AKAM 10Q 9/30/2012

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, 2012
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 6, 2012: 177,467,846


Table of Contents

AKAMAI TECHNOLOGIES, INC.
FORM 10-Q
For the quarterly period ended September 30, 2012
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 
 
 


2


PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements

AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
September 30,
2012
 
December 31,
2011
 
(In thousands,
except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
182,650

 
$
559,197

Marketable securities (including restricted securities of $54 at September 30, 2012)
282,579

 
290,029

Accounts receivable, net of reserves of $5,778 and $4,555 at September 30, 2012 and December 31, 2011, respectively
236,232

 
210,936

Prepaid expenses and other current assets
45,784

 
55,414

Deferred income tax assets
6,444

 
6,444

Total current assets
753,689

 
1,122,020

Property and equipment, net
331,218

 
293,043

Marketable securities (including restricted securities of $44 and $42 at September 30, 2012 and December 31, 2011, respectively)
593,105

 
380,729

Goodwill
721,601

 
452,914

Other intangible assets, net
82,375

 
45,386

Deferred income tax assets
42,101

 
43,485

Other assets
15,365

 
7,924

Total assets
$
2,539,454

 
$
2,345,501

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
52,749

 
$
38,247

Accrued expenses and other current liabilities
131,616

 
85,371

Deferred revenue
27,927

 
21,344

Accrued restructuring
628

 
3,430

Total current liabilities
212,920

 
148,392

Other liabilities
64,499

 
38,389

Deferred revenue
2,097

 
2,470

Total liabilities
279,516

 
189,251

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; 198,954,007 shares issued and 177,331,901 shares outstanding at September 30, 2012 and 195,561,243 shares issued and 177,504,624 shares outstanding at December 31, 2011
2,000

 
1,959

Additional paid-in capital
5,146,092

 
5,068,235

Accumulated other comprehensive income (loss)
483

 
(1,259
)
Treasury stock, at cost, 21,622,106 shares at September 30, 2012 and 18,056,619 shares at December 31, 2011
(594,643
)
 
(482,994
)
Accumulated deficit
(2,293,994
)
 
(2,429,691
)
Total stockholders’ equity
2,259,938

 
2,156,250

Total liabilities and stockholders’ equity
$
2,539,454

 
$
2,345,501

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

3


AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands,
except per share data)
Revenues
$
345,321

 
$
281,856

 
$
996,075

 
$
834,798

Costs and operating expenses:
 
 
 
 
 
 
 
Cost of revenues
109,995

 
93,284

 
320,018

 
271,999

Research and development
19,351

 
13,542

 
54,373

 
37,142

Sales and marketing
75,924

 
54,520

 
219,096

 
160,722

General and administrative
54,511

 
50,834

 
168,214

 
140,710

Amortization of other intangible assets
5,381

 
4,185

 
15,611

 
12,754

Restructuring charge

 
158

 
14

 
158

Total costs and operating expenses
265,162

 
216,523

 
777,326

 
623,485

Income from operations
80,159

 
65,333

 
218,749

 
211,313

Interest income
1,568

 
2,703

 
4,823

 
8,675

Other (expense) income, net
(241
)
 
(188
)
 
449

 
(1,330
)
Gain on investments, net
25

 
299

 
42

 
383

Income before provision for income taxes
81,511

 
68,147

 
224,063

 
219,041

Provision for income taxes
33,280

 
25,862

 
88,366

 
78,218

Net income
$
48,231

 
$
42,285

 
$
135,697

 
$
140,823

Net income per weighted average share:
 
 
 
 
 
 
 
Basic
$
0.27

 
$
0.23

 
$
0.76

 
$
0.76

Diluted
$
0.27

 
$
0.23

 
$
0.75

 
$
0.74

Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
177,455

 
183,085

 
178,040

 
185,515

Diluted
181,053

 
185,704

 
181,738

 
189,089

















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

4



AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)

 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Net income
$
48,231

 
$
42,285

 
$
135,697

 
$
140,823

Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments
3,770

 
(5,588
)
 
740

 
(1,200
)
Change in unrealized gain (loss) on investments, net
1,246

 
(6,517
)
 
1,540

 
(3,840
)
Income tax (expense) benefit related to unrealized gain (loss) on investments, net
(425
)
 
2,507

 
(538
)
 
1,482

Other comprehensive income (loss)
4,591

 
(9,598
)
 
1,742

 
(3,558
)
Comprehensive income
$
52,822

 
$
32,687

 
$
137,439

 
$
137,265





















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


5



AKAMAI TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
135,697

 
$
140,823

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
149,203

 
124,228

Stock-based compensation expense
69,180

 
42,465

Provision for doubtful accounts
(61
)
 
1,236

Excess tax benefits from stock-based compensation
(17,589
)
 
(11,460
)
Provision for deferred income taxes, net
826

 
20,906

Gain on investments and disposal of property and equipment, net
(62
)
 
(172
)
Changes in operating assets and liabilities, net of effects of acquisitions:
 
 
 
Accounts receivable
(21,587
)
 
(7,821
)
Prepaid expenses and other current assets
11,103

 
(78
)
Accounts payable, accrued expenses and other current liabilities
54,732

 
(5,268
)
Deferred revenue
5,542

 
(1,386
)
Accrued restructuring
(2,897
)
 
(180
)
Other non-current assets and liabilities
(536
)
 
13,355

Net cash provided by operating activities
383,551

 
316,648

Cash flows from investing activities:
 
 
 
Cash paid for acquisition of businesses, net of cash acquired
(306,030
)
 
(550
)
Purchases of property and equipment
(119,256
)
 
(105,769
)
Capitalization of internal-use software costs
(39,921
)
 
(30,523
)
Purchases of short- and long-term marketable securities
(554,303
)
 
(727,453
)
Proceeds from sales of short- and long-term marketable securities
135,993

 
545,568

Proceeds from maturities of short- and long-term marketable securities
214,159

 
354,552

Proceeds from the sale of property and equipment
12

 
135

Decrease in restricted investments held for security deposits

 
221

Net cash (used in) provided by investing activities
(669,346
)
 
36,181

Cash flows from financing activities:
 
 
 
Proceeds from the issuance of common stock under stock option plans and employee stock purchase plans
28,635

 
13,305

Excess tax benefits from stock-based compensation
17,589

 
11,460

Employee taxes paid related to net share settlement of equity awards
(26,566
)
 
(5,680
)
Repurchases of common stock
(111,649
)
 
(247,738
)
Net cash used in financing activities
(91,991
)
 
(228,653
)
Effects of exchange rate changes on cash and cash equivalents
1,239

 
(443
)
Net (decrease) increase in cash and cash equivalents
(376,547
)
 
123,733

Cash and cash equivalents at beginning of period
559,197

 
231,866

Cash and cash equivalents at end of period
$
182,650

 
$
355,599

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
51,822

 
$
26,530

Non-cash financing and investing activities:
 
 
 
Capitalization of stock-based compensation, net of impairments
$
6,694

 
$
5,406




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

6


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 80 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, 2011, filed with the Securities and Exchange Commission on February 29, 2012.
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 May 2011, the Financial Accounting Standards Board ("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. The Company adopted this guidance during the first quarter of 2012. The adoption of the guidance did not 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 Company adopted this guidance during the first quarter of 2012. There is 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 simplifies how entities test goodwill for impairment. Under the amended guidance, after assessment of certain qualitative factors, if an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test(s) are optional. The Company adopted this guidance during the first quarter of 2012. The adoption of the guidance did not have a material impact on the Company's consolidated financial statements.
In July 2012, the FASB issued amended guidance on the periodic testing of indefinite-lived intangible assets for impairment. This guidance will allow companies to assess qualitative factors to determine if it is more likely than not that the indefinite-lived intangible asset might be impaired and whether it is necessary to perform the quantitative impairment test required under current accounting standards. The updated accounting guidance is effective for interim and annual periods beginning after September 15, 2012 with early adoption permitted. The Company will adopt the updated guidance in the fourth quarter of fiscal year 2012. The adoption of the guidance is not expected to have a material impact on the Company's consolidated financial statements.

