AKAM 10Q 9/30/11
Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________ 
Form 10-Q
 ______________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2011
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to    
            
Commission file number 0-27275
______________________________________________ 
Akamai Technologies, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
04-3432319
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
8 Cambridge Center
Cambridge, MA 02142
(617) 444-3000
(Address, Including Zip Code, and Telephone Number,
Including Area Code, of Registrant’s Principal Executive Offices)
______________________________________________ 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
The number of shares outstanding of the registrant’s common stock as of November 4, 2011: 179,431,186 shares.
Table of Contents

AKAMAI TECHNOLOGIES, INC.
FORM 10-Q
For the quarterly period ended September 30, 2011
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 


2
Table of Contents

PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
September 30,
2011
 
December 31,
2010
 
(In thousands,
except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
355,599

 
$
231,866

Marketable securities (including restricted securities of $51 and $272 at September 30, 2011 and December 31, 2010, respectively)
331,967

 
375,005

Accounts receivable, net of reserves of $5,676 and $5,232 at September 30, 2011 and December 31, 2010, respectively
182,665

 
175,366

Prepaid expenses and other current assets
47,085

 
48,029

Deferred income tax assets
7,163

 
28,201

Total current assets
924,479

 
858,467

Property and equipment, net
285,476

 
255,929

Marketable securities (including restricted securities of $45 at September 30, 2011 and December 31, 2010)
503,429

 
636,531

Goodwill
452,914

 
452,914

Other intangible assets, net
49,702

 
62,456

Deferred income tax assets
76,747

 
75,226

Other assets
9,210

 
11,153

Total assets
$
2,301,957

 
$
2,352,676

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
30,349

 
$
26,375

Accrued expenses and other current liabilities
85,265

 
94,661

Deferred revenue
23,201

 
23,808

Accrued restructuring
63

 
307

Total current liabilities
138,878

 
145,151

Other liabilities
38,013

 
26,278

Deferred revenue
3,055

 
3,642

Total liabilities
179,946

 
175,071

Commitments, contingencies and guarantees (Note 15)

 

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; 194,682,252 shares issued and 179,519,564 shares outstanding at September 30, 2011 and 192,383,121 shares issued and 186,603,380 shares outstanding at December 31, 2010
1,947

 
1,924

Additional paid-in capital
5,025,797

 
4,970,278

Accumulated other comprehensive income (loss)
(9,299
)
 
(5,741
)
Treasury stock, at cost, 15,162,688 shares at September 30, 2011 and 5,779,741 shares at December 31, 2010
(406,662
)
 
(158,261
)
Accumulated deficit
(2,489,772
)
 
(2,630,595
)
Total stockholders’ equity
2,122,011

 
2,177,605

Total liabilities and stockholders’ equity
$
2,301,957

 
$
2,352,676

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

3
Table of Contents

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
 
(In thousands,
except per share data)
Revenues
$
281,856

 
$
253,551

 
$
834,798

 
$
738,898

Costs and operating expenses:
 
 
 
 
 
 
 
Cost of revenues
93,284

 
77,812

 
271,999

 
217,126

Research and development
13,542

 
14,235

 
37,142

 
40,991

Sales and marketing
54,520

 
55,603

 
160,722

 
160,474

General and administrative
50,834

 
42,729

 
140,710

 
125,986

Amortization of other intangible assets
4,185

 
4,130

 
12,754

 
12,390

Restructuring charge
158

 
—

 
158

 
—

Total costs and operating expenses
216,523

 
194,509

 
623,485

 
556,967

Income from operations
65,333

 
59,042

 
211,313

 
181,931

Interest income
2,703

 
2,809

 
8,675

 
9,321

Interest expense
—

 
(222
)
 
—

 
(1,549
)
Other expense, net
(188
)
 
(1,366
)
 
(1,330
)
 
(1,319
)
Gain on investments, net
299

 
49

 
383

 
297

Loss on early extinguishment of debt
—

 
—

 
—

 
(294
)
Income before provision for income taxes
68,147

 
60,312

 
219,041

 
188,387

Provision for income taxes
25,862

 
20,603

 
78,218

 
69,677

Net income
$
42,285

 
$
39,709

 
$
140,823

 
$
118,710

Net income per weighted average share:
 
 
 
 
 
 
 
Basic
$
0.23

 
$
0.22

 
$
0.76

 
$
0.68

Diluted
$
0.23

 
$
0.21

 
$
0.74

 
$
0.63

Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
183,085

 
181,457

 
185,515

 
175,292

Diluted
185,704

 
191,271

 
189,089

 
190,254

















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

4
Table of Contents

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
140,823

 
$
118,710

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
124,228

 
104,113

Stock-based compensation expense
42,465

 
57,973

Provision for deferred income taxes, net
20,906

 
66,898

Amortization of deferred financing costs
—

 
457

Provision for doubtful accounts
1,236

 
2,107

Excess tax benefits from stock-based compensation
(11,460
)
 
(22,379
)
Loss on investments and disposal of property and equipment, net
(172
)
 
(223
)
Non-cash portion of loss on early extinguishment of debt
—

 
294

Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable
(7,821
)
 
(6,342
)
Prepaid expenses and other current assets
(78
)
 
(41,393
)
Accounts payable, accrued expenses and other current liabilities
(5,268
)
 
20,573

Deferred revenue
(1,386
)
 
(7,126
)
Accrued restructuring
(180
)
 
(167
)
Other non-current assets and liabilities
13,355

 
(1,399
)
Net cash provided by operating activities
316,648

 
292,096

Cash flows from investing activities:
 
 
 
Cash paid for acquisition of business, net of cash acquired
(550
)
 
(12,210
)
Purchases of property and equipment
(105,769
)
 
(119,591
)
Capitalization of internal-use software costs
(30,523
)
 
(23,754
)
Purchases of short- and long-term marketable securities
(727,453
)
 
(900,087
)
Proceeds from sales of short- and long-term marketable securities
545,568

 
538,645

Proceeds from maturities of short- and long-term marketable securities
354,552

 
250,537

Increase in other investments
—

 
(500
)
Proceeds from the sale of property and equipment
135

 
52

Decrease in restricted investments held for security deposits
221

 
8

Net cash provided by (used in) investing activities
36,181

 
(266,900
)
Cash flows from financing activities:
 
 
 
Proceeds from the issuance of common stock under stock option and employee stock purchase plans
13,305

 
31,946

Excess tax benefits from stock-based compensation
11,460

 
22,379

Employee taxes paid related to net share settlement of equity awards
(5,680
)
 
—

Repurchases of common stock
(247,738
)
 
(65,126
)
Net cash used in financing activities
(228,653
)
 
(10,801
)
Effects of exchange rate changes on cash and cash equivalents
(443
)
 
1,867

Net increase in cash and cash equivalents
123,733

 
16,262

Cash and cash equivalents at beginning of period
231,866

 
181,305

Cash and cash equivalents at end of period
$
355,599

 
$
197,567

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
26,530

 
$
23,829

Cash paid for interest
—

 
967

Non-cash financing and investing activities:
 
 
 
Capitalization of stock-based compensation, net of impairments
$
5,406

 
$
5,597

Common stock issued upon conversion of 1% convertible senior notes
—

 
141,135

Common stock returned upon settlement of escrow claims related to prior business acquisitions
—

 
(125
)
The accompanying notes are an integral part of the consolidated financial statements.

5
Table of Contents

AKAMAI TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS
1. Nature of Business and Basis of Presentation
Akamai Technologies, Inc. (“Akamai” or the “Company”) provides services for accelerating and improving the delivery of content and applications over the Internet. Akamai’s globally distributed platform comprises thousands of servers in hundreds of networks in approximately 75 countries. The Company was incorporated in Delaware in 1998 and is headquartered in Cambridge, Massachusetts. Akamai currently operates in one industry segment: providing services for accelerating and improving delivery of content and 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 Akamai 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 or omitted in 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 Akamai’s annual report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange Commission on March 1, 2011.
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 and accruals, consisting only of normal recurring adjustments that are necessary for a fair statement of the results of all interim periods reported herein.
2. Recent Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update for business combinations specifically related to the disclosure of supplementary pro forma information for business combinations. This guidance specifies that pro forma disclosures should be reported as if the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period, and the pro forma disclosures must include a description of material, nonrecurring pro forma adjustments. This standard was effective for business combinations with an acquisition date of January 1, 2011 or later. The adoption of the guidance did not have an impact on the Company's financial position or results of operations.
In May 2011, the FASB issued amended guidance and disclosure requirements for fair value measurements. This guidance provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between U.S. GAAP and international financial reporting standards. The guidance changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. This standard will be effective for interim and annual periods beginning after December 15, 2011 and will be applied prospectively. The adoption of the guidance is not expected to have a material impact on the Company's consolidated financial statements.
In June 2011, the FASB issued amended disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (“OCI”) as part of the statement of changes in equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes will be effective January 1, 2012 and early adoption is permitted. There will be no impact to the Company's consolidated financial results as the amendments relate only to changes in financial statement presentation.
In September 2011, the FASB issued amended guidance that will simplify how entities test goodwill for impairment. Under the amended guidance, after assessment of certain qualitative factors, if it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test(s) are optional. The guidance is effective January 1, 2012 with early adoption permitted. The adoption of the guidance is not expected to have a material impact on the Company's financial position or results of operations.



