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LIMELIGHT NETWORKS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this quarterly report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2010 included in our annual report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 11, 2011. This quarterly report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements as to industry trends and future expectations of ours and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" set forth in Part II, Item 1A of this quarterly report on Form 10-Q and in our other SEC filings. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Prior period information has been modified to conform to current year presentation. Overview We were founded in 2001 as a provider of content delivery network, or CDN, services to deliver digital content over the Internet. We began development of our infrastructure in 2001 and began generating meaningful revenue in 2002. In May 2009, January 2010, April 2010, July 2010, May 2011 and May 2011, respectively, we acquired Kiptronic, chors, EyeWonder, Delve, Clickability and AcceloWeb. In April 2011, we moved into our new Global Headquarters in downtown Tempe, Arizona. Today, Limelight Networks provides on-demand software, platform, and infrastructure services that help global businesses reach and engage audiences on any mobile or connected device, enabling them to enhance their brand presence, build stronger customer relationships, manage video assets, analyze viewer preferences, optimize their advertising, and monetize their digital assets. We provide services to customers in North America, EMEA, and the Asia Pacific region. As of June 30, 2011, we had approximately 1,873 active customers worldwide. We derive revenue from the sale of services to our customers. These services include the delivery of digital media, including video, music, games, software and social media, the acceleration of web sites and web-based applications, and value-added services such as mobility, interactive advertising, storage, video and web content management and consulting. We operate in one business segment. Our CDN and web content management customers normally execute 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 applicable for actual usage above the monthly minimum 25 -------------------------------------------------------------------------------- Table of Contents commitment. We define usage as customer data sent or received using our content delivery network ("CDN") service, or content that is hosted or cached by us at the request or direction of our customer. Usage is tracked using a software system that measures either the gigabytes transferred ("GB Transfer") or megabits per second ("Mbps") of usage per customer per month. GB Transfer measures usage by counting each GB of a customer's content that is sent or received using our network. Mbps measures usage by determining the rate at which a customer's content moves across our network. We have entered into an increasing number of customer contracts that have minimum usage commitments that are based on twelve-month or longer periods and in some cases, other arrangements. The nature of services provided as part of the minimum commitment may vary by customer; but substantially all of the services provided us and associated with a minimum commitment are core CDN services. We believe that 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 any customer cancellations or terminations and build on that base by adding new customers and increasing the number of services, features and functionalities our existing customers purchase. We also derive revenue from campaigns, services and events sold as discrete, non-recurring events or based solely on usage. For these services, we recognize revenue after an enforceable contract has been signed by both parties, the fee is fixed or determinable, the event or usage has occurred and collection is reasonably assured. During the second quarter, we achieved revenue of $50.5 million, which did not meet our expectations. There were two primary factors that contributed to this revenue shortfall. First, we encountered delays in the completion of our ad server product, which impacted the revenue growth we had anticipated achieving from our interactive advertising services. This made up just over half of our shortfall in the quarter. We believe that until this ad server is brought to market in early 2012, growth of our interactive advertising services revenue will be stalled. Our CDN services contributed just under half of our revenue shortfall in the quarter. The bulk of the CDN shortfall was the result of a widely reported third party security breach on a customer's platform which led to less content streaming and less software downloads to that platform, which led to lighter than forecasted revenue from two of our largest customers. We continue to see strong momentum in the long-term growth trends that drive demand for our services. These trends include the ongoing shift of content and advertising to online properties; the growth of mobile devices, applications, and content consumption; and the migration of software applications; data, and IT services into multi-tenant large scale distributed computing platforms, sometimes referred to as the "cloud." We continue to make progress on our long-term, strategic growth plan, which has four components. First, grow our CDN market share to be #1 or #2 in the world; expand our services to be relevant in the web and application acceleration segment of the CDN market; build a value-added services business that is complimentary to our CDN business; and develop products and services that enable us to increase our participation in the online advertising market. As part of this overall strategy, we plan to grow our value-added services to 50% of our revenue by the end of 2014. Our value-added services are comprised of our EyeWonder interactive advertising services, as well as our software-as-a-service solutions for mobility, web and video content management, web application acceleration, cloud storage, and consulting. As our value-added services grow as a percentage of revenue, we believe they will help us deepen our relationships with our customers and improve our overall margin mix. On March 2, 2011 we completed an underwritten public offering of our common stock in which we sold and issued 11,500,000 shares of our common stock, including 1,500,000 shares subject to the underwriters' over-allotment option, at a price to the public of $7.10 per share. The newly issued common shares began trading on the Nasdaq Global Select Market on March 2, 2011. We raised a total of approximately $81.7 million in gross proceeds from the offering, or approximately $77.1 million in net proceeds after deducting underwriting discounts and commissions of approximately $4.0 million and other offering costs of approximately $0.6 million. The offering was made pursuant to the effective registration statement on Form S-3 (Registration Statement No. 333-170609) previously filed with and declared effective by the SEC on November 26, 2010 and the prospectus supplement thereunder filed with the SEC on February 28, 2011. On May 2, 2011, we acquired Clickability Inc. (Clickability), a privately-held software-as-a-service (SaaS) provider of web content management (WCM) located in San Francisco, California. The aggregate purchase price consisted of approximately $4.9 million of cash paid at the closing (cash paid net of cash acquired was $2.8 million), $0.1 million held by us to cover future claims and 732,000 shares of our common stock with an estimated fair value of approximately $4.6 million on the date of acquisition. We issued 382,000 common shares at the closing with an estimated fair value of approximately $2.4 million. Under the terms of the merger agreement, 350,000 shares of the common stock portion of the purchase price or approximately $2.2 million will remain unissued for a period of up to 18 months following the closing date to satisfy any unresolved future claims. (See footnote 4 for a more detailed description of the Clickability acquisition.) On May 9, 2011, we acquired AcceloWeb, (IL) Ltd. (AcceloWeb), a privately-held provider of advanced technology that helps speed the presentation of web sites and applications located in Tel Aviv, Israel. The aggregate purchase price consisted of approximately $5.0 million of cash paid at the closing (cash paid net of cash acquired was $4.7 million) and 1,100,629 shares of our common stock issued at closing with an estimated