AKAM 10Q 6/30/2013

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________ 
FORM 10-Q
 ______________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2013
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 No.)

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 August 6, 2013: 178,158,848

Table of Contents

AKAMAI TECHNOLOGIES, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 5.
Item 6.
 
 
 
 


2
Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS

(In thousands, expect share data)
June 30,
2013
 
December 31,
2012
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents (including restricted cash of $200 at December 31, 2012)
$
204,865

 
$
201,989

Marketable securities (including restricted securities of $222 and $57 at June 30, 2013 and December 31, 2012, respectively)
326,077

 
235,592

Accounts receivable, net of reserves of $4,632 and $3,807 at June 30, 2013 and December 31, 2012, respectively
237,286

 
218,777

Prepaid expenses and other current assets
70,734

 
51,604

Deferred income tax assets
20,422

 
20,422

Total current assets
859,384

 
728,384

Property and equipment, net
405,653

 
345,091

Marketable securities (including restricted securities of $50 and $43 at June 30, 2013 and December 31, 2012, respectively)
587,470

 
657,659

Goodwill
729,386

 
731,325

Acquired intangible assets, net
68,562

 
84,554

Deferred income tax assets
14,527

 
13,803

Other assets
60,288

 
39,811

Total assets
$
2,725,270

 
$
2,600,627

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
50,370

 
$
43,291

Accrued expenses and other current liabilities
143,652

 
133,087

Deferred revenue
32,019

 
26,291

Accrued restructuring
533

 
275

Total current liabilities
226,574

 
202,944

Other liabilities
47,928

 
49,364

Deferred revenue
2,895

 
2,565

Total liabilities
277,397

 
254,873

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; 202,712,865 shares issued and 178,115,006 shares outstanding at June 30, 2013 and 200,199,536 shares issued and 177,782,814 shares outstanding at December 31, 2012
2,045

 
2,015

Additional paid-in capital
5,256,348

 
5,195,543

Accumulated other comprehensive loss
(10,955
)
 
(1,640
)
Treasury stock, at cost, 24,597,859 shares at June 30, 2013 and 22,416,722 shares at December 31, 2012
(707,245
)
 
(624,462
)
Accumulated deficit
(2,092,320
)
 
(2,225,702
)
Total stockholders’ equity
2,447,873

 
2,345,754

Total liabilities and stockholders’ equity
$
2,725,270

 
$
2,600,627


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

3
Table of Contents

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
    
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands, except per share data)
2013
 
2012
 
2013
 
2012
Revenues
$
378,106

 
$
331,306

 
$
746,152

 
$
650,754

Costs and operating expenses:
 
 
 
 
 
 
 
Cost of revenues
124,705

 
131,260

 
245,097

 
256,185

Research and development
20,597

 
17,542

 
42,502

 
35,022

Sales and marketing
67,825

 
56,480

 
130,515

 
105,475

General and administrative
61,351

 
53,596

 
116,731

 
105,238

Amortization of acquired intangible assets
5,734

 
5,463

 
11,794

 
10,230

Restructuring charge (benefit)
391

 
(46
)
 
822

 
14

Total costs and operating expenses
280,603

 
264,295

 
547,461

 
512,164

Income from operations
97,503

 
67,011

 
198,691

 
138,590

Interest income
1,446

 
1,622

 
3,002

 
3,255

Other income, net
341

 
1,131

 
209

 
690

Gain on investments, net
31

 
4

 
83

 
17

Income before provision for income taxes
99,321

 
69,768

 
201,985

 
142,552

Provision for income taxes
37,426

 
25,529

 
68,603

 
55,086

Net income
$
61,895

 
$
44,239

 
$
133,382

 
$
87,466

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.35

 
$
0.25

 
$
0.75

 
$
0.49

Diluted
$
0.34

 
$
0.24

 
$
0.73

 
$
0.48

Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
177,891

 
178,547

 
177,895

 
178,333

Diluted
181,388

 
181,817

 
181,475

 
182,080


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

4
Table of Contents

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In thousands)
2013
 
2012
 
2013
 
2012
Net income
$
61,895

 
$
44,239

 
$
133,382

 
$
87,466

Other comprehensive loss:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(3,746
)
 
(3,702
)
 
(7,760
)
 
(3,030
)
Change in unrealized (loss) gain on investments, net of income tax benefit (expense) of $913, $62, $903 and $(113) for the three and six months ended June 30, 2013 and 2012, respectively
(1,626
)
 
(99
)
 
(1,555
)
 
181

Other comprehensive loss
(5,372
)
 
(3,801
)
 
(9,315
)
 
(2,849
)
Comprehensive income
$
56,523

 
$
40,438

 
$
124,067

 
$
84,617


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


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Table of Contents

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

 
Six Months Ended June 30,
(In thousands)
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
133,382

 
$
87,466

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
86,501

 
95,746

Stock-based compensation
47,732

 
46,545

Provision for doubtful accounts
1,199

 
284

Excess tax benefits from stock-based compensation
(9,622
)
 
(15,049
)
Loss (gain) on disposal of property and equipment, net
309

 
(204
)
Gain on divestiture of a business
(1,188
)
 
—

Unrealized gain on convertible note receivable
(1,093
)
 
—

Changes in operating assets and liabilities, net of effects of acquisitions and divestitures:
 
 
 
Accounts receivable
(35,203
)
 
6,387

Prepaid expenses and other current assets
(19,106
)
 
8,972

Accounts payable, accrued expenses and other current liabilities
25,311

 
10,141

Deferred revenue
6,612

 
4,141

Accrued restructuring
(223
)
 
(2,869
)
Other non-current assets and liabilities
(1,849
)
 
495

Net cash provided by operating activities
232,762

 
242,055

Cash flows from investing activities:
 
 
 
Cash received (paid) for acquired businesses, net of cash acquired
80

 
(291,638
)
Purchases of property and equipment
(100,847
)
 
(72,620
)
Capitalization of internal-use software costs
(35,127
)
 
(26,263
)
Purchases of short- and long-term marketable securities
(309,875
)
 
(416,494
)
Proceeds from sales of short- and long-term marketable securities
77,720

 
110,161

Proceeds from maturities of short- and long-term marketable securities
209,473

 
141,424

Proceeds from the sale of property and equipment
426

 
12

Net cash used in investing activities
(158,150
)
 
(555,418
)
Cash flows from financing activities:
 
 
 
Proceeds from the issuance of common stock under stock option plans
28,050

 
22,569

Excess tax benefits from stock-based compensation
9,622

 
15,049

Employee taxes paid related to net share settlement of stock-based awards
(21,125
)
 
(24,196
)
Repurchases of common stock
(82,782
)
 
(75,126
)
Net cash used in financing activities
(66,235
)
 
(61,704
)
Effects of exchange rate changes on cash and cash equivalents
(5,501
)
 
(1,134
)
Net increase (decrease) in cash and cash equivalents
2,876

 
(376,201
)
Cash and cash equivalents at beginning of period
201,989

 
559,197

Cash and cash equivalents at end of period
$
204,865

 
$
182,996











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Table of Contents

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued

 
Six Months Ended June 30,
 
2013
 
2012
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
35,796

 
$
35,563

Non-cash financing and investing activities:
 
 
 
Purchases of property and equipment included in accrued expenses
$
14,344

 
$
13,103

Capitalization of stock-based compensation, net of impairments
$
6,183

 
$
4,133

Convertible note receivable received for divestiture of a business
$
18,882

 
$
—


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

7
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 more than 130,000 servers in 1,100 networks in 87 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, 2012, filed with the Securities and Exchange Commission on March 1, 2013.

