[March 02, 2012] LIMELIGHT NETWORKS, INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) This annual report on Form 10-K contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. 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 I, Item 1A of this annual report on Form 10-K. 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 services to deliver digital content over the Internet. We began development of our infrastructure in 2001 and began generating meaningful revenue in 2002. Today, we operate a globally distributed, high-performance computing platform (our global computing platform) upon which we provide an integrated suite of services including content delivery services, web content management services, video content management services, web acceleration services, mobility and monetization services, cloud storage services and related consulting services. Our web content management and video content management services are provided as Software as a Service (SaaS) solutions, our cloud storage services and content delivery services are provided as a Platform as a Service (PaaS) solutions and we sometimes refer to all of these integrated services and solutions (other than content delivery services) collectively as our value-added services (VAS). We derive revenue from the sale of services to our customers. Our scalable cloud solutions improve the quality of online media and content, accelerate the performance of web applications, enable secure online transactions and manage and monetize digital assets. These services are provided in the cloud as they are supported by our global computing platform, which provides highly-available, highly-redundant storage, bandwidth and computing resources as well as connectivity to last-mile broadband network providers. We also offer other platform and infrastructure services, such as transit and rack space services. We operate in one industry segment. Our services enable global businesses to build and manage their digital presence across Internet, mobile and social channels by reaching and delivering a brilliant experience to their audiences on mobile and connected devices, enabling them to enhance their brand presence, build stronger customer relationships, manage web content and 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 December 31, 2011, we had approximately 1,565 active customers worldwide. 38 -------------------------------------------------------------------------------- Table of Contents In addition to expanding our suite of value-added services, we have also continued to expand the capacity and capabilities, and to enhance the performance and efficiency of our global computing platform. Although we believe that we may have improved margins in our content delivery services as we expand our customer base and use a greater proportion of our capacity, we expect the majority of our margin increases to result from our value-added services increasing as a percentage of our revenue. On September 12, 2011, our board of directors approved a repurchase plan in compliance with Rules 10b-18 and 10b5-1 of the Securities Exchange Act of 1934 that authorizes us to repurchase up to $25 million of our shares of common stock, exclusive of any commissions, markups or expenses, from time to time through March 12, 2012. Any repurchased shares will be cancelled and return to authorized but unissued status. During the year ended December 31, 2011, we repurchased and cancelled approximately 9.5 million shares at an average price per share of approximately $2.56 per share. The price range of the shares repurchased was between $2.15 and $3.17 per share. The total amount expended before commissions, markups and expenses was approximately $24.2 million. On September 1, 2011, we completed the sale of EyeWonder LLC and chors GmbH video and rich media advertising services (EyeWonder and chors) to DG FastChannel, Inc. (DG) (now Digital Generation, Inc.) for net proceeds of $61.0 million ($66.0 million gross cash proceeds less $5.0 million held in escrow) plus an estimated $10.9 million receivable. Accordingly, the results related to the sale of EyeWonder and chors for the year ended December 31, 2011 and prior periods have been reclassified to discontinued operations and have not been included in our management's discussion and analysis of financial condition and results of operations. At the time of purchase, we were pursuing a strategy of business growth through our core content delivery services and our value-added services offerings which through the acquisition provided us access directly to the "Rich Media" advertising market. Rich Media refers to online advertising that uses a range of interactive digital media, including streaming video and audio. We subsequently determined to concentrate our value-added services in mobility, web and video content management, web application acceleration, cloud storage, and consulting which we collectively refer to as our software-as-a-service solutions (SaaS). This divestiture will enable us to focus on continuing to grow and invest in our globally distributed computing platform and our rapidly expanding SaaS solutions. See Note 5 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this annual report on Form 10-K for additional information about the sale of EyeWonder and chors rich media advertising services. 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 $3.8 million and other offering costs of approximately $0.8 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 Securities and Exchange Commission (SEC) on November 26, 2010 and the related prospectus supplement thereunder filed with the SEC on February 28, 2011. On May 2, 2011, we acquired all of the issued and outstanding shares of Clickability, Inc. (Clickability), a privately-held SaaS provider of web content management located in San Francisco, California. This transaction created the foundation for our web content management services. The aggregate purchase price consisted of approximately $4.9 million of cash paid at the closing (cash paid net of cash acquired was $2.7 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. See Note 4 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this annual report on Form 10-K for additional information about our Clickability acquisition. 39 -------------------------------------------------------------------------------- Table of Contents On May 9, 2011, we acquired all of the issued and outstanding shares of AcceloWeb, (IL) Ltd. (AcceloWeb), a Tel Aviv, Israel-based privately-held provider of advanced technology that helps speed the presentation of websites and applications. This transaction created the foundation for our web acceleration services. 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 potential value of $8.0 million ($4.0 million payable in cash and $4.0 million payable in the Company's 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 Earn-Out). The fair value of the Earn-Out was determined to be approximately $0.8 million, which is comprised of $0.4 million payable in cash (the Cash Earn-Out) and $0.4 million payable in common stock (the Common Stock Earn-Out). The carrying value of the Earn-Out is accreted to its estimated redemption value with a charge to interest expense. See Note 4 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this annual report on Form 10-K for additional information about our AcceloWeb acquisition. The following table sets forth our historical operating results, as a percentage of revenue for the periods indicated. Year Ended December 31, 2011 2010 2009 Consolidated Statement of Operations Data: Revenue 100 % 100 % 100 % Cost of revenue: Cost of services 48 47 47 Depreciation - network 16 14 18 Total cost of revenue 64 61 65 Gross profit 36 39 35 Operating expenses: General and administrative 19 19 26 Sales and marketing 23 25 25 Research and development 10 7 6 Depreciation and amortization 3 2 2 Provision for Litigation - - (50 ) Total operating expenses 55 53 9 Operating (loss) income (19 ) (14 ) 26 Other income (expense): Interest expense - - - Interest income - 1 1 Other income (expense) - - - Total other income (expense) - - 1 (Loss) income before income taxes (19 ) (14 ) 27 Income tax (benefit) expense (1 ) - 1 (Loss) income from continuing operations (18 ) (14 ) 26 Discontinued operations: Income (loss) from discontinued operations, net of income taxes 3 1 - Net (loss) income (15 )% (13 )% 26 % 40 -------------------------------------------------------------------------------- Table of Contents 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 content delivery 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 as a result of unit price compression. Our value-added services revenue represented substantially all of our revenue growth during the year ended December 31, 2011. During 2011, we added new customers through new business and through our business acquisitions, and we also elected not to renew some customers. Our average number of products per customer during the three month period ended December 31, 2011 was 1.9. Our international revenue has continued its growth, and we expect this trend to continue as we focus on our strategy of expanding our network and customer base internationally. For the years ended December 31, 2011, 2010 and 2009, respectively, revenue derived from customers outside North America accounted for approximately 30%, 27% and 22% respectively, of our total revenue. For the years ended December 31, 2011, 2010 and 2009, respectively, we derived approximately 50%, 57% and 69%, respectively of our international revenue from EMEA and approximately 50%, 43% and 31%, respectively of our international revenue from Asia Pacific. We anticipate that our Asia Pacific revenue may continue to grow as a percentage of our total international revenue. No single country outside of the United States accounted for 10% or more of our revenues during the years ended December 31, 2011, 2010 and 