fair value of approximately $7.0 million on the acquisition date. In addition, the purchase price included contingent consideration with an aggregate value of $8.0 million ($4.0 million payable in cash and $4.0 million payable in our common stock) which may be earned upon the achievement of certain performance milestones which will be measured quarterly during the eight full consecutive quarters ending June 30, 2013. The fair value of the contingent consideration as of the acquisition date was $6.2 million. (See footnote 4 for a more detailed description of the AcceloWeb acquisition.) Traffic on our network and our value-added services business has continued to grow. This traffic growth is primarily the result of growth in the traffic delivered to existing customers and to a lesser extent on behalf of new customers. Our CDN revenue is generated by charging for traffic delivered. While our traffic continued to grow, our revenue generated from such traffic grew at a much slower rate. Our value-added services revenue represented substantially all of our revenue growth during the three month period ended June 30, 2011. During 2010, we added new customers both through new business and through our business acquisitions. During the three month period ended June 30, 2011, we continued to add new customers, again through new business and our business acquisitions, and we also elected to not renew some customers as we continue to focus on customer quality. We have increased our average number of products per customer to 1.8, as we continue to see that new and existing customers want the benefits of the specialized services that we bring to the market. Both our value-added services and our core CDN business (to a much lesser extent) continue to show year over year growth, which we believe is a result of growth in traffic on our network, our acquisitions and market share gains. Historically, we have derived a portion of our revenue from outside of the United States. Our international revenue has grown recently, and we expect this trend to continue as we focus on our strategy of expanding our network and customer base internationally. For the year ended December 31, 2010 revenue derived from customers outside North America accounted for approximately 29% of our total revenue. For the year ended December 31, 2010 we derived approximately 65% of our international revenue from EMEA and approximately 35% of our international revenue from Asia Pacific. For the three month periods ended June 30, 2011 and 2010, 26 -------------------------------------------------------------------------------- Table of Contents revenue derived from customers outside North America accounted for approximately 33% and 30%, respectively, of our total revenue. For the six month periods ended June 30, 2011 and 2010 revenue derived from customers outside North America accounted for approximately 32% and 29%, respectively, of our total revenue. For the three and six month periods ended June 30, 2011, we derived approximately 62% and 63%, respectively, of our international revenue from EMEA and approximately 38% and 37%, respectively, of our international revenue from Asia Pacific, respectively. We expect foreign revenue to continue to increase in absolute dollars in 2011. Our international business is managed as a single-geographic segment, and we report our financial results on this basis. During any given fiscal period, a relatively small number of customers typically account for a significant percentage of our revenue. For example, in 2010, sales to our top 10 customers, in terms of revenue, accounted for approximately 30% of our total revenue and we had no customer that accounted for more than 10% of our revenue. For the three and six month periods ended June 30, 2011, sales to our top 10 customers, in terms of revenue, accounted for approximately 30% and 31%, respectively, of our total revenue. During the three and six month periods ended June 30, 2011 we had no customer that accounted for more than 10% of our revenue during the period. We anticipate customer concentration levels will remain consistent with 2010. In addition to selling to our direct customers, we maintain relationships with a number of resellers that purchase our services and charge a mark-up to their end customers. Revenue generated from sales to reseller customers accounted for approximately 5% of our total revenue for the year ended December 31, 2010. For the three and six month periods ended June 30, 2011, revenue generated from sales to reseller customers accounted for approximately 3% of our total revenue. In addition to these revenue-related business trends, our cost of revenue increased in absolute dollars and as a percentage of revenue for the three and six month periods ended June 30, 2011 compared to the three and six month periods ended June 30, 2010. The three and six month periods ended June 30, 2011 includes two months of cost of revenue from our acquisitions of Clickability and AcceloWeb and also includes a full quarter and full six months of cost of revenue for EyeWonder, whom we acquired on April 30, 2010. The increase in absolute dollars was primarily due to increased bandwidth and co-location fees, due to increased traffic and expansion of our CDN, increased payroll and related employee costs for operations personnel, who are responsible for managing and monitoring our CDN and delivery of our value-added services and increased depreciation expense on our network equipment. Operating expenses increased in absolute dollars and as a percentage of revenue for the three month period ended June 30, 2011 compared to the three month period ended June 30, 2010. The three month period ended June 30, 2011 includes two months of operating expenses from our recent acquisitions of Clickability and AcceloWeb and also includes a full quarter of operating expenses for EyeWonder, whom we acquired on April 30, 2010. This increase was primarily due to increased general and administrative costs (primarily payroll and related employee costs, due to increased staffing, increased facilities and facilities related costs, increased professional fees and increased fees and licenses, off-set by lower litigation expenses), increased sales and marketing expenses (primarily payroll and related employee costs due to increased staffing and increased marketing programs), increased research and development costs (primarily payroll and related employee costs due to increased staffing and increased stock based compensation), and increased non-network related depreciation and amortization (primarily due to increased amortization of intangible assets from our business acquisitions). For the six month period ended June 30, 2011, operating expenses increased in absolute dollars and as a percentage of revenue compared to the six month period ended June 30, 2010. The six month period ended June 30, 2011 includes two months of operating expenses from our recent acquisitions of Clickability and AcceloWeb and also includes a six months of operating expenses for EyeWonder, whom we acquired on April 30, 2010. This increase was primarily due to increased general and administrative costs (primarily payroll and related employee costs, due to increased staffing, increased facilities and facilities related costs, increased professional fees, and increased fees and licenses, off-set by lower litigations expenses, lower acquisition related expenses and lower bad debt expense), increased sales and marketing expenses (primarily payroll and related employee costs due to increased staffing, increased marketing expenses, increased travel and travel related expenses and increased employee events), increased research and development costs (primarily payroll and related employee costs due to increased staffing and increased professional services) and increased non-network related depreciation and amortization (primarily due to increased amortization of intangible assets from our business acquisitions). We make our capital investment decisions based upon careful evaluation of a number of variables, such as the amount of traffic we anticipate on our network, the cost of the physical infrastructure required to deliver that traffic, and the forecasted capacity utilization of our network. Our capital expenditures have varied over time, in particular as we purchased servers and other network equipment associated with our network build-out. For example, in 2008, 2009, and 2010 we made capital purchases of $17.4 million, $20.4 million, and $34.2 million, respectively. For the six month period ended June 30, 2011, we made capital investments of $20.0 million. We expect to have ongoing capital expenditure requirements as we continue to invest in, refresh and expand our CDN. For 2011, we currently anticipate making aggregate capital expenditures of approximately 13%-15% of total revenue for the year. Occasionally we generated revenue from certain customers that are entities related to certain of our founders. For the year ended December 31, 2010 revenue derived from these related parties was less than 1% of our total revenue. For the three and six month periods ended June 30, 2011, revenue generated from related parties was less than 1% of our total revenue. 