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.

Revision of Prior Period Amounts

In the first quarter of 2013, the Company conducted a reevaluation of its business model. Following the review, the Company determined it was appropriate to change the classification of cost of services and support and cost of network build-out and support from sales and marketing and general and administrative expenses, respectively, to costs of revenues because such costs directly support the Company's revenues. The Company has concluded that the prior classification was an error and that it is immaterial to all annual and quarterly periods previously presented. However, to facilitate period-over-period comparisons, the Company has revised its prior period financial statements to reflect the corrections in the period in which the expenses were incurred.

The effect of the revisions to the consolidated statements of operations for the three and six months ended June 30, 2012, is as follows (in thousands):

 
Three Months Ended
 
Six Months Ended
 
As Previously Reported
 
Adjustment
 
As Revised
 
As Previously Reported
 
Adjustment
 
As Revised
Cost of revenues
$
107,457

 
$
23,803

 
$
131,260

 
$
210,023

 
$
46,162

 
$
256,185

Research and development
17,542

 
—

 
17,542

 
35,022

 
—

 
35,022

Sales and marketing
75,882

 
(19,402
)
 
56,480

 
143,172

 
(37,697
)
 
105,475

General and administrative
57,997

 
(4,401
)
 
53,596

 
113,703

 
(8,465
)
 
105,238

Amortization of acquired intangible assets
5,463

 
—

 
5,463

 
10,230

 
—

 
10,230

Restructuring (benefit) charge
(46
)
 
—

 
(46
)
 
14

 
—

 
14

Total costs and operating expenses
$
264,295

 
$
—

 
$
264,295

 
$
512,164

 
$
—

 
$
512,164


The classification error did not affect reported revenues, total costs and operating expenses, income from operations, net income or net income per share; our cash flows; or any balance sheet line item. See Item 5 of this quarterly report for the impact on the periods reported in our 2012 annual report and in our 2012 quarterly reports.


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Table of Contents

2. Changes to Significant Accounting Policies

Property and Equipment

Property and equipment are recorded at cost, net of accumulated depreciation and amortization. Property and equipment generally includes purchases of items with a per-unit value greater than $1,000 and a useful life greater than one year. Depreciation and amortization are computed on a straight-line basis over the estimated useful lives of the assets. The Company periodically reviews the estimated useful lives of property and equipment. Changes to the estimated useful lives are recorded prospectively from the date of the change. Upon retirement or sale, the cost of the assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in income from operations.

The Company implemented software and hardware initiatives to manage its global network more efficiently and, as a result, the expected average useful life of its network assets, primarily servers, increased from three to four years effective January 1, 2013. This change decreased depreciation on network assets in place at January 1, 2013 by approximately $9.0 million and $19.7 million on an after-tax basis, or $0.05 and $0.11 per share, for the three and six months ended June 30, 2013, respectively.

Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board ("FASB") issued guidance and disclosure requirements for reporting of comprehensive income: amounts reclassified out of accumulated other comprehensive income. The guidance requires that an entity provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP. The guidance became effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The adoption of this guidance in the first quarter of 2013 did not have a material impact on the Company's consolidated financial results.

3. Business Acquisitions and Divestitures

During 2012, the Company completed four acquisitions, in each case by purchasing all of the outstanding capital stock of the acquired company. The consolidated financial statements include the operating results of each business from the date of acquisition. Pro forma results of operations for these acquisitions have not been presented because the effects of the acquisitions, individually or in the aggregate, were not material to the Company’s consolidated financial results. The total amount of acquisition-related costs for the acquisitions completed in 2012 was approximately $5.8 million for the year ended December 31, 2012. These costs were included in general and administrative costs in the consolidated statements of operations.

The acquisitions completed in 2012 were accounted for using the purchase method of accounting. The total purchase consideration was allocated to the assets acquired and liabilities assumed at their estimated fair values as of the date of each acquisition, as determined by management and, with respect to identified intangible assets, by management with the assistance of an appraisal provided by a third-party valuation firm. The excess of the purchase price over the amounts allocated to assets acquired and liabilities assumed has been recorded as goodwill. Goodwill associated with these acquisitions will not be amortized and will be tested for impairment at least annually as required by the accounting guidance for goodwill and other intangible assets (see Note 10).

Verivue Acquisition
     
On December 4, 2012, the Company acquired all of the outstanding common and preferred stock of Verivue, Inc. ("Verivue") in exchange for $30.9 million in cash. In addition, the Company recorded a liability of $1.2 million for contingent consideration related to expected achievement of post-closing milestones. The Company acquired Verivue with a goal of complementing its Aura Network Solutions and accelerating time to market in providing a comprehensive, licensed content delivery network solution for network operators. The Company allocated $20.7 million of the cost of the acquisition to goodwill and $7.5 million to acquired intangible assets. The allocation of the purchase price is preliminary, pending the finalization of deferred tax assets and liabilities. The total weighted average useful life of the intangible assets acquired from Verivue is 6.4 years. The value of the goodwill from the acquisition can be attributed to a number of business factors, including a trained technical workforce in place in the United States and cost synergies. The total amount of goodwill related to the acquisition of Verivue expected to be deducted for tax purposes is $5.6 million. As of March 31, 2013, the Company determined the agreed upon post-closing milestones were not expected to be achieved and therefore reversed the $1.2 million liability recorded at December 31, 2012 for

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the contingent consideration and recorded it as general and administrative expense in the consolidated statement of operations. As of June 30, 2013, the Company continues to believe the milestones will not be achieved.

FastSoft Acquisition

On September 13, 2012, the Company acquired all of the outstanding common and preferred stock of FastSoft, Inc. ("FastSoft") in exchange for $14.4 million in cash. The Company acquired FastSoft with a goal of complementing the Company's media delivery solutions with technology for optimizing the throughput of video and other digital content across IP networks. The Company allocated $8.9 million of the cost of the acquisition to goodwill and $3.7 million to acquired intangible assets. The allocation of the purchase price is preliminary, pending the finalization of deferred tax assets and liabilities. The total weighted average useful life of the intangible assets acquired from FastSoft is 9.0 years. The value of the goodwill from the acquisition can be attributed to a number of business factors including a trained technical workforce in place in the United States and cost synergies. The total amount of goodwill related to the acquisition of FastSoft expected to be deducted for tax purposes is $2.0 million.

