TMCnet News
AKAMAI TECHNOLOGIES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This quarterly report on Form 10-Q, particularly Management's Discussion and Analysis of Financial Condition and Results of Operations set forth below, and notes to our unaudited consolidated financial statements included herein contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties and are based on the beliefs and assumptions of our management as of the date hereof based on information currently available to our management. Use of words such as "believes," "expects," "anticipates," "intends," "plans," "estimates," "should," "forecasts," "if," "continues," "goal," "likely" or similar expressions indicates a forward-looking statement. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions. Actual results may differ materially from the forward-looking statements we make. See "Risk Factors" elsewhere in this quarterly report on Form 10-Q for a discussion of certain risks associated with our business. We disclaim any obligation to update forward-looking statements as a result of new information, future events or otherwise. Our management's discussion and analysis of our financial condition and results of operations is based upon our unaudited consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which we have prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim periods and with Regulation S-X promulgated under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The preparation of these unaudited consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related items, including, but not limited to, revenue recognition, accounts receivable and related reserves, valuation and impairment of marketable securities, goodwill and acquired intangible assets, capitalized internal-use software costs, impairment and useful lives of long-lived assets, income tax, and stock-based compensation. We base our estimates and judgments on historical experience and on various other assumptions that we believe to be reasonable under the circumstances at the time they are made. Actual results may differ from our estimates. See the section entitled "Application of Critical Accounting Policies and Estimates" in our annual report on Form 10-K for the year ended December 31, 2013 for further discussion of our critical accounting policies and estimates. Overview We provide cloud services for delivering, optimizing and securing online content and business applications. We primarily derive income from sales of services to customers executing contracts with terms of one year or longer. We believe that this emphasis on longer-term contracts generally allows us to have a consistent and predictable base level of revenue which is important to our financial success. Accordingly, to be successful, we must maintain our base of recurring revenue contracts by minimizing customer cancellations or terminations and limiting the impact of price reductions reflected in contract renewals and build on that base by adding new customers and increasing the amount and value of services, features and functionalities that our existing customers purchase. Accomplishing these goals requires that we compete effectively in the marketplace on the basis of quality, price and overall attractiveness of our services and technology. Our revenue is also impacted by factors such as the timing and variability of customer-specific one-time events, the prices we are able to charge for our services, the amount of traffic we serve on our network and the impact of seasonal variations on our business. We have observed the following trends related to our revenue in recent years: • On a consistent basis, we have been able to offset lost committed recurring revenue by adding new customers and increasing sales of incremental services to our existing customers. We have also experienced increases in the rate of traffic delivered to our customers that use our solutions for video, gaming, social media and software downloads. • The unit prices paid by some of our customers have declined, reflecting the impact of competition. These price reductions have primarily impacted customers for which we deliver high volumes of traffic over our network, such as media customers. • We have experienced variations in certain types of revenue from quarter to quarter; in particular, we experience higher revenue in the fourth quarter of the year for some of our solutions as a result of the holiday season. We also experience lower revenue in the summer months, particularly in Europe, from both e-commerce and media customers because overall Internet use declines during that time. In addition, we experience quarterly variations in revenue attributable to the nature and timing of software and gaming releases by our customers using our software download solutions. 19-------------------------------------------------------------------------------- Table of Contents Our profitability is also impacted by our expense levels, including direct costs to support our revenue, such as co-location and bandwidth costs, and expenses incurred to support strategic initiatives that we anticipate will generate revenue in the future. We have observed the following trends related to our profitability in recent years: • We have increased headcount to support our revenue growth and strategic initiatives, and as a result, our payroll and related compensation costs have increased. We increased our headcount by more than 800 employees in 2013 and during the nine months ended September 30, 2014 we hired an additional 950 employees, including approximately 200 employees who were part of the acquisition of Prolexic Technologies, Inc., or Prolexic, in the first quarter of 2014. We expect to continue to hire additional employees and expand globally in support of our strategic initiatives. • Network bandwidth costs represent a significant portion of our cost of revenue. Historically, we have been able to mitigate increases in these costs by reducing our network bandwidth costs per unit and investing in internal-use software development to improve the performance and efficiency of our network. Our total bandwidth costs may increase in the future as a result of expected higher traffic levels, but we believe such costs would be partially offset by anticipated continued reductions in bandwidth costs per unit and efficiency measures we take. • Co-location