6
Table of Contents

3. Business Acquisition
In June 2010, the Company acquired substantially all of the assets and liabilities of Velocitude LLC (“Velocitude”), in exchange for payment of approximately $12.0 million in cash. In addition, the Company recorded a liability of $2.4 million for contingent consideration related to the expected achievement of certain post-closing milestones. In May 2011, the Company made a final payment of $0.4 million related to the contingent consideration. The acquisition of substantially all of the assets of Velocitude was intended to further Akamai’s strategic position in the mobile market and was accounted for using the purchase method of accounting. The Company allocated $11.6 million of the cost of the acquisition to goodwill and $2.8 million to other intangible assets.
4. Marketable Securities and Investments
The Company accounts for financial assets and liabilities in accordance with a fair value measurement accounting standard. The accounting standard provides a framework for measuring fair value under GAAP and requires expanded disclosures regarding fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The accounting standard also establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1 — Quoted prices in active markets for identical assets or liabilities.
Level 2 — Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in markets that are inactive, or other inputs that are observable or can be corroborated by observable market data.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, including certain pricing models, discounted cash flow methodologies and similar techniques.
The following is a summary of marketable securities held at September 30, 2011 and December 31, 2010 (in thousands):

7
Table of Contents

 
 
 
Gross Unrealized
 
 
 
Classification on Balance Sheet
As of September 30, 2011
Cost
 
Gains
 
Losses
 
Aggregate
Fair Value
 
Short-term
Marketable
Securities
 
Long-term
Marketable
Securities
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
96

 
$
—

 
$
—

 
$
96

 
$
51

 
$
45

Commercial paper
59,989

 
—

 
(23
)
 
59,966

 
59,966

 
—

U.S. corporate debt securities
539,365

 
867

 
(995
)
 
539,237

 
261,922

 
277,315

U.S. government agency obligations
117,227

 
102

 
(7
)
 
117,322

 
10,028

 
107,294

Auction rate securities
135,350

 
—

 
(16,575
)
 
118,775

 
—

 
118,775

 
$
852,027

 
$
969

 
$
(17,600
)
 
$
835,396

 
$
331,967

 
$
503,429

 
 
 
Gross Unrealized
 
 
 
Classification on Balance Sheet
As of December 31, 2010
Cost
 
Gains
 
Losses
 
Aggregate
Fair Value
 
Short-term
Marketable
Securities
 
Long-term
Marketable
Securities
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
96

 
$
—

 
$
—

 
$
96

 
$
51

 
$
45

Commercial paper
59,912

 
34

 
(2
)
 
59,944

 
59,944

 
—

U.S. corporate debt securities
651,855

 
1,416

 
(736
)
 
652,535

 
301,625

 
350,910

U.S. government agency obligations
161,722

 
102

 
(119
)
 
161,705

 
13,385

 
148,320

Auction rate securities
150,800

 
—

 
(13,544
)
 
137,256

 
—

 
137,256

 
$
1,024,385

 
$
1,552

 
$
(14,401
)
 
$
1,011,536

 
$
375,005

 
$
636,531


Unrealized gains and unrealized temporary losses on investments classified as available-for-sale are included within accumulated other comprehensive income (loss). Upon realization, those amounts are reclassified from accumulated other comprehensive income (loss) to gain (loss) on investments, net in the statement of operations. Realized gains and losses and gains and losses on other-than-temporary impairments on investments are reflected in the income statement as gain (loss) on investments, net. As of September 30, 2011, the Company had recorded $135.4 million of auction rate securities ("ARS") at cost with gross unrealized losses that have been in a continuous loss position for more than 12 months.
The following table details the fair value measurements within the fair value hierarchy of the Company’s financial assets, including investments and cash equivalents, at September 30, 2011 and December 31, 2010 (in thousands):

8
Table of Contents

 
 
 
Fair Value Measurements at Reporting
 
Total Fair Value at
 
Date Using
 
September 30, 2011
 
Level 1    
 
Level 2    
 
Level 3    
Money market funds
$
21,057

 
$
21,057

 
$
—

 
$
—

Certificates of deposit
96

 
96

 
—

 
—

Commercial paper
195,707

 
—

 
195,707

 
—

U.S. corporate debt securities
570,062

 
—

 
570,062

 
—

U.S. government agency obligations
117,322

 
—

 
117,322

 
—

Auction rate securities
118,775

 
—

 
—

 
118,775

 
$
1,023,019

 
$
21,153

 
$
883,091

 
$
118,775

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at Reporting
 
Total Fair Value at
 
Date Using
 
December 31, 2010
 
Level 1
 
Level 2
 
Level 3
Money market funds
$
55,648

 
$
55,648

 
$
—

 
$
—

Certificates of deposit
96

 
96

 
—

 
—

Commercial paper
59,944

 
—

 
59,944

 
—

U.S. corporate debt securities
652,535

 
—

 
652,535

 
—

U.S. government agency obligations
161,705

 
—

 
161,705

 
—

Auction rate securities
137,256

 
—

 
—

 
137,256

 
$
1,067,184

 
$
55,744

 
$
874,184

 
$
137,256

The following tables reflect the activity for the Company’s major classes of financial assets measured at fair value using Level 3 inputs, consisting solely of ARS, for the nine month periods ended September 30, 2011 and 2010 (in thousands):
 
Auction Rate
Securities
Balance as of December 31, 2010
$
137,256

Redemptions of securities
(15,450
)
Unrealized loss included in accumulated other comprehensive income (loss), net
(3,031
)
Balance as of September 30, 2011
$
118,775


 
Auction Rate
Securities
 
Put Option Related to Auction Rate Securities
 
Total
Balance as of December 31, 2009
$
244,505

 
$
9,614

 
$
254,119

Redemptions of securities
(109,700
)
 
—

 
(109,700
)
Unrealized gain included in accumulated other comprehensive income (loss), net
5,721

 
—

 
5,721

Unrealized gain on auction rate securities included in the statement of operations
9,614

 
—

 
9,614

Unrealized loss on other investment-related assets included in the statement of operations
—

 
(9,614
)
 
(9,614
)
Balance as of September 30, 2010
$
150,140

 
$
—

 
$
150,140


As of September 30, 2011, the Company had grouped money market funds and certificates of deposit using a Level 1 valuation because market prices for such investments are readily available in active markets. As of September 30,

9
Table of Contents

2011, the Company had grouped commercial paper, U.S. government agency obligations and U.S. corporate debt securities using a Level 2 valuation because quoted prices for identical or similar assets are available in markets that are inactive. As of September 30, 2011, the Company’s assets grouped using a Level 3 valuation consisted of ARS.
Historically, the carrying value (par value) of the Company’s ARS holdings approximated fair market value due to the resetting of variable interest rates in a “Dutch auction” process. Beginning in mid-February 2008 and continuing throughout the period ended September 30, 2011, however, the auctions for ARS held by the Company failed. As a result, the interest rates on ARS reset to the maximum rate per the applicable investment offering statements. The Company will not be able to liquidate affected ARS until a future auction on these investments is successful, a buyer is found outside the auction process, the securities are called or refinanced by the issuer, or the securities mature. Due to these liquidity issues, the Company used a discounted cash flow analysis to determine the estimated fair value of these investments. The discounted cash flow analysis considered the timing of expected future successful auctions, the impact of extended periods of maximum interest rates, collateralization of underlying security investments and the creditworthiness of the issuer. The discounted cash flow analysis as of September 30, 2011 assumed a weighted average discount rate of 4.11% and expected term of five years. The discount rate was determined using a proxy based upon the current market rates for recent debt offerings. The expected term was based on management’s estimate of future liquidity. As a result, as of September 30, 2011, the Company has estimated an aggregate loss of $16.6 million, which was related to the impairment of ARS deemed to be temporary and included in accumulated other comprehensive income (loss) within stockholders’ equity. The discounted cash flow analysis performed as of December 31, 2010 for ARS assumed a weighted average discount rate of 3.21% and expected term of five years. As a result, as of that date, the Company estimated an aggregate loss of $13.5 million, which was related to the impairment of ARS deemed to be temporary and included in accumulated other comprehensive income (loss) within stockholders’ equity.
The ARS the Company holds are primarily AAA-rated bonds, most of which are collateralized by federally guaranteed student loans as part of the Federal Family Education Loan Program through the U.S. Department of Education. The Company believes the quality of the collateral underlying these securities will enable it eventually to recover the Company’s principal balance.
Despite the failed auctions, the Company has continued to receive cash flows in the form of specified interest payments from the issuers of ARS. In addition, the Company does not believe it will be required to sell the ARS prior to a recovery of par value and currently intends to hold the investments until such time because it believes it has sufficient cash, cash equivalents and other marketable securities on-hand and from expected operating cash flows to fund its operations.
As of September 30, 2011 and December 31, 2010, the Company classified $118.8 million and $137.3 million, respectively, of ARS as long-term marketable securities on its consolidated balance sheet due to management’s estimate of its inability to liquidate these investments within the succeeding twelve months.
Contractual maturities of the Company’s marketable securities held at September 30, 2011 and December 31, 2010 were as follows (in thousands): 
 
September 30, 2011
 
December 31, 2010
Available-for-sale securities:
 
 
 
Due in 1 year or less
$
331,967

 
$
375,005

Due after 1 year through 5 years
384,654

 
499,275

Due after 10 years
118,775

 
137,256

 
$
835,396

 
$
1,011,536

5. Accounts Receivable
Net accounts receivable consisted of the following (in thousands):
 

10
Table of Contents

 
September 30,
2011
 
December 31,
2010
Trade accounts receivable
$
127,210

 
$
116,212

Unbilled accounts
61,131

 
64,386

Gross accounts receivable
188,341

 
180,598

Allowance for doubtful accounts
(2,127
)
 
(1,329
)
Reserve for cash-basis customers
(3,549
)
 
(3,903
)
Total accounts receivable reserves
(5,676
)
 
(5,232
)
Accounts receivable, net
$
182,665

 
$
175,366

The Company’s accounts receivable balance includes unbilled amounts that represent revenues recorded for customers that are typically billed monthly in arrears. The Company records reserves against its accounts receivable balance. These reserves consist of allowances for doubtful accounts and reserves for cash-basis customers. Increases and decreases in the allowance for doubtful accounts are included as a component of general and administrative expenses. The Company’s reserve for cash-basis customers increases as services are provided to customers where collection is no longer assured. Increases to the reserve for cash-basis customers are recorded as reductions of revenues. The reserve decreases and revenue is recognized when and if cash payments are received.
Estimates are used in determining these reserves and are based upon the Company’s review of outstanding balances on a customer-specific, account-by-account basis. The allowance for doubtful accounts is based upon a review of customer receivables from prior sales with collection issues where the Company no longer believes that the customer has the ability to pay for services previously provided. The Company also performs ongoing credit evaluations of its customers. If such an evaluation indicates that payment is no longer reasonably assured for services provided, any future services provided to that customer will result in the creation of a cash-basis reserve until the Company receives consistent payments. The Company does not have any off-balance sheet credit exposure related to its customers.
6. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the following (in thousands):
 
September 30,
2011
 
December 31,
2010
Payroll and other related benefits
$
28,097

 
$
51,591

Bandwidth and co-location
21,189

 
21,787

Property, use and other taxes
29,806

 
15,849

Professional service fees
4,292

 
2,678

Contingent consideration
—

 
990

Other
1,881

 
1,766

Total
$
85,265

 
$
94,661

7. 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, deferred stock units, restricted stock units (“RSUs”) and convertible notes.
The following table sets forth the components used in the computation of basic and diluted net income per common share (in thousands, except per share data):
 

11
Table of Contents

 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
Numerator:
 
 
 
 
 
 
 
Net income
$
42,285

 
$
39,709

 
$
140,823

 
$
118,710

Add back of interest expense on 1% convertible senior notes (net of taxes)
—

 
146

 
—

 
964

Numerator for diluted net income per common share
$
42,285

 
$
39,855

 
$
140,823

 
$
119,674

Denominator:

 

 

 

Denominator for basic net income per common share
183,085

 
181,457

 
185,515

 
175,292

Effect of dilutive securities:

 

 

 

