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AKAM > SEC Filings for AKAM > Form 10-Q on 9-Aug-2007All Recent SEC Filings

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Form 10-Q for AKAMAI TECHNOLOGIES INC


9-Aug-2007

Quarterly Report


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

This quarterly report on Form 10-Q, particularly Management's Discussion and Analysis of Financial Condition and Results of Operations set forth below, contains "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," "continues," "goal," "likely" or similar expressions, indicate a forward-looking statement. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions. Actual results may differ materially from the forward-looking statements we make. See "Risk Factors" elsewhere in this quarterly report on Form 10-Q for a discussion of certain risks associated with our business. We disclaim any obligation to update forward-looking statements as a result of new information, future events or otherwise.

We primarily derive income from the sale of services to customers executing contracts with terms of one year or longer, which we refer to as recurring revenue contracts or long-term contracts. These contracts generally commit the customer to a minimum monthly level of usage with additional charges applicable for actual usage above the monthly minimum. In recent years, however, we have entered into an increasing number of customer contracts that have minimum usage commitments that are based on twelve-month or longer periods. We believe that having a consistent and predictable base level of income is important to our financial success. Accordingly, to be successful, we must maintain our base of recurring revenue contracts by eliminating or reducing customer cancellations or terminations and build on that base by adding new customers and increasing the number of services, features and functionalities our existing customers purchase. At the same time, we must ensure that our expenses do not increase faster than, or at the same rate as, our revenues. Accomplishing these goals requires that we compete effectively in the marketplace on the basis of price, quality and the attractiveness of our services and technology.

Recent Events

On April 12, 2007, we acquired all of the outstanding equity of Red Swoosh, Inc., or Red Swoosh, in exchange for approximately 350,000 shares of our common stock.

On July 17, 2007, our Board of Directors elected David Kenny to fill a vacancy on the Board.


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Overview of Financial Results

The following sets forth, as a percentage of revenues, consolidated statements
of operations data, for the periods indicated:



                                                   For the                  For the
                                             Three Months Ended        Six Months Ended
                                                  June 30,                 June 30,
                                              2007         2006        2007         2006
 Revenues                                      100.0 %      100.0 %     100.0 %     100.0 %

 Cost of revenues                               26.0         21.1        25.4        21.2
 Research and development expense                7.6          8.3         7.6         7.9
 Sales and marketing expense                    24.7         29.5        25.5        29.3
 General and administrative expense             19.5         21.7        19.6        21.1
 Amortization of other intangible assets         1.9          2.2         2.0         2.3
 Restructuring benefit                          (0.1 )         -         (0.1 )        -

 Total cost and operating expenses              79.6         82.8        80.0        81.8

 Income from operations                         20.4         17.2        20.0        18.2
 Interest income                                 3.9          4.1         3.9         4.0
 Interest expense                               (0.5 )       (0.8 )      (0.5 )      (0.8 )
 Other (expense) income, net                    (0.4 )        0.5        (0.3 )       0.4
 Loss on early extinguishment of debt             -            -           -           -
 Gain on investments, net                         -            -           -          0.1

 Income before provision for income taxes       23.4         21.0        23.1        21.9
 Provision for income taxes                      9.2          9.8         9.1        10.0

 Net income                                     14.2 %       11.2 %      14.0 %      11.9 %

We were profitable for the fiscal year 2006 and for the six months ended June 30, 2007; however, we cannot guarantee continued profitability or profitability at the levels we have recently experienced for any period in the future. We have observed the following trends and events that are likely to have an impact on our financial condition and results of operations in the foreseeable future:

• During each quarter of 2006 and for the first two quarters of 2007, the dollar volume of new recurring revenue contracts that we booked exceeded the dollar volume of the contracts we lost through cancellations, terminations and non-payment. A continuation of this trend would likely lead to increased revenues.

• During the first two quarters of 2007, we continued to reduce our network bandwidth costs per unit by entering into new supplier contracts with lower pricing and amending existing contracts to take advantage of price reductions offered by our existing suppliers. Additionally, we continue to invest in internal-use software development to improve the performance and efficiency of our network. However, due to increased traffic delivered over our network, our total bandwidth costs have increased during these periods. We believe that our overall bandwidth costs will continue to increase as a result of expected higher traffic levels, but we expect continued reductions in bandwidth costs per unit. If we do not experience lower per unit bandwidth pricing and we are unsuccessful at effectively routing traffic over our network through lower cost providers, network bandwidth costs could increase in excess of our expectations for the remainder of 2007.

• During each of the first two quarters of 2007, no customer accounted for 10% or more of our total revenues. We expect that customer concentration levels will continue to decline compared to those in prior years if our customer base continues to grow.