7



3. Business Acquisitions
In September 2012, the Company acquired FastSoft, Inc. ("FastSoft"). In February and March 2012, the Company acquired Blaze Software, Inc. ("Blaze") and Cotendo, Inc. ("Cotendo"), respectively. 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 of FastSoft, Blaze and Cotendo was $5.1 million for the nine months ended September 30, 2012. These costs were included in general and administrative costs in the consolidated statements of operations.
The acquisitions of FastSoft, Blaze and Cotendo 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).
FastSoft
On September 13, 2012, the Company acquired all of the outstanding common and preferred stock of FastSoft in exchange for $14.4 million in cash. Akamai acquired FastSoft with a goal of complementing Akamai's cloud infrastructure solutions with technology for optimizing the throughput of video and other digital content across IP networks. The Company allocated $12.2 million of the cost of the acquisition to goodwill and $3.7 million to other intangible assets. The allocation of the purchase price is preliminary. 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 $2.9 million.
Blaze
On February 7, 2012, the Company acquired all of the outstanding common and preferred stock, including vested and unvested stock options, of Blaze in exchange for $19.3 million in cash and assumption of unvested options. Akamai acquired Blaze with a goal of complementing Akamai'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 other intangible assets. The allocation of the purchase price is preliminary. 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.
Cotendo
On March 6, 2012, the Company acquired all of the outstanding common and preferred stock, including vested and unvested stock options, of Cotendo in exchange for $278.9 million in cash and assumption of unvested options. Akamai acquired Cotendo with the intention of increasing Akamai’s pace of innovation in the areas of cloud and mobile optimization.
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 Akamai 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.

8



The following table presents the preliminary allocation of the purchase price for Cotendo (in thousands):
 
 
Total purchase consideration
$
278,877

Allocation of the purchase consideration
 
         Current assets, including cash and cash equivalents of $6,405
$
6,751

         Trade receivables
2,920

         Property and equipment
5,812

         Indemnification assets
6,200

         Long-term assets
75

         Identifiable intangible assets
43,800

         Goodwill
241,386

         Deferred tax liabilities
(22,934
)
         Other liabilities assumed
(5,133
)
 
$
278,877

The following were the identified intangible assets acquired and the respective estimated periods over which such assets will be amortized (in thousands except for years):
 
Gross
Carrying
Amount
 
Weighted Average Useful Life
Completed technology
$
24,100

 
6

Customer relationships
13,400

 
9

Non-compete agreements
3,900

 
6

Trademarks and trade names
2,400

 
10

Total
$
43,800

 


In determining the purchase price allocation, the Company considered, among other factors, its intention to use the acquired assets and the historical and estimated future demand for Cotendo services. The fair value of intangible assets was based upon the income approach. In applying this approach, the values of the intangible assets acquired were determined using projections of revenues and expenses specifically attributed to the intangible assets. The income streams were then discounted to present value using estimated risk-adjusted discount rates. The rate used to discount the expected future net cash flows from the intangible assets to their present values was based upon a weighted average cost of capital of 15%. The discount rate was determined after consideration of market rates of return on debt and equity capital, the weighted average return on invested capital and the risk associated with achieving forecasted sales related to the technology and assets acquired from Cotendo.
The relief-from-royalty method was used to value the completed technologies acquired from Cotendo. The relief-from-royalty method estimates the cost savings that accrue to the owner of an intangible asset that would otherwise be required to pay royalties or license fees on revenues earned through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Typically, revenue is projected over the expected remaining useful life of the completed technology. The market-derived royalty rate is then applied to estimate the royalty savings. The key assumptions used in valuing the completed technologies are as follows: royalty rate of 15%, discount rate of 16%, tax rate of 39% and estimated average economic life of six years.
The customer relationships were valued using the excess earnings method of income approach. The key assumptions used in valuing the customer relationships were as follows: discount rate of 16%, tax rate of 39% and estimated average economic life of nine years.
The lost-profits method was used to value the non-compete agreements Akamai entered into with certain members of Cotendo's management team. The lost-profits method recognizes that the current value of an asset may be premised

9


upon the expected receipt of future economic benefits protected by clauses within an agreement. These benefits are generally considered to be higher income resulting from the avoidance of a loss in revenue that would likely occur without an agreement. The key assumptions used in valuing the non-compete agreements were as follows: discount rate of 16%, tax rate of 39% and estimated average economic life of six years.
The relief-from-royalty method was used to value trade names. The relief-from-royalty method recognizes that the current value of an asset may be premised upon the expected receipt of future economic benefits from the use of trade names. These benefits are generally considered to be higher income resulting from the avoidance of a loss in revenue that would likely occur without the specific trade names. The key assumptions used in valuing trade names were as follows: royalty rate of 1%, discount rate of 16%, tax rate of 39% and estimated average economic life of ten years.
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 $55.8 million.
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.

10



The following is a summary of marketable securities held at September 30, 2012 and December 31, 2011 (in thousands):
 
 
 
Gross Unrealized
 
 
 
Classification on Balance Sheet
As of September 30, 2012
Cost
 
Gains
 
Losses
 
Aggregate
Fair Value
 
Short-term
Marketable
Securities
 
Long-term
Marketable
Securities
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
98

 
$

 
$

 
$
98

 
$
54

 
$
44

Commercial paper
9,975

 
2

 

 
9,977

 
9,977

 

Corporate debt securities
682,983

 
1,769

 
(167
)
 
684,585

 
272,548

 
412,037

U.S. government agency obligations
180,883

 
143

 
(2
)
 
181,024

 

 
181,024

 
$
873,939

 
$
1,914

 
$
(169
)
 
$
875,684

 
$
282,579

 
$
593,105

 
 
 
Gross Unrealized
 
 
 
Classification on Balance Sheet
As of December 31, 2011
Cost
 
Gains
 
Losses
 
Aggregate
Fair Value
 
Short-term
Marketable
Securities
 
Long-term
Marketable
Securities
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
Certificates of deposit
$
42

 
$

 
$

 
$
42

 
$

 
$
42

Corporate debt securities
524,515

 
873

 
(580
)
 
524,808

 
285,012

 
239,796

U.S. government agency obligations
145,995

 
78

 
(165
)
 
145,908

 
5,017

 
140,891

 
$
670,552

 
$
951

 
$
(745
)
 
$
670,758

 
$
290,029

 
$
380,729


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 are reflected in the income statement as gain (loss) on investments, net. As of September 30, 2012, the Company did not hold any investment-related assets that have been in a continuous loss position for more than 12 months.