Stock options
1,928

 
3,988

 
2,698

 
3,807

Effect of escrow contingencies
—

 
339

 
—

 
339

RSUs and deferred stock units
691

 
1,399

 
876

 
1,332

Assumed conversion of 1% convertible senior notes
—

 
4,088

 
—

 
9,484

Denominator for diluted net income per common share
185,704

 
191,271

 
189,089

 
190,254

Basic net income per common share
$
0.23

 
$
0.22

 
$
0.76

 
$
0.68

Diluted net income per common share
$
0.23

 
$
0.21

 
$
0.74

 
$
0.63

Outstanding options to acquire an aggregate of 4.1 million and 0.9 million shares of common stock for the three months ended September 30, 2011 and 2010, respectively, were excluded from the calculation of diluted earnings per share because the exercise prices of these stock options were greater than the average market price of the Company’s common stock during the respective periods. As a result, the effect of including these options would be anti-dilutive. Similarly, outstanding options to acquire an aggregate of 2.8 million and 1.4 million shares of common stock for the nine months ended September 30, 2011 and 2010, respectively, were excluded from the calculation of diluted earnings per share because the exercise prices of the stock options were greater than the average market price of the Company's common stock during the respective periods. Additionally, 2.8 million and 3.0 million shares of common stock issuable in respect of outstanding performance-based RSUs were excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2011, respectively, and 3.1 million and 3.3 million shares of common stock issuable in respect of outstanding performance-based RSUs were excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2010, respectively, because the performance conditions had not been met as of those dates.
The calculation of assumed proceeds used to determine the diluted weighted average shares outstanding under the treasury stock method in the periods presented was adjusted by tax windfalls and shortfalls associated with all of the Company’s outstanding stock awards. Such windfalls and shortfalls are computed by comparing the tax deductible amount of outstanding stock awards to their grant date fair values and multiplying the results by the applicable statutory tax rate. A positive result creates a windfall, which increases the assumed proceeds, and a negative result creates a shortfall, which reduces the assumed proceeds.
8. Stockholders’ Equity
Stock Repurchase Program
On April 29, 2009, the Company announced that its Board of Directors had authorized a stock repurchase program permitting purchases of up to $100.0 million of the Company’s common stock from time to time on the open market or in privately negotiated transactions. On April 28, 2010, the Company announced that its Board of Directors had authorized an extension of the stock repurchase program permitting purchases of an additional $150.0 million of the Company’s common stock from time to time over the next twelve months commencing in May 2010 on the open market or in privately negotiated transactions. The unused balance from the May 2010 extension was not carried forward for future purchases. On April 19, 2011, the Company’s Board of Directors authorized a new program authorizing up to an additional $150.0 million of repurchases over the next twelve months commencing in May 2011. On August 8, 2011, the Company's Board of Directors authorized an additional $250.0 million of stock repurchases over the twelve-month

12
Table of Contents

period that commenced in May 2011. The total authorized funding for stock repurchases in that twelve-month period is now $400.0 million. The timing and amount of any shares repurchased will be determined by the Company’s management based on its evaluation of market conditions and other factors. Repurchases may also be made under a Rule 10b5-1 plan, which would permit the Company to repurchase shares when the Company might otherwise be precluded from doing so under insider trading laws. Subject to applicable securities laws, the Company may choose to suspend or discontinue the repurchase program at any time.
During the three and nine months ended September 30, 2011, the Company repurchased 6.8 million and 9.4 million shares, respectively, of its common stock for $155.1 million and $248.4 million, respectively. During the three and nine months ended September 30, 2010, the Company repurchased 0.5 million and 1.9 million shares, respectively, of its common stock for $22.7 million and $65.1 million, respectively. As of September 30, 2011, the Company had $206.0 million remaining available for future purchases of shares under the current repurchase program.
Stock-Based Compensation Expense
The following table summarizes the components of total stock-based compensation expense included in the Company’s consolidated statements of operations for the three and nine months ended September 30, 2011 and 2010 (in thousands):
 
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
Stock-based compensation expense by type of award:
 
 
 
 
 
 
 
Stock options
$
3,312

 
$
3,843

 
$
10,518

 
$
11,240

Deferred stock units
—

 
—

 
1,885

 
1,885

RSUs
12,628

 
15,615

 
31,276

 
47,208

Shares issued under the Employee Stock Purchase Plan
1,142

 
1,049

 
4,192

 
3,237

Amounts capitalized as internal-use software
(1,941
)
 
(1,918
)
 
(5,406
)
 
(5,597
)
Total stock-based compensation before income taxes
15,141

 
18,589

 
42,465

 
57,973

Less: Income tax benefit
(5,746
)
 
(6,350
)
 
(15,119
)
 
(21,349
)
Total stock-based compensation, net of taxes
$
9,395

 
$
12,239

 
$
27,346

 
$
36,624

Effect of stock-based compensation on income by line item:

 
 
 
 
 
 
Cost of revenues
$
634

 
$
702

 
$
1,779

 
$
2,110

Research and development expense
2,629

 
3,687

 
7,515

 
11,222

Sales and marketing expense
6,951

 
8,862

 
19,112

 
26,662

General and administrative expense
4,927

 
5,338

 
14,059

 
17,979

Provision for income taxes
(5,746
)
 
(6,350
)
 
(15,119
)
 
(21,349
)
Total cost related to stock-based compensation, net of taxes
$
9,395

 
$
12,239

 
$
27,346

 
$
36,624

In addition to the amounts of stock-based compensation reported in the table above, the Company’s consolidated statements of operations for the three and nine months ended September 30, 2011 also included stock-based compensation reflected as a component of amortization of capitalized internal-use software; such additional stock-based compensation for such period was $1.6 million and $5.6 million, respectively, before taxes. The Company's consolidated statements of operations for the three and nine months ended September 30, 2010 also included stock-based compensation reflected as a component of amortization of capitalized internal-use software; such additional stock-based compensation for such period was $1.8 million and $5.5 million, respectively, before taxes.
9. Comprehensive Income
The following table presents the calculation of comprehensive income and its components (in thousands):
 

13
Table of Contents

 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
Net income
$
42,285

 
$
39,709

 
$
140,823

 
$
118,710

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
(5,588
)
 
6,581

 
(1,200
)
 
1,701

Change in unrealized gain (loss) on investments, net
(6,517
)
 
1,874

 
(3,840
)
 
5,864

Income tax expense related to unrealized gain (loss) on investments, net
2,507

 
(726
)
 
1,482

 
(2,272
)
Other comprehensive income (loss)
(9,598
)
 
7,729

 
(3,558
)
 
5,293

Comprehensive income
$
32,687

 
$
47,438

 
$
137,265

 
$
124,003

Accumulated other comprehensive income (loss) consisted of (in thousands):
 
September 30, 2011
 
December 31,
2010
Foreign currency translation adjustment
$
903

 
$
2,103

Net unrealized (loss) gain on investments, net of taxes of $6,487 at September 30, 2011 and $5,005 at December 31, 2010
(10,202
)
 
(7,844
)
Total accumulated other comprehensive income (loss)
$
(9,299
)
 
$
(5,741
)
10. Goodwill and Other Intangible Assets
The Company recorded goodwill and other intangible assets as a result of business acquisitions that occurred between 2000 and 2010. The Company also acquired license rights from the Massachusetts Institute of Technology in 1999.
Other intangible assets that are subject to amortization consist of the following (in thousands):
 
September 30, 2011
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Completed technology
$
36,731

 
$
(21,173
)
 
$
15,558

Customer relationships
88,700

 
(57,940
)
 
30,760

Non-compete agreements
8,340

 
(4,970
)
 
3,370

Trademarks and trade names
800

 
(786
)
 
14

Acquired license rights
490

 
(490
)
 
—

Total
$
135,061

 
$
(85,359
)
 
$
49,702

 
December 31, 2010
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Completed technology
$
36,731

 
$
(16,520
)
 
$
20,211

Customer relationships
88,700

 
(50,832
)
 
37,868

Non-compete agreements
8,340

 
(4,070
)
 
4,270

Trademarks and trade names
800

 
(693
)
 
107

Acquired license rights
490

 
(490
)
 
—

Total
$
135,061

 
$
(72,605
)
 
$
62,456

Aggregate expense related to amortization of other intangible assets for the three months ended September 30, 2011 and 2010 was $4.2 million and $4.1 million, respectively. For the nine months ended September 30, 2011 and

14
Table of Contents

2010, aggregate expense related to the amortization of other intangible assets was $12.8 million and $12.4 million, respectively. Based on the Company’s other intangible assets as of September 30, 2011, aggregate expense related to amortization of other intangible assets is expected to be $4.2 million for the remainder of 2011, and $15.9 million, $13.1 million, $7.6 million and $5.1 million for fiscal years 2012, 2013, 2014 and 2015, respectively.
11. Concentration of Credit Risk
Financial instruments that subject the Company to credit risk consist of cash and cash equivalents, marketable securities and accounts receivable. The Company maintains the majority of its cash, cash equivalents and marketable securities balances principally with domestic financial institutions that the Company believes are of high credit standing.
At September 30, 2011 and December 31, 2010, the Company held ARS, with an estimated fair value of $118.8 million and $137.3 million, respectively, that have experienced failed auctions preventing the Company from liquidating those investments. Based on its ability to access its cash and short-term investments and its expected cash flows, the Company does not anticipate the current lack of liquidity with respect to these ARS to have a material impact on its financial condition or results of operations during 2011. As of September 30, 2011, the Company had recorded a pre-tax cumulative unrealized loss of $16.6 million related to the temporary impairment of the ARS, which was included in accumulated other comprehensive income (loss) withing stockholders' equity on its consolidated balance sheet. See Note 4.
Concentrations of credit risk with respect to accounts receivable are limited to certain customers to which the Company makes substantial sales. The Company’s customer base consists of a large number of geographically dispersed customers diversified across numerous industries. To reduce risk, the Company routinely assesses the financial strength of its customers. Based on such assessments, the Company believes that its accounts receivable credit risk exposure is limited. As of September 30, 2011 and December 31, 2010, one customer accounted for more than 10% of the Company's accounts receivable. The Company believes that, at September 30, 2011, concentration of credit risk related to accounts receivable was not significant.
12. Segment and Geographic Information
Akamai’s chief decision-maker, as defined under the authoritative guidance that discusses disclosures about segments of an enterprise and related information, is the Chief Executive Officer and the executive management team. As of September 30, 2011, Akamai operated in one industry segment: providing services for accelerating and improving the delivery of content and applications over the Internet. The Company is not organized by market and is managed and operated as one business. A single management team that reports to the Chief Executive Officer comprehensively manages the entire business. The Company does not operate any material separate lines of business or separate business entities with respect to its services. Accordingly, the Company does not accumulate discrete financial information with respect to separate product lines and does not have separately reportable segments as defined in the guidance.
The Company deploys its servers into networks worldwide. As of September 30, 2011, the Company had $184.7 million and $100.8 million of property and equipment, net of accumulated depreciation, located in the United States and in foreign locations, respectively. As of December 31, 2010, the Company had $174.9 million and $81.0 million of property and equipment, net of accumulated depreciation, located in the United States and in foreign locations, respectively.
Akamai sells its services through a direct sales force and through channel partners located both in the United States and abroad. The following table summarizes the percentage of the Company's revenues derived from operations outside of the United States:
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
Revenues derived from outside of the United States
29
%
 