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• During the quarter ended June 30, 2007, revenues derived from customers outside the United States accounted for 23% of our total revenues. We expect revenues from such customers as a percentage of our total revenues to be between 20% and 25% for the remainder of 2007.

• As of January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123(R), "Share-Based Payment," or SFAS No. 123(R), which requires us to record compensation expense for employee stock awards at fair value at the time of grant. For the three and six months ended June 30, 2007, our stock-based compensation expense was $17.2 million and $34.0 million, respectively; as compared to $13.2 million and $20.3 million for the three and six months ended June 30, 2006. We expect that stock-based compensation expense will continue at the current level, or slightly increase in the future, because we have a significant number of unvested employee awards outstanding and plan to continue to grant stock-based compensation awards in the future. As of June 30, 2007, our total unrecognized compensation costs for stock-based awards were $137.8 million, which we expect to recognize as expense over a weighted average period of 1.6 years.

• Depreciation expense related to our network equipment increased during the second quarter of 2007 as compared to the first quarter of 2007. Due to expected future purchases of network equipment during the remainder of this year, we believe that depreciation expense related to our network equipment will continue to increase, on a quarterly basis, during the remainder of 2007. We expect to continue to enhance and add functionality to our service offerings and capitalize stock-based compensation expense attributable to employees working on such projects, which would increase the amount of capitalized internal-use software costs. As a result, we believe that the amortization of internal-use software development costs, which we include in cost of revenues, will increase on a quarterly basis in 2007 compared to corresponding periods in 2006.

• During the six months ended June 30, 2007, our effective income tax rate, including discrete items, was 39.4%. While we expect our annual effective income tax rate to remain relatively constant on a quarterly basis during the remainder of 2007, we do not expect to make significant cash tax payments due to the continued utilization of our deferred tax assets.

Based on our analysis of, among other things, the aforementioned trends and events, as of the date of this quarterly report on Form 10-Q, we expect to continue to generate net income on a quarterly basis during the remainder of 2007; however, our future results will be affected by many factors identified in the section captioned "Risk Factors" and elsewhere in this quarterly report on Form 10-Q, including our ability to:

• increase our revenue by adding customers through long-term contracts and limiting customer cancellations and terminations;

• offset price declines with higher volumes of traffic delivered on our network;

• prevent disruptions to our services and network due to accidents or intentional attacks; and

• maintain our network bandwidth costs and other operating expenses consistent with our revenues.

As a result, there is no assurance that we will achieve our expected financial objectives, including generating positive net income in 2007 or any other future period.

Overview

Our management's discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, which have been prepared by us in accordance with accounting principles generally accepted in the United States of America for interim periods and Regulation S-X of the Securities Act of 1934, as amended. The preparation of these unaudited condensed 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 reserves, investments, intangible assets, capitalized internal-use software costs, income and other taxes, depreciable lives of property and equipment,


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stock-based compensation costs, restructuring accruals and contingent obligations. 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 were 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, 2006 for further discussion of our critical accounting policies and estimates.

Results of Operations

Revenues. Revenues increased 52%, or $52.0 million, to $152.7 million for the three months ended June 30, 2007 as compared to $100.6 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, revenues increased 52%, or $100.4 million, to $291.9 million as compared to $191.5 million for the six months ended June 30, 2006. The increase in revenues for the three- and six-month periods ended June 30, 2007, as compared to the same periods in the prior year was primarily attributable to an increase in the number of customers under recurring revenue contracts, as well as an increase in traffic and additional services sold to new and existing customers, the latter leading to increases in the average revenue per customer during the period. We believe that the continued growth in use of the Internet by businesses and consumers is the principal factor driving increased purchases of our services. Also contributing to the increase in revenues for the three and six months ended June 30, 2007 were revenues generated through the acquisitions of Netli, Inc., or Netli, and Nine Systems Corporation, or Nine Systems. As of June 30, 2007, we had 2,555 customers under recurring revenue contracts as compared to approximately 2,060 as of June 30, 2006.

For the three months ended June 30, 2007 and 2006, 23% and 22%, respectively, of our revenues were derived from our operations located outside of the United States, including 18% derived from Europe during each of these periods. For each of the six months ended June 30, 2007 and 2006, 23% of our total revenues were derived from our operations located outside of the United States, including 18% respectively, derived from Europe. No single country outside of the United States accounted for 10% or more of revenues during these periods. For each of the three and six months ended June 30, 2007, resellers accounted for 20% of revenues, as compared to 22% of revenues for the three and six months ended June 30, 2006. For each of the three- and six-month periods ended June 30, 2007 and 2006, no customer accounted for 10% or more of revenues.