2009, respectively. We expect foreign revenue to continue to increase in absolute dollars in 2012. Our business is managed as a single 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 2011, sales to our top 10 customers, in terms of revenue, accounted for approximately 34% of our total revenue. During 2010 and 2009, revenue generated from sales to our top 10 customers, in terms of revenue, accounted for approximately 34% and 36%, respectively, of our total revenue. During 2011, we had one customer, Netflix, who represented more than 10% of our total revenue. For the year ended December 31, 2011, Netflix represented approximately 11% of our total revenue. During 2010, we had no customer that accounted for more than 10% of our total revenue. During 2009 we had one customer, Microsoft, who represented more than 10% of our total revenue. For the year ended December 31, 2009, Microsoft represented approximately 14% of our total revenue. We anticipate our top 10 customer concentration levels will be consistent with 2011. In addition to selling to our direct customers, we maintain relationships with a number of resellers that purchase our services for resale to their end customers. Revenue generated from sales to reseller customers was approximately 4%, 5% and 2%, respectively of our total revenue for the years ended December 31, 2011, 2010 and 2009, respectively. In addition to these revenue-related business trends, our cost of revenue increased in absolute dollars and increased as a percentage of revenue in 2011 when compared to 2010. For the year ended December 31, 2011, cost of revenue included approximately eight months of cost of revenue for Clickability and AcceloWeb, respectively. We acquired each company in May 2011. The increase in absolute dollars was primarily due to increased bandwidth and co-location fees (which included increased peering costs), due to increased traffic and expansion of our global computing platform, increased depreciation expense on our network equipment, as we continue to build-out our expanding network and refresh our network equipment, and increased payroll and related employee costs for operations personnel, who are responsible for managing and monitoring our global computing platform and delivery of our value-added services. We enter into contracts with third party network and data center providers, with terms typically ranging from several months to several years. Our contracts related to transit bandwidth provided by network operators generally commit us to pay either a fixed monthly fee or monthly fees plus additional fees for bandwidth usage above a contracted level. In March 2011 and January and September 2009, we entered into multi-year arrangements with Global Crossing for additional bandwidth and backbone capacity. The agreements required us to make advanced payments for future services to be received. Our recently amended master contract with Global Crossing provides for the use of private lines of varying capacity for our backbone. The amended agreement provides for added capacity for a four year term, and includes a substantial 41-------------------------------------------------------------------------------- Table of Contents prepayment of fees and charges. In addition to purchasing services from communications providers, we connect directly to over 900 broadband Internet service providers, or ISPs, generally without either party paying the other. This industry practice, known as settlement free peering, benefits us by allowing us to place content objects directly on user access networks, which helps us provide higher performance delivery for our customers and eliminate paying transit bandwidth fees to network operators. This practice also benefits the ISP and its customers by allowing them to receive improved content delivery through our local servers and eliminate cost of transit bandwidth associated with delivery receipt of the traffic. We do not consider these relationships to represent the culmination of an earnings process. Accordingly, we do not recognize as revenue the value to the ISPs associated with the use of our servers nor do we recognize as expense the value of the bandwidth received at discounted or no cost. These peering relationships are mutually beneficial and are not contractual commitments. In addition to settlement free peering, we incur costs for non settlement free peering as well as costs associated with connecting to the Internet service providers. During 2011, we continued to reduce our network transit bandwidth delivery costs per gigabyte transferred by entering into new supplier contracts with lower pricing and amending existing contracts to take advantage of price reductions from our existing suppliers associated with higher purchase commitments. However, due to increased traffic delivered over our network, our total transit bandwidth delivery costs increased during 2011. We anticipate our overall transit bandwidth delivery costs will continue to increase in absolute dollars as a result of expected higher traffic levels, partially offset by continued reductions in bandwidth costs per unit. In addition, during 2011, we entered into relationships for fixed price paid peering ports that will assist in cost management as we continue to increase the volume of traffic moving through our global computing platform. We expect that our overall transit bandwidth delivery costs as a percentage of revenue will remain relatively constant in 2012 compared to 2011. For the year ended December 31, 2011, operating expenses increased in absolute dollars and increased as a percentage of revenue compared to the year ended December 31, 2010. The year ended December 31, 2011 included approximately eight months of operating expenses from our acquisitions of Clickability and AcceloWeb. This increase was primarily due to increased general and administrative costs (primarily increased facility and facilities related costs, and increased payroll and related employee costs, due to increased staffing, and increased fees, licenses and non-income taxes, offset by lower litigations expenses and lower bad debt expense), increased sales and marketing expenses (primarily increased marketing expenses, increased employee events and increased fees and licenses, offset by a decrease in share-based compensation), increased research and development costs (primarily payroll and related employee costs due to increased staffing and increased share-based compensation) 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 2009, 2010 and 2011, we made capital purchases of $20.4 million, $33.5 million and $30.4 million, respectively, which represented 16%, 22% and 18%, respectively, of total revenue for each of those years. We expect to have ongoing capital expenditure requirements, as we continue to invest in, refresh and expand our global computing platform. For 2012, we currently anticipate making aggregate capital expenditures of approximately 9%-11% of total revenue for the year. Occasionally we generate revenue from certain customers that are entities related to certain of our executives. The aggregate amounts of revenue derived from these related party transactions was less than 1% for the year ended December 31, 2011. For the years ended December 31, 2010 and 2009, respectively, we did not generate any revenue from related parties. We are currently engaged in litigation with one of our principal competitors, Akamai Technologies, Inc. (Akamai) and its licensor, the Massachusetts Institute of Technology (MIT), in which these parties have alleged 42-------------------------------------------------------------------------------- Table of Contents 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. On November 18, 2011, the Federal Circuit heard oral argument regarding the case. We believe that we presented our case and positions well both in our briefs and in oral argument. The issues in this case are complex, and it is likely that it will be several months before the Federal Circuit publishes its opinion in the case. We believe that we do not infringe Akamai's patents and will continue to vigorously defend our position; however, we cannot provide any assurance that the lawsuit ultimately will be resolved in our favor. An adverse ruling could seriously impact our ability to conduct our business and to offer our products and services to our customers. A permanent injunction could prevent us from operating our content delivery services or from delivering certain types of traffic, which could impact the viability of our business. Any adverse ruling, in turn, would harm our revenue, market share, reputation, liquidity and overall financial position. We are not able at this time to estimate the range of potential loss nor, in light of the favorable United States district court order, do we believe that a loss is probable. Therefore, we have made no provision for this lawsuit in our financial statements. Our future results will be affected by many factors identified in the section captioned "Risk Factors," in this annual report on Form 10-K, including 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; • 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; • successfully integrate the businesses we have acquired; and • successfully manage the disposition of businesses we have divested from. 