costs are a significant percentage of total cost of revenue. By improving our internal-use software and managing our hardware deployments to enable us to use servers more efficiently, we have been able to manage the growth of co-location costs. We expect to continue to scale our network in the future and will need to manage our co-location costs to maintain current levels of profitability. In February 2014, we completed the acquisition of Prolexic. Prolexic is expected to be slightly dilutive to our earnings per share in the first full year following the acquisition. Revenues and expenses from the acquired operations have been included in our earnings since the acquisition date of February 18, 2014. Also in February 2014, we completed an offering of $690.0 million in par value of convertible senior notes. The notes do not bear regular interest, but have an effective interest rate of 3.2% attributable to the conversion feature. Results of Operations The following table sets forth, as a percentage of revenue, consolidated statements of operations data for the periods indicated: For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenue 31.9 33.4 31.4 33.0 Research and development expense 6.5 6.3 6.5 5.9 Sales and marketing expense 19.3 17.1 18.8 17.4 General and administrative expense 16.4 16.8 16.8 16.1 Amortization of acquired intangible assets 1.7 1.2 1.7 1.5 Restructuring (benefits) charges - - 0.1 0.1 Total costs and operating expenses 75.8 74.8 75.3 74.0 Income from operations 24.2 25.2 24.7 26.0 Interest income 0.4 0.4 0.4 0.4 Interest expense (0.9 ) - (0.8 ) - Other expense, net - (0.1 ) (0.1 ) - Income before provision for income taxes 23.7 25.5 24.2 26.4 Provision for income taxes 5.3 5.3 7.6 7.8 Net income 18.4 % 20.2 % 16.6 % 18.6 % 20-------------------------------------------------------------------------------- Table of Contents Revenue Revenue during the periods presented was as follows (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 % Change 2014 2013 % Change Revenue $ 498,042 $ 395,790 25.8 % $ 1,427,579 $ 1,141,942 25.0 % During the three- and nine-month periods ended September 30, 2014, the increase in our revenue as compared to the same periods in 2013 was driven by continued strong demand for our services across all of our solutions and geographies. For the three- and nine-month periods ended September 30, 2014 and 2013, no single customer accounted for 10% or more of revenue. For the three- and nine-month periods ended September 30, 2014, approximately 27% and 28%, respectively, of our revenue was derived from our operations located outside of the United States. For each of the three- and nine-month periods ended September 30, 2013, approximately 27% of our revenue was derived from our operations located outside the United States. No single country outside of the United States accounted for 10% or more of revenue during any of these periods. Revenue from our operations in the United States experienced strong performance driven by our large social media, gaming and video delivery customer base during the nine months ended September 30, 2014. During the first three quarters of 2014, we also experienced strong revenue growth from our operations in the Asia Pacific region and continued improvement in revenue growth from our operations in Europe, the Middle East and Africa, primarily driven by growth across all of our solutions. Changes in foreign currency exchange rates positively impacted our revenue by $0.5 million and $1.8 million during the three- and nine-month periods ended September 30, 2014, respectively, as compared to the same periods in 2013. For the each of the three- and nine-month periods ended September 30, 2014, resellers accounted for 25% of revenue as compared to 21% of revenue for the same periods in 2013. The increase in revenue from resellers was attributable to continued traction with our carrier channel partners, as well as contributions from Prolexic's reseller relationships. The following table quantifies the contribution to revenue during the periods presented from our solution categories (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 % Change 2014 2013 % Change Media Delivery Solutions $ 230,576 $ 189,066 22.0 % $ 661,583 $ 549,672 20.4 % Performance and Security Solutions 224,169 173,864 28.9 639,561 498,387 28.3 Service and Support Solutions 43,297 32,860 31.8 126,435 91,754 37.8 Advertising Decision Solutions and other - - - - 2,129 (100.0 ) Total revenue $ 498,042 $ 395,790 25.8 % $ 1,427,579 $ 1,141,942 25.0 % The increase in Media Delivery Solutions revenue for the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, was due to strong demand across most of our customer base. We experienced particularly strong growth from our social media, gaming, video and software download customers. The increase in Performance and Security Solutions revenue for the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, was partially due to increased revenue attributable to Prolexic. Additionally, there was an increase in demand for our web performance and cloud security solutions. The increase in Service and Support Solutions revenue for the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, was due to increases in sales of our service and support offerings due to strong service attachment rates for customers of our Media Delivery and Performance and Security Solutions. The Advertising Decision Solutions business was divested in the first quarter of 2013. 