Cost of Revenues. Cost of revenues includes fees paid to network providers for bandwidth and co-location of our network equipment. Cost of revenues also includes payroll and payroll-related costs and stock-based compensation expense for network operations personnel, cost of software licenses, depreciation of network equipment used to deliver our services, amortization of internal-use software and amortization of capitalized stock-based compensation.

Cost of revenues increased 88%, or $18.6 million, to $39.8 million for the three months ended June 30, 2007, as compared to $21.2 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, cost of revenues increased 83%, or $33.7 million, to $74.2 million as compared to $40.5 million for the six months ended June 30, 2006. These increases were primarily due to an increase in amounts paid to network suppliers due to higher traffic levels, partially offset by reduced bandwidth costs per unit, and an increase in depreciation expense of network equipment as we continued to invest in our infrastructure. Additionally, for the three and six months ended June 30, 2007, cost of revenues includes stock-based compensation expense which increased by $314,000 and $780,000, respectively, as compared to the same periods in the prior year.

Cost of revenues during the three and six months ended June 30, 2007 also included credits received of approximately $1.1 million and $1.6 million, respectively, from settlements and renegotiations entered into in connection with billing disputes related to bandwidth contracts. During the three and six months ended June 30, 2006, cost of revenues included similar credits of approximately $330,000 and $820,000, respectively. Credits of this nature may occur in the future; however, the timing and amount of future credits, if any, is unpredictable.


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Cost of revenues is comprised of the following (in millions):

                                                        For the                   For the
                                                   Three Months Ended         Six Months Ended
                                                        June 30,                  June 30,
                                                   2007          2006         2007        2006
Bandwidth, co-location and storage fees         $     24.1    $     13.2    $    45.8    $  25.3
Payroll and related costs of network
operations personnel                                   2.2           1.3          3.8        2.8
Stock-based compensation                               0.8           0.5          1.6        0.8
Depreciation and impairment of network
equipment and amortization of internal-use
software and stock-based compensation                 12.7           6.2         23.0       11.6

Total cost of revenues                          $     39.8    $     21.2    $    74.2    $  40.5

We have long-term purchase commitments for bandwidth usage and co-location services with various network and Internet service providers. For the remainder of 2007 and for the years ending December 31, 2008, 2009 and 2010, the minimum commitments related to bandwidth usage and co-location services under agreements currently in effect are approximately $20.5 million, $19.9 million, $3.2 million and $225,000, respectively.

We expect that cost of revenues will increase on a quarterly basis during the remainder of 2007. We expect to deliver more traffic on our network, which would result in higher expenses associated with the increased traffic; however, such costs are likely to be partially offset by lower bandwidth costs per unit. Additionally, for the remainder of 2007, we anticipate increases in depreciation expense related to our network equipment and amortization of internal-use software development costs, along with payroll and related costs, as we expect to continue to make investments in our network as we believe our customer base will expand. Additionally, cost of revenues is expected to increase as a result of higher stock-based compensation expense under SFAS 123(R) due to additional equity awards we expect to grant.

Research and Development. Research and development expenses consist primarily of payroll and related costs and stock-based compensation expense for research and development personnel who design, develop, test and enhance our services, network and software. Research and development costs are expensed as incurred, except certain internal-use software development costs requiring capitalization. During the three and six months ended June 30, 2007, we capitalized software development costs of $3.9 million and $7.6 million, respectively, net of impairments. During the three and six months ended June 30, 2006, we capitalized software development costs of $3.3 million and $5.5 million, respectively, net of impairments. These development costs consisted of external consulting and payroll and payroll-related costs for personnel involved in the development of internal-use software used to deliver our services and operate our network. Additionally, during the three and six months ended June 30, 2007, we capitalized $1.4 million and $2.8 million, respectively, of stock-based compensation, as compared to $1.2 million and $1.8 million during the three and six months ended June 30, 2006, respectively. These capitalized internal-use software costs are amortized to costs of revenues over their estimated useful lives of two years.


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Research and development expenses increased 39%, or $3.3 million, to $11.7 million for the three months ended June 30, 2007, as compared to $8.4 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, research and development expenses increased 47%, or $7.2 million, to $22.3 million as compared to $15.1 million for the six months ended June 30, 2006. Reflecting an increased emphasis on increasing investment in research and development, the increase in these expenses in 2007 over the same periods in 2006 was due to an increase in payroll and related costs due to an increase in headcount, as well as additional stock-based compensation expense. The following table quantifies the net increase in the various components of our research and development expenses for the periods presented (in millions):

                                                  For the                             For the
                                            Three Months Ended                   Six Months Ended
                                               June 30, 2007                       June 30, 2007
                                            as Compared to 2006                 as Compared to 2006
Payroll and related costs                  $                 3.5               $                 6.3
Stock-based compensation                                     0.6                                 2.9
Capitalized salaries and other
expenses                                                    (0.8 )                              (2.0 )

Total net increase                         $                 3.3               $                 7.2

We believe that research and development expenses will continue to increase on a quarterly basis in the remainder of 2007, as we expect to increase further our hiring of development personnel in order to make investments in our core technology and refinements to our other service offerings. Additionally, research and development expenses are expected to increase as a result of higher stock-based compensation expense under SFAS No. 123(R) due to additional equity awards we expect to grant.