Cotendo Acquisition

On March 6, 2012, the Company acquired all of the outstanding common and preferred stock, including vested and unvested stock options, of Cotendo, Inc. ("Contendo") in exchange for $278.9 million in cash and assumption of unvested options. The Company acquired Cotendo with the intention of increasing the Company's pace of innovation in the areas of site acceleration and mobile optimization. The Company allocated $233.8 million of the cost of the acquisition to goodwill and $43.8 million to acquired intangible assets. The allocation of the purchase price has been finalized. The value of the goodwill from the acquisition of Cotendo can be attributed to a number of business factors, including potential sales opportunities to provide services to Cotendo customers; a trained technical workforce in place in the United States and Israel; an existing sales pipeline and a trained sales force; and cost synergies expected to be realized. The total weighted average amortization period for the intangible assets acquired from Cotendo is 7.1 years. The intangible assets are being amortized based upon the pattern in which the economic benefits of the intangible assets are being utilized. The total amount of goodwill related to the acquisition of Cotendo expected to be deducted for tax purposes is $45.0 million.

Blaze Acquisition

On February 7, 2012, the Company acquired all of the outstanding common and preferred stock, including vested and unvested stock options, of Blaze Software, Inc. ("Blaze") in exchange for $19.3 million in cash and assumption of unvested options. The Company acquired Blaze with a goal of complementing the Company's site acceleration solutions with technology designed to optimize the speed at which a web page is rendered. The Company allocated $15.1 million of the cost of the acquisition to goodwill and $5.1 million to acquired intangible assets. The allocation of the purchase price has been finalized. The total weighted average useful life of the intangible assets acquired from Blaze is 5.3 years. The value of the goodwill from this acquisition can be attributed to a number of business factors, including a trained technical workforce in place in Canada and cost synergies expected to be realized. The total amount of goodwill related to the acquisition of Blaze expected to be deducted for tax purposes is $13.5 million.

ADS Divestiture

Consistent with its strategy to prioritize higher-margin businesses, the Company sold its Advertising Decision Solutions ("ADS") business to MediaMath, Inc. ("MediaMath") in exchange for a $25.0 million face value convertible note receivable that is due and payable on July 24, 2014 (see Note 4). The transaction closed during the first quarter of 2013. These operations were not material to the Company's annual net sales, net income or earnings per share. No significant gains or losses were realized on this transaction. The accompanying interim consolidated financial statements for the six months ended June 30, 2013 include the impact of approximately one month of ADS operations prior to the sale. All assets and liabilities used by the business have been excluded from the consolidated balance sheet presentation. Simultaneously with the sale, the Company entered into a multi-year relationship agreement whereby MediaMath will have exclusive rights to leverage the Company's pixel-free technology for use within digital advertising and marketing applications.

4. Fair Value Measurements

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

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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 available-for-sale marketable securities held as of June 30, 2013 and December 31, 2012 (in thousands):

 
 
 
Gross Unrealized
 
 
 
Classification on Balance Sheet
 
Amortized Cost
 
Gains
 
Losses
 
Aggregate
Fair Value
 
Short-term
Marketable
Securities
 
Long-term
Marketable
Securities
As of June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
272

 
$
—

 
$
—

 
$
272

 
$
222

 
$
50

Commercial paper
7,496

 
3

 
—

 
7,499

 
7,499

 
—

Corporate bonds
716,669

 
558

 
(1,477
)
 
715,750

 
298,816

 
416,934

U.S. government agency obligations
190,455

 
6

 
(435
)
 
190,026

 
19,540

 
170,486

 
$
914,892

 
$
567

 
$
(1,912
)
 
$
913,547

 
$
326,077

 
$
587,470

 
 
 
 
 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
3,100

 
$
—

 
$
—

 
$
3,100

 
$
3,057

 
$
43

Commercial paper
7,481

 
2

 
(1
)
 
7,482

 
7,482

 
—

Corporate bonds
691,931

 
1,269

 
(205
)
 
692,995

 
217,548

 
475,447

U.S. government agency obligations
189,607

 
95

 
(28
)
 
189,674

 
7,505

 
182,169

 
$
892,119

 
$
1,366

 
$
(234
)
 
$
893,251

 
$
235,592

 
$
657,659


Unrealized gains and unrealized temporary losses on investments classified as available-for-sale are included within accumulated other comprehensive loss. Upon realization, those amounts are reclassified from accumulated other comprehensive loss to gain on investments, net in the statements of operations. As of June 30, 2013, the Company did not hold any investment-related assets that have been in a continuous loss position for more than 12 months.


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The following table details the fair value measurements within the fair value hierarchy of the Company’s financial assets, including investments and cash equivalents and liabilities, at June 30, 2013 and December 31, 2012 (in thousands):

 
Total Fair Value
 
Fair Value Measurements at Reporting Date Using
 
 
Level 1    
 
Level 2    
 
Level 3    
As of June 30, 2013
 
 
 
 
 
 
 
Cash Equivalents and Marketable Securities:
 
 
 
 
 
 
 
Money market funds
$
4,550

 
$
4,550

 
$
—

 
$
—

Certificates of deposit
4,436

 
4,436

 
—

 
—

Commercial paper
7,499

 
—

 
7,499

 
—

Corporate bonds
715,750

 
—

 
715,750

 
—

U.S. government agency obligations
190,026

 
—

 
190,026

 
—

 
$
922,261

 
$
8,986

 
$
913,275

 
$
—

Other Assets:
 
 
 
 
 
 
 
Note receivable
$
19,975

 
$
—

 
$
—

 
$
19,975

 
 
 
 
 
 
 
 
As of December 31, 2012
 
 
 
Cash Equivalents and Marketable Securities:
 
 
 
 
 
 
 
Money market funds
$
22,255

 
$
22,255

 
$
—

 
$
—

Certificates of deposit
7,473

 
7,473

 
—

 
—

Commercial paper
9,482

 
—

 
9,482

 
—

Corporate bonds
692,995

 
—

 
692,995

 
—

U.S. government agency obligations
189,674

 
—

 
189,674

 
—

 
$
921,879

 
$
29,728

 
$
892,151

 
$
—

Other Liabilities:
 
 
 
 
 
 
 
Contingent consideration obligation related to Verivue acquisition
$
(1,200
)
 
$
—

 
$
—

 
$
(1,200
)

As of June 30, 2013 and December 31, 2012, 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 June 30, 2013 and December 31, 2012, the Company had grouped commercial paper, U.S. government agency obligations and corporate bonds using a Level 2 valuation because quoted prices for identical or similar assets are available in markets that are inactive.

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

The valuation technique used to measure fair value for our Level 3 asset, which consists of a $25.0 million face value convertible note receivable that is due and payable on July 24, 2014, is primarily an income approach, where the expected weighted average future cash flows are discounted back to present value. The significant unobservable inputs used in the fair value measurement of the convertible note receivable are the probability of conversion to equity and the fair value of equity in which the note is convertible into. The valuation assumed a 90% probability of being converted to equity. If a 70% probability of conversion was used, the fair value of the note would have been $21.1 million.

The valuation technique used to measure fair value of our Level 3 liability, which consists of contingent consideration related to the acquisition of Verivue, is primarily an income approach. The significant unobservable inputs used in the fair value measurement of the contingent consideration are the likelihood of achieving defined levels of specified and other customer revenue and payments to these levels.


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Significant increases or decreases in the underlying assumptions used to value our Level 3 asset and liability held at June 30, 2013 and December 31, 2012, respectively, could significantly increase or decrease the fair value estimates recorded in the consolidated balance sheet.