28
%
 
29
%
 
28
%
Revenues derived from Europe
18
%
 
16
%
 
18
%
 
17
%
No single country outside the United States accounted for 10% or more of revenues during these periods. For each of the three- and nine- month periods ended September 30, 2011 and 2010, no customer accounted for 10% or

15
Table of Contents

more of total revenues.
13. Income Taxes
The Company’s effective income tax rate, including discrete items, was 35.7% and 37.0% for the nine months ended September 30, 2011 and 2010, respectively. The effective income tax rate is based upon estimated income for the year, the estimated composition of the income in different jurisdictions and discrete adjustments, if any, in the applicable quarterly periods including settlements of tax audits or assessments, the resolution or identification of tax position uncertainties, and acquisitions of other companies. The discrete items also include the tax effect of disqualifying dispositions of incentive stock options and shares purchased under the Company's Employee Stock Purchase Plan. For each of the nine months ended September 30, 2011 and September 30, 2010, the effective income tax rate was higher than the federal statutory tax rate mainly due to the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments, and state income tax expense.
14. Forward Currency Contracts
Substantially all of the Company's foreign subsidiaries use the currency of the country in which it is located as its functional currency. Assets and liabilities are translated at exchange rates prevailing at the balance sheet dates. Revenues, costs and expenses are translated at the average exchange rates for the reported period. Gains and losses resulting from translation are recorded as a component of accumulated other comprehensive income (loss) within stockholders' equity. Gains and losses resulting from foreign currency transactions are recognized as other expense, net within the statement of operations.

The Company enters into short-term foreign currency forward contracts to offset the foreign exchange gains and losses generated by the re-measurement of certain assets and liabilities recorded in non-functional currencies. Changes in the fair value of these derivatives, as well as re-measurement gains and losses, are recognized in current earnings in other expense, net. As of September 30, 2011, the fair value of the forward currency contracts and the underlying net loss for the three and nine months ended September 30, 2011 were deemed to be immaterial.

The Company's foreign currency forward contracts include credit risk to the extent that its counterparties may be unable to meet the terms of the agreements. The Company minimizes counterparty credit (or repayment) risk by entering into transactions only with major financial institutions of investment grade credit rating.
15. Commitments, Contingencies and Guarantees
Operating Lease Commitments
The Company leases its facilities under non-cancelable operating leases. These operating leases expire at various dates through December 2019 and generally require the payment of real estate taxes, insurance, maintenance and operating costs.
The expected minimum aggregate future obligations under non-cancelable leases as of September 30, 2011 were as follows (in thousands):
 
 
Operating
Leases
Remaining 2011
$
6,218

2012
23,682

2013
22,079

2014
20,919

2015
19,447

Thereafter
56,288

Total
$
148,633

Purchase Commitments
The Company has long-term commitments for bandwidth usage and co-location services with various network

16
Table of Contents

and Internet service providers. For the remainder of 2011 and for the years ending December 31, 2012, 2013, 2014 and 2015, the minimum commitments pursuant to these contracts in effect as of September 30, 2011, are approximately $37.0 million, $51.3 million, $8.6 million, $0.3 million and $0.1 million, respectively. In addition, as of September 30, 2011, the Company had entered into purchase orders with various vendors for aggregate purchase commitments of $50.6 million, which are expected to be paid over the next twelve months.
Litigation
Between July 2, 2001 and November 7, 2001, purported class action lawsuits seeking monetary damages were filed in the U.S. District Court for the Southern District of New York against the Company as well as against the underwriters of its October 28, 1999 initial public offering of common stock. The complaints were filed allegedly on behalf of persons who purchased the Company’s common stock during different time periods, all beginning on October 28, 1999 and ending on various dates. The complaints are similar and allege violations of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, primarily based on the allegation that the underwriters received undisclosed compensation in connection with the Company’s initial public offering. On April 19, 2002, a single consolidated amended complaint was filed, reiterating in one pleading the allegations contained in the previously filed separate actions. The consolidated amended complaint defines the alleged class period as October 28, 1999 through December 6, 2000. A Special Litigation Committee of the Company’s Board of Directors authorized management to negotiate a settlement of the pending claims substantially consistent with a Memorandum of Understanding that was negotiated among class plaintiffs, all issuer defendants and their insurers. The parties negotiated a settlement that was subject to approval by the District Court. On February 15, 2005, the Court issued an Opinion and Order preliminarily approving the settlement, provided that the defendants and plaintiffs agree to a modification narrowing the scope of the bar order set forth in the original settlement agreement. On June 25, 2007, the District Court signed an order terminating the settlement. On August 25, 2009, the lead plaintiffs filed a motion for final approval of a new proposed settlement (among plaintiffs, the underwriter defendants, the issuer defendants and the insurers for the issuer defendants), plan of distribution of the settlement fund, and certification of the settlement classes. On October 5, 2009, the District Court issued an opinion and order granting the lead plaintiffs’ motion for final approval of the settlement, approval of the plan of distribution of the settlement fund, and certification of the settlement classes. An order and final judgment was entered on November 4, 2009. Notices of appeal of the District Court’s October 5, 2009 opinion and order have been filed in the United States Court of Appeals for the Second Circuit by certain objecting plaintiffs. If the District Court’s order is upheld on appeal, the Company would have no material liability in connection with this litigation, and the litigation would be resolved. The Company has recorded no liability for this matter as of September 30, 2011.
In addition, on or about October 3, 2007, a purported Akamai shareholder, Vanessa Simmonds, filed a complaint in the U.S. District Court for the Western District of Washington, against the underwriters of its 1999 initial public offering of common stock, alleging violations of Section 16(b) of the Securities Exchange Act of 1934, as amended. The complaint alleges that the combined number of shares of the Company’s common stock beneficially owned by the lead underwriters and certain unnamed officers, directors and principal shareholders exceeded ten percent of its outstanding common stock from the date of the Company’s initial public offering on October 29, 1999, through at least October 28, 2000. The complaint further alleges that those entities and individuals were thus subject to the reporting requirements of Section 16(a) and the short-swing trading prohibition of Section 16(b) and failed to comply with those provisions. The complaint seeks to recover from the lead underwriters any “short-swing profits” obtained by them in violation of Section 16(b). The Company was named as a nominal defendant in the action but has no liability for the asserted claims. None of the Company’s directors or officers serving in such capacities at the time of its initial public offering are currently named as defendants in this action, but there can be no guarantee that the complaint will not be amended or a new complaint or suit filed to name such directors or officers as defendants in this action or another action alleging a violation of the same provisions of the Securities Exchange Act of 1934, as amended. On March 12, 2009, the Court granted a joint motion by the Company and other issuer defendants to dismiss the complaint without prejudice on the grounds that the plaintiff had failed to make an adequate demand on the Company prior to filing her complaint. In its order, the Court stated it would not permit the plaintiff to amend her demand letters while pursuing her claims in the litigation.

Because the Court dismissed the case on the grounds that it lacked subject matter jurisdiction, it did not specifically reach the issue of whether the plaintiff’s claims were barred by the applicable statute of limitations. However, the Court also granted a Joint Motion to Dismiss by the underwriter defendants in the action with respect to cases involving non-

17
Table of Contents

moving issuers, holding that the cases were barred by the applicable statute of limitations because the issuers’ shareholders had notice of the potential claims more than five years prior to filing suit. Ms. Simmonds appealed. On December 2, 2010, the Ninth Circuit Court of Appeals affirmed the District Court’s decision to dismiss the moving issuers’ cases (including the Company’s) on the grounds that plaintiff’s demand letters were insufficient to put the issuers on notice of the claims asserted against them and further ordered that the dismissals be made with prejudice. The Ninth Circuit, however, reversed and remanded the District Court’s decision on the underwriters’ motion to dismiss as to the claims arising from the non-moving issuers’ IPOs, finding plaintiff’s claims were not time-barred under the applicable statute of limitations. On January 18, 2011, the Ninth Circuit denied various parties’ petitions for rehearing and for rehearing en banc but stayed its rulings to allow for appeals to the United States Supreme Court. On April 5, 2011, Ms. Simmonds filed a Petition for Writ of Certiorari with the U.S. Supreme Court seeking reversal of the Ninth Circuit's decision relating to the adequacy of the pre-suit demand.  On April 15, 2011, underwriter defendants filed a Petition for Writ of Certiorari with the U.S. Supreme Court seeking reversal of the Ninth Circuit's decision relating to the statute of limitation issue.  On June 27, 2011, the Supreme Court denied Simmonds' petition regarding the demand issue and granted the underwriters' petition relating to the statute of limitations issue. The Company does not expect the results of this action to have a material adverse effect on its business, results of operations or financial condition. The Company has recorded no liability for this matter as of September 30, 2011.
The Company is party to various other litigation matters that management considers routine and incidental to its business. Management does not expect the results of any of these routine actions to have a material adverse effect on the Company’s business, results of operations or financial condition.
Guarantees
The Company has identified guarantees in accordance with the authoritative guidance for guarantor’s accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others, which is an interpretation of previous accounting statements and a rescission of previous guidance. This guidance elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. The guidance also clarifies that at the time an entity issues a guarantee, that entity must recognize an initial liability for the fair value, or market value, of the obligation it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The Company evaluates losses for guarantees under the statement for accounting for contingencies, as interpreted by the guidance for guarantor’s accounting and disclosure requirements for guarantees, including direct guarantees of indebtedness of others. The Company considers such factors as the degree of probability that the Company would be required to satisfy the liability associated with the guarantee and the ability to make a reasonable estimate of the amount of loss. To date, the Company has not encountered material costs as a result of such obligations and has not accrued any liabilities related to such obligations in its financial statements. The fair value of the Company’s outstanding guarantees as of September 30, 2011 was determined to be immaterial.
16. Restructuring

During the three months ended September 30, 2011, the Company recorded $0.2 million as a restructuring charge in connection with an excess and vacated facility under a long-term non-cancelable lease that is scheduled to expire in June 2014. This charge includes estimated future lease payments, less estimated sublease income, for the vacated facility.