21 -------------------------------------------------------------------------------- Table of Contents Cost of Revenue Cost of revenue consisted of the following for the periods presented (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 % Change 2014 2013 % Change Bandwidth fees $ 32,391 $ 26,628 21.6 % $ 90,638 $ 77,339 17.2 % Co-location fees 28,716 27,749 3.5 85,610 83,191 2.9 Network build-out and supporting services 9,721 9,332 4.2 31,018 27,279 13.7 Payroll and related costs 36,825 29,404 25.2 104,517 82,152 27.2 Stock-based compensation, including amortization of prior capitalized amounts 6,498 5,017 29.5 16,118 14,048 14.7 Depreciation of network equipment 28,135 21,960 28.1 78,586 60,457 30.0 Amortization of internal-use software 16,526 11,949 38.3 41,255 32,670 26.3 Total cost of revenue $ 158,812 $ 132,039 20.3 % $ 447,742 $ 377,136 18.7 % As a percentage of revenue 31.9 % 33.4 % 31.4 % 33.0 % The increase in total cost of revenue for the three- and nine-month periods ended September 30, 2014 as compared to the same periods in 2013 was primarily due to increases in: • payroll and related costs of service personnel due to headcount growth to support our Service and Support Solutions revenue growth, as well as headcount growth related to our network operations to support our other solution categories; • amounts paid to network providers for bandwidth fees to support the increase in traffic served on our network; and • depreciation and amortization of network equipment and internal-use software as we continued to invest in our infrastructure and release internally developed software onto our network. In recent years, we have reduced our network bandwidth costs per unit and have successfully managed our co-location fees, which contributed to the decrease in our cost of revenue as a percentage of revenue during the three- and nine-month periods ended September 30, 2014 as compared to the same periods in 2013. We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. Our minimum commitments related to bandwidth usage and co-location services may vary from period to period depending on the timing and length of contract renewals with our service providers. There have been no significant changes to the commitments reported in our annual report on Form 10-K for the year ended December 31, 2013, other than normal period-to-period variations. We believe that cost of revenue will increase during the fourth quarter of 2014 as compared to each of the first three quarters of 2014, primarily because we expect to deploy more servers and deliver more traffic on our network, which will result in higher expenses associated with the increased traffic and additional co-location fees. Additionally, for the remainder of 2014, we anticipate higher payroll and related costs, as compared to the first three quarters of 2014, associated with an increase in headcount of our network and professional services personnel. We plan to continue to make investments in our network in the foreseeable future in the expectation that our customer base and sales of services to our existing customers will continue to grow. 22-------------------------------------------------------------------------------- Table of Contents Research and Development Expenses Research and development expenses consisted of the following for the periods presented (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 % Change 2014 2013 % Change Payroll and related costs $ 49,617 $ 36,526 35.8 % $ 138,421 $ 100,830 37.3 % Stock-based compensation 4,979 4,583 8.6 14,517 12,819 13.2 Capitalized salaries and related costs (24,496 ) (17,692 ) 38.5 (66,552 ) (50,137 ) 32.7 Other expenses 2,483 1,440 72.4 6,483 3,847 68.5 Total research and development $ 32,583 $ 24,857 31.1 % $ 92,869 $ 67,359 37.9 % As a percentage of revenue 6.5 % 6.3 % 6.5 % 5.9 % The increase in research and development expenses during the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, was due to increases in payroll and related costs as a result of continued growth in headcount to support investments in new product development, partially offset by increases in capitalized salaries and related costs. Research and development costs consist of external consulting expenses and payroll and related costs for personnel involved in the development of internal-use software used to deliver our services and operate our network. These development costs are expensed as incurred, other than certain internal-use software development costs eligible for capitalization. During the three- and nine-month periods ended September 30, 2014, we capitalized $3.4 million and $10.3 million, respectively, of stock-based compensation. During the three- and nine-month periods ended September 30, 2013, we capitalized $2.8 million and $8.6 million, respectively, of stock-based compensation. These capitalized internal-use software costs are amortized to cost of revenue over their estimated useful lives of two years. We believe that research and development expenses will increase in absolute dollars during the fourth quarter of 2014 as compared to each of the first three quarters of 2014, as we expect to continue to hire additional development personnel in order to make improvements to our core technology and develop new and enhanced services. Sales and Marketing Expenses Sales and marketing expenses consisted of the following for the periods presented (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 % Change 2014 2013 % Change Payroll and related costs $ 68,684 $ 48,562 41.4 % $ 185,461 $ 133,761 38.7 % Stock-based compensation 12,110 10,048 20.5 35,438 29,278 21.0 Marketing programs and related costs 7,314 4,184 74.8 25,093 18,545 35.3 Other expenses 8,107 5,017 61.6 22,750 16,742 35.9 Total sales and marketing $ 96,215 $ 67,811 41.9 % $ 268,742 $ 198,326 35.5 %As a percentage of revenue 19.3 % 17.1 % 18.8 % 17.4 % The increase in sales and marketing expenses during the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, was primarily due to higher payroll and related costs, as we invested in our sales and marketing organization, and to an increase in marketing programs and related costs in support of our go-to-market strategy and ongoing geographic expansion. We believe that sales and marketing expenses will increase in absolute dollars during the fourth quarter of 2014 as compared to each of the first three quarters of 2014, due to an expected increase in payroll and related costs as a result of continued headcount growth, primarily with respect to our direct sales team and corporate marketing function. 