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 consolidated financial statements have been prepared in accordance with United States general accepted accounting principles and necessarily include certain estimates and judgments made by management. The following is a list of accounting policies that we believe are the most critical in understanding our consolidated 43 -------------------------------------------------------------------------------- Table of Contents financial position, results of operations or cash flows and that may require management to make subjective or complex judgments about matters that are inherently uncertain. Revenue Recognition We primarily derive revenue from the sale of content delivery and value-added services to our customers. Our customers generally 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 commitment. We define usage as customer data sent or received using our content delivery service, or content that is hosted or cached by us at the request or direction of our customer. We recognize the monthly minimum as revenue each month provided that an enforceable contract has been signed by both parties, the service has been delivered to the customer, the fee for the service is fixed or determinable and collection is reasonably assured. Should a customer's usage of our services exceed the monthly minimum commit, we recognize revenue for such excess in the period of the usage. For annual or other non-monthly period revenue commitments, we recognize revenue monthly based upon the customer's actual usage each month of the commitment period and only recognize any remaining committed amount for the applicable period in the last month thereof. We typically charge the customer an installation fee when the services are first activated. We do not charge installation fees for contract renewals. Installation fees are recorded as deferred revenue and recognized as revenue ratably over the estimated life of the customer arrangement. We also derive revenue from 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. We have on occasion entered into multi-element arrangements. In October 2009, the FASB issued ASU 2009-13 and this ASU addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. Specifically, this guidance amends the criteria in ASC 605-25 for separating consideration in multiple-deliverable arrangements. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) management's best estimate. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In the third quarter of 2010, we early adopted ASU 2009-13 with such adoption being effective for revenue arrangements entered into or materially modified after January 1, 2010. We recognized $1.1 million of revenue related to a multi-element arrangement accounted for in accordance with ASU 2009-13 during the year ended December 31, 2010. Prior to the adoption of ASU 2009-13 effective January 1, 2010, we accounted for multiple element arrangements in accordance with ASC 605-25. When we entered into such arrangements, each element was accounted for separately over its respective service period or at the time of delivery, provided that there was objective evidence of fair value for the separate elements. Objective evidence of fair value was based on the price charged for the element when sold separately. If the fair value of each element could not be objectively determined, the total value of the arrangement was recognized ratably over the entire service period to the extent that all services have begun to be provided, and other revenue recognition criteria have been satisfied. If the multi-element arrangement included a significant software component, we recognized software license revenue when persuasive evidence of an arrangement exists, delivery occurs, the fee is fixed or determinable and collection of the receivable is reasonably assured. If a software license contained an undelivered element, the vendor-specific objective evidence (VSOE) of fair value of the undelivered element is deferred and the revenue recognized once the element is delivered. The undelivered elements related to these arrangements are primarily software support and professional services. VSOE of fair value of software support 44 -------------------------------------------------------------------------------- Table of Contents and professional services is based upon hourly rates or fixed fees charged when those services are sold separately. If VSOE could not be established for all elements to be delivered, we deferred all amounts received under the arrangement and did not begin to recognize revenue until the delivery of the last element of the contract started. Subsequent to commencement of delivery of the last element, we commenced revenue recognition. Amounts to be received under the contract are then included in the amortizable base and recognized as revenue ratably over the remaining term of the arrangement until we have delivered all elements and have no additional performance obligations. We had certain multi-element arrangements as of December 31, 2010 that were entered into prior to the adoption of ASU 2009-13 in 2010. Under these arrangements, we recognized approximately $4.3 million, $11.0 million and $6.9 million, respectively, in revenue for the years ended December 31, 2011, 2010 and 2009. As of December 31, 2011, we had deferred revenue related to these multi-element arrangements of approximately $0.5 million that will be recognized over the remaining terms of the respective arrangements based on the underlying elements of the arrangements in accordance with our revenue recognition policies. We also sell services through a reseller channel. Assuming all other revenue recognition criteria are met, revenue from reseller arrangements is recognized over the term of the contract, based on the reseller's contracted non-refundable minimum purchase commitments plus amounts sold by the reseller to its customers in excess of the minimum commitments. These excess commitments are recognized as revenue in the period in which the service is provided. Reseller revenue was approximately 4%, 5% and 2%, respectively, of our total revenue for the years ended December 31, 2011, 2010 and 2009, respectively. At the inception of a customer contract for service, we make an assessment as to that customer's ability to pay for the services provided. If we subsequently determine that collection from the customer is not reasonably assured, we record an allowance for doubtful accounts and bad debt expense or deferred revenue for all of that customer's unpaid invoices and cease recognizing revenue for continued services provided until cash is received. Accounts Receivable and Related Reserves Trade accounts receivable are recorded at the invoiced amounts and do not bear interest. We record reserves as a reduction of our accounts receivable balance. Estimates are used in determining these reserves. We calculate the allowance for doubtful accounts using the aging of the accounts receivable method. Under this method, the allowance for doubtful accounts is based upon a calculation that uses our aging of accounts receivable and applies a reserve percentage to the specific age of the receivable to estimate the allowance for doubtful accounts. The reserve percentages are determined based on our historical write-off experience. These estimates could change significantly if our customers' financial condition changes or if the economy in general deteriorates. We perform on-going credit evaluations of our customers. If such an evaluation indicates that payment is no longer reasonably assured for current services provided, any future services provided to that customer will result in the deferral of revenue until payment is made or we determine payment is reasonably assured. In addition, we record a reserve for service credits. Reserves for service credits are measured based on an analysis of credits issued in previous periods. We do not have any off-balance sheet credit exposure related to our customers. Share-Based Compensation We account for our share-based compensation awards using the fair-value method. The grant date fair value was determined using the Black-Scholes-Merton pricing model. The Black-Scholes-Merton valuation calculation requires us to make key assumptions such as future stock price volatility, expected terms, risk-free rates and dividend yield. Our expected volatility is derived from our volatility rate as a publicly traded company and historical volatilities of similar public companies within the Internet services and network industry. Each company's historical volatility is weighted based on certain qualitative factors and combined to produce a single volatility factor used by us. The expected term is calculated using the "short-cut" method provided in the Securities Exchange Commission's Staff Accounting Bulletin No. 107, which takes into consideration the grant's 45 -------------------------------------------------------------------------------- Table of Contents contractual life and the vesting periods. The risk-free interest factor is based on the United States Treasury yield curve in effect at the time of the grant for zero coupon United States Treasury notes with maturities of approximately equal to each grant's expected term. We develop an estimate of the number of share-based awards that will be forfeited due to employee turnover. Annual changes in the estimated forfeiture rate may have a significant effect on share-based payments expense, as the effect of adjusting the rate is recognized in the period the forfeiture estimate is changed. If the actual forfeiture rate is higher than the estimated forfeiture rate, then an adjustment is made to increase the estimated forfeiture rate, which will result in a decrease to the expense recognized in the financial statements. If the actual forfeiture rate is lower than the estimated forfeiture rate, then an adjustment is made to decrease the estimated forfeiture rate, which will result in an increase to the expense recognized in the financial statements. We have never paid cash dividends, and do not currently intend to pay cash dividends, and thus have assumed a 0% dividend yield. We will continue to use judgment in evaluating the expected term, volatility and forfeiture rate related to our own share-based awards on a prospective basis, and in incorporating these factors into the model. If our actual experience differs significantly from the assumptions used to compute our share-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little share-based compensation cost. We recognize share-based compensation expense using