11



The following tables detail the fair value measurements within the fair value hierarchy of the Company’s financial assets, including investments and cash equivalents, at September 30, 2012 and December 31, 2011 (in thousands):
 
 
 
Fair Value Measurements at Reporting
 
Total Fair Value at
 
Date Using
 
September 30, 2012
 
Level 1    
 
Level 2    
 
Level 3    
Money market funds
$
5,685

 
$
5,685

 
$

 
$

Certificates of deposit
4,577

 
4,577

 

 

Commercial paper
9,977

 

 
9,977

 

Corporate debt securities
684,585

 

 
684,585

 

U.S. government agency obligations
181,024

 

 
181,024

 

 
$
885,848

 
$
10,262

 
$
875,586

 
$

 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at Reporting
 
Total Fair Value at
 
Date Using
 
December 31, 2011
 
Level 1
 
Level 2
 
Level 3
Money market funds
$
302,507

 
$
302,507

 
$

 
$

Certificates of deposit
42

 
42

 

 

Commercial paper
57,498

 

 
57,498

 

Corporate debt securities
524,808

 

 
524,808

 

U.S. government agency obligations
145,908

 

 
145,908

 

 
$
1,030,763

 
$
302,549

 
$
728,214

 
$

As of September 30, 2012 and December 31, 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, 2012 and December 31, 2011, the Company had grouped commercial paper, U.S. government agency obligations and 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, 2012 and December 31, 2011, the Company had no assets grouped using a Level 3 valuation.
Contractual maturities of the Company’s marketable securities held at September 30, 2012 and December 31, 2011 were as follows (in thousands): 
 
September 30,
2012
 
December 31,
2011
Available-for-sale securities:
 
 
 
Due in 1 year or less
$
282,579

 
$
290,029

Due after 1 year through 5 years
593,105

 
380,729

 
$
875,684

 
$
670,758

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

12


 
September 30,
2012
 
December 31,
2011
Trade accounts receivable
$
170,963

 
$
142,166

Unbilled accounts
71,047

 
73,325

Gross accounts receivable
242,010

 
215,491

Allowance for doubtful accounts
(1,791
)
 
(1,627
)
Reserve for cash-basis customers
(3,987
)
 
(2,928
)
Total accounts receivable reserves
(5,778
)
 
(4,555
)
Accounts receivable, net
$
236,232

 
$
210,936

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,
2012
 
December 31,
2011
Payroll and other related benefits
$
58,158

 
$
39,920

Bandwidth and co-location
31,535

 
29,291

Property, use and other taxes
35,573

 
9,923

Professional service fees
4,238

 
4,162

Other
2,112

 
2,075

Total
$
131,616

 
$
85,371

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 common share (in thousands, except per share data):
 

13


 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
Numerator:
 
 
 
 
 
 
 
Net income
$
48,231

 
$
42,285

 
$
135,697

 
$
140,823

Denominator:

 

 
 
 
 
Shares used for basic net income per common share
177,455

 
183,085

 
178,040

 
185,515

Effect of dilutive securities:

 

 
 
 
 
Stock options
2,101

 
1,928

 
2,207

 
2,698

RSUs and deferred stock units
1,497

 
691

 
1,491

 
876

Shares used for diluted net income per common share
181,053

 
185,704

 
181,738

 
189,089

Basic net income per common share
$
0.27

 
$
0.23

 
$
0.76

 
$
0.76

Diluted net income per common share
$
0.27

 
$
0.23

 
$
0.75

 
$
0.74

For the three and nine months ended September 30, 2012 and 2011 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 potentially outstanding shares excluded from the computation of diluted earnings per share is as follows (in thousands):
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
Options
2,438

 
4,508

 
2,735

 
3,265

Service-based RSUs
1,321

 
1,481

 
1,401

 
787

Performance-based RSUs
1,518

 
2,836

 
1,536

 
2,973

Total shares excluded from computation
5,277

 
8,825

 
5,672

 
7,025

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 28, 2010, the Company announced that its Board of Directors had authorized a $150.0 million stock repurchase program of the Company’s common stock from time to time, over the twelve months commencing in May 2010, on the open market or in privately negotiated transactions. On April 19, 2011, the Company’s Board of Directors authorized an extension of the stock repurchase program authorizing up to an additional $150.0 million of repurchases over the twelve months commencing in May 2011. The unused balance from the May 2010 repurchase program was not carried forward for future purchases. On August 8, 2011, the Company's Board of Directors authorized an additional $250.0 million of stock repurchases over the twelve-month period that commenced in May 2011. As a result, the total authorized funding for stock repurchases during that twelve-month period increased to $400.0 million. On April 25, 2012, the Company announced that its Board of Directors had authorized an extension of its share repurchase program. Under this extension, the Company may purchase up to $150.0 million of its common stock during the twelve-month period beginning in May 2012. The unused balance from the May and August 2011 extensions was not carried forward

14


for future purchases. 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, 2012, the Company repurchased 1.2 million and 3.6 million shares, respectively, of its common stock for $36.5 million and $111.6 million, respectively. During the three and nine months ended September 30, 2011, the Company repurchased 6.8 million and 9.4 million shares of its common stock, respectively, for $155.1 million and $248.4 million, respectively. As of September 30, 2012, the Company had $68.4 million remaining available for future purchases of shares under the current repurchase program.

15



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, 2012 and 2011 (in thousands):
 
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
Stock-based compensation by type of award:
 
 
 
 
 
 
 
Stock options
$
3,579

 
$
3,312

 
$
11,045

 
$
10,518

Deferred stock units

 

 
1,885

 
1,885

RSUs
20,159

 
12,628

 
58,621

 
31,276

Shares issued under the Employee Stock Purchase Plan
1,458

 
1,142

 
4,323

 
4,192

Amounts capitalized as internal-use software
(2,561
)
 
(1,941
)
 
(6,694
)
 
(5,406
)
Total stock-based compensation before income taxes
22,635

 
15,141

 
69,180

 
42,465

Less: Income tax benefit
(9,242
)
 
(5,746
)
 
(27,114
)
 
(15,119
)
Total stock-based compensation, net of taxes
$
13,393

 
$
9,395

 
$
42,066

 
$
27,346

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

 
 
 
 
 
 
Cost of revenues
$
684

 
$
634

 
$
2,251

 
$
1,779

Research and development expense
4,427

 
2,629

 
13,258

 
7,515

Sales and marketing expense
10,896

 
6,951

 
32,024

 
19,112

General and administrative expense
6,628

 
4,927

 
21,647

 
14,059

Provision for income taxes
(9,242
)
 
(5,746
)
 
(27,114
)
 
(15,119
)
Total cost related to stock-based compensation, net of taxes
$
13,393

 
$
9,395

 
$
42,066

 
$
27,346

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, 2012 include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $2.0 million and $5.7 million, respectively, before taxes. The Company's consolidated statements of operations for the three and nine months ended September 30, 2011 also include stock-based compensation reflected as a component of amortization of capitalized internal-use software of $1.6 million and $5.6 million, respectively, before taxes.
9. Accumulated Other Comprehensive Income (Loss)
Accumulated other comprehensive income (loss) is reported as a component of stockholders' equity and consisted of the following (in thousands):
 
September 30, 2012
 
December 31, 2011

Foreign currency translation adjustments
$
(710
)
 
$
(1,450
)
Net unrealized gain on investments, net of taxes of $(552) at September 30, 2012 and $(14) at December 31, 2011
1,193

 
191

Total accumulated other comprehensive income (loss)
$
483

 
$
(1,259
)
10. Goodwill and Other Intangible Assets
The Company has recorded goodwill and other 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 other intangible assets of $5.1

16


million as a result of the acquisition of Blaze. In March 2012, the Company recorded goodwill of $241.4 million and acquired other intangible assets of $43.8 million as a result of the acquisition of Cotendo. In September 2012, the Company recorded goodwill of $12.2 million and acquired other intangible assets of $3.7 million as a result of the acquisition of FastSoft. (See Note 3). In accordance with current accounting standards, goodwill will not be amortized as it does not qualify as an amortizable intangible asset. The Company will test goodwill for impairment at least annually as required by the accounting guidance for goodwill and other intangible assets.
The changes in the carrying amount of goodwill for the three and nine months ended September 30, 2012 were as follows (in thousands):
 