The following table summarizes the accrual and usage of the restructuring charges (in millions):

 
Leases
 
Severance
 
Total
Ending Balance, December 31, 2010
$
—

 
$
0.3

 
$
0.3

        Restructuring charge
0.2

 
—

 
0.2

        Cash payments
—

 
(0.3
)
 
(0.3
)
Ending Balance, September 30, 2011
$
0.2

 
$
—

 
$
0.2





18
Table of Contents

17. Subsequent Event

On October 24, 2011, David W. Kenny resigned as the Company's president and as a Director. The Board of Directors elected Paul Sagan to the position of president; Mr. Sagan retains his titles of Chief Executive Officer and Director.

19
Table of Contents

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This quarterly report on Form 10-Q, particularly Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our unaudited consolidated financial statements included herein contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management as of the date hereof based on information currently available to our management. Use of words such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “should,” “forecasts,” “if,” “continues,” “goal,” “likely” or similar expressions indicates a forward-looking statement. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions. Actual results may differ materially from the forward-looking statements we make. See “Risk Factors” elsewhere in this quarterly report on Form 10-Q for a discussion of certain risks associated with our business. We disclaim any obligation to update forward-looking statements as a result of new information, future events or otherwise.
We provide services for accelerating and improving the delivery of content and applications over the Internet. We primarily derive income from the sale of services to customers executing contracts with terms of one year or longer, which we refer to as recurring revenue contracts or long-term contracts. These contracts generally commit the customer to a minimum monthly level of usage with additional charges that apply to actual usage above the monthly minimum. In recent years, however, we have also entered into customer contracts that have minimum usage commitments that are based on quarterly, twelve-month or longer periods. Having a consistent and predictable base level of revenue is important to our financial success. Accordingly, to be successful, we must maintain our base of recurring revenue contracts by eliminating or reducing lost monthly, quarterly or annual recurring revenue due to customer cancellations or terminations and limiting the impact of price reductions reflected in contract renewals and build on that base by adding new customers and increasing the number of services, features and functionalities that our existing customers purchase. At the same time, we must ensure that our expenses do not increase faster than, or at the same rate as, our revenues. Accomplishing these goals requires that we compete effectively in the marketplace on the basis of quality, price and the attractiveness of our services and technology.
Overview of Financial Results
The following sets forth, as a percentage of revenues, consolidated statements of operations data, for the periods indicated:

20
Table of Contents

 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
Revenues
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of revenues
33.1

 
30.7

 
32.6

 
29.4

Research and development expense
4.8

 
5.6

 
4.4

 
5.5

Sales and marketing expense
19.3

 
21.9

 
19.3

 
21.7

General and administrative expense
18.0

 
16.9

 
16.9

 
17.1

Amortization of other intangible assets
1.5

 
1.6

 
1.5

 
1.7

Restructuring charge
0.1


—

 
—


—

Total cost and operating expenses
76.8

 
76.7

 
74.7

 
75.4

Income from operations
23.2

 
23.3

 
25.3

 
24.6

Interest income
1.0

 
1.1

 
1.0

 
1.3

Interest expense
—

 
(0.1
)
 
—

 
(0.2
)
Other expense, net
(0.1
)
 
(0.5
)
 
(0.2
)
 
(0.2
)
Gain on investments, net
0.1

 
—

 
0.1

 
—

Loss on early extinguishment of debt
—

 
—

 
—

 
—

Income before provision for income taxes
24.2

 
23.8

 
26.2

 
25.5

Provision for income taxes
9.2

 
8.1

 
9.4

 
9.4

Net income
15.0
 %
 
15.7
 %
 
16.8
 %
 
16.1
 %
We were profitable for the fiscal year 2010 and for the nine months ended September 30, 2011; however, we cannot guarantee continued profitability or profitability for any period in the future at the levels we have recently experienced. We have observed the following trends and events that are likely to have an impact on our financial condition and results of operations in the foreseeable future:
•
During each of the first three quarters of 2011, we were able to offset lost committed recurring revenue due to customer cancellations, terminations or price reductions by adding new customers and increasing the number of services, features and functionalities, which we refer to as value-added services, that our existing customers purchase. A continuation of this trend, in conjunction with increased revenues from non-recurring revenue contracts, could lead to increased revenues; however, any such increased revenues would be offset if lower traffic reduces the revenues we earn on a non-committed basis or as a result of further declines in the prices we charge. If we do not offset lost committed revenue in this manner, our revenues will decrease.
•
During each of the first three quarters of 2011, unit prices offered to some new and existing customers declined, primarily as a result of competition from new and established competitors. These price reductions primarily impacted customers for which we deliver high volumes of traffic over our network, such as digital media customers. If we continue to experience decreases in unit prices for new and existing customers and we are unable to offset such reductions with increased traffic or enhanced efficiencies in our network or increased sales of value-added services to customers, our revenues and profit margins could decrease.
•
Historically, we have experienced seasonal variations in our quarterly revenues attributable to e-commerce services used by our retail customers, with higher revenues in the fourth quarter of the year and lower revenues during the summer months. If this trend continues, our ability to generate quarterly revenue growth on a sequential basis could be impacted.
•
In the first three quarters of 2011, we experienced a moderation in the rate of traffic growth in our volume-driven solutions as compared to the first three quarters of 2010. If this trend continues, our ability to generate revenue growth could be adversely impacted.
•
During the first three quarters of 2011, we reduced our network bandwidth costs per unit by entering into new supplier contracts with lower pricing and amending existing contracts to take advantage of price reductions offered by our existing suppliers. Additionally, we continued to invest in internal-use software development to improve the performance and efficiency of our network. Due to the increased traffic delivered over our

21
Table of Contents

network, our total bandwidth costs increased during the first three quarters of 2011 as compared to the same period in 2010. We believe that our overall bandwidth costs will continue to increase as a result of expected higher traffic levels, partially offset by anticipated continued reductions in bandwidth costs per unit. If we do not experience lower per unit bandwidth pricing, or we are unsuccessful at effectively routing traffic over our network through lower cost providers, total network bandwidth costs could increase more than expected during the remainder of 2011.
•
In recent quarters, we have seen co-location costs increase and become a higher percentage of total cost of revenues due to the expansion of our network. Continuation of this trend may negatively impact our profitability.
•
For the nine months ended September 30, 2011, revenues derived from customers outside the United States accounted for 29% of our total revenues. For the remainder of 2011, we anticipate revenues from such customers as a percentage of our total revenues to be consistent with each of the first three quarters.
•
Depreciation and amortization expense related to our network equipment and internal-use software development costs increased during each of the first three quarters of 2011 as compared to the same quarters in 2010. Due to the purchases of network equipment during 2011, we believe that depreciation expense, as well as co-location costs, related to our network equipment will continue to increase during the remainder of 2011. We also expect to continue to enhance and add functionality to our service offerings, which would increase capitalized stock-based compensation expense attributable to employees working on such projects. As a result, we believe that the amortization of internal-use software development costs, which we include in cost of revenues, will be higher in 2011 as compared to 2010. All of these increased costs could negatively affect our profitability.
•
For the three and nine months ended September 30, 2011, our stock-based compensation expense was $15.2 million and $42.5 million, respectively, as compared to $18.6 million and $58.0 million, respectively, for the three and nine months ended September 30, 2010. The decrease in stock-based compensation expense for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 was primarily due to management's assessment, as of September 30, 2011, that certain outstanding restricted stock units, or RSUs, with performance-based vesting conditions will not vest because the associated performance targets are unlikely to be met. We expect this trend of lower stock-based compensation expense to continue for the remainder of 2011 as compared to 2010. As of September 30, 2011, our total pre-tax unrecognized compensation costs for stock-based awards were $109.3 million, which we expect to recognize as expense over a weighted average period of 1.3 years through 2015.
•
As of September 30, 2011, we held $135.4 million in par value of auction rate securities, which we refer to as ARS. Based upon our cash, cash equivalents and marketable securities balance of $1.2 billion at September 30, 2011 and expected operating cash flows, we do not anticipate that the lack of liquidity associated with our ARS will adversely affect our ability to conduct business during the remainder of 2011. We believe we have the ability to hold these ARS until a recovery of the auction process, a buyer is found outside the auction process, the securities are called or refinanced by the issuer, or until maturity.
•
During the nine months ended September 30, 2011, our effective income tax rate was 35.7%. We expect our annual effective income tax rate in 2011 to remain relatively consistent in the fourth quarter of 2011; this expectation does not take into consideration the effect of discrete items such as those relating to stock-based compensation. In 2010, due to our continued utilization of available net operating losses, or NOLs, and tax credit carryforwards, our tax payments were significantly lower than our recorded income tax provision. We expect to utilize substantially all of our tax credit carryforwards in 2011. Once we have done so, the amount of cash tax payments we make will increase over those made in previous years.
Based on our analysis of, among other things, the aforementioned trends and events, as of the date of this quarterly report on Form 10-Q, we expect to continue to generate net income on a quarterly and annual basis during 2011 and 2012; however, our future results are likely to be affected by the factors discussed in the paragraphs above as well as those identified in the section captioned “Risk Factors” and elsewhere in this quarterly report on Form 10-Q, including our ability to:
•
increase our revenue by adding customers through long-term contracts and limiting customer cancellations and terminations;
•
offset unit price declines for our services with higher volumes of traffic delivered on our network as well as increased sales of our value-added solutions;

22
Table of Contents

•
prevent disruptions to our services and network due to accidents or intentional attacks; and
•
maintain our network bandwidth and co-location costs and other operating expenses consistent with our revenues.
As a result, there is no assurance that we will achieve our expected financial objectives, including generating positive net income, in any future period.
Our management’s discussion and analysis of our financial condition and results of operations are based upon our unaudited consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which we have prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim periods and with Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The preparation of these unaudited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related items, including, but not limited to, revenue recognition, accounts receivable and related reserves, valuation and impairment of investments and marketable securities, goodwill and other intangible assets, capitalized internal-use software costs, impairment and useful lives of long-lived assets, tax reserves, loss contingencies and stock-based compensation costs. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances at the time they are made. Actual results may differ from our estimates. See the section entitled “Application of Critical Accounting Policies and Estimates” in our annual report on Form 10-K for the year ended December 31, 2010 for further discussion of our critical accounting policies and estimates.
Recent Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board, or FASB, issued an accounting standard update for business combinations specifically related to the disclosure of supplementary pro forma information for business combinations. This guidance specifies that pro forma disclosures should be reported as if the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period, and the pro forma disclosures must include a description of material, nonrecurring pro forma adjustments. This standard was effective for business combinations with an acquisition date of January 1, 2011 or later. The adoption of the guidance did not have an impact on our financial position or results of operations.
In May 2011, the FASB issued amended guidance and disclosure requirements for fair value measurements. This guidance provides a consistent definition of fair value and ensures that the fair value measurement and disclosure requirements are similar between U.S. GAAP and international financial reporting standards. The guidance changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. This standard will be effective for interim and annual periods beginning after December 15, 2011 and will be applied prospectively. The adoption of the guidance is not expected to have a material impact on our consolidated financial statements.
In June 2011, the FASB issued amended disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income, or OCI, as part of the statement of changes in equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes will be effective January 1, 2012 and early adoption is permitted. There will be no impact on our consolidated financial results as the amendments relate only to changes in financial statement presentation.
In September 2011, the FASB issued amended guidance that will simplify how entities test goodwill for impairment. Under the amended guidance, after assessment of certain qualitative factors, if it is determined to be more likely than not that the fair value of a reporting unit is less than its carrying amount, entities must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test(s) are optional. The guidance is effective January 1, 2012 with early adoption permitted. The adoption of the guidance is not expected to have a material impact on our financial position or results of operations.
Results of Operations
Revenues. Total revenues increased 11%, or $28.3 million, to $281.9 million for the three months ended September 30, 2011 as compared to $253.6 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, revenues increased 13%, or $95.9 million, to $834.8 million as compared to $738.9 million