the straight-line attribution method. We also estimate when and if performance-based awards will be earned. If an award is not considered probable of being earned, no amount of stock-based compensation is recognized. If the award is deemed probable of being earned, related compensation expense is recorded over the estimated service period. To the extent our estimates of awards considered probable of being earned changes, the amount of stock-based compensation recognized will also change. Contingencies We record contingent liabilities resulting from asserted and unasserted claims against us, when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. We disclose contingent liabilities when there is a reasonable possibility that the ultimate loss will exceed the recorded liability. Estimating probable losses requires analysis of multiple factors, in some cases including judgments about the potential actions of third party claimants and courts. Therefore, actual losses in any future period are inherently uncertain. Contingent Consideration Contingent consideration is included in Other Current Liabilities, Other Long Term Liabilities or as a component of Equity on our consolidated Balance Sheet depending upon characteristics of the obligation. In connection with certain of our acquisitions, additional contingent considerations may be earned in the future by the selling entity upon completion of certain financial milestones. We record a liability or equity that is recognized on the acquisition date for an estimate of the acquisition date fair value of the contingent consideration based on the estimated probability of achieving the milestones and the probability weighted discount on cash flows. Any change in the fair value of contingent consideration subsequent to the acquisition date is recognized in the consolidated statements of operations. Contingent consideration classified as a liability is re-measured to fair value each reporting period until the contingency is resolved. The changes in fair value are recognized in earnings. Contingent consideration classified as equity is not re-measured. Deferred Taxes and Uncertain Tax Positions We utilize the liability method of accounting for income taxes in accordance with the provisions of ASC 740. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. 46-------------------------------------------------------------------------------- Table of Contents In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. We also follow ASC 740 to account for uncertainty in income taxes recognized in the financial statements. ASC 740 states that forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence such as cumulative losses in recent years. As a result of our recent cumulative losses, we have recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income taxes in the period of such realization. ASC 740 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Our unrecognized tax benefit from uncertain tax positions decreased from January 1, 2011 to December 31, 2011. We anticipate that our unrecognized tax benefits will continue to decrease within twelve months of the reporting date, as a result of settling potential tax liabilities in certain foreign jurisdictions. We recognize interest and penalties related to unrecognized tax benefits in our tax provision. Our effective tax rate is influenced by the recognition of tax positions pursuant to the more likely than not standard that such positions will be sustained upon examination by the taxing authority. In addition, other factors such as changes in tax laws, rulings by taxing authorities and court decisions, and significant changes in our operations through acquisitions or divestitures can have a material impact on the effective tax rate. Differences between our estimated and actual effective income tax rates and related liabilities are recorded in the period they become known. We conduct business in various foreign countries. As a multinational corporation, we are subject to taxation in multiple locations, and the calculation of our foreign tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. If we ultimately determine that the payment of these liabilities will be unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine the liability no longer applies. Conversely, we record additional tax charges in a period in which we determine that a recorded tax liability is less than we expect the ultimate assessment to be. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws and regulations themselves are subject to change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for United States or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially reverse previously recorded tax liabilities. Impairment and Useful Lives of Long-Lived Assets We review our long-lived assets, such as fixed assets and amortizable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Events that would trigger an impairment review include a change in the use of the asset or forecasted negative cash flows related to the asset. When such events occur, we compare the carrying amount of the asset to the undiscounted expected future cash flows related to the asset. If this comparison indicates that impairment is present, the amount of the impairment is calculated as the difference between the carrying amount and the fair value of the asset. If a readily determinable market price does not exist, fair value is estimated using discounted expected cash flows attributable to the asset. The estimates required to apply this accounting policy include forecasted usage of the long-lived assets, the useful lives of these assets and expected future cash flows. Changes in these estimates could materially impact results from operations. 47-------------------------------------------------------------------------------- Table of Contents Goodwill and Other Intangible Assets We test goodwill for impairment on an annual basis or more frequently if events or changes in circumstances indicate that goodwill might be impaired. As of December 31, 2011 and 2010, we concluded that we had one reporting unit and assigned the entire balance of goodwill to this reporting unit. The fair value of the reporting unit was determined using our market capitalization as of October 31, 2011 and 2010. We performed an impairment test of goodwill as of each of such dates and the tests did not indicate an impairment of goodwill. Other intangible assets consist of existing technologies, customer relationships, trade names and trademarks. Purchased intangible assets, other than goodwill, are amortized over their estimated useful lives based upon the estimated economic value derived from the related intangible assets. Goodwill is carried at its historical cost. Fair Value of Financial Instruments We measure certain financial assets and liabilities at fair value based on the price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. As of December 31, 2011, our financial instruments consist principally of cash and cash equivalents, marketable securities, accounts receivable, indemnity claim assets, accounts payable, accrued expenses, contingent consideration and income taxes payable. See Note 24 of Notes to Condensed Consolidated Financial Statements included in Part II, Item 8 of this annual report on Form 10-K for additional information on the fair value of our financial instruments. Results of Continuing Operations Comparison of the Years Ended December 31, 2011 and 2010 Revenue Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Revenue $ 171,292 $ 154,223 $ 17,069 11 % Revenue increased 11%, or $17.0 million, to $171.3 million for the year ended December 31, 2011 as compared to $154.2 million for the year ended December 31, 2010. The increase in revenue for the year ended December 31, 2011 as compared to the year ended December 31, 2010, was primarily attributable to an increase in our value-added services revenue of approximately $19.6 million. Our value-added services revenue, which collectively refers to our SaaS solutions for mobility, web and video content management, web application acceleration, cloud storage, and consulting, includes revenue from the date of acquisition of Delve, Clickability and AcceloWeb. The increase in value-added services revenue is primarily attributable to increases in our web content management, storage, video publishing and mobile product offerings. The increase in value-added services revenue was offset by a decrease in our content delivery services revenue of approximately $2.5 million. During 2011, we continued to increase the amount of traffic moving through our network; however, the revenue generated from 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 content delivery services revenue increased approximately $3.7 million; however, this increase was offset by a decrease of approximately $6.2 million in our network pop-build and license revenue from Microsoft. As of December 31, 2011, we had approximately 1,565 customers as compared to approximately 1,567 as of December 31, 2010. For the years ended December 31, 2011 and 2010, approximately 30% and 27%, respectively, of our total revenues were derived from our operations located outside of North America. For the years ended December 31, 2011 and 2010, we derived approximately 50% and 57%, respectively, of our international revenue from EMEA and approximately 50% and 43%, 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. 