27-------------------------------------------------------------------------------- Table of Contents We are currently engaged in litigation with one of our principal competitors, Akamai Technologies, Inc., or Akamai, and its licensor, the Massachusetts Institute of Technology, or MIT, in which these parties have alleged that we are infringing three of their patents. In February 2008, a jury returned a verdict in this lawsuit, finding that we infringed four claims of the patent at issue (United States Patent No. 6,108,703 (the '703 patent) and rejecting our invalidity defenses. The court conducted a bench trial in November 2008, regarding our equitable defenses; and we filed a motion for reconsideration of the court's earlier denial of our motion for Judgment as a Matter of Law (JMOL). Our motion for reconsideration of JMOL was based largely upon a clarification in the standard for a finding of joint infringement articulated by the Federal Circuit in the case of Muniauction, Inc. v. Thomson Corp. (the Muniauction Case), released after the court denied our initial motion for JMOL. On April 24, 2009 the court issued its order and memorandum setting aside the adverse jury verdict and ruling that we did not infringe Akamai's '703 patent and that we are entitled to judgment as a matter of law. Based upon the court's April 24, 2009 order we reversed the $65.6 million provision for litigation previously recorded for this lawsuit as we no longer believe that payment of any amounts represented by the litigation provision is probable. The court entered final judgment in favor of us on May 22, 2009. Akamai filed a notice of appeal of the court's decision on May 26, 2009; and the Court of Appeals for the Federal Circuit heard arguments by both parties on June 7, 2010. On December 20, 2010 the Court of Appeals for the Federal Circuit issued its opinion affirming the District Court's entry of judgment in our favor. On February 18, 2011, Akamai filed a motion with the Court of Appeals for the Federal Circuit seeking a rehearing and rehearing en banc. On April 21, 2011, the Court of Appeals for the Federal Circuit issued an order denying the petition for rehearing, granting the petition for rehearing en banc, vacating the December 20, 2010 opinion affirming the District Court's entry of judgment in our favor, and reinstated the appeal. We believe that we do not infringe Akamai's patents and will continue to vigorously defend our position. We are not able at this time to estimate the range of potential loss nor, in light of the favorable U.S. district court order, do we believe that a loss is probable. Therefore, we have made no provision for this lawsuit in our financial statements. In December 2007, Level 3 Communications, LLC, or Level 3, filed a lawsuit against us in the United States District Court for the Eastern District of Virginia alleging that we were infringing certain patents Level 3 acquired from Savvis Communications Corp. In addition to monetary relief, including treble damages, interest, fees and costs, the complaint sought an order permanently enjoining us from conducting our business in a manner that infringed the relevant patents. A jury trial was conducted in January 2009, and on January 23, 2009 the jury returned a verdict favorable to us finding that we did not infringe the Level 3 patents. We believe the jury verdict finding that we did not infringe the Level 3 patents is correct, and that the claims of infringement asserted against us by Level 3 in the litigation were without merit. The court denied Level 3's subsequent motion for JMOL or alternatively for a new trial, and entered a judgment in our favor. Level 3 filed a notice of appeal on July 21, 2009. On May 3, 2010 the United States Court of Appeals for the Federal Circuit heard oral argument on this matter, and on May 5, 2010 the court affirmed the District Court judgment in our favor. Level 3 subsequently filed a motion for rehearing and rehearing en banc that the Court subsequently denied. In light of the favorable rulings from the Court of Appeals we consider this matter successfully concluded. Our legal and other expenses associated with this case have been significant. We include these litigation expenses in general and administrative expenses, as reported in our condensed consolidated statement of operations. In August 2007, we, certain of our officers and current and former directors, and the firms that served as the lead underwriters in our initial public offering were named as defendants in several purported class action lawsuits filed in the United States District Courts for the District of Arizona and the Southern District of New York. All of the New York cases were transferred to Arizona and consolidated into a single action. The plaintiffs' consolidated complaint asserted causes of action under Sections 11, 12, and 15 of the Securities Act of 1933, as amended, on behalf of a purported class of individuals who purchased our common stock in our initial public offering and/or pursuant to our prospectus. The complaint alleged, among other things, that we omitted and/or misstated certain facts concerning the seasonality of our business and the loss of revenue related to certain customers. On March 17, 2008, we and the individual defendants moved to dismiss all of the plaintiffs' claims, a hearing was held on this motion on June 16, 2008. On August 8, 2008, the court granted the motion to dismiss, dismissing plaintiffs' claims under Section 12 with prejudice and granting leave to amend the claims under Sections 11 and 15. Plaintiffs chose not to amend the claims under Sections 11 and 15, and on August 29, 2008, the court entered judgment in favor of us. On September 5, 2008 plaintiffs filed a notice of appeal, and appellate briefs were filed by the parties in January and February, 2009. We believe that we and the individual defendants have meritorious defenses to the plaintiffs' claims and intend to contest the lawsuit vigorously. In November 2009 the parties entered into a memorandum of understanding to settle this lawsuit for an amount well within the coverage limits of the primary carrier of our directors and officers liability insurance, and on July 7, 2010 the parties entered into a settlement agreement consistent with the terms of the memorandum of understanding, which required court approval. On March 22, 2011 the Federal District Court held a hearing pursuant to which the Court approved the settlement. Accordingly, we do not believe that a loss is probable and believe that this litigation is now successfully concluded. Therefore, we have made no provision for this lawsuit in our financial statements. Our future results will be affected by many factors, including those identified in the section captioned "Risk Factors," in this quarterly report on Form 10-Q, and our ability to: • increase our revenue by adding customers and limiting customer cancellations and terminations, as well as increasing the amount of monthly recurring revenue that we derive from our existing customers; • manage the prices we charge for our services, as well as the costs associated with operating our network in light of increased competition; 28 -------------------------------------------------------------------------------- Table of Contents • successfully manage our litigation with Akamai to a favorable conclusion; • prevent disruptions to our services and network due to accidents or intentional attacks; • continued ability to deliver a significant portion of our traffic through settlement free peering relationships which significantly reduce our cost of delivery; and • successfully integrate the businesses we have acquired. As a result, we cannot assure you that we will achieve our expected financial objectives, including positive net income. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which have been prepared by us in accordance with United States generally accepted accounting principles for interim periods. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, cash flow and related disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, accounts receivable and related reserves, useful lives and realizability of long-term assets, capitalized software, acquired intangibles, provision for litigation, income and other taxes, the fair value of stock-based compensation and other contingent liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. We review these estimates and judgments on an ongoing basis. We also have other policies that we consider key accounting policies, such as our policy regarding foreign currency translation described below; however, we do not believe this policy requires us to make estimates or judgments that are as difficult or subjective as those noted above and disclosed in our annual report on Form 10-K for the year ended December 31, 2010, filed with the SEC on March 11, 2011. Foreign Currency Translation We analyze the functional currency for each of our international subsidiaries periodically to determine if a significant change in facts and circumstances indicate that the primary economic currency has changed. As of December 31, 2010, the international subsidiaries we acquired as part of the EyeWonder and chors acquisitions had local currencies as their functional currencies, while our remaining international subsidiaries had the U.S. dollar as their functional currencies. During the first quarter of 2011, we analyzed the various economic factors of our international subsidiaries and determined that the operations of our subsidiaries that were previously determined to operate in a U.S. dollar functional currency environment had changed and that their functional currencies changed to the local currencies. Effective January 1, 2011, the adjustment from translating these subsidiaries' financial statements from the local currency to the U.S. dollar was recorded as a separate component of accumulated other comprehensive loss. These foreign currency translation adjustments reflect the translation of the balance sheet at period end exchange rates and the income statement at an average exchange rate in effect during each period. Upon the change in functional currency, we recorded a cumulative translation adjustment, or CTA, of approximately $0.5 million, which is included in the condensed consolidated balance sheet. Because of the change in exchange rates between reporting periods and changes in certain account balances, the foreign currency translation adjustment will change from period to period. As of June 30, 2011, there have been no material changes to any of the critical accounting policies as described in our annual report on Form 10-K for the year ended December 31, 2010, filed with the SEC on March 11, 2011. Results of Operations Revenue Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Revenue $ 50,539 $ 42,195 $ 8,344 20 % $ 100,355 $ 78,281 $ 22,074 28 % Revenue increased 20%, or $8.3 million, to $50.5 million for the three months ended June 30, 2011 as compared to $42.2 million for the three months ended June 30, 2010. For the six months ended June 30, 2011, total revenues increased 28%, or $22.1 million, to $100.4 million as compared to $78.3 million for the six months ended June 30, 2010. The increase in revenue for the three and six month periods ended June 30, 2011 as compared to the same periods in the prior year was primarily attributable to an increase in our value-added services revenue of approximately $8.2 million and $19.4 million, respectively, which includes revenue from the date of acquisition of chors, EyeWonder, Delve, and Clickability. We provide value-added services in the following areas: mobility, web and video content management, web application acceleration, interactive advertising services, storage services, and strategic consulting. We continued to increase the amount of traffic moving through our network; however the revenue generated from 29 -------------------------------------------------------------------------------- Table of Contents the increase in traffic grew at a much lower rate and we continue to see a decline in our average unit sales price. Our core delivery revenue increased approximately $0.1 million and $2.7 million, respectively, for the three and six month periods ended June 30, 2011, compared to the same periods in the prior year. This small increase is the results of a reduction in our core revenue generated from Microsoft. As of June 30, 2011, we had approximately 1,873 customers compared to approximately 1,655 as of June 30, 2010. For the three months ended June 30, 2011 and 2010, approximately 33% and 30%, respectively, of our total revenues were derived from our operations located outside of North America. For the three months ended June 30, 2011 and 2010, we derived approximately 62% and 65%, respectively of our international revenue from EMEA and approximately 38% and 35%, respectively of our international revenue from Asia Pacific. For the six months ended June 30, 2011 and 2010, approximately 32% and 29%, respectively, of our total revenues were derived from our operations located outside of North America. For the six months ended June 30, 2011 and 2010, we derived approximately 68% and 62%, respectively of our international revenue from EMEA and approximately 32% and 38%, respectively of our international revenue from Asia Pacific. No single country outside of the United States accounted for 10% or more of revenues during these periods. Cost of Revenue Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Cost of revenue $ 31,861 $ 23,825 $ 8,036 34 % $ 61,273 $ 44,807 $ 16,466 37 % Cost of revenue includes fees paid to network providers for bandwidth and backbone, costs incurred for non settlement free peering and connection to Internet service provider networks or ISPs, and fees paid to data center operators for co-location of our network equipment. Cost of revenue also includes depreciation of network equipment used to deliver our CDN services, payroll and related costs and equity-related compensation for our network operations, operations and value-added services personnel. Cost of revenue increased 34%, or $8.0 million, to $31.9 million for the three months ended June 30, 2011 as compared to $23.8 million for the three months ended June 30, 2010. These increases were primarily due to an increase in aggregate bandwidth and co-location fees of $2.5 million due to higher traffic levels, increased peering costs, and increased amounts of deployed network assets, an increase in payroll and related employee costs of $2.4 million associated with increased staff to build and operate our CDN, as well as increased operations personnel from our business acquisitions whose primary focus is on our delivery of value-added services, an increase in depreciation of $2.1 million, due to increased amounts of deployed assets, as we continue to build-out our expanding network and to re-fresh our network equipment, and an increase in other costs of $0.6 million. The increase in other costs is primarily related to costs associated with our value-added services. For the six months ended June 30, 2011, cost of revenues increased 37%, or $16.5 million, to $61.3 million as compared to $44.8 million for the six months ended June 30, 2010. These increases were primarily due to an increase in payroll and related employee costs of $5.5 million associated with increased staff to build and operate our CDN, as well as increased operations personnel from our business acquisitions whose primary focus is on our delivery of value-added services, an increase in aggregate bandwidth and co-location fees of $5.0 million due to higher traffic levels, increased peering costs, and increased amounts of deployed network assets, an increase in depreciation of $4.1 million, due to increased amounts of deployed assets, as we continue to build-out our expanding network and to re-fresh our network equipment, and an increase in other costs of $0.6 million. Additionally, we had increases in professional fees and outside services of $0.3 million, an increase in travel and travel-related expenses of $0.2 million and an increase in royalty expense of $0.3 million. Cost of revenue share-based compensation expense increased $0.2 million for both the three and six month periods ended June 30, 2011 compared to the three and six month periods ended June 30, 2010. Cost of revenue was composed of the following (in millions): For the For the Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Bandwidth and