Sales and Marketing. Sales and marketing expenses consist primarily of payroll and related costs, stock-based compensation expense and commissions for personnel engaged in marketing, sales and service support functions, as well as advertising and promotional expenses.

Sales and marketing expenses increased 27%, or $8.0 million, to $37.7 million for the three months ended June 30, 2007, as compared to $29.7 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, sales and marketing expenses increased 33%, or $18.5 million, to $74.5 million as compared to $56.0 million for the six months ended June 30, 2006. The increase in sales and marketing expenses during the three and six months ended June 30, 2007 as compared to the same period in the prior year was primarily due to higher payroll and related costs, particularly commissions for sales and marketing personnel, attributable to revenue growth. The following table quantifies the net increase in the various components of our sales and marketing expenses for the periods presented (in millions):

                                                                  For the
                                            For the           Six Months Ended
                                      Three Months Ended       June 30, 2007
                                         June 30, 2007         as Compared to
                                      as Compared to 2006           2006
       Payroll and related costs     $                 4.0   $              8.4
       Stock-based compensation                        1.4                  5.6
       Marketing and related costs                     1.3                  2.0
       Other expenses                                  1.3                  2.5

       Total net increase            $                 8.0   $             18.5

We believe that sales and marketing expenses will continue to increase on a quarterly basis during the remainder of 2007 due to an expected increase in commissions on higher forecasted sales, the expected increase in hiring of sales and marketing personnel, and anticipated increases in other marketing costs such as advertising. Additionally, sales and marketing expenses are expected to increase as a result of higher stock-based compensation expense under SFAS 123(R) because of additional equity awards we expect to grant.


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General and Administrative. General and administrative expenses consist primarily of the following components:

• payroll, stock-based compensation and other related costs, including related expenses for executive, finance, business applications, network management, human resources and other administrative personnel;

• depreciation of property and equipment we use internally;

• fees for professional services;

• rent and other facility-related expenditures for leased properties;

• the provision for doubtful accounts;

• insurance costs; and

• non-income related taxes.

General and administrative expenses increased 36%, or $7.9 million, to $29.8 million for the three months ended June 30, 2007, as compared to $21.9 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, general and administrative expenses increased 42%, or $16.8 million, to $57.3 million as compared to $40.4 million for the six months ended June 30, 2006. The increase in general and administrative expenses was primarily due to an increase in payroll and related costs as a result of headcount growth, as well as stock-based compensation expense. Additionally, facility and related costs have increased due to office expansions and increased expenditures on professional services, particularly legal fees related to current litigation matters. The following table quantifies the net increase in various components of our general and administrative expenses for the periods presented (in millions):

                                           For the                 For the
                                     Three Months Ended       Six Months Ended
                                        June 30, 2007           June 30, 2007
                                     as Compared to 2006     as Compared to 2006
    Payroll and related costs       $                 1.7   $                 4.6
    Stock-based compensation                          1.7                     4.4
    Depreciation and amortization                     0.8                     1.4
    Facilities and related costs                      1.6                     2.4
    Professional services                             1.4                     2.7
    Other expenses                                    0.7                     1.3

    Total net increase              $                 7.9   $                16.8

During the remainder of 2007, we expect general and administrative expenses to increase on a quarterly basis due to anticipated higher payroll and related costs attributable to increased hiring, an increase in non-income tax expense and an increase in rent and facility costs. Additionally, general and administrative expenses are expected to increase as a result of higher stock-based compensation expense under SFAS No. 123(R) because of additional equity awards we expect to grant.

Amortization of Other Intangible Assets. Amortization of other intangible assets consists of amortization of intangible assets acquired in business combinations and amortization of acquired license rights. Amortization of other intangible assets increased 33%, or $734,000, to $2.9 million for the three months ended June 30, 2007 as compared to $2.2 million for the three months ended June 30, 2006. For the six months ended June 30, 2007, amortization of other intangible assets increased 28%, or $1.2 million, to $5.7 million as compared to $4.5 million for the six months ended June 30, 2006. The increase in amortization of other intangible assets during the three and six months ended June 30, 2007, as . . .

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