48-------------------------------------------------------------------------------- Table of Contents We anticipate revenues will increase in 2012, which will include a full year of revenue from our business acquisitions. We expect to deliver more traffic on our network and expect continued growth in our value added services. Additionally, we expect our international revenue to continue to increase in absolute dollars and that our Asia Pacific revenue may continue to grow as a percentage of our total international revenue compared to 2011. We anticipate that our customer concentrations levels will be consistent with 2011. Cost of Revenue Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Cost of revenue $ 109,586 $ 94,582 $ 15,004 16 % 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 content delivery services, payroll and related costs and equity-related compensation for our network operations, and professional services personnel. Cost of revenue increased 16%, or $15.0 million, to $109.6 million for the year ended December 31, 2011 as compared to $94.6 million for the year ended December 31, 2010. These increases were primarily due to an increase in aggregate bandwidth and co-location fees of $6.1 million. This increase was primarily due to increased peering costs of approximately $7.6 million, increased costs associated with our transit backbone of approximately $0.7 million, and an increase in rack fees of approximately $0.5 million, associated with increased amounts of deployed network assets. These increases were offset by a decrease in our cost of bandwidth transit of approximately $2.3 million, and a decrease in other recurring cost of sales of approximately $0.4 million. In addition, depreciation increased approximately $5.8 million, due to increased amounts of deployed assets, as we continue to build-out our expanding network and to refresh our network equipment, and an increase in payroll and related employee costs of $2.9 million associated with increased staff to build and operate our global computing platform, as well as increased and professional services personnel. Additionally, we had increases in professional fees and outside services of $0.3 million, primarily due to an increase in outside consulting expense, an increase in royalty expense of $0.4 million and an increase in travel and travel-related expenses of $0.2 million. These increases were offset by a decrease in other costs of $0.7 million. The decrease in other costs is primarily related to $0.8 million of costs in 2010 associated with the sale of equipment to a customer and reduced fees and licenses of approximately $0.4 million in 2011. These decreases were offset by an increase of approximately $0.4 million in other costs associated with the delivery of our services and an increase in office and computer supplies of approximately $0.1 million. Additionally, for both the years ended December 31, 2011 and 2010, cost of revenue includes share-based compensation expense of approximately $2.4 million. Cost of revenue in 2011 and 2010 was composed of the following: Year Ended December 31, 2011 2010 (in millions) Bandwidth and co-location fees $ 57.4 $ 51.3 Depreciation - network 28.0 22.2 Payroll and related employee costs 15.6 12.7 Share-based compensation expense 2.4 2.4 Travel and travel-related expenses 0.9 0.7 Professional fees and outside services 0.9 0.6 Royalty expenses 0.8 0.4 Other costs 3.6 4.3 Total cost of revenue $ 109.6 $ 94.6 49 -------------------------------------------------------------------------------- Table of Contents We anticipate cost of revenue will increase in 2012, which will include a full year of expenses from our business acquisitions. We expect to deliver more traffic on our network, which would 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 remain constant compared to 2011 in absolute dollars, 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 share-based compensation expense will decrease compared to 2011. General and Administrative Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) General and administrative $ 32,138 $ 29,827 $ 2,311 8 % 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 8%, or $2.3 million, to $32.1 million for the year ended December 31, 2011 as compared to $29.8 million for the year ended December 31, 2010. These increases were primarily due to an increase in payroll and related employee costs of $0.6 million, which was primarily due to new hires and, to a lesser extent, to the addition of general and administrative personnel of our business acquisitions, an increase in travel and travel-related expenses of $0.2 million, and an increase in other costs of $2.4 million. The increase in other costs was primarily due to increased facilities and facilities-related costs of $1.3 million, primarily due to our relocation to our new worldwide headquarters in Tempe, Arizona in April 2011, increased fees, licenses and non-income taxes of $0.6 million, an increase in telephone and other employee costs of $0.3 million and an increase in general office expenses (office and computer supplies, postage and shipping) of approximately $0.2 million. These increases were offset by a decrease in litigation expenses of $0.7 million and a decrease in bad debt expense of $0.2 million. Other expenses include such items as rent, utilities, telephone, insurance, fees and licenses and property taxes. Additionally, general and administrative share-based compensation expense increased $0.1 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. 50 -------------------------------------------------------------------------------- Table of Contents General and administrative expenses in 2011 and 2010 were composed of the following: Year Ended December 31, 2011 2010 (in millions) Payroll and related employee costs $ 9.1 $ 8.5 Share-based compensation 6.1 6.0 Professional fees 5.8 5.9 Litigation expenses 1.4 2.1 Bad debt expense 1.1 1.3 Travel and travel related expenses 0.8 0.6 Other expenses 7.8 5.4 Total general and administrative $ 32.1 $ 29.8 In 2012, we expect our general and administrative expenses to increase in absolute dollars and decrease as a percentage of revenue compared to 2011. During 2012, which will include a full year of expenses from our business acquisitions, we expect to see increased salaries and related employee cost, increased costs and fees associated with intellectual property, as well as increased facility costs. These increases will be offset by lower litigation costs and reduced professional fees. In 2013 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 share-based compensation expense will increase in absolute dollars and decrease as a percentage of revenue in 2012. Sales and Marketing Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Sales and marketing $ 40,081 $ 38,614 $ 1,467 4 % 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 4%, or $1.5 million, to $40.1 million for the year ended December 31, 2011, as compared to $38.6 million for the year ended December 31, 2010. The increase in sales and marketing expenses was primarily due to an increase in marketing programs of approximately $0.8 million, an increase in travel and travel-related expenses of $0.2 million and an increase in other costs of $1.9 million. The increase in other costs was primarily due to increased employee events of $0.5 million, increased fees and licenses of $0.4 million, increased facility and facility-related costs of $0.3 million, increased training and seminars of $0.2 million and an increase in telephone costs of $0.2 million. These increases were offset by a decrease in share-based compensation of $1.0 million, a decrease in payroll and payroll-related expenses of $0.3 million, primarily due to increased salaries and related employee costs of $1.6 million, which included approximately $0.5 million of salaries and related employee costs from our business acquisitions, offset by lower variable compensation of $1.3 million and a lower annual bonus accrual of approximately $0.6 million. In addition, professional fees and outside services decreased $0.1 million. As mentioned above, sales and marketing share-based compensation expense decreased $1.0 million for the year ended December 31, 2011 compared to the year ended December 31, 2010. 51 -------------------------------------------------------------------------------- Table of Contents Sales and marketing expenses in 2011 and 2010 were composed of the following: Year Ended December 31, 2011 2010 (in millions) Payroll and related employee costs $ 24.3 $ 24.6 Share-based compensation expense 3.8 4.8 Travel and travel-related expense 3.2 3.0 Marketing programs 2.3 1.5 Professional fees and outside services 1.5 1.6 Other expenses 5.0 3.1 Total sales and marketing $ 40.1 $ 38.6 We anticipate our sales and marketing expense will increase in 2012 in both absolute dollars and as a percentage of revenue compared to 2011. The increase in absolute dollars (which will include a full year of expenses from our business acquisitions) is due to an expected increase in salaries and related employee costs for our sales and marketing personnel, increased commissions on higher forecast sales, an increase in marketing costs such as advertising and other lead-generating activities and an increase in facility and facility-related expenses for our sales and marketing personnel. We expect that share-based compensation expense will decrease in absolute dollars in 2012, and will remain consistent with 2011 as a percent of revenue. Research and Development Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Research and development $ 17,146 $ 10,841 $ 6,305 58 % 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 58%, or $6.3 million, to $17.1 million for the year ended December 31, 2011, as compared to $10.8 million for the year ended December 31, 2010. The increase in research and development expenses was primarily due to an increase of $5.0 million in payroll and related employee costs, primarily due to the addition of research and development personnel from our acquisitions, an increase in share-based compensation of $0.6 million, an increase in professional fees and outside services of $0.3 million and an increase in other costs of $0.4 million. The increases in payroll and related employee costs is primarily associated with our hiring of additional network and software engineering personnel and the addition of research and development personnel resulting from our business acquisitions. Other expenses include such items as travel