Contractual maturities of the Company’s available-for-sale marketable securities held at June 30, 2013 and December 31, 2012 were as follows (in thousands):

 
June 30,
2013
 
December 31,
2012
Due in 1 year or less
$
326,077

 
$
235,592

Due after 1 year through 5 years
587,470

 
657,659

 
$
913,547

 
$
893,251


The following tables reflect the activity for the Company’s major classes of assets and liabilities measured at fair value using Level 3 inputs for the six months ended June 30, 2013 (in thousands):
 
 
Other Assets:
Note Receivable
 
Other Liabilities:
Contingent Consideration Obligation
Balance as of January 1, 2013
$
—

 
$
(1,200
)
Fair value adjustment to contingent consideration for acquisition of Verivue included in general and administrative expense
—

 
1,200

Convertible note receivable from divestiture of a business
18,882

 
—

Unrealized gain on convertible note receivable included in general and administrative expense
1,093

 
—

Balance as of June 30, 2013
$
19,975

 
$
—


5. Accounts Receivable

Net accounts receivable consisted of the following (in thousands):
 
 
June 30,
2013
 
December 31,
2012
Trade accounts receivable
$
163,220

 
$
143,533

Unbilled accounts
78,698

 
79,051

Gross accounts receivable
241,918

 
222,584

Allowance for doubtful accounts
(1,137
)
 
(1,154
)
Reserve for cash-basis customers
(3,495
)
 
(2,653
)
Total accounts receivable reserves
(4,632
)
 
(3,807
)
Accounts receivable, net
$
237,286

 
$
218,777


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

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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):

 
June 30,
2013
 
December 31,
2012
Payroll and other related benefits
$
52,293

 
$
75,039

Bandwidth and co-location
20,838

 
27,260

Income, property and other taxes
61,458

 
22,093

Professional service fees
4,309

 
3,643

Other
4,754

 
5,052

Total
$
143,652

 
$
133,087


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 and restricted stock units (“RSUs”) issued by the Company.

The following table sets forth the components used in the computation of basic and diluted net income per share (in thousands, except per share data):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Numerator:
 
 
 
 
 
 
 
Net income
$
61,895

 
$
44,239

 
$
133,382

 
$
87,466

Denominator:

 

 
 
 
 
Shares used for basic net income per share
177,891

 
178,547

 
177,895

 
178,333

Effect of dilutive securities:

 

 
 
 
 
Stock options
1,724

 
2,092

 
1,750

 
2,259

RSUs and deferred stock units
1,773

 
1,178

 
1,830

 
1,488

Shares used for diluted net income per share:
181,388

 
181,817

 
181,475

 
182,080

Basic net income per share
$
0.35

 
$
0.25

 
$
0.75

 
$
0.49

Diluted net income per share
$
0.34

 
$
0.24

 
$
0.73

 
$
0.48



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For the three and six months ended June 30, 2013 and 2012, certain potential outstanding stock options and service-based RSUs were excluded from the computation of diluted earnings per share because the effect of including these options and RSUs would be anti-dilutive. Additionally, certain performance-based RSUs were excluded from the computation of diluted net income per share because the underlying performance conditions for such RSUs had not been met as of these dates. The number of potentially outstanding shares excluded from the computation of diluted earnings per share are as follows (in thousands):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Options
1,888

 
3,084

 
2,018

 
2,883

Service-based RSUs
159

 
1,858

 
327

 
1,441

Performance-based RSUs
1,148

 
2,424

 
1,148

 
2,276

Total shares excluded from computation
3,195

 
7,366

 
3,493

 
6,600


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

In April 2012, the Company's Board of Directors authorized a $150.0 million stock repurchase program covering a twelve-month period commencing on May 1, 2012. In January 2013, the Board of Directors authorized a $150.0 million extension of its share repurchase program, effective for a twelve-month period beginning February 1, 2013. The timing and amount of any future share repurchases 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. The Company 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 for financing activities. Unused amounts from the May 2012 program were not carried over to the program approved in January 2013.

During the three and six months ended June 30, 2013, the Company repurchased 1.1 million and 2.2 million shares, respectively, of its common stock for $42.5 million and $82.8 million, respectively. During the three and six months ended June 30, 2012, the Company repurchased 2.2 million and 2.4 million shares, respectively, of its common stock for $67.2 million and $75.1 million, respectively. As of June 30, 2013, the Company had $76.8 million remaining available for future purchases of shares under the current repurchase program.


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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 six months ended June 30, 2013 and 2012 (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Stock-based compensation by type of award:
 
 
 
 
 
 
 
Stock options
$
3,104

 
$
4,366

 
$
6,293

 
$
7,466

Deferred stock units
1,705

 
1,885

 
1,705

 
1,885

RSUs
21,608

 
19,734

 
42,526

 
38,462

Shares issued under the Employee Stock Purchase Plan
1,629

 
1,471

 
3,391

 
2,865

Amounts capitalized as internal-use software
(3,245
)
 
(1,835
)
 
(6,183
)
 
(4,133
)
Total stock-based compensation before income taxes
24,801

 
25,621

 
47,732

 
46,545

Less: Income tax benefit
(9,345
)
 
(9,375
)
 
(16,309
)
 
(17,872
)
Total stock-based compensation, net of taxes
$
15,456

 
$
16,246

 
$
31,423

 
$
28,673

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

 
 
 
 
 
 
Cost of revenues
$
2,718

 
$
3,063

 
$
5,345

 
$
5,769

Research and development expense
3,867

 
4,901

 
8,236

 
8,831

Sales and marketing expense
9,799

 
8,814

 
19,230

 
16,925

General and administrative expense
8,417

 
8,843

 
14,921

 
15,020

Provision for income taxes
(9,345
)
 
(9,375
)
 
(16,309
)
 
(17,872
)
Total cost related to stock-based compensation, net of taxes
$
15,456

 
$
16,246

 
$
31,423

 
$
28,673


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 six months ended June 30, 2013 include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $2.0 million and $3.9 million, respectively, before taxes. The Company’s consolidated statements of operations for the three and six months ended June 30, 2012 include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $1.9 million and $3.7 million, respectively, before taxes.

9. Accumulated Other Comprehensive Loss

The following table summarizes the changes in accumulated other comprehensive loss, which is reported as a component of stockholders' equity, for the six months ended June 30, 2013 (in thousands):
 
Foreign Currency Translation Adjustments
 
Net Unrealized Gain (Loss) on Investments
 
Total
Balance as of January 1, 2013
$
(2,354
)
 
$
714

 
$
(1,640
)
Other comprehensive loss, net of tax
(7,760
)
 
(1,555
)
 
(9,315
)
Balance as of June 30, 2013
$
(10,114
)
 
$
(841
)
 
$
(10,955
)

The tax effect on accumulated unrealized gain (loss) on investments was $(0.5) million and $0.4 million as of June 30, 2013 and December 31, 2012, respectively. Amounts reclassified from accumulated other comprehensive loss to net income were insignificant for the six months ended June 30, 2013.

