |
| | 19.1 |
| | 19.3 |
|
General and administrative | 25.7 |
| | 20.4 |
| | 24.4 |
| | 19.8 |
|
Amortization of acquired intangible assets | 1.3 |
| | 1.3 |
| | 1.3 |
| | 1.3 |
|
Restructuring charges | — |
| | 0.5 |
| | 1.1 |
| | 0.2 |
|
Total costs and operating expenses | 91.4 |
| | 85.9 |
| | 90.6 |
| | 84.2 |
|
Income from operations | 8.6 |
| | 14.1 |
| | 9.4 |
| | 15.8 |
|
Interest income | 1.0 |
| | 0.7 |
| | 0.8 |
| | 0.7 |
|
Interest expense | (1.4 | ) | | (0.8 | ) | | (1.1 | ) | | (0.8 | ) |
Other (expense) income, net | (0.4 | ) | | 0.1 |
| | (0.2 | ) | | — |
|
Income before provision for income taxes | 7.8 |
| | 14.1 |
| | 8.9 |
| | 15.7 |
|
Provision for income taxes | 1.3 |
| | 4.8 |
| | 1.7 |
| | 4.9 |
|
Net income | 6.5 | % | | 9.3 | % | | 7.2 | % | | 10.8 | % |
Revenue
Revenue by division during the periods presented was as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | % Change | | % Change at Constant Currency | | 2018 | | 2017 | | % Change | | % Change at Constant Currency |
Web Division | $ | 351,084 |
| | $ | 317,408 |
| | 10.6 | % | | 9.2 | % | | $ | 703,921 |
| | $ | 620,896 |
| | 13.4 | % | | 11.2 | % |
Media and Carrier Division | 311,675 |
| | 288,424 |
| | 8.1 |
| | 6.9 |
| | 627,562 |
| | 585,229 |
| | 7.2 |
| | 5.4 |
|
Total revenue | $ | 662,759 |
| | $ | 605,832 |
| | 9.4 | % | | 8.1 | % | | $ | 1,331,483 |
| | $ | 1,206,125 |
| | 10.4 | % | | 8.4 | % |
During the three- and six-month periods ended June 30, 2018, the increase in our revenue as compared to the same periods in 2017 was primarily the result of higher media traffic volumes, increased sales of our new product offerings and continued strong growth from our Cloud Security Solutions. During the three-month period ended June 30, 2018, our Cloud Security Solutions revenue was $155.3 million, as compared to $116.8 million during the three-month period ended June 30, 2017, which represents a 32.9% increase. During the six-month period ended June 30, 2018, our Cloud Security Solutions revenue
was $304.5 million, as compared to $226.8 million during the six-month period ended June 30, 2017, which represents a 34.3% increase.
The increase in Web Division revenue during the three- and six-month periods ended June 30, 2018, as compared to the same periods in 2017, was primarily the result of increased sales of new products, particularly Image Manager, Digital Performance Management and Bot Manager, as well as continued strong growth in our core Kona and Prolexic Cloud Security Solutions.
The increase in Media and Carrier Division revenue during the three- and six-month periods ended June 30, 2018, as compared to the same periods in 2017, was primarily the result of increased customer traffic volumes driven primarily by video delivery and gaming customers as well as a few large sporting events that took place during the three-month period ended June 30, 2018. The increase in Media and Carrier Division revenue was offset by a decline in revenue from our Internet Platform Customers to $44.1 million and $88.5 million, respectively, for the three- and six-month periods ended June 30, 2018, as compared to $51.2 million and $102.6 million, respectively, for the three- and six-month periods ended June 30, 2017. Excluding these customers, revenue increased within the Media and Carrier Division by 12.8% and 11.9%, respectively, for the three- and six-month periods ended June 30, 2018 as compared to the same periods in 2017.
Revenue derived in the U.S. and internationally during the periods presented is as follows (in thousands):
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| For the Three Months Ended June 30, | | For the Six Months Ended June 30, |
| 2018 | | 2017 | | % Change | | % Change at Constant Currency | | 2018 | | 2017 | | % Change | | % Change at Constant Currency |
U.S. | $ | 413,129 |
| | $ | 400,236 |
| | 3.2 | % | | 3.2 | % | | $ | 836,468 |
| | $ | 799,106 |
| | 4.7 | % | | 4.7 | % |
International | 249,630 |
| | 205,596 |
| | 21.4 |
| | 17.7 |
| | 495,015 |
| | 407,019 |
| | 21.6 |
| | 15.6 |
|
Total revenue | $ | 662,759 |
| | $ | 605,832 |
| | 9.4 | % | | 8.1 | % | | $ | 1,331,483 |
| | $ | 1,206,125 |
| | 10.4 | % | | 8.4 | % |
For the three- and six-month periods ended June 30, 2018, the increase to our U.S. revenue was the result of increases in our media traffic, which was partially offset by decreased revenue from our Internet Platform Customers, which are concentrated in the U.S. Excluding the Internet Platform Customers, our U.S. revenue growth rates would have been 5.7% and 7.4%, respectively, for the three- and six-month periods ended June 30, 2018, as compared to the same periods in 2017.
For the three- and six-month periods ended June 30, 2018, approximately 37.7% and 37.2%, respectively, of our revenue was derived from our operations located outside the U.S., compared to 33.9% and 33.7% for the three- and six-month periods ended June 30, 2017, respectively. No single country outside the U.S. accounted for 10.0% or more of revenue during any of these periods. During the three- and six-month periods ended June 30, 2018, we continued to see strong revenue growth from our operations in the Asia-Pacific region. Changes in foreign currency exchange rates impacted our revenue by an unfavorable $5.1 million and a favorable $7.7 million, respectively, during the three- and six-month periods ended June 30, 2018, as compared to the same periods in 2017.
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, |
| 2018 | | 2017 | | % Change | | 2018 | | 2017 | | % Change |
Bandwidth fees | $ | 40,106 |
| | $ | 41,238 |
| | (2.7 | )% | | $ | 82,223 |
| | $ | 82,721 |
| | (0.6 | )% |
Co-location fees | 32,391 |
| | 31,542 |
| | 2.7 |
| | 65,494 |
| | 63,352 |
| | 3.4 |
|
Network build-out and supporting services | 21,033 |
| | 18,835 |
| | 11.7 |
| | 39,558 |
| | 35,735 |
| | 10.7 |
|
Payroll and related costs | 59,607 |
| | 54,607 |
| | 9.2 |
| | 119,615 |
| | 105,020 |
| | 13.9 |
|
Stock-based compensation, including amortization of prior capitalized amounts | 11,091 |
| | 8,760 |
| | 26.6 |
| | 21,622 |
| | 16,648 |
| | 29.9 |
|
Depreciation of network equipment | 37,748 |
| | 35,404 |
| | 6.6 |
| | 75,983 |
| | 70,659 |
| | 7.5 |
|
Amortization of internal-use software | 33,511 |
| | 24,294 |
| | 37.9 |
| | 65,817 |
| | 46,272 |
| | 42.2 |
|
Total cost of revenue | $ | 235,487 |
| | |