23
Table of Contents

for the nine months ended September 30, 2010. The following table quantifies the contribution to growth in revenues during the periods presented from the different industry verticals in which we sell our services (in millions):
 
For the
Three Months Ended
September 30, 2011
as compared to 2010
 
For the
Nine Months Ended
September 30, 2011
as compared to 2010
Media & Entertainment
$
5.6

 
$
31.9

Commerce
11.4

 
33.3

Enterprise
9.1

 
25.9

High Tech
1.5

 
0.4

Public Sector
0.7

 
4.4

Total net increase
$
28.3

 
$
95.9

A significant portion of the increase in revenues for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 was driven by increased sales of value-added services to customers in our commerce and enterprise verticals. The revenues from our media and entertainment vertical increased due to traffic growth and were partially offset by reduced prices charged to our customers. Revenues from our high tech vertical remained relatively flat as increased demand for value-added solutions offset the decline in software download revenues. The increase in revenues from public sector customers was primarily attributable to new contracts with government agencies.
For the three- and nine-month periods ended September 30, 2011 and 2010, approximately 29% and 28%, respectively, of our revenues were derived from our operations located outside of the United States, including 18% derived from Europe during each of the three and nine month periods ended September 30, 2011 and 16% and 17% derived from Europe during each of the three and nine month periods ended September 30, 2010, respectively. No single country outside of the United States accounted for 10% or more of revenues during these periods. For the three- and nine-month periods ended September 30, 2011 and 2010, resellers accounted for 19% and 18% of revenues, respectively. For each of the three- and nine-month periods ended September 30, 2011 and 2010, no customer accounted for 10% or more of revenues.
Cost of Revenues. Cost of revenues was comprised of the following (in millions) for the periods presented: 
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
Bandwidth and service-related fees
$
21.8

 
$
19.6

 
$
63.5

 
$
56.7

Co-location fees
33.7

 
25.2

 
96.3

 
68.2

Payroll and related costs of network operations personnel
3.9

 
4.0

 
11.3

 
10.4

Stock-based compensation, including amortization of prior capitalized amounts
2.2

 
2.5

 
7.3

 
7.6

Depreciation and impairment of network equipment
24.8

 
20.0

 
71.2

 
54.9

Amortization of internal-use software
6.9

 
6.5

 
22.4

 
19.3

Total cost of revenues
$
93.3

 
$
77.8

 
$
272.0

 
$
217.1

Cost of revenues increased 20%, or $15.5 million, to $93.3 million for the three months ended September 30, 2011 as compared to $77.8 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, cost of revenues increased 25%, or $54.9 million, to $272.0 million as compared to $217.1 million for the nine months ended September 30, 2010. This increase was primarily due to:

•
increases in co-location costs as we deployed more servers worldwide;
•
an increase in depreciation expense of network equipment and amortization of internal-use software as we continued to invest in our infrastructure; and
•
an increase in amounts paid to network providers for bandwidth due to higher traffic levels, partially

24
Table of Contents

offset by reduced bandwidth costs per unit.
Cost of revenues during the three and nine months ended September 30, 2011 also included credits received of approximately $2.7 million and $5.6 million, respectively, from settlements and renegotiated contracts entered into in connection with billing disputes related to bandwidth contracts. During the three and nine months ended September 30, 2010, cost of revenues included similar credits of approximately $2.3 million and $4.5 million, respectively. Credits of this nature may occur in the future; however, the timing and amount of future credits, if any, are unpredictable.
We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2011 and for the years ending December 31, 2012, 2013, 2014 and 2015, we estimate that the minimum commitments related to bandwidth usage and co-location services under agreements currently in effect are approximately $37.0 million, $51.3 million, $8.6 million, $0.3 million and $0.1 million, respectively.
We believe that cost of revenues will increase during the fourth quarter of 2011 as compared to each of the first three quarters of 2011. We expect to deploy more servers and deliver more traffic on our network, which would result in higher expenses associated with the increased traffic and co-location fees; however, such costs are likely to be partially offset by lower bandwidth costs per unit. Additionally, for the remainder of 2011, we anticipate increases in depreciation expense related to our network equipment and amortization of internal-use software development costs, along with increased payroll and related costs, as we continue to make investments in our network with the expectation that our customer base will continue to expand.
Research and Development. Research and development expenses consist primarily of payroll and related costs and stock-based compensation expense for research and development personnel who design, develop, test and enhance our services and our network. Research and development costs are expensed as incurred, except certain internal-use software development costs eligible for capitalization. During the three and nine months ended September 30, 2011, we capitalized software development costs of $8.8 million and $28.1 million, respectively, net of impairments. During the three and nine months ended September 30, 2010, we capitalized software development costs of $8.4 million and $22.1 million, respectively, net of impairments. These development costs consisted of external consulting expenses and payroll and payroll-related costs for personnel involved in the development of internal-use software used to deliver our services and operate our network. Additionally, during the three and nine months ended September 30, 2011, we capitalized $1.8 million and $5.2 million of stock-based compensation, respectively, as compared to $1.9 million and $5.4 million during the three and nine months ended September 30, 2010, respectively. These capitalized internal-use software costs are amortized to cost of revenues over their estimated useful lives of two years.
Research and development expenses decreased 5%, or $0.7 million, to $13.5 million for the three months ended September 30, 2011 as compared to $14.2 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, research and development expenses decreased 9%, or $3.8 million, to $37.1 million as compared to $41.0 million for the nine months ended September 30, 2010. The decrease during the three and nine months ended September 30, 2011 as compared to the same periods in 2010 was due to higher capitalized salaries and a decrease in stock-based compensation, partially offset by an increase in payroll and related costs as a result of headcount growth.
The following table quantifies the changes in the various components of our research and development expenses for the periods presented (in millions):
 
For the
Three Months Ended
September 30, 2011
as compared to 2010
 
For the
Nine Months Ended
September 30, 2011
as compared to 2010
Payroll and related costs
$
1.2

 
$
6.6

Stock-based compensation
—

 
(2.6
)
Capitalized salaries and other expenses
(1.9
)
 
(7.8
)
Total net decrease
$
(0.7
)
 
$
(3.8
)
We believe that research and development expenses, in absolute dollar terms, will increase during the fourth quarter of 2011 as compared to the first nine months of 2011 because we expect to continue to hire additional development

25
Table of Contents

personnel in order to make improvements in our core technology, develop new services and make refinements to our existing service offerings.
Sales and Marketing. Sales and marketing expenses consist primarily of payroll and related costs, stock-based compensation expense and commissions for personnel engaged in marketing, sales and support functions, as well as advertising and promotional expenses.
Sales and marketing expenses decreased 2%, or $1.1 million, to $54.5 million for the three months ended September 30, 2011 as compared to $55.6 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, sales and marketing expenses increased $0.2 million, to $160.7 million as compared to $160.5 million for the nine months ended September 30, 2010. The decrease in sales and marketing expenses during the three months ended September 30, 2011 as compared to the same period in 2010 was primarily due to a decrease in stock-based compensation, partially offset by an increase in payroll and related costs. The increase in sales and marketing expenses during the nine months ended September 30, 2011 as compared to the same period in 2010 was primarily due to an increase in payroll and related costs due to an increase in headcount, partially offset by a decrease in stock-based compensation, as well as a decrease in marketing and related costs and other expenses.
The following table quantifies the changes in the various components of our sales and marketing expenses for the periods presented (in millions):
 
 
For the
Three Months Ended
September 30, 2011
as compared to 2010
 
For the
Nine Months Ended
September 30, 2011
as compared to 2010
Payroll and related costs
$
1.6

 
$
10.4

Stock-based compensation
(1.9
)
 
(7.5
)
Marketing and related costs
(0.4
)
 
(1.3
)
Other expenses
(0.4
)
 
(1.4
)
Total net (decrease) increase
$
(1.1
)
 
$
0.2

We believe that sales and marketing expenses will increase, in absolute dollar terms, during the fourth quarter of 2011 as compared to the first three quarters of 2011 due to an expected increase in commissions on higher forecasted sales of our services and an increase in payroll and related costs due to continued headcount growth in our sales and marketing organization.
General and Administrative. General and administrative expenses consist primarily of the following components:
•
payroll, stock-based compensation expense and other related costs, including expenses for executive, finance, legal, business applications, network management, human resources and other administrative personnel;
•
depreciation and amortization of property and equipment we use internally;
•
fees for professional services;
•
rent and other facility-related expenditures for leased properties;
•
provision for doubtful accounts;
•
insurance costs; and
•
non-income related taxes.
General and administrative expenses increased 19%, or $8.1 million, to $50.8 million for the three months ended September 30, 2011 as compared to $42.7 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, general and administrative expenses increased 12%, or $14.7 million, to $140.7 million as compared to $126.0 million for the nine months ended September 30, 2010. The increase in general and administrative expenses for the three and nine months ended September 30, 2011 as compared to the same periods in 2010 was primarily due to an increase in payroll and related costs as a result of headcount growth, facilities and related costs and legal fees due to ongoing litigation. These increases were partially offset by reductions in stock-based compensation.
The following table quantifies the changes in various components of our general and administrative expenses for the periods presented (in millions):

26
Table of Contents

 
 
For the
Three Months Ended
September 30, 2011
as compared to 2010
 
For the
Nine Months Ended
September 30, 2011
as compared to 2010
Payroll and related costs
$
3.1

 
$
7.0

Stock-based compensation
(0.4
)
 