co-location fees $ 14.8 $ 12.3 $ 29.0 $ 24.0 Depreciation - network 7.4 5.3 14.2 10.1 Payroll and related employee costs 6.6 4.2 12.7 7.2 Share-based compensation 0.8 0.6 1.4 1.2 Professional fees and outside services 0.3 0.2 0.6 0.3 Travel and travel-related expenses 0.3 0.2 0.5 0.3 Royalty expenses 0.2 0.1 0.4 0.1 Other costs 1.5 0.9 2.5 1.6 Total cost of revenues $ 31.9 $ 23.8 $ 61.3 $ 44.8 30 -------------------------------------------------------------------------------- Table of Contents We have long-term purchase commitments for bandwidth usage and co-location with various Tier 1 network providers and data center operators. The minimum commitments related to bandwidth usage and co-location services under agreements currently in effect are approximately: $17.3 million for the remainder of 2011, $25.3 million for 2012, $17.7 million for 2013, $16.0 million for 2014 and $15.9 million for 2015 and beyond. We anticipate cost of revenues will increase in 2011 compared to 2010, due partly to 2011 including a full year of expenses from our recent business acquisitions. We also expect to deliver more traffic on our network, which will result in higher expenses associated with the increased bandwidth, peering, rack and co-location costs to support increased traffic; however, such costs are likely to be partially offset by lower bandwidth costs per unit. We anticipate depreciation expense related to our network equipment to increase compared to 2010, as we continue to expand our network and to re-fresh older servers. Additionally, we expect an increase in payroll and related costs, as we continue to make investments in our network to service our expanding customer base as well as our increase in value-added services personnel. We expect that cost of revenue share-based compensation expense will increase in 2011 compared to 2010. The increase is primarily due to the granting of stock options and restricted stock units associated with our business acquisitions and the recognition of stock-based compensation expense related to performance based restricted stock units. General and Administrative Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) General and administrative $ 10,435 $ 9,609 $ 826 9 % $ 19,244 $ 17,735 $ 1,509 9 % General and administrative expenses consist primarily of the following components: • payroll, share-based compensation and other related costs, including related expenses for executive, finance, legal, business applications, internal network management, human resources and other administrative personnel; • fees for professional services and litigation expenses; • rent and other facility-related expenditures for leased properties; • the provision for doubtful accounts; and • non-income related taxes. General and administrative expenses increased 9%, or $0.8 million, to $10.4 million for the three months ended June 30, 2011 as compared to $9.6 million for the three months ended June 30, 2010. The increase in general and administrative expenses for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 was primarily due to an increase in payroll and related employee costs of $0.4 million which were primarily associated with our business acquisitions, an increase in professional fees of $0.4 million, primarily due to increased general legal fees, tax services and increased Sarbanes Oxley (SOX) compliance related costs, an increase in travel and travel related expenses of $0.2 million, and an increase in other costs of $1.0 million, primarily due to increased facilities and facilities related costs of $0.6 million, increased fees, licenses and non-income taxes of $0.3 million, and a increase in telephone and general office expenses (office and computer supplies, postage and shipping) of approximately $0.1 million. These increases were off-set by a decrease of $1.4 million in litigation expenses related to our litigation with Akamai and MIT, and Level 3 and a decrease in bad debt expense of $0.2 million. For the six months ended June 30, 2011, general and administrative expenses increased 9%, or $1.5 million, to $19.2 million as compared to $17.7 million for the six months ended June 30, 2010. The increase in general and administrative expenses for the six months ended June 30, 2011 compared to the six months ended June 30, 2010 was primarily due to an increase in payroll and related employee costs of $1.6 million which were primarily associated with our business acquisitions, an increase in professional fees of $0.2 million, primarily due to increases of $0.3 million in accounting fees, $0.3 million in consulting and casual labor and 0.2 million in general legal fees off-set by lower acquisition related expenses of $0.6 million, an increase in travel and travel related expenses of $0.2 million, and an increase in other costs of $2.0 million, primarily due to increased facilities and facilities related costs of $1.1 million, increased fees, licenses and non-income taxes of $0.5 million, and a increase in telephone and general office expenses (office and computer supplies, postage and shipping) of approximately $0.3 million. These increases were off-set by a decrease of $1.5 million in litigation expenses related to our litigation with Akamai and MIT, and Level 3 and a decrease in bad debt expense of $1.2 million. Other expenses include such items as rent, utilities, telephone, insurance, fees and licenses and property taxes. 31-------------------------------------------------------------------------------- Table of Contents Additionally, general and administrative share-based compensation expense increased $0.4 million and $0.2 million, respectively for the three and six month periods ended June 30, 2011 compared to the same periods of the prior year. General and administrative expense was composed of the following (in millions): For the For the Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Payroll and related employee costs $ 2.6 $ 2.2 $ 5.7 $ 4.1 Share-based compensation 2.0 1.6 3.6 3.4 Professional fees 1.9 1.5 3.1 2.9 Bad debt expense 0.4 0.6 0.6 1.8 Travel and travel-related expenses 0.4 0.2 0.6 0.4 Litigation expenses 0.3 1.7 0.6 2.1 Other expenses 2.8 1.8 5.0 3.0 Total general and administrative $ 10.4 $ 9.6 $ 19.2 $ 17.7 We expect our general and administrative expense to increase in 2011 compared to 2010 due partly to 2011 including a full year of expenses from our recent business acquisitions. During 2011, we also expect to see increased salaries and related employee cost, as well as increased facility costs. These increases will be off-set partly by reduced professional fees. In 2012 and in the longer term, we expect our general and administrative expense to decrease as a percentage of revenue as our costs are expected to grow slower than our top line revenue. We expect that general and administrative share-based compensation expense will slightly increase in 2011 compared to 2010. The increase is primarily due to the granting of stock options and restricted stock units associated with our business acquisitions and the recognition of stock-based compensation expense related to performance based restricted stock units. Sales and Marketing Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Sales and marketing $ 13,023 $ 11,319 $ 1,704 15 % $ 26,916 $ 20,706 $ 6,210 30 % Sales and marketing expenses consist primarily of payroll and related costs, share-based compensation and commissions for personnel engaged in marketing, sales and service support functions, professional fees (consultants and recruiting fees), travel and travel-related expenses as well as advertising and promotional expenses. Sales and marketing expenses increased 15%, or $1.7 million, to $13.0 million for the three months ended June 30, 2011, as compared to $11.3 million for the three months ended June 30, 2010. The increase in sales and marketing expenses for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 was primarily due to an increase in payroll and related employee costs of $0.8 million, primarily due to increased staffing, which resulted in higher salaries, plus the addition of sales and marketing personnel from our business acquisitions, an increase in travel and travel-related expenses of $0.3 million, an increase in marketing expenses of $0.3 million, and an increase in other costs of $0.5 million, primarily due to increased employee events of $0.3 million, and increased fees and licenses of approximately $0.2 million. These increases were off-set by a decrease in professional fees for outside services of approximately $0.1 million. For the six months ended June 30, 