23-------------------------------------------------------------------------------- Table of Contents General and Administrative Expenses General and administrative expenses consisted of the following for the periods presented (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 % Change 2014 2013 % Change Payroll and related costs $ 38,611 $ 27,185 42.0 % $ 106,635 $ 75,583 41.1 % Stock-based compensation 7,889 6,963 13.3 25,944 21,883 18.6 Depreciation and amortization 10,883 7,054 54.3 28,932 18,858 53.4 Facilities-related costs 13,538 11,514 17.6 39,010 31,451 24.0 Provision for doubtful accounts 784 (140 ) (660.0 ) 955 391 144.2 Acquisition-related costs - 219 (100.0 ) 3,836 587 553.5 Professional and otherfees 10,200 13,839 (26.3 ) 34,634 34,612 0.1 Total general and administrative $ 81,905 $ 66,634 22.9 % $ 239,946 $ 183,365 30.9 % As a percentage of revenue 16.4 % 16.8 % 16.8 % 16.1 % The increase in general and administrative expenses for the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, was primarily due to the expansion of company infrastructure to support investments in engineering, go-to-market capacity and enterprise expansion initiatives. In particular, we increased general and administrative headcount and our facility footprint, which increased payroll and related costs, facilities-related costs and depreciation and amortization. In addition, acquisition-related costs increased for the nine-month period ended September 30, 2014 due to the acquisition of Prolexic. During the last quarter of 2014, we expect general and administrative expenses to increase in absolute dollars as compared to each of the first three quarters of 2014, due to anticipated higher payroll and related costs and facilities-related costs attributable to increased hiring, investment in information technology and planned facility expansion. Amortization of Acquired Intangible Assets For the Three Months For the Nine Months Ended September 30, Ended September 30, (in thousands) 2014 2013 % Change 2014 2013 % Change Amortization of acquired intangible assets $ 8,403 $ 4,859 72.9 % $ 23,654 $ 16,653 42.0 % As a percentage of revenue 1.7 % 1.2 % 1.7 % 1.5 % The increase in amortization of acquired intangible assets for the three- and nine-month periods ended September 30, 2014 as compared to the same periods in 2013 was primarily due to the amortization of assets related to the acquisition of Prolexic. Based on our intangible assets at September 30, 2014, we expect amortization of acquired intangible assets to be approximately $8.4 million for the fourth quarter of 2014, and $26.8 million, $25.2 million, $23.1 million and $16.2 million for 2015, 2016, 2017 and 2018, respectively. 24-------------------------------------------------------------------------------- Table of Contents Restructuring (Benefits) Charges For the Three Months For the Nine Months Ended September 30, Ended September 30, (in thousands) 2014 2013 % Change 2014 2013 % Change Restructuring (benefits) charges $ (115 ) $ 69 (266.7 )% $ 1,189 $ 891 33.4 % As a percentage of revenue - % - % 0.1 % 0.1 % The restructuring (benefits) charges for the three- and nine-month periods ended September 30, 2014 consisted of severance and related activity as a result of the acquisition of Prolexic, in addition to a contract termination fee incurred during the second quarter of 2014. The charges for the three- and nine-month periods ended September 30, 2013 consisted of pending workforce claims prior to 2013. Interest Income For the Three Months For the Nine Months Ended September 30, Ended September 30, (in thousands) 2014 2013 % Change 2014 2013 % Change Interest income $ 2,010 $ 1,458 37.9 % $ 5,389 $ 4,543 18.6 % As a percentage of revenue 0.4 % 0.4 % 0.4 % 0.4 % For the periods presented, interest income consists of interest earned on invested cash balances and marketable securities. Interest Expense For the Three Months For the Nine Months Ended September 30, Ended September 30, (in thousands) 2014 2013 % Change 2014 2013 % Change Interest expense $ (4,482 ) $ - 100.0 % $ (10,939 ) $ - 100.0 % As a percentage of revenue (0.9 )% - % (0.8 )% - % For the periods presented, interest expense consists of the amortization of the debt discount and debt issuance costs related to our convertible senior notes issued in February 2014. Other Expense, Net For the Three Months For the Nine Months Ended September 30, Ended September 30, (in thousands) 2014 2013 % Change 2014 2013 % Change Other expense, net $ (188 ) $ (305 ) (38.4 )% $ (1,968 ) $ (96 ) 1,950.0 % As a percentage of revenue - % (0.1 )% (0.1 )% - % Other expense, net primarily represents net foreign exchange gains and losses incurred and other non-operating expense and income items. The fluctuations in other expense, net for the three- and nine-month periods ended September 30, 2014, as compared to the same periods in 2013, were primarily due to foreign currency exchange rate fluctuations on inter-company and other non-functional currency transactions. Other expense, net may fluctuate in the future based upon changes in foreign exchange rates or other events. 25-------------------------------------------------------------------------------- Table of Contents Provision for Income Taxes For the Three Months For the Nine Months Ended September 30, Ended September 30, (in thousands) 2014 2013 % Change 2014 2013 % Change Provision for income taxes $ 26,424 $ 20,918 26.3 % $ 109,078 $ 89,521 21.8 % As a percentage of revenue 5.3 % 5.3 % 7.6 % 7.8 % Effective income tax rate 22.5 % 20.8 % 31.5 % 29.6 % For the nine months ended September 30, 2014, our effective income tax rate was primarily lower than the federal statutory tax rate due to a state tax benefit from software development activities and income from foreign jurisdictions that is taxed at lower rates compared to the statutory tax rates in the United States; partially offset by the effects of accounting for stock-based compensation in accordance with the authoritative guidance for share-based payments and state income taxes. For the nine months ended September 30, 2013, our effective income tax rate was lower than the federal statutory tax rate mainly due to the federal benefit recorded related to the domestic production activities deduction, the composition of income in foreign jurisdictions with lower rates, as well as the reinstatement of the federal research and development credit at the beginning of 2013, which included a one-time retroactive impact for fiscal year 2012. The increase in the provision for income taxes in the nine-month period ended September 30, 2014 as compared to the same period in 2013 was mainly due to the increase in operating income in 2014, a change in the composition of projected income in different jurisdictions and the expiration of the federal research and development credit at the end of 2013, partially offset by the federal domestic production activities deduction and state software development activities benefit. While we expect our effective income tax rate to increase slightly during the fourth quarter of 2014, due to discrete items in the third quarter