 
Balance as of December 31, 2011
$
452,914

       Purchase price allocation associated with Blaze acquisition
15,068

       Purchase price allocation associated with Cotendo acquisition
241,646

Balance as of March 31, 2012
709,628

       Purchase price adjustment associated with Cotendo acquisition
40

Balance as of June 30, 2012
709,668

       Purchase price allocation associated with FastSoft acquisition
12,233

       Purchase price adjustment associated with Cotendo acquisition
(300
)
Balance as of September 30, 2012
$
721,601

Other intangible assets that are subject to amortization consist of the following (in thousands except for years):
 
September 30, 2012
 
 
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Weighted Average Amortization period in years
Completed technology
$
66,931

 
$
(30,229
)
 
$
36,702

 
6
Customer relationships
102,100

 
(66,657
)
 
35,443

 
9
Non-compete agreements
14,440

 
(6,999
)
 
7,441

 
5
Trademarks and trade names
3,700

 
(911
)
 
2,789

 
9
Acquired license rights
490

 
(490
)
 

 
10
Total
$
187,661

 
$
(105,286
)
 
$
82,375

 
 
 
December 31, 2011
 
 
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Weighted Average Amortization period in years
Completed technology
$
36,731

 
$
(22,913
)
 
$
13,818

 
6
Customer relationships
88,700

 
(60,202
)
 
28,498

 
9
Non-compete agreements
8,340

 
(5,270
)
 
3,070

 
4
Trademarks and trade names
800

 
(800
)
 

 
4
Acquired license rights
490

 
(490
)
 

 
10
Total
$
135,061

 
$
(89,675
)
 
$
45,386

 
 
Aggregate expense related to amortization of other intangible assets for the three months ended September 30, 2012 and 2011 was $5.4 million and $4.2 million, respectively. For the nine months ended September 30, 2012 and 2011, aggregate expense related to the amortization of other intangible assets was $15.6 million and $12.8 million, respectively. Based on the Company’s other intangible assets as of September 30, 2012, aggregate expense related to amortization of other intangible assets is expected to be $5.4 million for the remainder of 2012, and $23.6 million, $18.2 million, $14.5 million and $10.1 million for 2013, 2014, 2015 and 2016, respectively.

17


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 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 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 September 30, 2012 and December 31, 2011, one customer accounted for 10% of the Company's accounts receivable. The Company believes that, at September 30, 2012, 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 its Chief Executive Officer and executive management team. As of September 30, 2012, 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, 2012, the Company had $235.7 million and $95.5 million of property and equipment, net of accumulated depreciation, located in the United States and in foreign locations, respectively. As of December 31, 2011, the Company had $194.0 million and $99.0 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,
 
2012
 
2011
 
2012
 
2011
Revenues derived from outside of the United States
29
%
 
29
%
 
28
%
 
29
%
Revenues derived from Europe
16
%
 
18
%
 
17
%
 
18
%
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, 2012 and 2011, no customer accounted for 10% or more of total revenues.
13. Income Taxes
The Company’s effective income tax rate, including discrete items, was 39.4% and 35.7% for the nine months ended September 30, 2012 and 2011, 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 include the tax effect of certain stock options, interest and penalties related to uncertain tax positions, and return to provision adjustments. For each of the nine months ended September 30, 2012 and September 30, 2011, the effective income tax rate was higher than the federal statutory tax rate mainly due to the effect of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments and state income tax expense.

18


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 income (loss), a separate component of stockholders’ equity. Gains and losses on inter-company and other non-functional currency transactions are recorded in other (expense) income, net. For the three and nine months ended September 30, 2012, the Company recorded net foreign currency losses of $0.3 million and net foreign currency gains of $0.2 million, respectively, in the consolidated statement of operations. For the three and nine months ended September 30, 2011, the Company recorded net foreign currency losses of $0.2 million and $1.3 million, respectively, in the consolidated statement of operations.

Since 2011, 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 (expense) income, net. As of September 30, 2012 and 2011, the fair value of the forward currency contracts and the underlying net loss for the three and nine months ended September 30, 2012 and 2011 were deemed to be 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 September 30, 2012 were as follows (in thousands):
 
 
Operating
Leases
Remaining 2012
$
7,746

2013
28,659

2014
25,436

2015
22,825

2016
14,813

Thereafter
40,034

Total
$
139,513

Purchase Commitments
The Company has long-term commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2012 and for the years ending December 31, 2013, 2014, 2015 and 2016, the minimum commitments pursuant to these contracts in effect as of September 30, 2012 were approximately $38.6 million, $57.3 million, $4.4 million, $0.3 million and $0.1 million, respectively. In addition, as of September 30, 2012, the Company had entered into purchase orders with various vendors for aggregate purchase commitments of $62.5 million, most of which are expected to be paid over the next twelve months.
Litigation
The Company is party to various litigation matters that management considers routine and incidental to its

19


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 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 September 30, 2012 was determined to be immaterial.
16. Restructuring
In December 2011, the Company implemented a workforce reduction of approximately 70 employees from all areas of the Company. The Company recorded $4.2 million as a restructuring charge 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 of $0.4 million reflecting a modification of certain stock-based awards previously granted to the affected employees. Additionally, during 2011, in connection with excess and vacated facilities under long-term non-cancelable leases, the Company recorded $0.7 million as a restructuring charge for the estimated future lease payments, less estimated sublease income, for these vacated facilities.
The following table summarizes the accrual and usage of the restructuring charges (in thousands):

 
Leases
 
Severance
 
Total
Ending Balance, December 31, 2011
$
593

 
$
3,311

 
$
3,904

        Restructuring charge

 
60

 
60

        Cash payments
(28
)
 
(2,116
)
 
(2,144
)
Ending Balance, March 31, 2012
565

 
1,255

 
1,820

        Restructuring charge

 
(46
)
 
(46
)
        Cash payments
(28
)
 
(697
)
 
(725
)
Ending Balance, June 30, 2012
537

 
512

 
1,049

        Cash payments
(28
)
 

 
(28
)
Ending Balance, September 30, 2012
$
509

 
$
512

 
$
1,021

Current portion of accrued restructuring
$
116

 
$
512

 
$
628

Long-term portion of accrued restructuring
$
393

 
$

 
$
393


20



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. 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 an increasing number of 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:
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
Revenues
100.0
 %
 
100.0
 %
 
100.0
%
 
100.0
 %
Cost of revenues
31.8

 
33.1

 
32.1

 
32.6

Research and development expense
5.6

 
4.8

 
5.4

 
4.4

Sales and marketing expense
22.0

 
19.3

 
22.0

 
19.3

General and administrative expense
15.8

 
18.0

 
16.9

 
16.9

Amortization of other intangible assets
1.6

 
1.5

 
1.6

 
1.5

Restructuring charge


0.1

 



Total costs and operating expenses
76.8

 
76.8

 
78.0

 
74.7

Income from operations
23.2

 
23.2

 
22.0

 
25.3

Interest income
0.5

 
1.0

 
0.5

 
1.0

Other (expense) income, net
(0.1
)
 
(0.1
)
 

 
(0.2
)
Gain on investments, net

 
0.1

 