(3.9
)
Depreciation and amortization
0.1

 
0.2

Facilities-related costs
2.0

 
5.1

Provision for doubtful accounts
0.2

 
0.9

Legal fees
2.2

 
4.0

Non-income taxes
0.1

 
(0.6
)
Consulting and advisory services
0.7

 
(0.1
)
Other expenses
0.1

 
2.1

Total net increase
$
8.1

 
$
14.7

During the fourth quarter of 2011, we expect general and administrative expenses to increase, in absolute dollar terms, as compared to each of the first three quarters of 2011 due to anticipated higher payroll and related costs attributable to increased hiring as well as facilities and related costs.
Amortization of Other Intangible Assets. Amortization of other intangible assets consists of amortization of intangible assets acquired in business combinations and amortization of acquired license rights. Amortization of other intangible assets increased 1%, or $0.1 million, to $4.2 million for the three months ended September 30, 2011 as compared to $4.1 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, amortization of other intangible assets increased 3%, or $0.4 million, to $12.8 million as compared to $12.4 million for the nine months ended September 30, 2010. The increase in amortization of other intangible assets for the nine months ended September 30, 2011 as compared to the same periods in 2010 was primarily due to the amortization of assets related to our acquisition of substantially all of the assets and liabilities of Velocitude LLC during the second quarter of 2010. Based on our intangible assets at September 30, 2011, we expect amortization of other intangible assets to be approximately $4.2 million for the remainder of 2011, and $15.9 million, $13.1 million, $7.6 million and $5.1 million for fiscal years 2012, 2013, 2014 and 2015, respectively.
Interest Income. Interest income includes interest earned on invested cash balances and marketable securities. Interest income decreased 4%, or $0.1 million, to $2.7 million for the three months ended September 30, 2011 as compared to $2.8 million for the three months ended September 30, 2010. For the nine months ended September 30, 2011, interest income decreased 7%, or $0.6 million, to $8.7 million as compared to $9.3 million for the nine months ended September 30, 2010. The decreases were due to lower interest rates earned on our investments during the comparable periods.
Interest Expense. Interest expense includes interest paid on our debt obligations as well as amortization of deferred financing costs. Interest expense was $0.2 million and $1.5 million for the three and nine months ended September 30, 2010, respectively. As of September 30, 2010, we had $58.6 million in principal amount of outstanding senior convertible notes. During the nine months ended September 30, 2011, we had no outstanding indebtedness requiring the payment of interest.
Other Expense, net. Other expense, net primarily represents net foreign exchange gains and losses incurred, gains from legal settlements, and other non-operating (expense) income items. Other expense, net for the three months ended September 30, 2011 decreased to $0.2 million as compared to $1.4 million for the three months ended September 30, 2010. For each of the nine months ended September 30, 2011 and September 30, 2010, other expense, net was $1.3 million. The decrease in other expense, net for the three months ended September 30, 2011 as compared to the same period in 2010 was primarily due to foreign exchange rate fluctuations. Other expense, net may fluctuate in the future based upon changes in foreign exchange rates, the outcome of legal proceedings or other events.
Provision for Income Taxes. For the nine months ended September 30, 2011 and 2010, our effective income tax rate, including discrete items, was 35.7% and 37.0%, respectively. For the each of the three and nine months ended

27
Table of Contents

September 30, 2011 and September 30, 2010, the effective income tax rate was higher than the federal statutory tax rate mainly due to the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments, and state income tax expense. The effective income tax rate is based upon the estimated income for the year, the estimated composition of the income in different jurisdictions and discrete adjustments, if any, in the applicable quarterly periods, including settlements of tax audits or assessments, the resolution or identification of tax position uncertainties, and acquisitions of other companies. Provision for income taxes increased 26%, or $5.3 million, to $25.9 million for the three months ended September 30, 2011 as compared to $20.6 million for the three months ended September 30, 2010. Provision for income taxes increased 12%, or $8.5 million, to $78.2 million for the nine months ended September 30, 2011 as compared to $69.7 million for the nine months ended September 30, 2010. The increase in the three and nine months ended September 30, 2011 as compared to the same periods in 2010 was mainly due to the increase in operating income partially offset by the lower effective income tax rate in 2011 as compared to 2010.

While we expect our effective income tax rate for the fourth quarter of 2011 to remain relatively consistent with the rate applicable through the third quarter of 2011, this expectation does not take into consideration the effect of any potential discrete items to be recorded in the future. The effective tax rate could be materially different depending on the nature and timing of dispositions of incentive stock options and other employee equity awards. Further, our effective tax rate may fluctuate within a fiscal year and from quarter to quarter, due to items arising from discrete events, including settlements of tax audits and assessments, the resolution or identification of tax position uncertainties and acquisitions of other companies. In 2010, due to our continued utilization of available NOLs and tax credit carryforwards, our tax payments were significantly lower than our recorded income tax provision. We expect to utilize substantially all of our tax credit carryforwards in 2011. Once we have done so, the amount of cash tax payments we make will increase over those made in previous years.
In determining our net deferred tax assets and valuation allowances, annualized effective tax rates, and cash paid for income taxes, management is required to make judgments and estimates about domestic and foreign profitability, the timing and extent of the utilization of NOL carryforwards, applicable tax rates, transfer pricing methodologies and tax planning strategies. Judgments and estimates related to our projections and assumptions are inherently uncertain; therefore, actual results could differ materially from our projections.
We have recorded certain tax reserves to address potential exposures involving our income tax and sales and use tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. Our estimate of the value of these tax reserves reflects assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the ultimate tax liability or benefit from these matters may be materially greater or less than the amount that we have estimated.
Non-GAAP Measures
In addition to the traditional financial measurements reflected in our financial statements that have been prepared in accordance with GAAP, we also compile and monitor certain non-GAAP financial measures related to the performance of our business. We typically discuss the non-GAAP financial measures described below on our quarterly public earnings release calls. A “non-GAAP financial measure” is a numerical measure of a company’s historical or future financial performance that excludes amounts that are included in the most directly comparable measure calculated and presented in the GAAP statement of operations.
We believe that making available the non-GAAP financial measures described below helps investors to gain a meaningful understanding of our past performance and future prospects, especially when comparing such results to previous periods, forecasts or competitors’ financial statements. Our management uses these non-GAAP measures, in addition to GAAP financial measures, as the basis for measuring our core operating performance and comparing such performance to that of prior periods and to the performance of our competitors. These measures are also used by management in its financial and operational decision-making.
We consider normalized net income and normalized net income per diluted common share to be important indicators of our overall performance as they eliminate the effects of events that are either not part of our core operations or are non-cash. We define normalized net income as net income determined in accordance with GAAP excluding the following pre-tax items: amortization of other acquired intangible assets, stock-based compensation expense, stock-

28
Table of Contents

based compensation reflected as a component of amortization of capitalized internal-use software, restructuring charges and benefits, acquisition-related costs and benefits, certain gains and losses on investments, loss on early extinguishment of debt and restructuring charges.
These non-GAAP financial measures should be used in addition to, and in conjunction with, results presented in accordance with GAAP.
The following table reconciles GAAP net income to normalized net income and normalized net income per diluted share for the periods presented:
 
 
Unaudited
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011
 
2010
 
2011
 
2010
 
(in thousands, except per share data)
Net income
$
42,285

 
$
39,709

 
$
140,823

 
$
118,710

Amortization of other intangible assets
4,185

 
4,130

 
12,754

 
12,390

Stock-based compensation
15,141

 
18,589

 
42,465

 
57,973

Amortization of capitalized stock-based compensation
1,592

 
1,817

 
5,595

 
5,522

Loss on early extinguishment of debt
—

 
—

 
—

 
294

Acquisition-related costs (benefits)
—

 
—

 
(440
)
 
345

Restructuring charge
158

 
—

 
158

 
—

Total normalized net income
$
63,361

 
$
64,245

 
$
201,355

 
$
195,234

Normalized net income per diluted share
$
0.34

 
$
0.34

 
$
1.06

 
$
1.03

Shares used in per share calculations
185,704

 
191,271

 
189,089

 
190,254

We consider Adjusted EBITDA to be another important indicator of our operational strength and the performance of our business and a good measure of our historical operating trend. Adjusted EBITDA eliminates items that are either not part of our core operations or do not require a cash outlay. We define Adjusted EBITDA as net income determined in accordance with GAAP excluding interest, income taxes, depreciation and amortization of tangible and intangible assets, stock-based compensation expense, stock-based compensation reflected as a component of amortization of capitalized internal-use software, restructuring charges and benefits, acquisition-related costs and benefits, certain gains and losses on investments, foreign exchange gains and losses, loss on early extinguishment of debt and gains or losses on legal settlements.
The following table reconciles GAAP net income to Adjusted EBITDA for the periods presented:


29
Table of Contents

 
Unaudited
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2011

2010
 
2011

2010
 
(in thousands)
Net income
$
42,285

 
$
39,709

 
$
140,823

 
$
118,710

Amortization of other intangible assets
4,185

 
4,130

 
12,754

 
12,390

Stock-based compensation
15,141

 
18,589

 
42,465

 
57,973

Amortization of capitalized stock-based compensation
1,592

 
1,817

 
5,595

 
5,522

Loss on early extinguishment of debt
—

 
—

 
—

 
294

Acquisition-related costs (benefits)
—

 
—

 
(440
)
 
345

Restructuring charge
158

 
—

 
158

 
—

Interest income, net
(3,002
)
 
(2,636
)
 
(9,058
)
 
(8,069
)
Provision for income taxes
25,862

 
20,603

 
78,218

 
69,677

Depreciation and amortization
35,984

 
30,532

 
105,879

 
86,201

Other loss, net
188

 
1,366

 
1,330

 
1,319

Adjusted EBITDA
$
122,393

 
$
114,110

 
$
377,724

 
$
344,362

Liquidity and Capital Resources
To date, we have financed our operations primarily through public and private sales of debt and equity securities, proceeds from exercises of stock awards and cash generated by operations.
As of September 30, 2011, our cash, cash equivalents and marketable securities, which consisted of corporate debt securities, U.S. Treasury and government agency securities, commercial paper, corporate debt securities, and student loan-backed ARS, totaled $1.2 billion. We place our cash investments in instruments that meet high quality credit standards, as specified in our investment policy. Our investment policy also limits the amount of our credit exposure to any one issue or issuer and seeks to manage these assets to achieve our goals of preserving principal, maintaining adequate liquidity at all times, and maximizing returns subject to our investment policy.
As of September 30, 2011 and December 31, 2010, we held approximately $135.4 million and $150.8 million in par value of ARS, respectively. The ARS are primarily AAA-rated bonds, most of which are guaranteed by the U.S. government as part of the Federal Family Education Loan Program through the U.S. Department of Education. None of the ARS in our portfolio is mortgage-based or collateralized debt obligations. In mid-February 2008, all of our ARS experienced failed auctions, which failures continued throughout the period ended September 30, 2011. As a result, we have been unable to liquidate most of our holdings of ARS. Based on our ability to access our cash and other short-term investments, our expected operating cash flows, and our other sources of cash, we do not anticipate the current lack of liquidity on these investments to have a material impact on our financial condition or results of operations in 2011 or the foreseeable future.
Net cash provided by operating activities was $316.6 million for the nine months ended September 30, 2011, compared to $292.1 million for the nine months ended September 30, 2010. The increase in cash provided by operating activities for the nine months ended September 30, 2011 as compared to the same period in 2010 was primarily due to a reduction in cash used in working capital and an increase in net income, partially offset by a reduction in the provision for deferred income taxes. We expect that cash provided by operating activities will increase as a result of an expected increase in cash collections related to anticipated higher revenues, partially offset by an anticipated increase in operating expenses that require cash outlays such as salaries and higher commissions.
Net cash provided by investing activities was $36.2 million for the nine months ended September 30, 2011, compared to $266.9 million of net cash used in investing activities for the nine months ended September 30, 2010. Cash provided by investing activities for the nine months ended September 30, 2011 reflects net sales and maturities of short- and long-term marketable securities of $172.7 million. Cash used in investing activities for the nine months ended September 30, 2011 reflects purchases of property and equipment of $136.3 million, including $30.5 million