of 2014 that had a positive impact on our tax rate, this expectation does not take into consideration the effect of potential other one-time discrete items that may be recorded in the future. The effective tax rate could be different depending on the nature and timing of dispositions of incentive stock options and other employee equity awards. Further, our effective tax rate may fluctuate within a fiscal year and from quarter to quarter due to items arising from discrete events, including settlements of tax audits and assessments, the resolution or identification of tax position uncertainties and acquisitions of other companies. In determining our net deferred tax assets and valuation allowances, annualized effective tax rates and cash paid for income taxes, management is required to make judgments and estimates about domestic and foreign profitability, the timing and extent of the utilization of net operating loss carryforwards, applicable tax rates, transfer pricing methodologies and tax planning strategies. Judgments and estimates related to our projections and assumptions are inherently uncertain; therefore, actual results could differ materially from our projections. We have recorded certain tax reserves to address potential exposures involving our income tax and sales and use tax positions. These potential tax liabilities result from the varying application of statutes, rules, regulations and interpretations by different taxing jurisdictions. Our estimate of the value of these tax reserves reflects assumptions based on past experiences and judgments about the interpretation of statutes, rules and regulations by taxing jurisdictions. It is possible that the ultimate tax liability or benefit from these matters may be materially greater or less than the amount that we have estimated. Non-GAAP Financial Measures In addition to providing financial measurements based on GAAP, we publicly discuss additional financial measures that are not prepared in accordance with GAAP, or non-GAAP financial measures. Management uses non-GAAP financial measures, in addition to GAAP financial measures, to understand and compare operating results across accounting periods, for financial and operational decision making, for planning and forecasting purposes and to evaluate our financial performance. These non-GAAP financial measures are: non-GAAP income from operations, non-GAAP operating margin, non-GAAP net income, non-GAAP net income per diluted share, Adjusted EBITDA and Adjusted EBITDA margin, as discussed below. Management believes that these non-GAAP financial measures reflect our ongoing business in a manner that allows for meaningful comparisons and analysis of trends in our business, as they exclude expenses and gains that may be infrequent, unusual in nature or otherwise not reflective of our ongoing operating results. Management also believes that these non-GAAP financial measures provide useful information to investors in understanding and evaluating our operating results and future 26-------------------------------------------------------------------------------- Table of Contents prospects in the same manner as management and in comparing financial results across accounting periods and to those of peer companies. The non-GAAP financial measures do not replace the presentation of our GAAP financial measures and should only be used as a supplement to, not as a substitute for, our financial results presented in accordance with GAAP. The non-GAAP adjustments, and our basis for excluding them from non-GAAP financial measures, are outlined below: • Amortization of acquired intangible assets - We have incurred amortization of intangible assets, included in our GAAP financial statements, related to various acquisitions we made. The amount of an acquisition's purchase price allocated to intangible assets and term of its related amortization can vary significantly and are unique to each acquisition; therefore, we exclude amortization of acquired intangible assets from our non-GAAP financial measures to provide investors with a consistent basis for comparing pre- and post-acquisition operating results. • Stock-based compensation and amortization of capitalized stock-based compensation - Although stock-based compensation is an important aspect of the compensation paid to our employees and executives, the expense varies with changes in the stock price and market conditions at the time of grant, varying valuation methodologies, subjective assumptions and the variety of award types. This makes the comparison of our current financial results to previous and future periods difficult to interpret; therefore, we believe it is useful to exclude stock-based compensation and amortization of capitalized stock-based compensation from our non-GAAP financial measures in order to better understand the performance of our core business performance and to be consistent with the way investors evaluate our performance and compare our operating results to peer companies. • Acquisition-related costs - Acquisition-related costs include transaction fees, due diligence costs and other one-time direct costs associated with strategic activities. In addition, subsequent adjustments to our initial estimated amount of contingent consideration associated with specific acquisitions are included within acquisition-related costs. These amounts are impacted by the timing and size of the acquisitions. We exclude acquisition-related costs from our non-GAAP financial measures to provide a useful comparison of our operating results to prior periods and to our peer companies because such amounts vary significantly based on the magnitude of our acquisition transactions. • Restructuring (benefits) charges - We have incurred restructuring (benefits) charges that are included in our GAAP financial statements, primarily related to workforce reductions and estimated costs of exiting facility lease commitments. We exclude these items from our non-GAAP financial measures when evaluating our continuing business performance as such items are not consistently recurring and do not reflect expected future operating expense, nor provide meaningful insight into the fundamentals of current or past operations of our business. • Benefit from adoption of software development activities - We recognized a benefit to non-income-related tax expense associated with the adoption of software development activities. We exclude this item from our non-GAAP financial measures because transactions of this nature occur infrequently and are not considered part of our core business operations. • Gains and other activity related to divestiture of a business - We recognized a gain and other activity related to the divestiture of our Advertising Decision Solutions business. We exclude gains and other activity related to divestiture of a business from our non-GAAP financial measures because transactions of this nature occur infrequently and are not considered part of our core business operations. 