and travel-related expenses, consulting, contract labor, telephone, and office supplies. Research and development expenses in 2011 and 2010 were composed of the following: Year Ended December 31, 2011 2010 (in millions) Payroll and related employee costs $ 11.8 $ 6.8 Share-based compensation expense 3.6 3.0 Professional fees and outside services 0.7 0.4 Other 1.0 0.6 Total research and development $ 17.1 $ 10.8 52 -------------------------------------------------------------------------------- Table of Contents We anticipate our research and development expenses will increase in 2012 (which will include a full year of expenses from our business acquisitions) in absolute dollars and increase as a percentage of revenue as we continue to make 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. We expect that share-based compensation expense will decrease in 2012. Depreciation and Amortization (Operating Expenses) Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands)Depreciation and amortization $ 4,787 $ 2,460 $ 2,327 95 % Depreciation expense consists of depreciation on equipment and furnishing 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 95%, or $2.3 million, to $4.8 million for the year December 31, 2011, as compared to $2.5 million for the year ended December 31, 2010. The increase in depreciation and amortization expense was primarily due to an increase of approximately $2.0 million in amortization of intangible assets acquired in business combinations, and to a lesser extent increased general and administrative depreciation and amortization of $0.3 million when compared to the year ended December 31, 2010. For the year ended December 31, 2011, amortization of intangibles was approximately $2.3 million. Based on our other intangible assets as of December 31, 2011, aggregate expense related to amortization of other intangible assets is expected to be $2.9 million for 2012, and $2.8 million, $2.1 million, $1.1 million and $0.3 million for fiscal years 2013, 2014, 2015 and 2016 and beyond, respectively. Interest Expense Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Interest expense $ 299 $ 62 $ 237 382 % Interest expense consists of interest paid and the amortization of deferred financing costs. Interest expense increased 382%, or $237,000, to $299,000 for the year ended December 30, 2011, as compared to $62,000 for the year ended December 31, 2010. The increase in interest expense was primarily related to increased interest expense on capital leases (approximately $127,000), the accretion of contingent consideration related to our business acquisitions (approximately $97,000), and other interest (approximately $13,000). Interest expense for the year ended December 31, 2010 included interest paid in association with a filing of non-income tax related payments and interest paid on capital leases. As of December 31, 2011, with the exception of our capital leases, we had no outstanding credit facilities. Interest Income Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Interest income $ 752 $ 910 $ (158 ) (17 )% Interest income includes interest earned on invested cash balances and marketable securities. 53 -------------------------------------------------------------------------------- Table of Contents Interest income decreased 17%, or $158,000 to $752,000 for the year ended December 31, 2011, as compared to $910,000 for the year ended December 31, 2010. During 2012, we anticipate interest income to increase as a result of expected increased average cash balances. Other (Expense) Income Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Other (expense) income $ (311 ) $ (250 ) $ 61 24 % Other expense increased $61,000 to $311,000 for year ended December 31, 2011, as compared to $250,000 for the year ended December 31, 2010. Other income (expense) consists primarily of foreign currency gains and losses. Income Tax (Benefit) Expense Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Income tax (benefit) expense $ (2,238 ) $ 727 $ (2,965 ) (408 )% We had an income tax benefit during the year ended December 31, 2011 of $2.2 million or 7% of our pre-tax loss of $32.3 million which was different than our statutory income tax rate due primarily to the tax benefit on losses from continuing operations associated with the sale of EyeWonder and chors. For the year ended December 31, 2010, we had an income tax provision of $0.7 million or (3%) of our pre-tax loss of $21.5 million. Income (loss) from Discontinued Operations Year Ended December 31, Increase Percent 2011 2010 (Decrease) Change (in thousands) Income (loss) from discontinued operations $ 4,778 $ 1,879 $ 2,899 154 % Discontinued operations relates to our EyeWonder and chors rich media advertising services. On September 1, 2011, we completed the sale of EyeWonder and chors to DG. See Note 5 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this annual report on Form 10-K for additional information about discontinued operations. Comparison of the Years Ended December 31, 2010 and 2009 Revenue Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Revenue $ 154,223 $ 131,663 $ 22,560 17 % Revenue increased 17%, or $22.6 million, to $154.2 million for the year ended December 31, 2010 as compared to $131.7 million for the year ended December 31, 2009. The increase in revenue for the year ended December 31, 2010 as compared to the year ended December 31, 2009, was attributable to an increase in both 54 -------------------------------------------------------------------------------- Table of Contents our core delivery revenue and our value-added services revenue, which includes revenue from the date of acquisition of Delve. We continued to increase the amount of traffic moving through our network; however, we continue to see a decline in our average unit sales price. Our core delivery revenue increased approximately $12.3 million, or 11% for the year ended December 31, 2010, compared to the year ended December 31, 2009. Our value-added services revenue increased approximately $10.2 million, or 69% for the year ended December 31, 2010, compared to the year ended December 31, 2009. We provide value-added services in the following areas: website and enterprise application acceleration, mobile content delivery, online and mobile ad serving, cloud storage, transcoding, computing functions and strategic consulting. As of December 31, 2010, we had approximately 1,567 customers as compared to approximately 1,370 as of December 31, 2009. For the years ended December 31, 2010 and 2009, approximately 27% and 22%, respectively, of our total revenues were derived from our operations located outside of North America. For the years ended December 31, 2010 and 2009, we derived approximately 57% and 69%, respectively, of our international revenue from EMEA and approximately 43% and 31%, 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 Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Cost of revenue $ 94,582 $ 85,623 $ 8,959 10 % 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 content delivery services, payroll and related costs and equity-related compensation for our network operations, operations and value-added services personnel. Cost of revenue increased 10%, or $9.0 million, to $94.6 million for the year ended December 31, 2010 as compared to $85.6 million for the year ended December 31, 2009. These increases were primarily due to an increase in aggregate bandwidth and co-location fees of $5.4 million due to higher traffic levels and increased amounts of deployed network assets, an increase in payroll and related employee costs of $3.8 million associated with increased staff to build and operate our global computing platform, as well as increased operations personnel, whose primary focus is on our delivery of value-added services, an increase in travel and travel-related expenses of $0.4 million, and an increase in other costs of $1.5 million. The increase in other costs was primarily related to costs associated with value-added services and the sale of equipment to certain of our customers. These increases were offset by a reduction in depreciation expense of network equipment of $1.8 million and a reduction in royalty costs of $0.3 million. Additionally, for both the years ended December 31, 2010 and 2009, cost of revenue includes share-based compensation expense of approximately $2.4 million. 55 -------------------------------------------------------------------------------- Table of Contents Cost of revenue in 2010 and 2009 was composed of the following: Year Ended December 31, 2010 2009 (in millions) Bandwidth and co-location fees $ 51.3 $ 45.9 Depreciation - network 22.2 24.0 Payroll and related employee costs 12.7 8.9 Share-based compensation expense 2.4 2.4 Travel and travel-related expenses 0.7 0.3 Professional fees and outside services 0.6 0.6 Royalty expenses 0.4 0.7 Other costs 4.3 2.8 Total cost of revenue $ 94.6 $ 85.6 General and Administrative Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) General and administrative $ 29,827 $ 34,128 $ (4,301 ) (13 )% 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 decreased 13%, or $4.3 million, to $29.8 million for the year ended December 31, 2010 as compared to $34.1 million for the year ended December 31, 2009. The decrease in general and administrative expenses was primarily due to a decrease of $3.3 million in litigation expenses related to our decreased activity pertaining to litigation with Akamai and MIT, and Level 3, a decrease of $2.4 million in bad debt expense, and a decrease in professional fees of $1.3 million, primarily lower accounting fees of approximately $1.0 million, lower acquisition-related professional fees of approximately $0.2 million, lower consulting and casual labor of approximately $0.2 million and reduced general legal fees of approximately $0.1 million, offset by increased recruiting and outside services of approximately $0.2 million. These decreases were offset by an increase of $2.7 million in payroll and related employee cost, primarily due to increased personnel and bonus accruals for our annual bonus plan, and an increase in other costs of $1.4 million, primarily due to increased fees, licenses and non-income taxes of $1.1 million, increased facilities and facilities-related costs of $0.2 million, and increased general office expenses (office and computer supplies, postage and shipping) of approximately $0.1 million. Other expenses include such items as rent, utilities, telephone, insurance, fees and licenses and property taxes. In addition, travel and travel-related expenses increased $0.2 million during 2010. Additionally, general and administrative share-based compensation expense decreased $1.6 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. 