2011, sales and marketing expenses increased 30%, or $6.2 million, to $26.9 million, as compared to $20.7 million for the six months ended June 30, 2010. The increase in sales and marketing expenses for the six month period ended June 30, 2011 compared to the six month period ended June 30, 2010 was due to an increase in payroll and related employee costs of $3.8 million, primarily due to increased staffing, which resulted in higher salaries and commissions, plus the addition of sales and marketing personnel from our business acquisitions, an increase in marketing expenses of $0.8 million, an increase in travel and travel-related expenses of $0.4 million, and an increase in other expenses of $1.3 million. The increase in other costs was primarily due to increased employee events of $0.4 million, increased fees and licenses of $0.3 million, increased facility and facility related costs of $0.2 million, increased telephone costs of $0.2 million, and an increase in general office supplies of $0.1 million. Other expenses include such items as rent and property taxes for our Europe and Asia Pacific sales offices, telephone, and office supplies. Additionally, sales and marketing share-based compensation expense decreased $0.1 million during the three month period ended June 30, 2011 and remained constant during the six month period ended June 30, 2011, compared to the same periods of the prior year. 32 -------------------------------------------------------------------------------- Table of Contents Sales and marketing expense was composed of the following (in millions): For the For the Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Payroll and related employee costs $ 8.2 $ 7.4 $ 17.0 $ 13.2 Share-based compensation 1.2 1.3 2.5 2.5 Travel and travel-related expenses 1.2 0.9 2.1 1.7 Marketing programs 0.7 0.4 1.5 0.7 Professional fees and outside services 0.4 0.5 0.9 1.0 Other expenses 1.3 0.8 2.9 1.6 Total sales and marketing $ 13.0 $ 11.3 $ 26.9 $ 20.7 We anticipate our sales and marketing expense will increase in 2011 compared to 2010 due partly to 2011 including a full year of expenses from our recent business acquisitions. We also expect an increase in salaries and related employee costs for our sales and marketing personnel, increased commissions on higher forecast sales, and an increase in marketing costs such as advertising and other lead generating activities. We expect that sales and marketing share-based compensation expense will decrease in 2011 compared to 2010. The decrease is primarily due to lower stock-based compensation expense for restricted stock units granted in prior years. Research and Development Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Research and development $ 6,279 $ 3,478 $ 2,801 81 % $ 11,898 $ 6,122 $ 5,776 94 % Research and development expenses consist primarily of payroll and related costs and share-based compensation expense for research and development personnel who design, develop, test and enhance our services, network and software. Research and development expenses increased 81%, or $2.8 million, to $6.3 million for the three months ended June 30, 2011, as compared to $3.5 million for the three months ended June 30, 2010. For the six months ended June 30, 2011, research and development expenses increased 94%, or $5.8 million, to $11.9 million, as compared to $6.1 million for the six months ended June 30, 2010. The increase in research and development expenses in the three and six month periods ended June 30, 2011 as compared to the three and six month periods ended June 30, 2010 was primarily due to an increase of $2.0 million and $4.1 million respectively, in payroll and related employee costs associated with our hiring of additional network and software engineering personnel and the addition of research and development personnel resulting from our business acquisitions, an increase in share-based compensation of $0.6 million and $0.8 million, respectively, and an increase in professional fees and outside services of $0.1 million and $0.5 million, respectively, primarily for consulting and outside professional services. Other expenses include such items as travel and travel-related expenses, consulting, contract labor, telephone, and office supplies. Research and development expense was composed of the following (in millions): For the For the Three Months Ended Six Months Ended June 30, June 30, 2011 2010 2011 2010 Payroll and related employee costs $ 4.1 $ 2.1 $ 7.7 $ 3.6 Share-based compensation 1.3 0.7 2.2 1.4 Professional fees and outside services 0.6 0.5 1.3 0.8 Other expenses 0.3 0.2 0.7 0.3 Total research and development $ 6.3 $ 3.5 $ 11.9 $ 6.1 We anticipate our research and development expenses will increase in 2011 compared to 2010 due to 2011 including a full year of expenses from our recent business acquisitions and our continued investments in our core technology, refinements and additions to our other service offerings. We expect increased payroll and related employee costs associated with continued hiring of research and development personnel, as well as increased professional fees for outside services. We expect that research and development share-based compensation expense will increase in 2011 compared to 2010. The increase is primarily due to the granting of stock options and restricted stock units associated with our business acquisitions and the recognition of stock-based compensation expense related to performance based restricted stock units. 33-------------------------------------------------------------------------------- Table of Contents Depreciation and Amortization (Operating Expenses) Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Depreciation & amortization $ 2,619 $ 1,603 $ 1,016 63 % $ 4,574 $ 2,370 $ 2,204 93 % Depreciation expense consists of depreciation on equipment and furnishings used by general administrative, sales and marketing and research and development personnel. Amortization expense consists of amortization of intangible assets acquired in business combinations. Depreciation and amortization expenses increased 63%, or $1.0 million, to $2.6 million for the three months ended June 30, 2011, as compared to $1.6 million for the three months ended June 30, 2010. For the six months ended June 30, 2011, depreciation and amortization expenses increased 93%, or $2.2 million, to $4.6 million, as compared to $2.4 million for the six months ended June 30, 2010. The increase in depreciation and amortization expense in the three and six month periods ended June 30, 2011 as compared to the three and six month periods ended June 30, 2010 was primarily due to an increase of approximately $1.0 million and $2.2 million respectively, in amortization of intangibles acquired in business combinations. For the three and six months ended June 30, 2011, amortization of intangibles was approximately $1.9 million and $3.3 million respectively. Based on our intangible assets at June 30, 2011, we expect amortization of other intangible assets to be approximately $4.2 million for the remainder of 2011, and $7.9 million, $7.5 million, $3.8 million and $1.7 million for fiscal years 2012, 2013, 2014 and 2015 and beyond, respectively. Interest Expense Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Interest expense $ 105 $ 7 $ 98 NA % $ 147 $ 8 $ 139 NA % Interest expense increased $98,000, to $105,000 for the three months ended June 30, 2011, as compared to $7,000 for the three months ended June 30, 2010. The increase in interest expense for the three months ended June 30, 2011, compared to the three months ended June 30, 2010 was primarily related to increased interest expense on capital leases (approximately $37,000) and the accretion of contingent consideration related to our business acquisition of AcceloWeb, (approximately $62,000). For the six months ended June 30, 2011, interest expense increased $139,000, to $147,000, as compared to $8,000 for the six months ended June 30, 2010. The increase in interest expense for the six months ended June 30, 2011, compared to the six months ended June 30, 2010 was primarily related to increased interest expense on capital leases (approximately $78,000) and the accretion of contingent consideration related to our business acquisition of AcceloWeb, (approximately $62,000). Interest expense for the three and six month periods ended June 30, 2010 included interest paid in association with a filing of non-income tax related payments and interest paid on a capital lease. As of June 30, 2011, with the exception of our capital leases, we had no outstanding credit facilities. Interest Income Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Interest income $ 259 $ 255 $ 4 2 % $ 446 $ 557 $ (111 ) (20 )% Interest income includes interest earned on invested cash balances and marketable securities. Interest income increased 2%, to $0.3 million for the three months ended June 30, 2011, as compared to $0.3 million for the three months ended June 30, 2010. For the six months ended June 30, 2011, interest income decreased 20%, to $0.4 million, as compared to $0.6 million for the six months ended June 30, 2010. The decrease in interest income for the six month period ended June 30, 2011 was primarily due to decreased cash balances. We anticipate interest income to increase as a result of increased average cash balances. 