30
Table of Contents

related to the capitalization of internal-use software development costs. Cash used in investing activities for the nine months ended September 30, 2010 reflects net purchases of short- and long-term marketable securities of $110.9 million, purchases of property and equipment of $143.3 million, including $23.8 million related to the capitalization of internal-use software development costs, cash paid for the acquisition of substantially all of the assets of Velocitude of $12.2 million, and an increase in other investments of $0.5 million. For fiscal year 2011, we expect total capital expenditures, a component of cash used in investing activities, to be approximately 16% of total revenues for the year, which reflects our plan to continue expansion of our network capacity to meet expected future traffic growth. We expect to fund such capital expenditures through cash generated from operations.
Net cash used in financing activities was $228.7 million for the nine months ended September 30, 2011, as compared to $10.8 million in net cash used in financing activities for the nine months ended September 30, 2010. Cash used in financing activities during the nine months ended September 30, 2011 consisted of $247.7 million related to a common stock repurchase program as described more fully below, as well as $5.7 million used for taxes paid related to net share settlements of equity awards. This was offset by cash provided by financing activities for the nine months ended September 30, 2011 of $11.5 million related to excess tax benefits resulting from the exercise of stock options and vesting of RSUs and proceeds of $13.3 million from issuances of common stock upon exercises of stock options under our stock option plans and employee stock purchase plan. Cash used in financing activities during the nine months ended September 30, 2010 consisted of $65.1 million related to our common stock repurchase program. This was offset by cash provided by financing activities during the nine months ended September 30, 2010 of $22.4 million related to excess tax benefits resulting from the exercise of stock options and vesting of RSUs and proceeds of $31.9 million from issuances of common stock upon exercises of stock options under our stock option plans and employee stock purchase plan.
Changes in cash, cash equivalents and marketable securities are dependent upon changes in, among other things, working capital items such as deferred revenues, accounts payable, accounts receivable and various accrued expenses, as well as changes in our capital and financial structure due to common stock repurchases, debt repurchases and issuances, stock option exercises, purchases and sales of equity investments and similar events.
The following table presents the net inflows and outflows of cash, cash equivalents and marketable securities for the periods presented (in millions):
 
 
For the Nine Months
Ended September 30,
 
2011
 
2010
Cash, cash equivalents and marketable securities balance as of December 31, 2010 and 2009, respectively
$
1,243.4

 
$
1,061.5

Changes in cash, cash equivalents and marketable securities:

 

Receipts from customers
855.9

 
753.1

Payments to vendors
(459.8
)
 
(414.4
)
Payments for employee payroll
(223.7
)
 
(180.6
)
Debt interest and premium payments
—

 
(1.0
)
Stock option exercises and employee stock purchase plan issuances
13.3

 
31.9

Cash used in business acquisition
(0.6
)
 
(12.2
)
Employee taxes paid related to net share settlement of equity awards
(5.7
)

—

Common stock repurchases
(247.7
)
 
(65.1
)
Realized and unrealized (losses) gains on marketable investments and other investment-related assets, net
(3.5
)
 
6.2

Interest income
8.7

 
9.3

Other
10.7

 
1.5

Net increase
(52.4
)
 
128.7

Cash, cash equivalents and marketable securities balance as of September 30, 2011 and 2010, respectively
$
1,191.0

 
$
1,190.2


31
Table of Contents

On April 29, 2009, we announced that our Board of Directors had authorized a stock repurchase program permitting purchases of up to $100.0 million of our common stock from time to time on the open market or in privately-negotiated transactions. In April 2010, our Board of Directors authorized a new $150.0 million stock repurchase program. In April 2011, our Board of Directors authorized another, one-year $150.0 million stock repurchase program that began in May 2011. On August 8, 2011, our Board of Directors authorized an additional $250.0 million of stock repurchases over the twelve-month period that commenced in May 2011. The total authorized funding for stock repurchases in that twelve month period is now $400.0 million. Unused amounts from the prior year’s authorization were not carried over to the new program. During the nine months ended September 30, 2011, we repurchased 9.4 million shares of common stock for an aggregate of $248.4 million at an average price of $26.47 per share. During the nine months ended September 30, 2010, we repurchased 1.9 million shares of common stock for an aggregate of $65.1 million at an average price of $34.37 per share. The timing and amount of any future share repurchases will be determined by our management based on its evaluation of market conditions and other factors. Repurchases may also be made under a Rule 10b5-1 plan, which would permit us to repurchase shares when we might otherwise be precluded from doing so under insider trading laws. Subject to applicable securities laws requirements, we may choose to suspend or discontinue the repurchase program at any time. Any purchases made under the program will be reflected as an increase in cash used in financing activities. See Item 2 of Part II of this quarterly report on Form 10-Q for more detailed information about our repurchases.
We believe, based on our present business plan, that our current cash, cash equivalents and marketable securities and forecasted cash flows from operations will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 24 months. If the assumptions underlying our business plan regarding future revenue and expenses change, if we are unable to liquidate our marketable securities, or if unexpected opportunities or needs arise, we may seek to raise additional cash by selling equity or debt securities. We may not, however, be able to sell equity or debt securities on terms we consider reasonable, or at all. If additional funds are raised through the issuance of equity or debt securities, these securities could have rights, preferences and privileges senior to those accruing to holders of common stock, and the terms of any such debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in additional dilution to our existing stockholders. See “Risk Factors” in Item 1A of Part II of this quarterly report on Form 10-Q for a discussion of additional factors that could affect our liquidity.
Contractual Obligations, Contingent Liabilities and Commercial Commitments
The following table presents our contractual obligations and commercial commitments, as of September 30, 2011, for the next five years and thereafter (in millions): 
 
Payments Due by Period
Contractual Obligations
as of September 30, 2011
Total
 
Less than
12 Months
 
12-36
Months
 
36-60
Months
 
More than
60 Months
Bandwidth and co-location agreements
$
97.3

 
$
81.3

 
$
15.9

 
$
0.1

 
$
—

Real estate operating leases
148.6

 
24.2

 
43.5

 
35.6

 
45.3

Open vendor purchase orders
50.6

 
50.6

 
—

 
—

 
—

Total
$
296.5

 
$
156.1

 
$
59.4

 
$
35.7

 
$
45.3

In accordance with authoritative guidance issued by the FASB, as of September 30, 2011, we had unrecognized tax benefits of $17.5 million, which included approximately $4.9 million of accrued interest and penalties. We do not expect to recognize any material tax benefits in 2011. We are not, however, able to provide a reasonably reliable estimate of the timing of future payments relating to these unrecognized tax benefits and related obligations.
Letters of Credit
As of September 30, 2011, we had $5.4 million in outstanding irrevocable letters of credit in favor of third-party beneficiaries, primarily related to facility leases. These irrevocable letters of credit are unsecured and are expected to remain in effect until December 2019.
Off-Balance Sheet Arrangements
We have entered into indemnification agreements with third parties, including vendors, customers, landlords, our officers and directors, shareholders of acquired companies, joint venture partners and third parties to which we license

32
Table of Contents

technology. Generally, these indemnification agreements require us to reimburse losses suffered by a third party due to various events, such as lawsuits arising from patent or copyright infringement or our negligence. These indemnification obligations are considered off-balance sheet arrangements in accordance with the authoritative guidance for guarantor’s accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. See also Note 11 to our consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2010 for further discussion of these indemnification agreements. The fair value of guarantees issued or modified during the three and nine months ended September 30, 2011 was determined to be immaterial.
As of September 30, 2011, we did not have any additional material off-balance sheet arrangements.
Litigation
We are party to litigation that we consider to be routine and incidental to our business and certain non-routine legal proceedings. Management does not expect the results of any of these routine actions to have a material impact on our financial condition or results of operations. See “Legal Proceedings” in Item 1 of Part II of this quarterly report on Form 10-Q and Note 15 to our unaudited consolidated financial statements elsewhere in this quarterly report on Form 10-Q for further discussion on litigation, including any developments related to material non-routine proceedings that have arisen since the filing of our annual report on Form 10-K.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

Our portfolio of cash equivalents and short- and long-term investments is maintained in a variety of securities, including government agency obligations, high quality corporate bonds and money market funds. Investments are classified as available-for-sale securities and carried at their market value with cumulative unrealized gains or losses recorded as a component of accumulated other comprehensive income (loss) within stockholders' equity. A sharp rise in interest rates could have an adverse impact on the market value of certain securities in our portfolio. We do not currently hedge our interest rate exposure and do not enter into financial instruments for trading or speculative purposes.
At September 30, 2011, we held $135.4 million in par value of ARS that have experienced failed auctions, which has prevented us from liquidating those investments. Due to these liquidity issues, we used a discounted cash flow analysis to determine the estimated fair value of these ARS investments. Such analysis considered the timing of expected future successful auctions, the impact of extended periods of maximum interest rates, collateralization of underlying security investments and the creditworthiness of the issuer. The discounted cash flow analysis as of September 30, 2011 assumed a weighted average discount rate of 4.11% and expected term of five years. The discount rate was determined using a proxy based upon the current market rates for recent debt offerings. The expected term was based on management’s estimate of future liquidity. As a result, as of September 30, 2011, we have estimated an aggregate loss of $16.6 million, related to the impairment of ARS deemed to be temporary and included in accumulated other comprehensive income (loss) within stockholders’ equity. The impact for the three and nine months ended September 30, 2011 was a pre-tax loss of $4.3 million and $3.0 million, respectively, included in accumulated other comprehensive income (loss) within stockholders’ equity related to ARS having impairments deemed to be temporary. The aggregate loss in the fair value of ARS experienced in the nine months ended September 30, 2011 was primarily due to an increase in the weighted average discount rate used in the assumption of fair values from 3.21% used as of December 31, 2010 compared to 4.11% used as of September 30