10. Goodwill and Acquired Intangible Assets

The Company has recorded goodwill and acquired intangible assets as a result of business acquisitions that occurred between 2000 and 2012. The Company also acquired license rights from the Massachusetts Institute of Technology in 1999. In February 2012, the Company recorded goodwill of $15.1 million and acquired intangible assets of $5.1 million as a result of the acquisition of Blaze. In March 2012, the Company recorded goodwill of $233.8 million and acquired intangible assets of $43.8 million as a result of the acquisition of Cotendo. In September 2012, the Company recorded goodwill of $8.9 million and

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acquired intangible assets of $3.7 million as a result of the acquisition of FastSoft. In December 2012, the Company recorded goodwill of $20.7 million and acquired intangible assets of $7.5 million as a result of the acquisition of Verivue (see Note 3).

In accordance with current accounting standards, goodwill is not amortized as it does not qualify as an amortizing intangible asset. The Company tests goodwill for impairment at least annually as required by the accounting guidance for goodwill and acquired intangible assets. Through the date the consolidated financial statements were issued, no triggering events had occurred that would indicate a potential impairment exists.

The changes in the carrying amount of goodwill were as follows (in thousands):
Balance as of January 1, 2013
$
731,325

Divestiture of Advertising Decision Solutions business
(1,939
)
Balance as of June 30, 2013
$
729,386


Acquired intangible assets that are subject to amortization consist of the following (in thousands, except for years):

 
June 30, 2013
 
 
 
Gross
Carrying
Amount
 
Accumulated Amortization
 
Net
Carrying
Amount
 
Weighted Average Amortization Period in Years
Completed technology
$
62,331

 
$
(30,666
)
 
$
31,665

 
6
Customer relationships
100,400

 
(71,533
)
 
28,867

 
9
Non-compete agreements
9,170

 
(3,716
)
 
5,454

 
4
Trademarks and trade names
3,400

 
(824
)
 
2,576

 
9
Acquired license rights
490

 
(490
)
 
—

 
10
Total
$
175,791

 
$
(107,229
)
 
$
68,562

 
 

 
December 31, 2012
 
 
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Weighted Average Amortization Period in Years
Completed technology
$
71,531

 
$
(32,842
)
 
$
38,689

 
6
Customer relationships
104,700

 
(68,702
)
 
35,998

 
9
Non-compete agreements
14,770

 
(7,645
)
 
7,125

 
5
Trademarks and trade names
3,700

 
(958
)
 
2,742

 
9
Acquired license rights
490

 
(490
)
 
—

 
10
Total
$
195,191

 
$
(110,637
)
 
$
84,554

 
 

Aggregate expense related to amortization of acquired intangible assets for the three and six months ended June 30, 2013 was $5.7 million and $11.8 million, respectively. Aggregate expense related to amortization of acquired intangible assets for the three and six months ended June 30, 2012 was $5.5 million and $10.2 million, respectively. Based on the Company’s acquired intangible assets as of June 30, 2013, aggregate expense related to amortization of acquired intangible assets is expected to be $9.6 million for the remainder of 2013, and $18.8 million, $16.2 million, $11.4 million and $7.6 million for 2014, 2015, 2016 and 2017, respectively.

11. Concentration of Credit Risk

Financial instruments that subject the Company to credit risk consist of cash and cash equivalents, marketable securities, accounts receivable and the convertible note receivable issued to it by MediaMath. The Company maintains the majority of its cash, cash equivalents and marketable securities balances with major financial institutions that the Company believes are of high credit standing.

Concentrations of credit risk with respect to accounts receivable are primarily limited to certain customers to which the Company makes substantial sales. The Company’s customer base consists of a large number of geographically dispersed

17
Table of Contents

customers diversified across several 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 June 30, 2013 and December 31, 2012, one customer accounted for greater than 10% of the Company's accounts receivable. The Company believes that, at June 30, 2013, concentration of credit risk related to accounts receivable was not significant.

12. Segment and Geographic Information

The Company's chief decision-maker, as defined under the authoritative guidance that discusses disclosures about segments of an enterprise and related information, is its Chief Executive Officer and executive management team. As of June 30, 2013, the Company operated in one industry segment: providing services for accelerating and improving the delivery of content and applications over the Internet. The Company is managed and operated as one business and does not have separate reportable segments as defined in the guidance. A single management team that reports to the Chief Executive Officer comprehensively manages the entire business.

The Company deploys its servers into networks worldwide. As of June 30, 2013, the Company had $264.3 million and $141.4 million of property and equipment, net of accumulated depreciation, located in the United States and in foreign locations, respectively. As of December 31, 2012, the Company had $225.5 million and $119.6 million of property and equipment, net of accumulated depreciation, located in the United States and in foreign locations, respectively.

The Company 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:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenues derived from outside of the United States
29
%
 
27
%
 
29
%
 
28
%
Revenues derived from Europe
17
%
 
17
%
 
17
%
 
17
%

No single country outside the United States accounted for 10% or more of revenues during these periods. For the three and six months ended June 30, 2013 and 2012, no customer accounted for 10% or more of total revenues.

13. Income Taxes

The Company’s effective income tax rate, including discrete items, was 34.0% and 38.6% for the six months ended June 30, 2013 and 2012, 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 retroactive changes in tax legislation, settlements of tax audits or assessments, the resolution or identification of tax position uncertainties, and acquisitions of other companies.

The discrete items include the tax effect of the reinstatement of the federal research and development credit at the beginning of 2013, which was retroactive to 2012, certain stock options and interest and penalties related to uncertain tax positions.  For the six months ended June 30, 2013, the effective income tax rate was lower than the federal statutory tax rate mainly due to the composition of income in foreign jurisdictions that is taxed at lower rates compared to the statutory tax rates in the United States, as well as the reinstatement of the federal research and development credit at the beginning of 2013, which was retroactive to 2012.  For the six months ended June 30, 2012, 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.

During 2012, the Company corrected errors in its reported income tax expense attributable to prior fiscal periods. During the six months ended June 30, 2013, the Company concluded the review which gave rise to the corrections and recorded an additional $1.4 million of income tax expense.

14. Forward Currency Contracts

The assets and liabilities of the Company's international subsidiaries are translated at the applicable exchange rate as of the balance sheet date, and revenues and expenses are translated at an average rate over the period. Resulting currency translation adjustments are recorded as a component of accumulated other comprehensive loss, a separate component of stockholders’ equity. Gains and losses on inter-company and other non-functional currency transactions are recorded in other income, net in

18
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the consolidated statements of operations. For the three and six months ended June 30, 2013, the Company recorded an immaterial amount of net foreign currency losses. For the three and six months ended June 30, 2012, the Company recorded net foreign currency gains of $1.0 million and $0.5 million, respectively, in the consolidated statement of operations.

The Company has entered into short-term foreign currency forward contracts to offset 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 income, net in the consolidated statements of operations. As of June 30, 2013 and December 31, 2012, the fair value of the forward currency contracts and the underlying net loss for the three and six months ended June 30, 2013 and 2012 were immaterial.
 