34-------------------------------------------------------------------------------- Table of Contents Other Income (Expense) Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands) Other income (expense) $ 33 $ 28 $ 5 18 % $ 64 $ 3 $ 61 NA % Other income (expense) increased 18% or $5,000 to $33,000 for the three month period ended June 30, 2011, as compared to $28,000 for the three months ended June 30, 2010. For the six months ended June 30, 2011, other income (expense) increased $61,000, to $64,000, as compared to $3,000 for the six months ended June 30, 2010. Other income (expense) for the three and six months ended June 30, 2011 consists primarily of foreign currency transaction gains. Income Tax Expense Three months ended June 30, Six months ended June 30, Increase Percent Increase Percent 2011 2010 (Decrease) Change 2011 2010 (Decrease) Change (in thousands) (in thousands)Income tax expense (benefit) $ 444 $ (5,098 ) $ 5,542 (109 )% $ 566 $ (4,857 ) $ 5,423 (112 )% Based upon our estimated annual effective tax rate and discrete items, our tax expense for the six months ended June 30, 2011 was approximately $566,000. For the six months ended June 30, 2010 we had a tax benefit of approximately $4.9 million. Our income tax expense of $566,000 on our loss before taxes of $23.2 million was different than our statutory income tax rate due primarily to our providing for a valuation allowance on deferred tax assets in certain jurisdictions, and recording of discrete items and foreign tax for the period. The effective income tax rate is based primarily upon forecasted income or loss for the year, the composition of the income or loss in different countries, and adjustments, if any, for the potential tax consequences, benefits or resolutions for tax audits. For the six months ended June 30, 2010, our benefit for income taxes was $4.9 million, which included $0.9 million for income taxes related primarily to our foreign operations, $0.1 million for state tax expense and a tax benefit of $5.8 million related to the release of valuation allowance as a discrete item for the quarter as a result of deferred tax liabilities assumed in the acquisition of EyeWonder. During the six months ended June 30, 2010, we performed an assessment of the recoverability of deferred tax assets. As a result of the acquisition of EyeWonder, $5.8 million of net deferred tax liabilities were recorded resulting from the temporary differences generated by the differences between the fair value of assets and liabilities acquired (mainly intangible assets such as existing technologies) and their corresponding tax bases. We determined that $5.8 million of our pre-acquisition deferred tax assets that had a full valuation allowance are now more-likely-than-not to be realized as a result of the acquisition by offsetting such deferred tax assets against the $5.8 million net deferred tax liabilities recorded as of the acquisition date. Therefore, we recorded a tax benefit of $5.8 million related to the partial release of the related valuation allowance. For the remaining balance of deferred tax assets, there was sufficient negative evidence as a result of our cumulative losses to conclude that it was more-likely-than-not that our deferred tax assets would not be realized and we accordingly maintained the remaining valuation allowance. Liquidity and Capital Resources To date, we have financed our operations primarily through the following transactions: • private sales of common and preferred stock and subordinated notes; • an initial public offering of our common stock in June 2007; • an underwritten public offering of our common stock in March 2011; • borrowing on capital leases; • borrowing on credit facilities; and • cash generated by operations. As of June 30, 2011, our cash, cash equivalents and marketable securities classified as current totaled $116.5 million. Included in this amount, is approximately $14.0 million of cash and cash equivalents held outside the United States. 35 -------------------------------------------------------------------------------- Table of Contents Operating Activities Net cash used in operating activities was $1.1 million for the six months ended June 30, 2011 compared to net cash provided by operating activities of $6.2 million for the six months ended June 30, 2010. The change in operating cash flows comparing the six months ended June 30, 2011 to the six month period ended June 30, 2010, was primarily due to a larger net loss in 2011 compared to 2010 in addition to changes in operating assets and liabilities. Cash used due to changes in operating assets and liabilities was $5.9 million in the six months ended June 30, 2011 compared to $2.9 million in the six months ended June 30, 2010, a change of $3.0 million. The change relates primarily to greater cash usage during the six months ended June 30, 2011 related primarily to increases in prepaid expenses and other current and long-term assets associated with advanced payments for bandwidth and backbone services with a telecommunications provider offset by cash generated from a decrease in accounts receivable. We expect that cash provided by operating activities may not be sufficient to cover new purchases of property and equipment during 2011 and potential litigation expenses associated with patent litigation. The timing and amount of future working capital changes and our ability to manage our days sales outstanding will also affect the future amount of cash used in or provided by operating activities. Investing Activities Cash used in investing activities was $21.9 million for the six months ended June 30, 2011, compared to cash used in investing activities of $35.2 million for the six months ended June 30, 2010. Cash used in investing activities was principally comprised of cash used for the acquisition of businesses, the purchase of short-term marketable securities and capital expenditures primarily for computer equipment associated with the build-out and expansion of our CDN, offset by cash generated from the sale of short-term marketable securities. On May 9, 2011, we acquired AcceloWeb, (IL) Ltd. or AcceloWeb, a privately-held provider of advanced technology that helps speed the presentation of web sites and applications located in Tel Aviv, Israel. The purchase price included both cash and company stock for the acquisition. Cash paid, net of cash acquired, was $4.7 million. On May 2, 2011, we acquired Clickability, Inc. or Clickability, a privately-held software-as-a-service (SaaS) provider of web content management located in San Francisco, California. The purchase price included both cash and company stock for the acquisition. Cash paid, net of cash acquired, was $2.8 million. On April 30, 2010 we acquired EyeWonder, Inc. or EyeWonder. EyeWonder is a provider of interactive digital advertising products and services to advertisers, advertising agencies and publishers. The purchase price included both cash and company stock for the acquisition. Cash paid, net of cash acquired, was $61.9 million. In January 2010, we acquired chors Gmbh or chors, an on-line and direct marketing solutions provider located in Germany. Cash paid, net of cash acquired for the chors acquisition was approximately $2.0 million. We expect to have ongoing capital expenditure requirements as we continue to invest in and expand our CDN. We currently anticipate making aggregate capital expenditures of approximately 13%-15% of total revenue in 2011. Financing Activities Net cash provided by financing activities was $75.9 million for the six months ended June 30, 2011. Net cash provided by financing activities in the six months ended June 30, 2011 primarily related to proceeds from the public offering of our common stock of approximately $77.1 million and the exercise of stock options of $0.5 million off-set by payments of employee tax withholdings related to restricted stock of approximately $1.0 million and payments made on our capital lease obligations of approximately $0.7 million. On March 2, 2011 we completed an underwritten public offering of our common stock in which we sold and issued 11,500,000 shares of our common stock, including 1,500,000 shares subject to the underwriters' over-allotment option, at a price to the public of $7.10 per share. The newly issued common shares began trading on the Nasdaq Global Select Market on March 2, 2011. We raised a total of approximately $81.7 million in gross proceeds from the offering, or approximately $77.1 million in net proceeds after deducting underwriting discounts and commissions of approximately $3.9 million and other offering costs of approximately $0.6 million. As of June 30, 2011, we had no outstanding bank debt other than the aforementioned capital leases. 