 
0.1

Income before provision for income taxes
23.6

 
24.2

 
22.5

 
26.2

Provision for income taxes
9.6

 
9.2

 
8.9

 
9.4

Net income
14.0
 %
 
15.0
 %
 
13.6
%
 
16.8
 %

21


We were profitable in 2011 and for the three and nine months ended September 30, 2012; 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, results of operations or cash flows in the foreseeable future:
Revenues and Customers
During each of the first three quarters of 2012, 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 are also impacted favorably by amounts we are paid for items such as traffic usage in excess of committed amounts and one-time events but negatively impacted by price declines.
Our unit prices offered to some customers have declined as a result of increased competition. 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 and are unable to offset such reductions with increased traffic, enhanced efficiencies in our network, lower co-location and bandwidth expenses, or increased sales of incremental services to existing customers, our revenues and profit margins would decrease.
During each of the first three quarters of 2012, we experienced an increase in the rate of traffic growth in our video and software download solutions as compared to the fourth quarter of 2011. If this trend does not continue, our ability to generate revenue growth could be adversely impacted.
Although our revenues in the second and third quarters of 2012 were higher than our revenues in the fourth quarter of 2011, we have historically experienced seasonal variations of higher revenues in the fourth quarter of the year and lower revenues during the summer months. We primarily attribute such variations to patterns of usage of e-commerce services by our retail customers. If this trend continues, our ability to generate quarterly revenue growth on a sequential basis could be impacted.
For the nine months ended September 30, 2012, revenues derived from customers outside the United States accounted for 28% of our total revenues. For the remainder of 2012, we anticipate revenues from such customers as a percentage of our total revenues to be consistent with the first nine months of 2012.
Costs and Expenses
During the first three quarters of 2012, 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. Our total bandwidth costs increased during the first three quarters of 2012 as compared to the first three quarters of 2011 due to traffic growth on our network. 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 for the remainder of 2012.
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. If we are unable to achieve such cost reductions, our profitability will be negatively impacted.
Depreciation and amortization expense related to our network equipment and internal-use software development costs increased by $20.1 million during the first three quarters of 2012 as compared to the first three quarters of 2011. Due to expected future purchases of network equipment during 2012, we believe that depreciation expense related to our network equipment will continue to increase during the remainder of 2012. We also 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 2012 as compared to 2011. All of these increased costs could negatively affect our profitability.
We expect to continue to grant restricted stock units, or RSUs, to employees in the future; therefore, we anticipate that stock-based compensation expense will increase compared to 2011 levels. As of September 30,

22


2012, our total unrecognized compensation costs for stock-based awards were $141.0 million, which we expect to recognize as expense over a weighted average period of 1.3 years. We expect to recognize this expense through 2016.
During the nine months ended September 30, 2012, our effective income tax rate was 39.4%. We expect our annual effective income tax rate in 2012 to remain relatively consistent in the remaining quarter of 2012; this expectation does not take into consideration the effect of discrete items 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.
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 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:
innovate and respond to emerging technological trends and customers' changing needs;
manage expected growth and other changes to our business;
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 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 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, 2011 for further discussion of our critical accounting policies and estimates.
Recent Accounting Pronouncements
In May 2011, the Financial Accounting Standards Board, or 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. We adopted this guidance during the first quarter of 2012. The adoption of the guidance did not 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. We adopted this guidance during the first quarter of 2012. There was 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 simplifies how entities test goodwill for impairment. Under the amended guidance, after assessment of certain qualitative factors, if an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative tests are optional. We adopted this guidance during

23


the first quarter of 2012. The adoption of the guidance did not have a material impact on our financial condition or results of operations.
In July 2012, the FASB issued amended guidance on the periodic testing of indefinite-lived intangible assets for impairment. This guidance will allow entities to assess qualitative factors to determine if it is more likely than not that the indefinite-lived intangible asset might be impaired and whether it is necessary to perform the quantitative impairment test required under current accounting standards. The updated accounting guidance is effective for interim and annual periods beginning after September 15, 2012 with early adoption permitted. We will adopt the updated guidance in the fourth quarter of fiscal year 2012. The adoption of the guidance is not expected to have a material impact on our consolidated financial statements.
Results of Operations
Revenues. Total revenues increased 23%, or $63.5 million, to $345.3 million for the three months ended September 30, 2012 as compared to $281.9 million for the three months ended September 30, 2011. Total revenues increased 19%, or $161.3 million, to $996.1 million for the nine months ended September 30, 2012 as compared to $834.8 million for the nine months ended September 30, 2011. 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, 2012
as compared to 2011
 
For the
Nine Months Ended
September 30, 2012
as compared to 2011
Media & Entertainment
$
31.0

 
$
70.0

Commerce
12.6

 
37.5

Enterprise
8.4

 
21.5

High Tech
8.4

 
24.3

Public Sector
3.1

 
8.0

Total net increase
$
63.5

 
$
161.3

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 sold to customers in these verticals. Revenues from our high tech vertical grew due to increased demand for cloud performance solutions and higher software download volumes. Our revenues from the public sector vertical for the three and nine months ended September 30, 2012 as compared to the same periods in 2011 grew due to the timing of completion of certain elements of government agency contracts.
For the three and nine months ended September 30, 2012, approximately 29% and 28%, respectively, of our revenues were derived from our operations located outside of the United States, including 16% and 17%, respectively, derived from Europe. For each of the three- and nine-month periods ended September 30, 2011, approximately 29% and 29%, respectively, of our revenues were derived from operations outside of the United States, including 18% derived from Europe in each of these periods. No single country outside of the United States accounted for 10% or more of revenues during any of these periods. For each of the three- and nine-month periods ended September 30, 2012, resellers accounted for 22% and 21%, respectively, of revenues as compared to 19% of revenues for each of the three- and nine-month periods ended September 30, 2011. For each of the three- and nine-month periods ended September 30, 2012 and 2011, no single 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: 

24


 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012
 
2011
Bandwidth and service-related fees
$
28.4

 
$
21.8

 
$
84.4

 
$
63.5

Co-location fees
32.9

 
33.7

 
99.7

 
96.3

Payroll and related costs of network operations personnel
5.1

 
3.9

 
14.5

 
11.3

Stock-based compensation, including amortization of prior capitalized amounts
2.6

 
2.2

 
7.8

 
7.3

Depreciation and impairment of network equipment
30.8

 
24.8

 
86.3

 
71.2

Amortization of internal-use software
10.2

 
6.9

 
27.3

 
22.4

Total cost of revenues
$
110.0

 
$
93.3

 
$
320.0

 
$
272.0

Cost of revenues increased 18%, or $16.7 million, to $110.0 million for the three months ended September 30, 2012 as compared to $93.3 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, cost of revenues increased 18%, or $48.0 million, to $320.0 million as compared to $272.0 million for the nine months ended September 30, 2011.
For each period, this increase was primarily due to:

an increase in amounts paid to network providers for bandwidth due to higher traffic levels, partially offset by reduced bandwidth costs per unit; and
an increase in depreciation expense of network equipment as we continued to invest in our infrastructure.
We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2012 and for the years ending December 31, 2013, 2014, 2015 and 2016, our minimum commitments related to bandwidth usage and co-location services as of September 30, 2012 were approximately $38.6 million, $57.3 million, $4.4 million, $0.3 million and $0.1 million, respectively.
We believe that cost of revenues will increase during the fourth quarter of 2012 as compared to each of the first three quarters of 2012. We expect to deploy more servers and deliver more traffic on our network, which would result in higher expenses associated with the increased traffic; however, such costs are likely to be partially offset by lower bandwidth costs per unit. Additionally, for the fourth quarter of 2012, 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 expenses increased 43%, or $5.8 million, to $19.4 million for the three months ended September 30, 2012 as compared to $13.5 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, research and development expenses increased 46%, or $17.2 million, to $54.4 million as compared to $37.1 million for the nine months ended September 30, 2011. The increases during the three and nine months ended September 30, 2012 as compared to the same periods in 2011 were due to increases in payroll and related costs and stock-based compensation, 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. During the three and nine months ended September 30, 2012, we capitalized software development costs of $12.5 million and $37.4 million, respectively. During the three and nine months ended September 30, 2011, we capitalized software development costs of $8.8 million and $28.1 million, respectively. 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, 2012, we capitalized $2.5 million and $6.4 million, respectively, of stock-based compensation as compared to $1.8 million and $5.2 million, respectively, for the three and nine months