The Company's foreign currency forward contracts include credit risk to the extent that the counterparties may be unable to meet the terms of the agreements. The Company seeks to minimize 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 May 2022 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 June 30, 2013 were as follows (in thousands):
 
Remaining 2013
$
13,355

2014
25,846

2015
23,845

2016
19,961

2017
19,113

Thereafter
34,169

Total
$
136,289


Purchase Commitments

The Company has long-term commitments for bandwidth usage and co-location services with various network and Internet service providers. The following table reflects the Company's minimum commitments pursuant to these contracts in effect as of June 30, 2013, as well as aggregate purchase order commitments with various vendors (in thousands):
 
Payments Due by Period
 
Total
 
Remainder of 2013
 
2014
 
2015
 
2016
 
2017
Bandwidth and co-location agreements
$
73,034

 
$
53,032

 
$
16,244

 
$
3,000

 
$
559

 
$
199

Open vendor purchase orders
79,544

 
71,832

 
5,768

 
1,944

 
—

 
—

Total
$
152,578

 
$
124,864

 
$
22,012

 
$
4,944

 
$
559

 
$
199


Litigation

The Company is party to various 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 impact on the Company’s business, results of operations, financial condition or cash flows.

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

19
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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 incurred 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 June 30, 2013 was determined to be immaterial.

16. Restructuring

In prior years, the Company implemented workforce reductions of employees from all areas of the Company. The Company recorded restructuring charges for the amount of one-time benefits provided to affected employees. Included in these costs was a net increase in non-cash, stock-based compensation reflecting a modification of certain stock-based awards previously granted to the affected employees. Additionally, in connection with excess and vacated facilities under long-term non-cancelable leases, the Company recorded a restructuring charge for the estimated future lease payments, less estimated sublease income, for these vacated facilities. For the six months ended June 30, 2013, the Company recorded additional restructuring charges related to workforce reductions and relocation expenses.

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

 
Leases
 
Severance
 
Total
Beginning balance, January 1, 2013
$
517

 
$
124


$
641

        Restructuring charge
—

 
822

 
822

        Cash payments
(61
)
 
(560
)
 
(621
)
Ending balance, June 30, 2013
$
456

 
$
386

 
$
842

Current portion of accrued restructuring
$
147

 
$
386

 
$
533

Long-term portion of accrued restructuring
$
309

 
$
—

 
$
309



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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This quarterly report on Form 10-Q, particularly Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our unaudited consolidated financial statements included herein contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management as of the date hereof based on information currently available to our management. Use of words such as “believes,” “expects,” “anticipates,” “intends,” “plans,” “estimates,” “should,” “forecasts,” “if,” “continues,” “goal,” “likely” or similar expressions indicates a forward-looking statement. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions. Actual results may differ materially from the forward-looking statements we make. See “Risk Factors” elsewhere in this quarterly report on Form 10-Q for a discussion of certain risks associated with our business. We disclaim any obligation to update forward-looking statements as a result of new information, future events or otherwise.

We provide services for accelerating and improving the delivery of content and applications over the Internet. We primarily derive income from sales 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. This allows us to have a consistent and predictable base level of revenue which is important to our financial success. Accordingly, to be successful, we must maintain our base of recurring revenue contracts by minimizing customer cancellations or terminations and limiting the impact of price reductions reflected in contract renewals, and build on that base by adding new customers and increasing the number of services, features and functionalities that our existing customers purchase. Accomplishing these goals requires that we compete effectively in the marketplace on the basis of 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:

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
Revenues
100.0
%
 
100.0
 %
 
100.0
%
 
100.0
%
Cost of revenues
33.0

 
39.6

 
32.8

 
39.3

Research and development expense
5.5

 
5.3

 
5.7

 
5.4

Sales and marketing expense
17.9

 
17.0

 
17.5

 
16.2

General and administrative expense
16.2

 
16.2

 
15.6

 
16.2

Amortization of acquired intangible assets
1.5

 
1.7

 
1.6

 
1.6

Restructuring charge (benefit)
0.1


—

 
0.1


—

Total costs and operating expenses
74.2

 
79.8

 
73.3

 
78.7

Income from operations
25.8

 
20.2

 
26.7

 
21.3

Interest income
0.4

 
0.5

 
0.4

 
0.5

Other income, net
0.1

 
0.4

 
—

 
0.1

Gain on investments, net
—

 
—

 
—

 
—

Income before provision for income taxes
26.3

 
21.1

 
27.1

 
21.9

Provision for income taxes
9.9

 
7.7

 
9.2

 
8.5

Net income
16.4
%
 
13.4
 %
 
17.9
%
 
13.4
%

We have observed the following trends and events that are likely to have an impact on our financial condition, results of operations or cash flows in the foreseeable future:

Revenues and Customers

•
During each of the first two quarters of 2013, we were able to offset lost committed recurring revenues by adding new customers and increasing sales of incremental services to our existing customers. A continuation of this trend could lead to increased revenues. Overall revenues were also favorably impacted by amounts we were paid for traffic usage in excess of committed amounts and other one-time events.
•
In recent years, our unit prices offered to some customers declined as a result of increased competition. These price reductions have primarily impacted customers for which we deliver high volumes of traffic over our network, such as

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digital media customers. To increase or maintain revenues and our profit margin, it is important that we continue to offset price declines with increased traffic, increased sales of incremental services to existing customers, enhanced efficiencies in our network and lower co-location and bandwidth expenses.
•
During each of the first two quarters of 2013, we experienced an increase in the rate of traffic in our video and software download solutions as compared to the first two quarters of 2012. Our ability to generate revenue growth would be enhanced if the rate of traffic continues to increase.
•
We have historically experienced variations in revenue from quarter to quarter. We see seasonal impacts of higher revenues in the fourth quarter of the year and lower revenues during the summer months, which we primarily attribute such to patterns of usage of e-commerce services by our retail customers. We have also experienced quarterly variations in revenues attributable to our software download solutions due to the nature and timing of software releases by our customers. If these variable trends continue, our ability to generate quarterly revenue growth on a sequential basis could be impacted.
•
For the six months ended June 30, 2013, revenues derived from customers outside the United States accounted for 29% of our total revenues. For the remainder of 2013, we anticipate revenues from such customers as a percentage of our total revenues to be consistent with the first half of 2013.