27-------------------------------------------------------------------------------- Table of Contents • Amortization of debt discount and issuance costs and amortization of capitalized interest expense - In February 2014, we issued $690 million of convertible senior notes due 2019 with a coupon interest rate of 0%. The imputed interest rate of the convertible senior notes was approximately 3.2%. This is a result of the debt discount recorded for the conversion feature that is required to be separately accounted for as equity, thereby reducing the carrying value of the convertible debt instrument. The debt discount is amortized as interest expense together with the issuance costs of the debt which are recorded as an asset in the consolidated balance sheet. All of our interest expense is comprised of these non-cash components and is excluded from management's assessment of our operating performance because management believes the non-cash expense is not indicative of ongoing operating performance. • Loss on investments - We have incurred losses from the impairment of certain investments. We believe excluding these amounts from our non-GAAP financial measures is useful to investors as they occur infrequently, are not representative of our core business operations or meaningful in evaluating our business results. • Income tax effect of non-GAAP adjustments and certain discrete tax items - The non-GAAP adjustments described above are reported on a pre-tax basis. The income tax effect of non-GAAP adjustments is the difference between GAAP and non-GAAP income tax expense. Non-GAAP income tax expense is computed on non-GAAP pre-tax income (GAAP pre-tax income adjusted for non-GAAP adjustments) and excludes certain discrete tax items (such as recording or release of valuation allowances), if any. We believe that applying the non-GAAP adjustments and their related income tax effect allows us to more properly reflect the income attributable to our core operations. The following table reconciles GAAP income from operations to non-GAAP income from operations and non-GAAP operating margin for the periods presented (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Income from operations $ 120,239 $ 99,521 $ 353,437 $ 298,212 Amortization of acquired intangible assets 8,403 4,859 23,654 16,653 Stock-based compensation 28,008 24,479 84,800 72,211 Amortization of capitalized stock-based compensation 3,556 2,224 7,500 6,103 Amortization of capitalized interest expense 45 - 63 - Acquisition-related costs 270 219 4,454 587 Restructuring (benefits) charges (115 ) 69 1,189 891 Benefit from adoption of software development activities (2,670 ) - (2,670 ) - (Gain) and other activity related to divestiture of a business - 1,093 - (1,188 ) Non-GAAP income from operations $ 157,736 $ 132,464 $ 472,427 $ 393,469 Non-GAAP operating margin 32 % 33 % 33 % 34 % 28-------------------------------------------------------------------------------- Table of Contents The following table reconciles GAAP net income to non-GAAP net income and non-GAAP net income per diluted share for the periods presented (in thousands, except per share data): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Net income $ 91,155 $ 79,756 $ 236,841 $ 213,138 Amortization of acquired intangible assets 8,403 4,859 23,654 16,653 Stock-based compensation 28,008 24,479 84,800 72,211 Amortization of capitalized stock-based compensation 3,556 2,224 7,500 6,103 Amortization of capitalized interest expense 45 - 63 - Acquisition-related costs 270 219 4,454 587 Restructuring (benefits) charges (115 ) 69 1,189 891 Benefit from adoption of software development activities (2,670 ) - (2,670 ) - (Gain) and other activity related to divestiture of a business - 1,093 - (1,188 ) Amortization of debt discount and issuance costs 4,482 - 10,939 - Loss on investments - - 393 - Income tax effect of above non-GAAP adjustments and certain discrete tax items (21,771 ) (22,439 ) (45,333 ) (40,891 ) Non-GAAP net income $ 111,363 $ 90,260 $ 321,830 $ 267,504 GAAP net income per diluted share $ 0.50 $ 0.44 $ 1.31 $ 1.17 Non-GAAP net income per diluted share $ 0.62 $ 0.50 $ 1.78 $ 1.47 Shares used in diluted per share calculations 180,955 181,922 181,278 181,623 Non-GAAP net income per diluted share is calculated as non-GAAP net income divided by diluted weighted average common shares outstanding. GAAP diluted weighted average shares outstanding are adjusted in non-GAAP per share calculations for the shares that would be delivered to us pursuant to the note hedge transactions entered into in connection with the issuance of $690.0 million in par value of convertible senior notes due 2019. Under GAAP, shares delivered under hedge transactions are not considered offsetting shares in the fully diluted share calculation until they are delivered. However, we would receive a benefit from the note hedge transactions and would not allow the dilution to occur, so management believes that adjusting for this benefit provides a meaningful view of net income per share. Until our weighted average stock price is greater than $89.56, the initial conversion price, there will be no difference between our GAAP and non-GAAP diluted weighted average common shares outstanding. We consider Adjusted EBITDA to be another important indicator of the operational strength and performance of our business and a good measure of our historical operating trends. Adjusted EBITDA eliminates items that are either not part of our core operations or do not require a cash outlay. We define Adjusted EBITDA as GAAP net income excluding the following items: interest income; income taxes; depreciation and amortization of tangible and intangible assets; stock-based compensation; amortization of capitalized stock-based compensation; restructuring (benefits) charges; acquisition-related costs; certain gains and losses on investments; benefit from adoption of software development activities deduction; gains and other activity related to divestiture of a business; foreign exchange gains and losses; loss on early extinguishment of debt; amortization of debt discount and issuance costs; amortization of capitalized interest expense; gains and losses on legal settlements; and other non-recurring or unusual items that may arise from time to time. Adjusted EBITDA margin represents Adjusted EBITDA stated as a percentage of revenue. 