25


ended September 30, 2011. These capitalized internal-use software costs are amortized to cost of revenues over their estimated useful lives of two years.
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, 2012
as compared to 2011
 
For the
Nine Months Ended
September 30, 2012
as compared to 2011
Payroll and related costs
$
6.9

 
$
18.9

Stock-based compensation
1.8

 
5.7

Capitalized salaries and related costs
(3.0
)
 
(8.5
)
Other expenses
0.1

 
1.1

Total net increase
$
5.8

 
$
17.2

We believe that research and development expenses, in absolute dollar terms, will increase during the fourth quarter of 2012 as compared to each of the first three quarters of 2012 because we expect to continue to hire additional development personnel in order to make improvements to 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 increased 39%, or $21.4 million, to $75.9 million for the three months ended September 30, 2012 as compared to $54.5 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, sales and marketing expenses increased 36%, or $58.4 million, to $219.1 million as compared to $160.7 million for the nine months ended September 30, 2011. The increase in sales and marketing expenses during the three and nine months ended September 30, 2012 as compared to the same periods in 2011 was primarily due to higher payroll and related costs, increases in stock-based compensation and marketing and related costs.
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, 2012
as compared to 2011
 
For the
Nine Months Ended
September 30, 2012
as compared to 2011
Payroll and related costs
$
15.6

 
$
34.8

Stock-based compensation
3.9

 
12.9

Marketing and related costs
1.9

 
8.1

Other expenses

 
2.6

Total net increase
$
21.4

 
$
58.4

We believe that sales and marketing expenses will increase, in absolute dollar terms, during the fourth quarter of 2012 as compared to the first three quarters of 2012 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;

26


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 7%, or $3.7 million, to $54.5 million for the three months ended September 30, 2012 as compared to $50.8 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, general and administrative expenses increased 20%, or $27.5 million, to $168.2 million as compared to $140.7 million for the nine months ended September 30, 2011. The increase in general and administrative expenses for the three and nine months ended September 30, 2012 as compared to the same periods in 2011 was primarily due to costs associated with the acquisitions of Cotendo, Inc., or Cotendo, Blaze Software, Inc., or Blaze, and FastSoft, Inc., or FastSoft, as well as higher payroll and related costs due to headcount growth and increased stock-based compensation. These increases were partially offset by reductions in legal fees.
The following table quantifies the changes in various components of our general and administrative expenses for the periods presented (in millions):
 
 
For the
Three Months Ended
September 30, 2012
as compared to 2011
 
For the
Nine Months Ended
September 30, 2012
as compared to 2011
Payroll and related costs
$
3.5

 
$
12.1

Stock-based compensation
1.7

 
7.6

Depreciation and amortization
0.7

 
2.0

Legal fees
(1.6
)
 
(4.4
)
Non-income taxes
0.1

 
1.0

Acquisition related costs
0.3

 
5.5

Other expenses
(1.0
)
 
3.7

Total net increase
$
3.7

 
$
27.5

During the fourth quarter of 2012, we expect general and administrative expenses to increase in absolute dollars as compared to the first three quarters of 2012 due to anticipated higher payroll and related costs attributable to increased hiring.
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 29%, or $1.2 million, to $5.4 million for the three months ended September 30, 2012 as compared to $4.2 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, amortization of other intangible assets increased 22%, or $2.9 million, to $15.6 million as compared to $12.8 million for the nine months ended September 30, 2011. The increase in amortization of other intangible assets for the three and nine months ended September 30, 2012 as compared to the same periods in 2011 was primarily due to the amortization of assets related to the acquisitions of Blaze and Cotendo. Based on our intangible assets at September 30, 2012, we expect amortization of other intangible assets to be approximately $5.4 million for the remainder of 2012, and $23.6 million, $18.2 million, $14.5 million and $10.1 million for 2013, 2014, 2015 and 2016, respectively.
Interest Income. Interest income includes interest earned on invested cash balances and marketable securities. Interest income decreased 42%, or $1.1 million, to $1.6 million for the three months ended September 30, 2012 as compared to $2.7 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, interest income decreased 44%, or $3.9 million, to $4.8 million as compared to $8.7 million for the nine months ended September 30, 2011. The decreases were due to lower yields earned on our investments as well as a decline in cash and investment balances during the comparable periods.
Other (Expense) Income, net. Other (expense) income, net primarily represents net foreign exchange gains and losses incurred, gains from legal settlements, and other non-operating (expense) income items. For each of the three

27


months ended September 30, 2012 and 2011, other expense, net was $0.2 million. For the nine months ended September 30, 2012, other (expense) income, net was $0.4 million of other income, net as compared to $1.3 million of other expense, net for the nine months ended September 30, 2011. The increase in other income, net for the nine months ended September 30, 2012 as compared to the same period in 2011 was primarily due to foreign exchange rate fluctuations on inter-company and other non functional currency transactions. Other (expense) income, 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, 2012 and 2011, our effective income tax rate, including discrete items, was 39.4% and 35.7%, respectively. For each of the nine months ended September 30, 2012 and 2011, the effective income tax rate was higher than the federal statutory tax rate mainly due to the effect 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 29%, or $7.4 million, to $33.3 million for the three months ended September 30, 2012 as compared to $25.9 million for the three months ended September 30, 2011. Provision for income taxes increased 13%, or $10.1 million, to $88.4 million for the nine months ended September 30, 2012 as compared to $78.2 million for the nine months ended September 30, 2011. The increase in the three and nine months ended September 30, 2012 as compared to the same periods in 2011 was mainly due to the increase in estimated non-deductible equity compensation for 2012, a change in the composition of projected income in different jurisdictions, and the expiration of the federal research and development tax credit in 2011.
While we expect our effective income tax rate to remain consistent during the remaining quarter of 2012, this expectation does not take into consideration the effect of discrete items that may 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 determining our net deferred tax assets and valuation allowances, annualized effective tax rates, and cash paid for income taxes, management is required to make judgments and estimates about domestic and foreign profitability, the timing and extent of the utilization of net operating loss carryforwards, applicable tax rates, transfer pricing methodologies and tax planning strategies. Judgments and estimates related to our projections and assumptions are inherently uncertain; therefore, actual results could differ materially from our projections.