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, accrued provision for litigation and various accrued expenses, as well as changes in our capital and financial structure due to debt repurchases and issuances, stock option exercises, sales of equity investments and similar events. 36-------------------------------------------------------------------------------- Table of Contents We believe that our existing cash, cash equivalents and marketable securities will be sufficient to meet our anticipated cash needs for at least the next 12 months. If the assumptions underlying our business plan regarding future revenue and expenses change, or if unexpected opportunities or needs arise, we may seek to raise additional cash by selling equity or debt securities. Contractual Obligations, Contingent Liabilities and Commercial Commitments In the normal course of business, we make certain long-term commitments for operating leases, primarily office facilities, bandwidth and computer rack space. These leases expire on various dates ranging from 2011 to 2019. We expect that the growth of our business will require us to continue to add to and increase our long-term commitments in 2011 and beyond. As a result of our growth strategies, we believe that our liquidity and capital resources requirements will grow. The following table presents our contractual obligations and commercial commitments, as of June 30, 2011 over the next five years and thereafter (in thousands): Payments Due by Period Less than More thanContractual obligations as of June 30, 2011 Total 1 year 1-3 years 3-5 years 5 years Operating Leases Bandwidth leases $ 23,762 $ 15,274 $ 7,525 $ 963 $ - Rack space leases 68,477 15,728 29,938 22,734 77 Real estate leases 19,699 2,761 6,534 5,422 4,982 Total operating leases 111,938 33,763 43,997 29,119 5,059 Capital leases 3,871 1,597 1,798 476 - Bank debt - - - - - Interest on bank debt - - - - - Total commitments $ 115,809 $ 35,360 $ 45,795 $ 29,595 $ 5,059 Off Balance Sheet Arrangements As of June 30, 2011, we are not involved in any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Use of Non-GAAP Financial Measures To evaluate our business, we consider and use Non-GAAP net income (loss) and Adjusted EBITDA as a supplemental measure of operating performance. These measures include the same adjustments that management takes into account when it reviews and assesses operating performance on a period-to-period basis. We consider Non-GAAP net income (loss) to be an important indicator of overall business performance because it allows us to illustrate the impact of the effects of share-based compensation, litigation expenses, provision for litigation, amortization of intangibles and acquisition related expenses. We define EBITDA as GAAP net income (loss) before interest income, interest expense, other income and expense, provision for income taxes and, depreciation and amortization. We believe that EBITDA provides a useful metric to investors to compare us with other companies within our industry and across industries. We define Adjusted EBITDA as EBITDA adjusted for operational expenses that we do not consider reflective of our ongoing operations. We use Adjusted EBITDA as a supplemental measure to review and assess operating performance. We also believe use of Adjusted EBITDA facilitates investors' use of operating performance comparisons from period to period. In addition, it should be noted that our performance-based executive officer bonus structure is tied closely to our performance as measured in part by certain non-GAAP financial measures. In our August 8, 2011 earnings press release, as furnished on Form 8-K, we included Non-GAAP net income (loss), EBITDA and Adjusted EBITDA. The terms Non-GAAP net income (loss), EBITDA and Adjusted EBITDA are not defined under United States generally accepted accounting principles, or United States GAAP, and are not measures of operating income, operating performance or liquidity presented in accordance with United States GAAP. Our Non-GAAP net income (loss), EBITDA and Adjusted EBITDA have limitations as analytical tools, and when assessing our operating performance, Non-GAAP net income (loss), EBITDA and Adjusted EBITDA should not be considered in isolation, or as a substitute for net income (loss) or other consolidated income statement data prepared in accordance with United States GAAP. Some of these limitations include, but are not limited to: • EBITDA and Adjusted EBITDA do not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; • they do not reflect changes in, or cash requirements for, our working capital needs; • they do not reflect the cash requirements necessary for litigation costs; 37 -------------------------------------------------------------------------------- Table of Contents • they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt that we may incur; • they do not reflect income taxes or the cash requirements for any tax payments; • although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will be replaced sometime in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; • while share-based compensation is a component of operating expense, the impact on our financial statements compared to other companies can vary significantly due to such factors as the assumed life of the options and the assumed volatility of our common stock; and • other companies may calculate EBITDA and Adjusted EBITDA differently than we do, limiting their usefulness as comparative measures. We compensate for these limitations by relying primarily on our GAAP results and using Non-GAAP net income (loss) and Adjusted EBITDA only as supplemental support for management's analysis of business performance. Non-GAAP net income (loss), EBITDA and Adjusted EBITDA are calculated as follows for the periods presented. Reconciliation of Non-GAAP Financial Measures In accordance with the requirements of Regulation G issued by the Securities and Exchange Commission, we are presenting the most directly comparable GAAP financial measures and reconciling the non-GAAP financial metrics to the comparable GAAP measures. Reconciliation of GAAP Net Income (Loss) to Non-GAAP Net Income (Loss) (In thousands) (Unaudited) Three Months Ended Six Months Ended June 30, March 31, June 30, March 31, June 30, June 30, 2011 2011 2010 2010 2011 2010 GAAP net loss $ (13,935 ) $ (9,818 ) $ (2,265 ) $ (5,785 ) $ (23,753 ) $ (8,050 ) Share-based compensation 5,365 4,278 4,160 4,343 9,643 8,503 Litigation defense expenses 269 344 1,726 392 612 2,118 Acquisition related expenses 559 141 409 604 700 1,013 Amortization of intangibles 1,889 1,423 915 171 3,312 1,087 Non-GAAP net (loss) income $ (5,853 ) $ (3,632 ) $ 4,945 $ (275 ) $ (9,486 ) $ 4,671 Reconciliation of GAAP Net Income (Loss) to EBITDA to Adjusted EBITDA (In thousands) (Unaudited) Three Months Ended Six Months Ended June 30, March 31, June 30, March 31, June 30, June 30, 2011 2011 2010 2010 2011 2010 GAAP net loss $ (13,935 ) $ (9,818 ) $ (2,265 ) $ (5,785 ) $ (23,753 ) $ (8,050 ) Depreciation and amortization 10,049 8,681 6,927 5,544 18,730 12,472 Interest expense 105 42 7 1 147 8 Interest and other income (expense) (292 ) (217 ) (283 ) (277 ) (510 ) (560 ) Income tax (benefit) expense 444 122 (5,098 ) 240 566 (4,857 ) EBITDA $ (3,629 ) $ (1,190 ) $ (712 ) $ (277 ) $ (4,820 ) $ (987 ) Share-based compensation 5,365 4,278 4,160 4,343 9,643 8,503 Litigation defense expenses 269 344 1,726 392 612 2,118 Acquisition related expenses 559 141 409 604 700 1,013 Adjusted EBITDA $ 2,564 $ 3,573 $ 5,583 $ 5,062 $ 6,135 $ 10,647 38 -------------------------------------------------------------------------------- Table of Contents |