Costs and Expenses

•
During each of the first two quarters of 2013, we continued to reduce our network bandwidth costs per unit and to invest in internal-use software development to improve the performance and efficiency of our network. We believe our total bandwidth costs will continue to increase as a result of expected higher traffic levels, but will be partially offset by anticipated continued reductions in bandwidth costs per unit. To achieve these lower bandwidth costs per unit, we must effectively route traffic over our network through lower cost providers and continue to reduce our overall bandwidth pricing.
•
Co-location costs are a significant percentage of total cost of revenues. By improving our internal-use software and managing our hardware deployments to enable us to use servers more efficiently, we believe we can manage the growth of co-location costs by deploying fewer servers. We will need to continue to achieve such cost reductions to maintain and improve our profitability.
•
Depreciation and amortization expense related to our network equipment and internal-use software development costs decreased by $13.4 million during the first two quarters of 2013 as compared to the first two quarters of 2012. We implemented software and hardware initiatives to manage our global network more efficiently, and as a result, the expected average useful life of our network assets, primarily servers, increased from three to four years, effective January 1, 2013. This change is expected to continue to decrease depreciation expense related to our network equipment during 2013, as compared to 2012. Conversely, we expect to continue to enhance and add functionality to our service offerings, which would increase our internal-use software development costs 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 2013 as compared to 2012.
•
We expect to continue to grant restricted stock units, or RSUs, to employees in the future; therefore, we anticipate that stock-based compensation will increase in 2013 as compared to 2012. As of June 30, 2013, our total unrecognized compensation costs for stock-based awards were $164.0 million, which we expect to recognize as expense over a weighted average period of 1.3 years. We expect to recognize this expense through 2017.
•
During the six months ended June 30, 2013, our effective income tax rate was 34.0%. We expect our annual effective income tax rate in 2013 to increase slightly in the remaining quarters of 2013. This expectation does not take into consideration the effect of other discrete items that may be recorded as a result of our compliance with the accounting guidance for stock-based compensation, any tax planning strategies or the effect of changes in tax laws and regulations.
•
During the six months ended June 30, 2013, we have increased our headcount by 379 full-time employees and expect to continue to add resources as we continue to release new products and services, as well as continue our global expansion.

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 2013; 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 recurring revenue contracts and limiting customer cancellations and terminations;

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•
offset unit price declines for our services with higher volumes of traffic delivered over our network as well as increased sales of value-added services;
•
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.

Our management’s discussion and analysis of our financial condition and results of operations is based upon our unaudited consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which we have prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim periods and with Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The preparation of these unaudited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related items, including, but not limited to, revenue recognition, accounts receivable and related reserves, valuation and impairment of investments, marketable securities and note receivable, goodwill and acquired intangible assets, capitalized internal-use software costs, impairment and useful lives of long-lived assets, tax reserves, loss contingencies and stock-based compensation 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, 2012 for further discussion of our critical accounting policies and estimates.

Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board, or FASB, issued guidance and disclosure requirements for reporting of comprehensive income: amounts reclassified out of accumulated other comprehensive income. The guidance requires that an entity provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP. The guidance became effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The adoption of this guidance in the first quarter of 2013 did not have a material impact on our consolidated financial results.

Results of Operations

Revenues

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions)
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Revenues
$
378.1

 
$
331.3

 
14.1
%
 
$
746.2

 
$
650.8

 
14.7
%

During the three and six months ended June 30, 2013, the increase in our revenues was driven by strong demand for our services across our solution categories and in each geographic region. The increase in our revenues is attributable to the addition of new customers, increased sales of incremental services to our existing customers, amounts earned for traffic usage in excess of committed amounts and other one-time events. These contributions to higher revenues were partially offset by lost committed recurring revenues and price declines. Changes in foreign currency exchange rates negatively impacted our revenues during the second quarter of 2013 as compared to 2012.


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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Media Delivery Solutions
$
179.4

 
$
158.0

 
13.5
 %
 
$
360.6

 
$
313.0

 
15.2
 %
Performance and Security Solutions
167.9

 
140.6

 
19.4

 
324.5

 
274.6

 
18.2

Service and Support Solutions
31.4

 
22.2

 
41.4

 
59.0

 
42.6

 
38.5

Advertising Decision Solutions and other
(0.6
)
 
10.5

 
(105.7
)
 
2.1

 
20.6

 
(89.8
)
Total revenues
$
378.1

 
$
331.3

 
14.1
 %
 
$
746.2

 
$
650.8

 
14.7
 %

The increase in Media Delivery Solutions revenues for the three and six month periods ended June 30, 2013, as compared to the same periods in 2012, was due to increased online media consumption and higher software download volumes. The increase was partially offset by a large media customer finalizing the removal of its video content from our platform during the second quarter of 2013 and the resulting loss in revenues as compared to the same period in 2012.

The increase in Performance and Security Solutions revenues for the three and six month periods ended June 30, 2013, as compared to the same periods in 2012, was due to increase in demand for our performance and security solutions from both new and existing customers.

The increase in the Service and Support Solutions revenues for the three and six month period ended June 30, 2013, as compared to the same periods in 2012, was due to an increase in sales of our enterprise-class services and support offerings with our core solution offerings.

The following table quantifies the contribution to revenues during the periods presented from the industry verticals in which we sell our services (in millions):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Media and entertainment
$
162.1

 
$
139.6

 
16.1
%
 
$
322.3

 
$
274.1

 
17.6
%
Commerce
77.5

 
70.9

 
9.3

 
154.3

 
142.5

 
8.3

Enterprise
57.2

 
44.6

 
28.3

 
110.8

 
87.2

 
27.1

High tech
61.2

 
56.9

 
7.6

 
120.9

 
111.4

 
8.5

Public sector
20.1

 
19.3

 
4.1

 
37.9

 
35.6

 
6.5

Total revenues
$
378.1

 
$
331.3

 
14.1
%
 
$
746.2

 
$
650.8

 
14.7
%

A significant portion of the increase in revenues attributable to our media and entertainment vertical was driven by traffic growth stemming from increased online media consumption. Revenues from our commerce and enterprise verticals increased due to growth in application and cloud performance solutions, particularly security-related solutions, sold to customers in these verticals. Revenues from our high tech vertical grew due to increased demand for cloud performance solutions and a moderate increase in our software download volumes as compared to 2012.

For the three and six months ended June 30, 2013, approximately 29% of our revenues were derived from our operations located outside of the United States, including 17% derived from Europe. For the three and six months ended June 30, 2012, approximately 27% and 28%, respectively, of our revenues were derived from operations outside of the United States, including 17% derived from Europe. No single country outside of the United States accounted for 10% or more of revenues during any of these periods. During the quarter, we had strong growth in our Asia Pacific geography.

For the three and six months ended June 30, 2013, resellers accounted for 20% of revenues as compared to 21% of revenues for the three and six months ended June 30, 2012. For the three and six months ended June 30, 2013 and 2012, no single customer accounted for 10% or more of revenues.


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Cost of Revenues

Cost of revenues was comprised of the following for the periods presented (in millions):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Bandwidth, network build-out and support-related fees
$
30.0

 
$
33.2

 
(9.6
)%
 
$
59.2

 
$
64.5

 
(8.2
)%
Co-location fees
32.4

 
33.0

 
(1.8
)
 
65.0

 
66.8

 
(2.7
)
Payroll and related costs
27.5

 
22.1

 
24.4

 
52.8

 
42.9

 
23.1

Stock-based compensation, including amortization of prior capitalized amounts
4.6

 
5.0

 
(8.0
)
 
9.0

 
9.4

 
(4.3
)
Depreciation and impairment of network equipment
20.0

 
28.7

 
(30.3
)
 
38.5

 
55.5

 
(30.6
)
Amortization of internal-use software
10.2

 
9.3

 
9.7

 
20.6

 
17.1

 
20.5

Total cost of revenues
$
124.7

 
$
131.3

 
(5.0
)%
 
$
245.1

 
$
256.2

 
(4.3
)%
As a percentage of revenues
33.0
%
 
39.6
%
 
 
 
32.8
%
 
39.3
%
 
 

We have continued to reduce our network bandwidth costs per unit, which contributed to the decrease in our cost of revenues in the three and six months ended June 30, 2013 as compared to the same periods in 2012. These decreases were the result of recent initiatives to manage our global network more efficiently.