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

28


addition to, and in conjunction with, results presented in accordance with GAAP.
We consider normalized net income and normalized net income per diluted 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-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 and loss on early extinguishment of debt.
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,
 
2012
 
2011
 
2012
 
2011
 
(in thousands, except per share data)
Net income
$
48,231

 
$
42,285

 
$
135,697

 
$
140,823

Amortization of other intangible assets
5,381

 
4,185

 
15,611

 
12,754

Stock-based compensation
22,635

 
15,141

 
69,180

 
42,465

Amortization of capitalized stock-based compensation
2,025

 
1,592

 
5,719

 
5,595

Acquisition-related costs (benefits)
279

 

 
5,107

 
(440
)
Restructuring (benefit) charge

 
158

 
14

 
158

Total normalized net income
$
78,551

 
$
63,361

 
$
231,328

 
$
201,355

Normalized net income per diluted share
$
0.43

 
$
0.34

 
$
1.27

 
$
1.06

Shares used in per share calculations
181,053

 
185,704

 
181,738

 
189,089

We consider Adjusted EBITDA to be another important indicator of the operational strength and 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


 
Unaudited
 
For the Three Months
Ended September 30,
 
For the Nine Months
Ended September 30,
 
2012
 
2011
 
2012

2011
 
(in thousands)
Net income
$
48,231

 
$
42,285

 
$
135,697

 
$
140,823

Amortization of other intangible assets
5,381

 
4,185

 
15,611

 
12,754

Stock-based compensation
22,635

 
15,141

 
69,180

 
42,465

Amortization of capitalized stock-based compensation
2,025

 
1,592

 
5,719

 
5,595

Acquisition-related costs (benefits)
279

 

 
5,107

 
(440
)
Restructuring (benefit) charge

 
158

 
14

 
158

Interest income, net
(1,593
)
 
(3,002
)
 
(4,865
)
 
(9,058
)
Provision for income taxes
33,280

 
25,862

 
88,366

 
78,218

Depreciation and amortization
46,051

 
35,984

 
127,873

 
105,879

Other expense (income), net
241

 
188

 
(449
)
 
1,330

Adjusted EBITDA
$
156,530

 
$
122,393


$
442,253

 
$
377,724

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, 2012, our cash, cash equivalents and marketable securities, which consisted of corporate debt securities, U.S. Treasury and government agency securities and commercial paper totaled $1.1 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.
Net cash provided by operating activities was $383.6 million for the nine months ended September 30, 2012, compared to $316.6 million for the nine months ended September 30, 2011. The increase in cash provided by operating activities for the nine months ended September 30, 2012 as compared to the same period in 2011 was primarily due to an increase in cash provided by working capital, partially offset by a decrease in net income and an increase in excess tax benefits of stock-based compensation. We expect that cash provided by operating activities will increase in the fourth quarter of 2012 due to 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 commissions.
Net cash used in investing activities was $669.3 million for the nine months ended September 30, 2012, compared to $36.2 million of net cash provided by investing activities for the nine months ended September 30, 2011. Cash used in investing activities for the nine months ended September 30, 2012 reflects cash paid for the acquisitions of Blaze, Cotendo and FastSoft of $306.0 million, net of cash received, and purchases of property and equipment of $159.2 million, including $39.9 million related to the capitalization of internal-use software development costs. Cash used in investing activities for the nine months ended September 30, 2012 also reflects net purchases of short- and long-term marketable securities of $204.2 million. 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, partially offset by purchases of property and equipment of $136.3 million, including $30.5 million related to the capitalization of internal-use software development costs. For 2012, 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 $92.0 million for the nine months ended September 30, 2012, as compared to $228.7 million for the nine months ended September 30, 2011. Cash used in financing activities during the nine

30


months ended September 30, 2012 consisted of $111.6 million related to our common stock repurchase program as described more fully below, as well as $26.6 million used for taxes paid related to net share settlements of equity awards. This was partially offset by cash provided by financing activities for the nine months ended September 30, 2012 of $17.6 million related to excess tax benefits resulting from the exercise of stock options and vesting of RSUs and proceeds of $28.6 million from 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, 2011 consisted of $247.7 million related to our common stock repurchase program, as well as $5.7 million used for taxes paid related to net share settlements of equity awards. This was partially offset by cash provided by financing activities during 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 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,
 
2012
 
2011
Cash, cash equivalents and marketable securities balance as of December 31, 2011 and 2010, respectively
$
1,230.0

 
$
1,243.4

Changes in cash, cash equivalents and marketable securities:
 
 
 
Receipts from customers
1,014.8

 
855.9

Payments to vendors
(550.7
)
 
(459.8
)
Payments for employee payroll
(251.5
)
 
(223.7
)
Stock option exercises and employee stock purchase plan issuances
28.6

 
13.3

Cash used in business acquisitions, net of cash acquired
(306.0
)
 
(0.6
)
Employee taxes paid related to net share settlement of equity awards
(26.6
)

(5.7
)
Common stock repurchases
(111.6
)
 
(247.7
)
Realized and unrealized gains (losses) on marketable investments and other investment-related assets, net
1.6

 
(3.5
)
Interest income
4.8

 
8.7

Other
24.9

 
10.7

Net (decrease) increase
(171.7
)
 
(52.4
)
Cash, cash equivalents and marketable securities balance as of September 30, 2012 and 2011, respectively
$
1,058.3

 
$
1,191.0

In April 2010, our Board of Directors authorized a $150.0 million stock repurchase program. In April 2011, our Board of Directors authorized a one-year $150.0 million extension to our stock repurchase program commencing in May 2011. In August 2011, our Board of Directors authorized an additional $250.0 million of stock repurchases over the twelve-month period that commenced in May 2011. As a result, the total authorized funding for stock repurchases during this twelve-month period was $400.0 million. In April 2012, our Board of Directors authorized an additional one-year $150.0 million extension of the existing stock repurchase program. Unused amounts from the program covering the twelve-month period that began in May 2011 were not carried over to the extension. During the nine months ended September 30, 2012, we repurchased 3.6 million shares of common stock at an average price of $31.31 per share for an aggregate of $111.6 million. During the nine months ended September 30, 2011, we repurchased 9.4 million shares of common stock at an average price of $26.47 per share for an aggregate of $248.4 million. The timing and amount of any future share repurchases will be determined by our management based on its evaluation of market conditions

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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, 2012, for the next five years and thereafter (in millions): 
 
Payments Due by Period

Total
 
Less than
12 Months
 
12-36
Months
 
36-60
Months
 
More than
60 Months
Bandwidth and co-location agreements
$
100.9

 
$
89.2

 
$
11.5

 
$
0.1

 
$
0.1

Real estate operating leases
139.5

 
29.9

 
49.9

 
30.1

 
29.6

Open vendor purchase orders
62.5

 
60.0

 
2.5

 

 

Total
$
302.9

 
$
179.1

 
$
63.9

 
$
30.2

 
$
29.7

In accordance with authoritative guidance issued by the FASB, as of September 30, 2012, we had unrecognized tax benefits of $26.0 million, which included approximately $5.6 million of accrued interest and penalties. We do not expect to recognize any material tax benefits in 2012, but we are not otherwise 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, 2012, we had $6.0 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 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, 2011 for further discussion of these indemnification agreements. The fair value of guarantees issued or modified during the three and nine months ended September 30, 2012 was determined to be immaterial.
As of September 30, 2012, we did not have any additional material off-balance sheet arrangements.

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Litigation
We are party to litigation that we consider to be routine and incidental to our business. Management does not expect the results of any of these actions to have a material impact on our business, results of operations, financial condition, or cash flows.
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 fair 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 fair 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.
Foreign Currency Risk
Growth in our international operations will incrementally increase our exposure to foreign currency fluctuations as well as other risks typical of international operations that could impact our business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures and other regulations and restrictions. Foreign exchange rate fluctuations may adversely impact our consolidated results of operations as exchange rate fluctuations on transactions denominated in currencies other than our functional currencies result in gains and losses that are reflected in our consolidated statements of operations. To the extent the U.S. dollar weakens against foreign currencies, the translation of these foreign currency-denominated transactions will result in increased net revenues and operating expenses. Conversely, our net revenues and operating expenses will decrease when the U.S. dollar strengthens against foreign currencies. We do not enter into financial instruments for trading or speculative purposes.

Transaction Exposure
The Company enters 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 other income (expense), net. Foreign currency transaction gains and losses from these forward contracts were determined to be immaterial during the three and nine months ended September 30, 2012 and September 30, 2011.