56 -------------------------------------------------------------------------------- Table of Contents General and administrative expenses in 2010 and 2009 were composed of the following: Year Ended December 31, 2010 2009 (in millions) Payroll and related employee costs $ 8.5 $ 5.8 Share-based compensation 6.0 7.6 Professional fees 5.9 7.2 Litigation expenses 2.1 5.4 Bad debt expense 1.3 3.7 Travel and travel related expenses 0.6 0.4 Other expenses 5.4 4.0 Total general and administrative $ 29.8 $ 34.1 Sales and Marketing Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Sales and marketing $ 38,614 $ 32,587 $ 6,027 19 % 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 19%, or $6.0 million, to $38.6 million for the year ended December 31, 2010, as compared to $32.6 million for the year ended December 31, 2009. The increase in sales and marketing expenses was primarily due to an increase in payroll and related employee costs of $4.5 million, primarily due to increased staffing, which resulted in higher salaries, commissions and bonuses, plus the addition of sales and marketing personnel from our business acquisition, an increase in travel and travel-related expenses of $0.6 million, an increase in marketing expenses of $0.6 million, and an increase in other expenses of $0.5 million. Other expenses include such items as rent and property taxes for our Europe and Asia Pacific sales offices, fees, licenses and non-income taxes, telephone and office supplies. Additionally, sales and marketing share-based compensation expense decreased by $0.2 million for the year ended December 31, 2010 compared to the year ended December 31, 2009. Sales and marketing expenses in 2010 and 2009 were composed of the following: Year Ended December 31, 2010 2009 (in millions) Payroll and related employee costs $ 24.6 $ 20.1 Share-based compensation expense 4.8 5.0 Travel and travel-related expense 3.0 2.4 Professional fees and outside services 1.6 1.6 Marketing programs 1.5 0.9 Other expenses 3.1 2.6 Total sales and marketing $ 38.6 $ 32.6 57 -------------------------------------------------------------------------------- Table of Contents Research and Development Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Research and development $ 10,841 $ 7,937 $ 2,904 37 % 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 37%, or $2.9 million, to $10.8 million for the year ended December 31, 2010, as compared to $7.9 million for the year ended December 31, 2009. The increase in research and development expenses was primarily due to an increase of $2.2 million in payroll and related employee costs associated with our hiring of additional network and software engineering personnel, bonus accruals for our annual bonus plan, and the addition of research and development personnel resulting from our business acquisition, an increase in share-based compensation of $0.5 million, and an increase in other expenses of $0.4 million. Other expenses include such items as travel and travel-related expenses, telephone, training and seminars and office supplies. These increases were offset by a decrease in professional fees and outside services of $0.2 million, which was primarily due to reduced contract labor. Research and development expenses in 2010 and 2009 were composed of the following: Year Ended December 31, 2010 2009 (in millions) Payroll and related employee costs $ 6.8 $ 4.6 Share-based compensation expense 3.0 2.5 Professional fees and outside services 0.4 0.6 Other 0.6 0.2 Total research and development $ 10.8 $ 7.9 Depreciation and Amortization (Operating Expenses) Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Depreciation and amortization $ 2,460 $ 2,351 $ 109 5 % Depreciation expense consists of depreciation on equipment and furnishing 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 5%, or $0.1 million, to $2.5 million for the year ended December 31, 2010, as compared to $2.4 million for the year ended December 31, 2009. The increase in depreciation and amortization expense was primarily due to an increase of approximately $0.2 million in amortization of intangibles acquired in business combinations offset by reduced depreciation of $0.1 million when compared to the year ended December 31, 2009. For the year ended December 31, 2010, amortization of intangibles was approximately $0.3 million. 58-------------------------------------------------------------------------------- Table of Contents Provision for Litigation Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Provision for Litigation $ - $ (65,645 ) $ 65,645 100 % The provision for litigation related to our accrual for potential damages and interest associated with revenue generated from allegedly infringing methods associated with the Akamai litigation. At December 31, 2008, the total accrual was $65.6 million. Based upon an April 24, 2009 court order 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, we reversed this provision for litigation of $65.6 million during the first quarter of 2009 as we no longer believe that payment of any amounts represented by the litigation provision is probable. Interest Expense Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Interest expense $ 62 $ 39 $ 23 59 % Interest expense consists of interest paid and the amortization of deferred financing costs. Interest expense increased 59%, or $23,000, to $62,000 for the year ended December 30, 2010, as compared to $39,000 for the year ended December 31, 2009. Interest expense for the year ended December 31, 2010 included interest paid in association with a filing of non-income tax related payments and interest paid on capital leases. The $39,000 for the year ended December 31, 2009 represents the amortization of loan fees associated with a then unused line of credit. The line of credit expired on October 31, 2009 and we did not renew it. As of December 31, 2010, with the exception of our capital leases, we had no outstanding credit facilities. Interest Income Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Interest income $ 910 $ 1,345 $ (435 ) (32 )% Interest income includes interest earned on invested cash balances and marketable securities. Interest income decreased 32%, or $0.4 million, to $0.9 million for the year ended December 31, 2010, as compared to $1.3 million for the year ended December 31, 2009. The decrease in interest income was primarily due to decreased cash balances. Other (Expense) Income Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Other (expense) income $ (250 ) $ (14 ) $ 236 1,686 % Other expense increased $236,000 to $250,000 for year ended December 31, 2010, as compared to $14,000 for the year ended December 31, 2009. Other expense consists primarily of foreign exchange gains and losses. 59-------------------------------------------------------------------------------- Table of Contents Income Tax (Benefit) Expense Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Income tax (benefit) expense $ 727 $ 1,084 $ (357 ) (33 )% We had an income tax provision during the year ended December 31, 2010 of $0.7 million or (3%) of our pre-tax loss of $21.5 million which was different than our statutory income tax rate due primarily to the accounting for uncertainty in income taxes, state income tax expense, and tax expense from various foreign jurisdictions. For the year ended December 31, 2009, we had an income tax provision of $1.1 million or 3% of our pre-tax income of $36.0 million. Income (loss) from Discontinued Operations Year Ended December 31, Increase Percent 2010 2009 (Decrease) Change (in thousands) Income (loss) from discontinued operations $ 1,879 $ - $ 1,879 100 % Discontinued operations relates to our EyeWonder and chors rich media advertising services. On September 1, 2011, we completed the sale of EyeWonder and chors to DG. See Note 5 of Notes to Consolidated Financial Statements included in Part II, Item 8 of this annual report on Form 10-K for additional information about discontinued operations. 