29-------------------------------------------------------------------------------- Table of Contents The following table reconciles GAAP net income to Adjusted EBITDA and Adjusted EBITDA margin for the periods presented (in thousands): For the Three Months For the Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Net income $ 91,155 $ 79,756 $ 236,841 $ 213,138 Amortization of acquired intangible assets 8,403 4,859 23,654 16,653 Stock-based compensation 28,008 24,479 84,800 72,211 Amortization of capitalized stock-based compensation 3,556 2,224 7,500 6,103 Amortization of capitalized interest expense 45 - 63 - Acquisition-related costs 270 219 4,454 587 Restructuring (benefits) charges (115 ) 69 1,189 891 Benefit from adoption of software development activities (2,670 ) - (2,670 ) - (Gain) and other activity related to divestiture of a business - 1,093 - (1,188 ) Interest income (2,010 ) (1,458 ) (5,389 ) (4,543 ) Amortization of debt discount and issuance costs 4,482 - 10,939 - Provision for income taxes 26,424 20,918 109,078 89,521 Depreciation and amortization 55,411 40,871 148,426 111,699 Other expense, net 188 305 1,968 96 Adjusted EBITDA $ 213,147 $ 173,335 $ 620,853 $ 505,168 Adjusted EBITDA margin 43 % 44 % 43 % 44 % Impact of Foreign Currency Exchange Rates on Revenue Revenue from our international operations has historically been an important contributor to our total revenue. Consequently, our revenue results have been impacted, and management expects they will continue to be impacted, by fluctuations in foreign currency exchange rates. For example, when the local currencies of our foreign subsidiaries weaken, our consolidated results stated in U.S. dollars are negatively impacted. Because exchange rates are a meaningful factor in understanding period-to-period comparisons, management believes the presentation of the impact of foreign currency exchange rates on revenue enhances the understanding of our revenue results and evaluation of performance in comparison to prior periods. The information presented is calculated by translating current period results using the same average foreign currency exchange rates per month from the comparative period. Liquidity and Capital Resources To date, we have financed our operations primarily through public and private sales of debt and equity securities and cash generated by operations. As of September 30, 2014, our cash, cash equivalents and marketable securities, which consisted primarily of corporate bonds and U.S. government agency securities, totaled $1.6 billion. We place our cash investments in instruments that meet high quality credit standards, as specified in our investment policy. Our investment policy also limits the amount of our credit exposure to any one issue or issuer and seeks to manage these assets to achieve our goals of preserving principal and maintaining adequate liquidity at all times. Changes in cash, cash equivalents and marketable securities are dependent upon changes in, among other things, working capital items such as deferred revenues, accounts payable, accounts receivable and various accrued expenses, as well as changes in our capital and financial structure due to common stock repurchases, debt repurchases and issuances, stock option exercises, purchases and sales of marketable securities and similar events. We believe our strong balance sheet and cash position are important competitive differentiators that provide the financial flexibility necessary to make investments at opportune times. We expect to continue to evaluate strategic investments to strengthen our business on an ongoing basis. 30-------------------------------------------------------------------------------- Table of Contents As of September 30, 2014, we had cash and cash equivalents of $139.9 million held in accounts outside the United States. An immaterial amount of these funds would be subject to U.S. federal taxation if repatriated, with such tax liability partially offset by foreign tax credits. The remainder of our cash and cash equivalents held outside the United States are subject to, or offset by, inter-company obligations to our parent company in the United States and, therefore, are not subject to United States federal taxation. As a result, our liquidity is not materially impacted by the amount of cash and cash equivalents held in accounts outside the United States. Cash Provided by Operating Activities For the Nine Months Ended September 30, (in thousands) 2014 2013 Net income $ 236,841 $ 213,138 Non-cash reconciling items included in net income 264,581 188,200 Changes in operating assets and liabilities (38,893 ) (9,162 ) Net cash flows provided by operating activities $ 462,529 $ 392,176 The increase in cash provided by operating activities for the nine-month period ended September 30, 2014 as compared to the same period in 2013 was primarily due to increased profitability, partially offset by the timing of collections and payments of working capital, particularly in the timing of estimated tax payments. Cash Used in Investing Activities For the Nine Months Ended September 30, (in thousands) 2014 2013Cash paid for acquired businesses, net of cash acquired $ (386,532 ) $ (27,420 ) Purchases of property and equipment and capitalization of internal-use software development costs (226,307 ) (197,738 ) Net marketable securities activity (436,776 ) (58,854 ) Other investing activity 7,222 (2,559 ) Net cash used in investing activities $ (1,042,393 ) $ (286,571 ) The increase in cash used in investing activities for the nine-month period ended September 30, 2014 as compared to the same period in 2013, primarily relates to the acquisition of Prolexic. The increase also relates to the increase in net purchases of marketable securities as a result of investment of the proceeds of our convertible senior notes issuance. Expenditures for internal-use software also increased during the nine-month period ended September 30, 2014 as compared to the same period in 2013 as we continued to invest in our network with the goal of enhancing and adding functionality to our service offerings. We expect capital expenditures to increase in the fourth quarter of 2014 as compared to each of the first three quarters of 2014, related to planned investment in our network infrastructure intended to enable us to handle the traffic growth we expect on the network in the future. We also expect increased spending as a result of planned global facility build-outs and IT-related expenditures to support our increase in headcount and expansion of company infrastructure to support our engineering and go-to-market capacity. 