Translation Exposure
Foreign exchange rate fluctuations may adversely impact our consolidated financial condition as the assets and liabilities of our foreign operations are translated into U.S. dollars in preparing our consolidated balance sheet. These gains or losses are recognized as an adjustment to stockholders' equity which is reflected in our balance sheet under accumulated other comprehensive loss.

Credit Risk
Concentrations of credit risk with respect to accounts receivable are limited to certain customers to which we make substantial sales. Our customer base consists of a large number of geographically dispersed customers diversified across numerous industries. To reduce risk, we routinely assess the financial strength of our customers. Based on such assessments, we believe that our accounts receivable credit risk exposure is limited. As of September 30, 2012 and December 31, 2011, one customer had an account receivable balance of 10% of our accounts receivable. We believe that, at September 30, 2012, concentration of credit risk related to accounts receivable was not significant.
Item 4.
Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal

33


executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2012. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2012, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


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PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
See Item 3 of Part I of our annual report on Form 10-K for the year ended December 31, 2011 for a discussion of legal proceedings. There were no material developments in such legal proceedings during the quarter ended September 30, 2012.

Item 1A.
Risk Factors
The following are important factors, among others, that could cause our actual operating results to differ materially from those indicated or suggested by forward-looking statements made in this quarterly report on Form 10-Q or presented elsewhere by management from time to time. We have not made any material changes in the risk factors previously disclosed in our annual report on Form 10-K for the year ended December 31, 2011.
We face intense competition, the consequences of which could adversely affect our business.
We compete in markets that are intensely competitive and rapidly changing. The competitive landscape is varied and presents numerous different challenges including:
Current and potential competitors may have longer operating histories, greater name recognition, broader customer relationships and substantially greater financial, technical and marketing resources than we do.
Other competitors may attract customers by offering less-sophisticated versions of services than we provide at lower prices than those we charge.
Nimbler companies may be able to respond more quickly than we can to new or emerging technologies and changes in customer requirements, resulting in superior offerings.
Some current or potential competitors may bundle their offerings with other services, software or hardware in a manner that may discourage enterprises from purchasing any service we offer.
Both existing and potential customers may decide to purchase or develop their own hardware, software and other technology solutions rather than rely on an external provider like Akamai. As a result, our competitors include hardware manufacturers, software companies and other entities that offer Internet-related solutions that are not service-based.
Ultimately, increased competition of all types could result in price and revenue reductions, lower gross margins, loss of customers and loss of market share, each of which could materially impact our business, financial condition, results of operations and cash flows.
If we are unable to continue to innovate and respond to emerging technological trends and customers’ changing needs, our operating results may suffer.
The market for our services is characterized by rapidly changing technology, evolving industry standards and new product and service introductions. Our ability to provide new and innovative solutions to address the evolving ways enterprises use the Internet is important to our future growth and profitability. If we fail to do so, our operating results will likely be significantly harmed. If other companies develop technological or business model innovations in the markets we seek to address that are, or are perceived to be, equivalent or superior to our services, then our revenue and profitability could also suffer. In addition, our customers’ business models may change in ways that we do not anticipate, and the failure to address these changes could reduce or eliminate our customers’ needs for our services. The process of developing new technologies is complex and uncertain; we must commit significant resources to developing new services or enhancements to our existing services before knowing whether our investments will result in services the market will accept. Furthermore, we may not execute successfully our technology initiatives because of errors in planning or timing, technical hurdles that we fail to overcome in a timely fashion, misunderstandings about market demand or a lack of appropriate resources.
Failure to increase our revenues and keep our expenses consistent with revenues could prevent us from maintaining profitability at recent levels or at all.
Our revenue growth rate may decline in future periods as a result of a number of factors including increasing

35


competition, pricing pressure, the inevitable decline in growth rates as our revenues increase to higher levels and macroeconomic factors affecting certain aspects of our business. We also believe our gross margins may decrease because we have large fixed expenses and expect to continue to incur significant bandwidth, co-location and other expenses, including increased depreciation on network equipment purchased in recent years. As a result, we may not be able to continue to maintain our current level of profitability in 2012 or on a quarterly or annual basis thereafter.
There are numerous factors that could, alone or in combination with other factors, impede our ability to increase revenues and/or moderate expenses, including:
continuing market pressure to decrease our prices, particularly in our media business;
the impact of lower pricing and other terms in renewal agreements we enter into with existing customers;
failure to experience traffic growth and increase sales of our core services and advanced features to offset price declines;
significant increases in co-location and bandwidth costs, head count or other operating expenses;
increased competition;
inability to increase sales to new and existing customers faster than the rate of loss of existing customers and revenues; and
failure of a significant number of customers to pay our fees on a timely basis or at all or failure to continue to purchase our services in accordance with their contractual commitments.
We may be unable to replace lost revenues due to customer cancellations or renewals at lower rates.
Our customers have no obligation to renew their agreements for our services after the expiration of their existing terms, which are typically 12 to 24 months. Some may elect not to renew and others may renew at lower prices, lower committed traffic levels, or for shorter contract lengths. We cannot accurately predict renewal rates. Our renewal rates may decline or fluctuate as a result of a number of factors, including customer dissatisfaction with our service, customers' inability to continue their operations and spending levels, the impact of dual vendor policies, customers implementing or increasing their use of in-house technology solutions and deteriorating general economic conditions. It is key to our profitability that we offset lost committed recurring revenue due to customer cancellations, terminations, price reductions or other less favorable terms by adding new customers and increasing the number of services, features and functionalities that our existing customers purchase. If we are unable to do so, our revenue will decline and our business will suffer.
We may be unable to develop robust strategic relationships with third parties; such failure could significantly limit our long-term growth.
Our future success will likely require us to maintain and increase the number and depth of our relationships with resellers, systems integrators and other strategic partners. The need to develop such relationship can be particularly acute in areas outside of the United States. We have not always been successful at developing these relationships due to the complexity of our services, our historical reliance on an internal sales force, a past lack of strategic focus on such arrangements and other factors. Recruiting and retaining qualified channel partners and training them in the use of our technology and services require significant time and resources. In order to develop and expand our distribution channel, we must continue to expand and improve our portfolio of solutions as well as the systems, processes and procedures that support our channel. Those systems, processes and procedures may become increasingly complex and difficult to manage. The time and expense required for sales and marketing organizations of our channel partners to become familiar with our offerings, including our new services developments, may make it more difficult to introduce those products to enterprises. Our failure to maintain and increase the number of relationships with channel partners could significantly impede our revenue growth prospects in the short and long term.
Our failure to manage expected growth, diversification and changes to our business could harm us.
Our future operating results will depend on our ability to manage our operations. In the past, we have restructured aspects of our operations and made other adjustments to our organization in response to management changes, product changes, performance issues and other internal and external considerations, and we may take similar actions in the future. Such actions can result in a lack of focus and reduced productivity.
As a result of the diversification of our business, personnel growth, acquisitions and international expansion in recent years, many of our employees are now based outside of our Cambridge, Massachusetts headquarters. However,

36


most management decisions are made by a relatively small group of individuals based primarily at our headquarters. If we are unable to appropriately increase management depth and decentralize our decision making at a pace commensurate with our actual or desired growth rates, we may not be able to achieve our financial or operational goals. In addition, if we are unable to effectively manage a large and geographically dispersed group of employees, our business may be adversely affected.
As our business evolves, we must also expand and adapt our operational infrastructure. Our business relies on our data systems, billing systems, and other operational and financial reporting and control systems. All of these systems have become increasingly complex in the recent past due to the diversification and complexity of our business, acquisitions of new businesses with different systems and increased regulation over controls and procedures. To manage our technica