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; • sale of EyeWonder and chors in September 2011; and • cash generated by operations. As of December 31, 2011, our cash, cash equivalents and marketable securities classified as current totaled $140.2 million. Included in this amount is approximately $3.7 million of cash and cash equivalents held outside the United States. Cash Flow for the Years Ended December 31, 2011, 2010 and 2009 Operating Activities Net cash provided by operating activities decreased by $10.1 million, with net cash provided by operating activities equaling $4.9 million for the year ended December 31, 2011, compared to net cash provided by operating activities of approximately $15.0 million for the year ended December 31, 2010. The change in operating cash flows comparing the year ended December 31, 2011 to the year ended December 31, 2010 was primarily due to a larger net loss from continuing operations in 2011 compared to 2010, in addition to changes in 60-------------------------------------------------------------------------------- Table of Contents operating assets and liabilities. Cash used due to changes in operating assets and liabilities was $11.0 million in the year ended December 31, 2011, compared to cash used of $4.2 million in the year ended December 31, 2010. The change related primarily to greater cash usage during the year ended December 31, 2011 related primarily to an increase in prepaid expenses and other current and long-term assets associated with advanced payments for bandwidth and backbone services with a telecommunications provider, a decrease in accounts payable related to the timing of payments, a decrease in other current liabilities primarily related to employee salary related expenditures in 2011, and a decrease in deferred revenue. Net cash provided by operating activities improved by $14.7 million, with net cash provided by operating activities equaling $15.0 million for the year ended December 31, 2010, compared to net cash provided by operating activities of approximately $0.3 million for the year ended December 31, 2009. The increase in net cash provided by operating activities for the year ended December 31, 2010 compared to the year ended December 31, 2009 was primarily due to changes in operating assets and liabilities. Cash used due to changes in operating assets and liabilities was $4.2 million in the year ended December 31, 2010, compared to $17.7 million in the year ended December 31, 2009, a decrease in usage of $13.0 million. The change related primarily to greater cash usage during the year ended December 31, 2009 related primarily to an increase in prepaid expenses and other current and long-term assets associated with advanced payments for backbone services with a telecommunications provider, a decrease in accounts payable related to the timing of payments, a decrease in other current liabilities primarily due to the payment of certain accrued legal fees and cost of sales accruals, and a decrease in deferred revenue resulting from revenue recognition, offset by cash generated from a decrease in accounts receivable due to collection efforts during this period. We expect that cash provided by operating activities may not be sufficient to cover new purchases of property and equipment during 2012 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 provided by investing activities was $15.5 million for the year ended December 31, 2011, compared to cash used in investing activities of $47.6 million for the year ended December 30, 2010. Cash provided by investing activities was principally comprised of cash received from DG for the sale of EyeWonder and chors, offset by 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 global computing platform, offset by cash generated from the sale of short-term marketable securities. Cash used in investing activities was $47.6 million for the year ended December 31, 2010, compared to cash used in investing activities of $48.3 million for the year ended December 30, 2009. 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 global computing platform, offset by cash generated from the sale of short-term marketable securities. On September 1, 2011, we sold EyeWonder and chors to DG for net proceeds of $61.0 million ($66.0 million gross cash proceeds less $5.0 million held in escrow) plus an estimated $10.9 million net receivable. On May 9, 2011, we acquired AcceloWeb, a Tel Aviv, Israel-based privately-held provider of advanced technology that helps speed the presentation of websites and applications. 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, a privately-held 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 $2.7 million. 61 -------------------------------------------------------------------------------- Table of Contents On July 30, 2010, we acquired Delve Networks, Inc. a privately-held provider of cloud-based video publishing and analytics services located in Seattle, Washington. The transaction was completed with a combination of our common stock and cash. Cash paid, net of cash acquired, was $2.6 million. In January 2010 we acquired chors and on April 30, 2010 we acquired EyeWonder, Inc. Cash paid net of cash acquired related to these acquisitions totaled $63.9 million. On September 1, 2011, we sold EyeWonder and chors to DG. We expect to have ongoing capital expenditure requirements as we continue to invest in and expand our global computing platform. We currently anticipate making aggregate capital expenditures of approximately 9% -11% of total revenue in 2012. Financing Activities Net cash provided by financing activities increased to approximately $50.8 million for the year ended December 31, 2011 compared to $0.2 million for the year ended December 31, 2010. Net cash provided by financing activities in the year ended December 31, 2011 primarily related to proceeds from the public offering of our common stock of approximately $77.0 million and the exercise of stock options of $0.7 million offset by payments made for the re-purchase of our common stock of approximately $24.4 million, payments of employee tax withholdings related to restricted stock of approximately $1.2 million and payments made on our capital lease obligations of approximately $1.4 million. Net cash provided by financing activities increased to approximately $0.2 million for the year ended December 31, 2010 compared to cash used in financing activities of approximately $0.5 million for the year ended December 31, 2009. Net cash provided by financing activities as of December 31, 2011 relates to proceeds from the exercise of stock options of $1.9 million offset by payments of employee tax withholdings related to restricted stock of approximately $1.6 million and payments made on our capital lease obligations of approximately $0.2 million. On September 12, 2011, our board of directors approved a repurchase plan that authorizes us to repurchase up to $25 million of our shares of common stock, exclusive of any commissions, markups or expenses, from time to time through March 12, 2012. Any repurchased shares will be cancelled and return to authorized but unissued status. During the period September 12, 2011 through December 31, 2011, we purchased approximately 9.5 million shares of common stock for approximately $24.2 million ($24.4 million including commissions, markups and expenses) under the repurchase plan. 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 $3.8 million and other offering costs of approximately $0.8 million. During the year ended December 31, 2011, we continued to finance purchases of new equipment. The financings are being accounted for as capital leases and have been reflected as a non-cash transaction in the condensed consolidated statements of cash flows. For the year ended December 31, 2011, we financed approximately $2.3 million in equipment purchases, with terms ranging from one to five years. During the year ended December 31, 2010 we entered into capital leases totaling $2.8 million to finance equipment purchases which have been reflected as a non-cash transaction in the condensed consolidated statements of cash flows. 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 62-------------------------------------------------------------------------------- Table of Contents 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. 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 2012 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 2012 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 December 31, 2011 over the next five years and thereafter (in thousands): Payments Due by Period Less than More thanContractual Obligations as of December 31, 2011 Total 1 year 1-3 years 3-5 years 5 years Operating Leases Bandwidth leases $ 27,221 $ 16,862 $ 8,391 $ 1,968 $ - Rack space leases 63,609 16,187 30,934 16,456 32 Real estate leases 17,731 3,180 5,807 4,711 4,033 Total operating leases 108,561 36,229 45,132 23,135 4,065 Capital leases 4,170 1,922 1,877 371 - Total commitments $ 112,731 $ 38,151 $ 47,009 $ 23,506 $ 4,065 Off Balance Sheet Arrangements As of December 31, 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, acquisition related expenses, and discontinued operations. We define EBITDA as GAAP net income (loss) before interest income, interest expense, other income and expense, provision for income taxes, depreciation and amortization and discontinued operations. 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. 63-------------------------------------------------------------------------------- Table of Contents In our February 13, 2012 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 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; • 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) For the Year Ended December 31, 2011 2010 2009 GAAP net (loss) income $ (25,288 ) $ (20,351 ) $ 34,890 Provision for litigation - - (65,645 ) Share-based compensation 15,881 16,182 17,463 Litigation defense expenses 1,376 2,149 5,412 Acquisition related expenses 776 1,527 1,481 Amortization of intangibles 2,350 319 93 (Income) loss from discontinued operations (4,778 ) (1,879 ) - Non-GAAP net loss $ (9,683 ) $ (2,053 ) $ (6,306 ) 64 -------------------------------------------------------------------------------- Table of Contents Reconciliation of GAAP Net Income (Loss) to EBITDA to Adjusted EBITDA (In thousands) (Unaudited) For the Year Ended December 31, 2011 2010 2009 GAAP net (loss) income $ (25,288 ) $ (20,351 ) $ 34,890 Depreciation and amortization 32,817 24,684 26,402 Interest expense 299 62 39 Interest and other (income) expense (441 ) (660 ) (1,331 ) Income tax (benefit) expense (2,238 ) 727 1,084 (Income) loss from discontinued operations (4,778 ) (1,879 ) - EBITDA $ 371 $ 2,583 $ 61,084 Provision for litigation - - (65,645 ) Share-based compensation 15,881 16,182 17,463 Litigation defense expenses 1,376 2,149 5,412 Acquisition related expenses 776 1,527 1,481 Adjusted EBITDA $ 18,404 $ 22,441 $ 19,795 New Accounting Pronouncements We do not expect the provisions of recently issued accounting standards to have a significant impact on our future financial statements and disclosures. 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