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

•
depreciation expense of network equipment of approximately $11.0 million and $25.1 million for the three and six months ended June 30, 2013, respectively, due to software and hardware initiatives we have implemented to manage our global network more efficiently, resulting in an increase in the expected average useful life of our network assets, primarily servers, from three to four years, effective January 1, 2013; and
•
amounts paid to network providers due to lower bandwidth and service-related fees due to reduced bandwidth costs per unit.

These decreases were partially offset by increases in:

•
payroll and related costs of service personnel due to headcount growth to support our revenue growth; and
•
amortization of internal-use software as we continued to invest in our infrastructure.

Additionally, for each of the three and six months ended June 30, 2013 and 2012, cost of revenues included stock-based compensation expense and amortization of capitalized stock-based compensation. Such expense decreased for the three and six months ended June 30, 2013 as compared to the same period in 2012. Cost of revenues during the three and six months ended June 30, 2013 also included credits received of approximately $1.6 million and $5.0 million, respectively, from settlements and renegotiations entered into in connection with billing disputes related to bandwidth contracts. Cost of revenues during the three and six months ended June 30, 2012 included credits received of approximately $2.8 million and $4.8 million, respectively.

We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2013 and for the years ending December 31, 2014, 2015, 2016 and 2017, our minimum commitments related to bandwidth usage and co-location services as of June 30, 2013 were approximately $53.0 million, $16.2 million, $3.0 million, $0.6 million and $0.2 million, respectively.

We believe that cost of revenues will increase during the remaining quarters of 2013 as compared to the first two quarters of 2013. We expect to deploy more servers and deliver more traffic on our network, which will result in higher expenses associated with the increased traffic and additional co-location fees; however, such costs are likely to be partially offset by lower bandwidth costs per unit and continued efficiency in network deployment. Additionally, for the remainder of 2013, we anticipate amortization of internal-use software development costs to increase, along with increased payroll and related costs, as we continue to make investments in our network in the expectation that our customer base will continue to expand. We expect

25
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that the depreciation expense for the remainder of 2013 will be lower than depreciation expense reported in the same period in 2012 due to the change in estimated useful lives of our network equipment.

We have revised cost of revenues reported in 2012 in the table above as a result of a reevaluation of our business model. Costs which were previously classified as sales and marketing and general and administrative are now classified as cost of revenues. See Note 1 to the unaudited consolidated financial statements included in this quarterly report for additional information and amounts revised.

Research and Development Expenses

Research and development expenses were comprised of the following for the periods presented (in millions):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Payroll and related costs
$
32.5

 
$
24.3

 
33.7
 %
 
$
64.3

 
$
49.2

 
30.7
 %
Stock-based compensation
3.9

 
4.9

 
(20.4
)
 
8.2

 
8.8

 
(6.8
)
Capitalized salaries and related costs
(17.0
)
 
(12.5
)
 
36.0

 
(32.4
)
 
(24.8
)
 
30.6

Other expenses
1.2

 
0.8

 
50.0

 
2.4

 
1.8

 
33.3

Total research and development
$
20.6

 
$
17.5

 
17.7
 %
 
$
42.5

 
$
35.0

 
21.4
 %
As a percentage of revenues
5.5
%
 
5.3
%
 
 
 
5.7
%
 
5.4
%
 
 

The increases during the three and six month periods ended June 30, 2013, as compared to the same periods in 2012, were due to increases in payroll and related costs as a result of continued growth in headcount to invest in new product development, partially offset by increases in capitalized salaries and related costs.

Research and development costs are expensed as incurred, other than certain internal-use software development costs eligible for capitalization. These development costs consisted of external consulting expenses and payroll and related costs for personnel involved in the development of internal-use software used to deliver our services and operate our network. During the three and six months ended June 30, 2013, we capitalized $3.1 million and $5.9 million, respectively, of stock-based compensation. For the three and six months ended June 30, 2012, we capitalized $1.7 million and $3.9 million, respectively, of stock-based compensation. These capitalized internal-use software costs are amortized to cost of revenues over their estimated useful lives of two years.

We believe that research and development expenses, in absolute dollar terms, will increase during the remaining quarters of 2013 as compared to the first two quarters of 2013 as we expect to continue to hire additional development personnel in order to make improvements to our core technology and develop new services.

Sales and Marketing Expenses

Sales and marketing expenses were comprised of the following for the periods presented (in millions):

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Payroll and related costs
$
44.1

 
$
36.0

 
22.5
%
 
$
85.2

 
$
66.8

 
27.5
%
Stock-based compensation
9.8

 
8.8

 
11.4

 
19.2

 
16.9

 
13.6

Marketing and related costs
6.5

 
5.7

 
14.0

 
14.4

 
12.0

 
20.0

Other expenses
7.4

 
6.0

 
23.3

 
11.7

 
9.8

 
19.4

Total sales and marketing
$
67.8

 
$
56.5

 
20.0
%
 
$
130.5

 
$
105.5

 
23.7
%
As a percentage of revenues
17.9
%
 
17.0
%
 
 
 
17.5
%
 
16.2
%
 
 

The increase in sales and marketing expenses during the three and six months ended June 30, 2013, as compared to the same periods in 2012, was primarily due to higher payroll and related costs, as we invested in our marketing strategy to support new product introductions and our ongoing geographic expansion.


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We believe that sales and marketing expenses will increase, in absolute dollar terms, during the remaining quarters of 2013 as compared to the first two quarters of 2013 due to an expected increase in payroll and related costs as a result of continued headcount growth in our sales and marketing organization.

General and Administrative Expenses

General and administrative expenses were comprised of the following for the periods presented (in millions):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
% Change
 
2013
 
2012
 
% Change
Payroll and related costs
$
24.6

 
$
20.2

 
21.8
 %
 
$
48.4

 
$
39.3

 
23.2
 %
Stock-based compensation
8.4

 
8.8

 
(4.5
)
 
14.9

 
15.0

 
(0.7
)
Depreciation
6.2

 
4.8

 
29.2

 
11.8

 
9.3

 
26.9

Legal fees
1.5

 
1.9

 
(21.1
)
 
3.0

 
3.0

 
—

Non-income taxes
1.4

 
1.4

 
—

 
2.1

 
2.0

 
5.0

Provision for doubtful accounts
0.2

 
(0.5
)
 
(140.0
)
 
0.5

 
(0.3
)
 
(266.7
)
Facilities-related costs
10.3

 
8.4

 
22.6

 
19.9

 
16.9

 
17.8

Acquisition-related costs
(1.1
)
 
0.4

 
(375.0
)
 
(0.7
)
 
4.8

 
(114.6
)
Consulting, advisory and other expenses
9.9

 
8.2

 
20.7

 
16.8

 
15.2

 
10.5

Total general and administrative
$
61.4

 
$
53.6

 
14.6
 %
 
$
116.7

 
$
105.2

 
10.9
 %
As a percentage of revenues
16.2
%
 
16.2