31-------------------------------------------------------------------------------- Table of Contents Cash Provided by (Used in) Financing Activities For the Nine Months Ended September 30, (in thousands) 2014 2013 Activity related to convertible senior notes $ 655,413 $ - Activity related to stock-based compensation 56,114 44,011 Repurchases of common stock (226,513 ) (112,408 ) Other financing activities (19,437 ) - Net cash provided by (used in) financing activities $ 465,577 $ (68,397 ) Cash provided by financing activities during the nine-month period ended September 30, 2014 was primarily the result of the convertible senior notes issued in February 2014 and related note hedge and warrant transactions. Concurrent with the convertible senior notes issuance, we also repurchased $62.0 million of our common stock, which contributed to the increase in repurchases of common stock as compared to the nine-month period ended September 30, 2013. In October 2013, the Board of Directors authorized a $750.0 million share repurchase program, effective from October 16, 2013 through December 31, 2016. The goal of the October 2013 share repurchase program is to both offset dilution from our equity compensation plans and to provide the flexibility to increase distributions to our shareholders as business and market conditions warrant. During the nine-month period ended September 30, 2014, we repurchased 3.9 million shares of common stock at a weighted average price of $57.71 per share for an aggregate of $226.5 million. During the nine-month period ended September 30, 2013, we repurchased 2.8 million shares of common stock at a weighted average price of $39.65 per share for an aggregate of $112.4 million. The timing and amount of any future share repurchases will be determined by our management based on its evaluation of market conditions and other factors. Convertible Senior Notes In February 2014, we issued $690.0 million in par value of convertible senior notes due 2019 and entered into related convertible note hedge and warrant transactions. The terms of the notes, hedge and warrant transactions are discussed more fully in Note 6 to the consolidated financial statements included elsewhere in this quarterly report on Form 10-Q. We intend to use the net proceeds of the offering for share repurchases, working capital and general corporate purposes, including potential acquisitions and other strategic transactions. In February 2014, we used $62.0 million of the net proceeds from the convertible senior notes to repurchase 1.0 million shares of our common stock in accordance with the share repurchase program previously approved by our Board of Directors. Liquidity Outlook We believe, based on our present business plan, that our current cash, cash equivalents and marketable securities balances and our forecasted cash flows from operations will be sufficient to meet our foreseeable cash needs for at least the next 24 months. Our foreseeable cash needs include our planned capital expenditures, salaries related to increased hiring, investments in information technology and facility expansion costs, in addition to anticipated share repurchases, lease and purchase commitments and settlements of other long-term liabilities. Contractual Obligations Our principal commitments consist of obligations under leases for office space, service agreements with co-location facilities for data center capacity and bandwidth usage and open vendor purchase orders. Our minimum commitments related to bandwidth usage and co-location services may vary from period to period depending on the timing and length of contract renewals with our service providers. As of September 30, 2014, there have been no significant changes in our future non-cancelable minimum payments under these commitments from those reported in our annual report on Form 10-K for the year ended December 31, 2013, other than normal period to period variations. Additionally, as discussed above, we have issued $690.0 million in par value of convertible senior notes due 2019. The notes do not bear regular interest and mature in February 2019, unless repurchased or converted prior to maturity. 32-------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board issued updated guidance and disclosure requirements for recognizing revenue. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective for us on January 1, 2017 and may be applied retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the potential impact of adopting this new accounting guidance. Off-Balance Sheet Arrangements We have entered into indemnification agreements with third parties, including vendors, customers, landlords, our officers and directors, shareholders of acquired companies, joint venture partners and third parties to which we license technology. Generally, these indemnification agreements require us to reimburse losses suffered by a third party due to various events, such as lawsuits arising from patent or copyright infringement or our negligence. These indemnification obligations are considered off-balance sheet arrangements in accordance with the authoritative guidance for guarantor's accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others. See also Note 9 to our consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2013 for further discussion of these indemnification agreements. The fair value of guarantees issued or modified during the three months ended September 30, 2014 was determined to be immaterial. As of September 30, 2014, we did not have any additional material off-balance sheet arrangements. |